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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
COMMISSION FILE NUMBER 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
SCRANTON, PENNSYLVANIA
COMMONWEALTH OF PENNSYLVANIA
I.R.S. EMPLOYER IDENTIFICATION NUMBER 23-2939222
150 NORTH WASHINGTON AVENUE
SCRANTON, PENNSYLVANIA 18503-1848
TELEPHONE NUMBER 570-346-7741
SECURITIES REGISTERED UNDER
SECTION 12(g) OF THE ACT
Common Stock, Par Value $ .01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Website, if any, every Interactive Data File required to
be submitted and posted pursuant to Rule 405 of Regulation S-T (ss. 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
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 Act). Yes |_| No |X|
The aggregate market value of the Company's voting stock held by non-affiliates
of the registrant on June 30, 2009, based on the closing price of such stock on
that date, equals approximately $100,530,103.
The number of shares of common stock outstanding as of February 26, 2010 equals
3,276,079.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Corporation's definitive proxy statement relating to the 2010
Annual Meeting of Stockholders, to be held on May 4, 2010, are incorporated by
reference in Part III.
PENSECO FINANCIAL SERVICES CORPORATIONPART I
ITEM 1 BUSINESS
GENERAL
PENSECO FINANCIAL SERVICES CORPORATION, (the "Company"), which is headquartered
in Scranton, Pennsylvania, was formed under the general corporation laws of the
State of Pennsylvania in 1997 and is registered as a financial holding company.
The Company became a holding company upon the acquisition of all of the
outstanding shares of Penn Security Bank and Trust Company (the "Bank"), a
Pennsylvania state-chartered bank, on December 31, 1997. The Company is subject
to supervision by the Federal Reserve Board. The Bank, as a state-chartered
financial institution, is subject to supervision, regulation and examination by
the Federal Deposit Insurance Corporation and the Pennsylvania Department of
Banking.
The Company's principal banking office is located at 150 North Washington
Avenue, Scranton, Pennsylvania, containing trust, investor services, marketing,
audit, human resources, executive, data processing, central loan processing and
central bookkeeping offices. There are eleven additional offices.
Through its banking subsidiary, the Company generates interest income from its
outstanding loans receivable and its investment portfolio. Other income is
generated primarily from merchant transaction fees, trust fees and service
charges on deposit accounts. The Company's primary costs are interest paid on
deposits and borrowings and general operating expenses. The Company provides a
variety of commercial and retail banking services to business and professional
customers, as well as retail customers, on a personalized basis. The Company's
primary lending products are real estate, commercial and consumer loans. The
Company also offers ATM access, credit cards, active investment accounts, trust
department services and other various lending, depository and related financial
services. The Company's primary deposit products are savings and demand deposit
accounts and certificates of deposit. The Company also offers collateralized
repurchase agreements that have a one day maturity, as an alternative deposit
option for its customers.
The Company has a third party marketing agreement with UVEST Financial Services
that allows the Company to offer a full range of securities, brokerage and
annuity sales to its customers. The Investor Services division is located in the
headquarters building and the services are offered throughout the entire branch
system.
The Company is not dependent upon a single customer, or a few customers, the
loss of one or more of which would have a material adverse effect on its
operations. The operations and earnings of the Corporation are not materially
affected by seasonal changes or by Federal, state or local environmental laws or
regulations.
On April 1, 2009, the Company completed its acquisition of Old Forge Bank in a
cash and stock transaction valued at approximately $55.5 million (the "Merger").
The Merger was accounted for using the acquisition method of accounting and,
accordingly, the assets and liabilities of Old Forge Bank have been recorded at
their respective fair values on the date the Merger was completed. The Merger
was effected by the issuance of 1,128,079 shares of Company common stock to
former Old Forge Bank shareholders. Each share of Old Forge Bank common stock
was exchanged for 2.9012 shares of Company common stock, with any fractional
shares as a result of the exchange, paid to Old Forge Bank shareholders in cash
based on $35.255 per share of Company stock.
FORWARD LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements that are
based on assumptions and may describe future plans, strategies and expectations
of Penseco Financial Services Corporation. These forward-looking statements are
generally identified by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. Penseco Financial
Services Corporation's ability to predict results or the actual effect of future
plans or strategies is inherently uncertain. Factors which could have a material
adverse effect on the operations of Penseco Financial Services Corporation and
its subsidiary include, but are not limited to, changes in interest rates,
national and regional economic conditions, legislative and regulatory changes,
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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 Annual Report on Form 10-K titled "Risk Factors" below.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Except as
required by applicable law or regulation, Penseco Financial Services Corporation
does not undertake, and specifically disclaims any obligation, to release
publicly the result of any revisions that may be made to any forward-looking
statements to reflect events or circumstances after the date of the statements
or to reflect the occurrence of anticipated or unanticipated events.
Unless the context indicates otherwise, all references in this Annual Report to
"Company," "we," "us" and "our" refer to Penseco Financial Services Corporation
and its subsidiary.
ITEM 1A RISK FACTORS
In addition to the other information set forth in this report, one 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.
CHANGES IN THE CREDIT QUALITY OF OUR INVESTMENT PORTFOLIO MAY EFFECT OUR
EARNINGS.
Investments are evaluated periodically to determine whether a decline in their
value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term "other than temporary" is not intended to indicate that the decline is
permanent. It indicates that the prospects for a near term recovery of value are
not necessarily favorable, or that there is a lack of evidence to support fair
values equal to, or greater than, the carrying value of the investment. Once a
decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized.
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CHANGES IN INTEREST RATES COULD AFFECT OUR INVESTMENT VALUES AND NET INTEREST
INCOME WHICH COULD HURT OUR PROFITS.
At December 31, 2009, the Company owned approximately $155.5 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 December 31, 2009, the Company's available for sale marketable
securities portfolio had an unrealized gain, net of taxes, of $2.3 million. The
fair value of the Company's available for sale marketable securities is subject
to interest rate change, which would not affect recorded earnings, but would
increase or decrease comprehensive income and stockholders' equity.
The principal component of the Company's earnings is net interest income, which
is the difference between interest and fees earned on interest-earning assets
and interest paid on deposits and other borrowings. The most significant impact
on net interest income between periods is derived from the interaction of
changes in the volume of and rates earned or paid on interest-earning assets and
interest-bearing liabilities. The volume of earning dollars in loans and
investments, compared to the volume of interest-bearing liabilities represented
by deposits and borrowings, combined with the spread, produces the changes in
net interest income between periods.
The Company continually monitors the relationship of its interest rate sensitive
assets and liabilities through its Asset/Liability Committee.
STRONG COMPETITION WITHIN OUR MARKET COULD 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. In this current
economic environment there is increased competition in view of weaker loan
demand. 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.
Regulatory authorities have extensive discretion in their supervisory and
enforcement activities, including the imposition of restrictions on operations,
the classification of assets and determination of the level of allowance for
loan losses. Any change in such regulation and oversight, whether in the form of
regulatory policy, regulations, legislation or supervisory claim may have a
material impact on the Company's and the Bank's operations. The Obama
administration has also proposed comprehensive legislation intended to modernize
regulation of the United States financial system. Among other things, the
proposed legislation would also create a new federal agency, the Consumer
Financial Protection Agency that would be dedicated to administering and
enforcing fair lending and consumer compliance laws with respect to financial
products and services, which could result in new regulatory requirements and
increased regulatory costs for us. If enacted, the legislation may have a
substantial impact on our operations. However, because any final legislation may
differ significantly from the current administration's proposal, the specific
effects of the legislation cannot be evaluated at this time.
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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.
THE CURRENT ECONOMIC RECESSION COULD RESULT IN INCREASES IN OUR LEVEL OF
NON-PERFORMING LOANS AND/OR REDUCE DEMAND FOR OUR PRODUCTS AND SERVICES, WHICH
WOULD LEAD TO LOWER REVENUE, HIGHER LOAN LOSSES AND LOWER EARNINGS.
Our business activities and earnings are affected by general business conditions
in the United States and in our primary market area. These conditions include
short-term and long-term interest rates, inflation, unemployment levels,
monetary supply, consumer confidence and spending, fluctuations in both debt and
equity capital markets and the strength of the economy in the United States
generally and in our primary market area in particular. In the current
recession, the national economy has experienced general economic downturns, with
rising unemployment levels, declines in real estate values and an erosion in
consumer confidence. The current economic recession has also had a negative
impact on our primary market area, which has experienced a softening of the
local real estate market and reductions in local property values. A prolonged or
more severe economic downturn, continued elevated levels of unemployment,
further declines in the values of real estate, or other events that affect
household and/or corporate incomes could impair the ability of our borrowers to
repay their loans in accordance with their terms. The economic downturn could
also result in reduced demand for credit or fee-based products and services,
which also would decrease our revenues.
SPECIAL FDIC ASSESSMENTS AND INCREASED BASE ASSESSMENT RATES BY THE FDIC WILL
DECREASE OUR EARNINGS.
Beginning in late 2008, the economic environment caused higher levels of bank
failures, which dramatically increased FDIC resolution costs and led to a
significant reduction in the Deposit Insurance Fund. As a result, the FDIC has
significantly increased the initial base assessment rates paid by financial
institutions for deposit insurance. The base assessment rate was increased by
seven basis points (7 cents for every $100 of deposits) for the first quarter of
2009. Effective April 1, 2009, initial base assessment rates were changed to
range from 12 basis points to 45 basis points across all risk categories with
possible adjustments to these rates based on certain debt-related components.
These increases in the base assessment rate will increase our deposit insurance
costs and negatively impact our earnings. In addition, in May 2009, the FDIC
imposed a special assessment on all insured institutions due to recent bank and
savings association failures. The emergency assessment amounts to 5 basis points
on each institution's assets minus Tier 1 capital as of June 30, 2009, subject
to a maximum equal to 10 basis points times the institution's assessment base.
The assessment was collected on September 30, 2009. Based on our assets and Tier
1 capital as of June 30, 2009, our special assessment was approximately $385
thousand. The special assessment decreased our earnings. In addition, the FDIC
may impose additional emergency special assessments after June 30, 2009, of up
to 5 basis points per quarter on each institution's assets minus Tier 1 capital
if necessary to maintain public confidence in federal deposit insurance or as a
result of deterioration in the Deposit Insurance Fund reserve ratio due to
institution failures. Any additional emergency special assessment imposed by the
FDIC will further decrease our earnings.
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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 December 31, 2009, the Company employed 221 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. We rely heavily on our executive officers and employees.
The loss of certain executive officers or employees could have an adverse effect
on us because, as a community bank, our executive officers and employees
typically have more responsibility than would be typical at a larger financial
institution with more employees. In addition, as a community bank, we have fewer
management-level and other personnel who are in position to succeed and assume
the responsibilities of certain existing executive officers and employees.
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 1B UNRESOLVED STAFF COMMENTS
None
ITEM 2 PROPERTIES
The Company and Bank operate out of twelve offices positioned throughout the
greater Northeastern Pennsylvania region. These offices are located in the South
Scranton, East Scranton, Green Ridge, and Central City sections of Scranton, the
Borough of Moscow, the Town of Gouldsboro, South Abington Township, the Borough
of Mount Pocono, the Boroughs of East Stroudsburg at Eagle Valley Corners, Old
Forge, Peckville and Duryea. Through these offices, the Company provides a full
range of banking and trust services primarily to Lackawanna, Luzerne, Wayne,
Monroe and the surrounding counties. All offices are owned by the Bank or
through a wholly owned subsidiary of the Bank, Penseco Realty, Inc., with the
exception of the Mount Pocono Office, which is owned by the Bank but is located
on land occupied under a long-term lease. The Company also owns property in the
Borough of Dalton, Lackawanna County, to use for potential future expansion.
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The Company's and Bank's principal office, located at the corner of North
Washington Avenue and Spruce Street in the "Central City" of Scranton's business
district, houses the operations, trust, investor services, marketing and audit
departments as well as the Company's executive offices. Several remote ATM
locations are leased by the Bank, which are located throughout Northeastern
Pennsylvania. All branches and ATM locations are equipped with closed circuit
television monitoring.
ITEM 3 LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine
litigation incidental to the business of the Company and its subsidiary, as to
which the Company or subsidiary is a party or of which any of their property is
subject.
ITEM 4 RESERVED
PART II
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ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
This Form 10-K is the Company's annual disclosure statement as required under
Section 13 or 15(d) of the Securities Exchange Act of 1934. Questions may be
directed to any branch location of the Company or by contacting the Finance
Division Head's office at:
Patrick Scanlon, Senior Vice President, Finance Division Head
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, Pennsylvania 18503-1848
1-800-327-0394
Management of the Company is aware of the following securities dealers who make
a market in the Company stock:
Boenning & Scattergood, Inc. Knight Equity Markets, LP
Domestic Securities Monroe Securities, Inc.
Hudson Securities, Inc. Stifel, Nicolaus & Company, Inc.
Janney Montgomery Scott, LLC
The Company's capital stock is traded on the "Over-the-Counter" (Bulletin Board)
under the symbol "PFNS". The following table sets forth the price range together
with dividends paid for each of the past two years. These quotations do not
necessarily reflect the value of actual transactions.
<Table>
<Caption>
Dividends Paid Dividends Paid
2009 High Low Per Share 2008 High Low Per Share
- ---------------------------------------------- ----------------------------------------------
First Quarter $ 38 $ 34 $ .42 First Quarter $ 41 $ 35 $ .41
Second Quarter 39 31 .42 Second Quarter 42 37 .41
Third Quarter 36 32 .42 Third Quarter 41 38 .42
Fourth Quarter 35 30 .42 Fourth Quarter 40 36 .42
----- -----
$1.68 $1.66
</Table>
As of February 10, 2010 there were approximately 2,160 stockholders of the
Company based on the number of holders of record. Reference should be made to
the information about the Company's dividend policy and regulatory guidelines on
pages 24 and 56 of this Form 10-K.
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TRANSFER AGENT
Registrar & Transfer Co., 10 Commerce Drive, Cranford, NJ 07016 serves as the
Company's transfer agent. Stockholders' questions should be directed to the
Registrar & Transfer Co. investor relations department at 800-368-5948.
PENSECO FINANCIAL SERVICES CORPORATION
The following line graph sets forth comparative information regarding the
Company's cumulative shareholder return on its Common Stock over the last five
fiscal years. Total shareholder return is measured by dividing total dividends
(assuming dividend reinvestment) plus share price change for a period by the
share price at the beginning of the investment period. The Company's cumulative
shareholder return based on an investment of $100 at the beginning of the
five-year period beginning December 31, 2004 is compared to the cumulative total
return of the Russell 2000 Index ("Russell 2000") and the SNL Securities
Northeast Quadrant Pink Sheet Banks Index ("Pink Banks"), which more closely
reflects the Company's peer group. The yearly points marked on the horizontal
axis of the graph correspond to December 31st of that year.
[GRAPH APPEARS HERE]
<Table>
<Caption>
Period Ending
- --------------------------------------------------------------------------------------------------------------
Index 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08 12/31/09
- --------------------------------------------------------------------------------------------------------------
Penseco Financial Services
Corporation $100.00 $103.47 $109.06 $105.02 $102.02 $101.55
Russell 2000 100.00 104.55 123.76 121.82 80.66 102.58
SNL Northeast OTC-BB and
Pink Banks 100.00 99.70 103.03 100.33 81.72 76.78
</Table>
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ITEM 6 SELECTED FINANCIAL DATA
(in thousands, except per share amounts)RESULTS OF OPERATIONS:
<Table>
<Caption>
2009 2008 2007 2006 2005
- ----------------------------------------------------------------------------------------------------
Interest Income $ 40,151 $ 33,898 $ 34,329 $ 31,922 $ 28,170
Interest Expense 9,580 10,830 12,739 11,054 8,580
- ----------------------------------------------------------------------------------------------------
Net Interest Income 30,571 23,068 21,590 20,868 19,590
Provision for Loan Losses 2,260 861 657 433 263
- ----------------------------------------------------------------------------------------------------
Net Interest Income after
Provision for Loan Losses 28,311 22,207 20,933 20,435 19,327
Non-Interest Income 10,369 11,036 8,720 8,205 8,874
Non-Interest Expenses 28,420 22,172 21,331 21,037 20,719
Income Taxes 1,888 2,458 1,624 1,595 1,613
- ----------------------------------------------------------------------------------------------------
Net Income $ 8,372 $ 8,613 $ 6,698 $ 6,008 $ 5,869
- ----------------------------------------------------------------------------------------------------
BALANCE SHEET AMOUNTS:
Assets $ 883,327 $ 628,967 $ 580,793 $ 569,821 $ 575,688
Investment Securities $ 202,332 $ 157,480 $ 145,448 $ 166,080 $ 229,957
Net Loans $ 597,670 $ 435,873 $ 399,939 $ 365,722 $ 317,562
Deposits $ 645,434 $ 424,725 $ 416,533 $ 413,800 $ 397,867
Long-Term Borrowings $ 68,094 $ 72,720 $ 55,966 $ 65,853 $ 75,401
Stockholders' Equity $ 117,397 $ 73,642 $ 69,715 $ 66,571 $ 63,799
PER SHARE AMOUNTS:
Earnings per Share $ 2.80 $ 4.01 $ 3.12 $ 2.80 $ 2.73
Dividends per Share $ 1.68 $ 1.66 $ 1.58 $ 1.50 $ 1.44
Book Value per Share $ 35.84 $ 34.28 $ 32.45 $ 30.99 $ 29.70
Common Shares Outstanding 3,276,079 2,148,000 2,148,000 2,142,148 2,148,000
FINANCIAL RATIOS:
Net Interest Margin 4.11% 3.93% 3.92% 3.89% 3.57%
Return on Average Assets 1.04% 1.40% 1.15% 1.07% 1.03%
Return on Average Equity 7.93% 11.89% 9.75% 9.15% 9.23%
Average Equity to Average Assets 13.12% 11.76% 11.81% 11.68% 11.19%
Dividend Payout Ratio 60.00% 41.40% 50.64% 53.57% 52.75%
</Table>
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ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States (GAAP). The following discussion is
intended to provide information to facilitate the understanding and assessment
of significant changes and trends related to the financial condition of the
Company and the results of its operations. This discussion and analysis should
be read in conjunction with the Company's audited consolidated financial
statements and notes thereto. All information is presented in thousands of
dollars, except as indicated.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Provision (allowance) for possible loan losses - The provision for loan losses
is based on past loan loss experience, management's evaluation of the potential
loss in the current loan portfolio under current economic conditions and such
other factors as, in management's best judgment, deserve current recognition in
estimating loan losses. The annual provision for loan losses charged to
operating expense is that amount which is sufficient to bring the balance of the
allowance for possible loan losses to an adequate level to absorb anticipated
losses.
Actuarial assumptions associated with pension, post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan assets.
Income taxes - The calculation of the provision for federal income taxes is
complex and requires the use of estimates and judgments. Deferred federal income
tax assets or liabilities represent the estimated impact of temporary
differences between the recognition of assets and liabilities under GAAP, and
how such assets and liabilities are recognized under the federal tax code. The
Company uses an estimate of future earnings to support management's position
that the benefit of the deferred tax assets will be realized. If future income
should prove non-existent or less than the amount of the deferred tax assets
within the tax years to which they may be applied, the asset may not be realized
and net income will be reduced. Deferred tax assets are described further in
Note 17 of the "Notes to Consolidated Financial Statements."
The Company and its subsidiary file income tax and other returns in the U.S
Federal jurisdiction, Pennsylvania state jurisdiction and local jurisdictions.
Management evaluated the Company's tax positions and concluded that the
aggregate liabilities related to taxes are appropriately reflected in the
consolidated financial statements. With few exceptions, the Company is no longer
subject to income tax examinations by the U.S. Federal, state or local tax
authorities for years before 2006.
Fair Value Measurements - Fair values of financial instruments are estimated
using relevant market information and other assumptions. Fair value estimates
involve uncertainties and matters of significant judgment regarding interest
rates, credit risk, prepayment speeds and other factors. Changes in assumptions
or in market conditions could significantly affect the estimates. Fair value
measurements are classified within one of three levels within a valuation
hierarchy based on the transparency of inputs to each valuation as of the fair
value measurement date. The three levels are defined as follows:
Level I - quoted prices (unadjusted) for identical assets or liabilities in
active markets.
Level II - inputs include quoted prices for similar assets and liabilities in
active markets, quoted prices of identical or similar assets or liabilities in
markets that are not active, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
financial instrument.
10
<Page>
Level III - inputs that are unobservable and significant to the fair value
measurement. Financial instruments are considered Level III when values are
determined using pricing models, discounted cash flow methodologies, or similar
techniques, and at least one significant model assumption or input is
unobservable.
Other-than-temporary impairment of investments - Investments are evaluated
periodically to determine whether a decline in their value is other than
temporary. Management utilizes criteria such as the magnitude and duration of
the decline, in addition to the reasons underlying the decline, to determine
whether the loss in value is other than temporary. The term
"other-than-temporary" is not intended to indicate that the decline is
permanent. It indicates that the prospects for a near term recovery of value are
not necessarily favorable, or that there is a lack of evidence to support fair
values equal to, or greater than, the carrying value of the investment. Once a
decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized. In
2009, the Company recorded an other-than-temporary impairment charge of $787
related to the Company's equity investment portfolio containing stock of
financial institutions.
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.
Loans purchased - Loans purchased as a result of the Merger were recorded at the
acquisition date fair value. Management made three different types of fair value
adjustments in order to record the loans at fair value. An interest rate fair
value adjustment was made comparing current weighted average rates of the
acquired loans to stated market rates of similar loan types. A general credit
fair value adjustment was made on similar loan types based on historical loss
projections plus a discount for the weak economic environment. A specific credit
fair value adjustment was made to loans identified by management as being
problematic. The specific loans have been discounted by management based on
collateral values and expected cash flows. The interest rate and general credit
fair value adjustments are being accreted over an eight year period based on a
sum-of-the-years-digits basis. The specific credit fair value adjustment is
reduced only when cash flows are received.
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.
Time deposits - Time deposits acquired through the Merger have been recorded at
their acquisition date fair value. The fair value of time deposits represents
the present value of the time deposits' expected contractual payments discounted
by market rates for similar deposits. The fair value adjustment is amortized
monthly based a level yield methodology.
Core deposit intangible - The fair value assigned to the core deposit intangible
asset represents the future economic benefit of the potential cost savings from
acquiring core deposits in the Merger compared to the cost of obtaining
alternative funding, such as brokered deposits, from market sources. Management
utilized an income approach to present value the expected after tax cash flow
benefits of the acquired core deposits. The core deposit intangible is being
amortized over ten years on a sum-of-the-years-digits basis.
Goodwill - Goodwill arose in connection with the Old Forge Bank merger. It is
reviewed by management for possible impairment at least annually or more
frequently upon the occurrence of an event or when circumstances indicate that
its carrying amount exceeds fair value. Management has obtained a professional
evaluation of the Company value as of December 31, 2009. The evaluation
disclosed that the fair value of the Company stock is approximately 43% above
book value, considering both income and market approaches. Market conditions
that could negatively impact the value of Goodwill in the future are essentially
those Risk Factors discussed in Part 1A of this report. Based on the above,
Management has determined that the carrying value of Goodwill has not been
impaired at December 31, 2009.
11
<Page>
SUMMARY
Net income for 2009 decreased $241 or 2.8%, to $8,372 or $2.80 per weighted
average share compared with the year ago period of $8,613 or $4.01 per share.
The decrease in net income was primarily attributed to merger costs of
$1,550, the recognition of an impairment loss on bank equity investment
securities of $787, increased FDIC insurance costs of $909, along with the
effect of a one time gain of $1,129, net of tax, related to Visa International's
Initial Public Offering during 2008. Net interest margin increased from 3.93% at
December 31, 2008 to 4.11% at December 31, 2009. Net interest income increased
$7,503 or 32.5% to $30,571 for the twelve months ended December 31, 2009
compared to $23,068 for the same period of 2008. The increase was largely due to
an increased loan portfolio of $159.9 million from Old Forge Bank. Net interest
income after provision for loan losses increased $6,104 or 27.5% during the 2009
period, largely due to increased interest and fees on loans and reduced interest
expense from lower borrowing costs. The provision for loan losses increased
$1,399 to $2,260 during 2009 compared with $861 for the same period of 2008 due
to the softness in the economy.
Net income for 2008 increased $1,915 or 28.6%, to $8,613 or $4.01 per share
compared with the year ago period of $6,698 or $3.12 per share. The increase in
net income was primarily attributable to a one-time after tax increase in income
of $1,129 ($0.53 per share) related to VISA, Inc.'s Initial Public Offering,
which consisted of a gain from the mandatory partial share redemption by VISA
and the reversal of a litigation liability accrual that had been recorded by the
Company in the fourth quarter of 2007. Excluding the impact of the VISA
transaction, net income increased $458 or 6.5% from the twelve months of
2007(1). Net interest income increased $1,478 or 6.8% to $23,068 for the twelve
months ended December 31, 2008 compared to $21,590 for the same period of 2007.
The increase resulted from higher interest on investments of $504 or 7.1% due to
increased volume of securities of states & political subdivisions and U.S.
Agencies. Total interest expense declined $1,909 or 15.0% mainly due to lower
deposit costs. Net interest income after provision for loan losses increased
$1,274 or 6.1%. The provision for loan losses increased $204 to $861 during 2008
compared with $657 for the same period of 2007.
The Company's return on average assets was 1.04% in 2009 compared to 1.40% in
2008 and 1.15% in 2007. Return on average equity was 7.93%, 11.89% and 9.75% in
2009, 2008 and 2007, respectively.
Net income from accretion and amortization net of taxes of acquisition date
fair value adjustments included in the financial results during the period
indicated.
<Table>
<Caption>
Twelve Months Ended
December 31, 2009
-------------------
Homogeneous loan pools $ 550
Time deposits 305
Core deposit intangible expense (182)
-------------------
Net income from acquisition fair value adjustment $ 673
-------------------
</Table>
Accretion of the loan pools credit fair value adjustment and market rate fair
value adjustment is calculated on a sum-of-the-years digits basis over an eight
year period. The fair value market rate adjustment of the time deposits is
amortized monthly based on a level yield methodology over five years. The core
deposit intangible is being amortized over ten years on a
sum-of-the-years-digits basis.
RESULTS OF OPERATIONS
NET INTEREST INCOME
The principal component of the Company's earnings is net interest income, which
is the difference between interest and fees earned on interest-earning assets
and interest paid on deposits and other borrowings.
- ------------------
(1) See pages 26 and 27 for a reconciliation of GAAP net income excluding the
merger costs incurred during the year ended December31, 2009 and the gain
related to the VISA, Inc. initial public offering during the year ended
December 31, 2008.
12
<Page>
Net interest income increased $7.5 million or 32.5% to $30.6 million for 2009
compared to $23.1 million for 2008. Loan interest income increased $6.2 million
or 23.7% for 2009 largely due to the increased loan portfolio from Old Forge
Bank. Investment income remained relatively unchanged due to lower rates despite
a higher volume of investments. Interest expense for 2009 decreased $1.2 million
or 11.1% to $9.6 million for 2009 compared to $10.8 million in 2008, mainly due
to lower borrowing costs.
Net interest income increased $1.5 million or 6.8% to $23.1 million for 2008
compared to $21.6 million for 2007. Loan interest income was slightly lower for
2008. Investment income increased due to increased volume of securities of
states & political subdivisions and U.S. Agency securities. Interest expense for
2008 decreased $1.9 million or 15.0% to $10.8 million for 2008 compared to $12.7
million in 2007, mainly due to lower deposit costs.
Net interest income, when expressed as a percentage of average interest-earning
assets, is referred to as net interest margin. The Company's net interest margin
for the year ended December 31, 2009 was 4.11% compared with 3.93% for the year
ended December 31, 2008 and 3.92% for the year ended December 31, 2007.
Interest income in 2009 totaled $40.2 million, compared to $33.9 million in
2008, an increase of $6.3 million or 18.6%. The tax equivalent yield on average
interest-earning assets decreased to 5.70% in 2009, compared to 6.07% in 2008.
Average interest-earning assets increased in 2009 to $743.7 million from $586.7
million in 2008. Average loans, which are typically the Company's highest
yielding earning assets, increased $133.4 million or 31.7% in 2009 due to the
Merger. Average loans represented 74.5% of 2009 average interest-earning assets,
compared to 71.8% in 2008. Income on loans increased $6.2 million or 23.7% in
2009 due to the Merger, compared to a decrease in loan income of $0.2 million or
..8% during 2008. Investment securities increased on average by $25.4 million or
15.9% to $185.5 million in 2009 compared to $160.1 million in 2008 due to the
Merger. Income on investments increased $0.1 million or 1.3% to $7.7 million in
2009, from $7.6 million in 2008. Average earning assets, including Bank-Owned
Life Insurance (BOLI), decreased to 93.9% of average total assets for 2009
compared to 96.4% for the year ago period.
The average rate paid on interest-bearing liabilities decreased during 2009 to
1.61%, compared to 2.32% in 2008.
Interest income in 2008 totaled $33.9 million, compared to $34.3 million in
2007, a decrease of $0.4 million or 1.2%. The tax equivalent yield on average
interest-earning assets decreased to 6.07% in 2008, compared to 6.50% in 2007.
Average interest-earning assets increased in 2008 to $586.7 million from $551.3
million in 2007. Average loans, which are typically the Company's highest
yielding earning assets, increased $35.2 million or 9.1% in 2008. Average loans
represented 71.8% of 2008 average interest-earning assets, compared to 70.0% in
2007. Income on loans decreased $0.2 million or 0.8% in 2008, compared to an
increase in loan income of $3.0 million or 12.8% during 2007. Investment
securities increased on average by $10.7 million or 7.2% to $160.1 million in
2008 compared to $149.4 million in 2007. Income on investments increased $0.5
million or 7.0% to $7.6 million in 2008, from $7.1 million in 2007. Average
earning assets, including BOLI, increased to 96.4% of average total assets for
2008 compared to 96.0% for the year ago period.
The average rate paid on interest-bearing liabilities decreased during 2008 to
2.32%, compared to 2.94% in 2007.
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.
13
<Page>
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY/INTEREST RATES AND
INTEREST DIFFERENTIAL
The table below presents average weekly balances, interest income on a fully
taxable equivalent basis and interest expense, as well as average rates earned
and paid on the company's major asset and liability items for the years ended
December 31, 2009, 2008 and 2007.
<Table>
<Caption>
2009 2008 2007
ASSETS AVERAGE REVENUE YIELD/ AVERAGE REVENUE YIELD/ AVERAGE REVENUE YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- --------------------------------------------------------------------------------------------------------------------------------
Investment Securities:
Available-for-Sale
U.S. Agency obligations $ 60,030 $ 1,969 3.28% $ 47,530 $ 2,270 4.78% $ 38,992 $ 1,824 4.68%
States & political subdivisions 62,464 2,941 7.13 40,127 1,818 6.86 31,098 1,385 6.75
Federal Home Loan Bank stock 6,175 - - 4,911 164 3.34 3,948 248 6.28
Other 1,349 39 2.89 2,497 92 3.68 4,208 156 3.71
Held to Maturity:
U.S. Agency obligations 28,200 1,337 4.74 35,775 1,677 4.69 41,866 1,907 4.56
States & political subdivisions 27,235 1,454 8.09 29,235 1,562 8.10 29,246 1,559 8.08
Loans, net of unearned income:
Real estate mortgages 318,444 17,788 5.59 270,368 16,376 6.06 246,504 15,825 6.42
Commercial real estate 148,641 7,879 5.30 90,544 5,734 6.33 76,132 5,637 7.40
Commercial 25,656 1,551 6.05 24,286 1,612 6.64 23,036 1,928 8.37
Consumer & other 61,708 5,181 8.40 35,794 2,496 6.97 40,141 3,039 7.57
Federal funds sold - - - 1,739 29 1.67 8,795 456 5.18
Interest on balances with banks 3,833 12 .31 3,883 68 1.75 7,288 365 5.01
- --------------------------------------------------------------------------------------------------------------------------------
Total Interest Earning Assets/
Total Interest Income 743,735 $ 40,151 5.70% 586,689 $ 33,898 6.07% 551,254 $ 34,329 6.50%
- --------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks 10,326 9,687 10,575
Bank premises and equipment 11,804 9,362 9,609
Accrued interest receivable 3,829 3,350 3,338
Goodwill 19,798 - -
Cash surrender value life insurance 12,559 7,515 7,199
Other assets 9,140 4,693 4,067
Less: Allowance for loan losses 5,963 4,986 4,328
- --------------------------------------------------------------------------------------------------------------------------------
Total Assets $805,228 $616,310 $581,714
- --------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest Bearing $ 64,762 $ 393 .61% $ 53,915 $ 377 .70% $ 55,803 $ 570 1.02%
Savings 101,765 409 .40 76,326 412 .54 81,096 880 1.09
Money markets 137,527 1,379 1.00 114,521 2,131 1.86 93,089 2,851 3.06
Time-Over $100 67,075 1,726 2.57 37,745 1,451 3.84 41,146 2,010 4.89
Time-Other 117,507 2,634 2.24 70,436 2,602 3.69 74,923 3,064 4.09
Repurchase agreements 25,554 339 1.33 34,204 848 2.48 25,842 839 3.25
Federal funds purchased 4,568 29 .63 - - - - - -
Short-term borrowings 9,689 48 .50 7,069 175 2.48 1,254 62 4.94
Long-term borrowings 68,246 2,623 3.84 73,252 2,834 3.87 60,867 2,463 4.05
- --------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 596,693 $ 9,580 1.61% 467,468 $ 10,830 2.32% 434,020 $ 12,739 2.94%
- --------------------------------------------------------------------------------------------------------------------------------
Demand-Non-interest bearing 95,491 72,015 74,195
All other liabilities 7,431 4,366 4,818
Stockholders' equity 105,613 72,461 68,681
Total Liabilities
Stockholders' Equity $805,228 $616,310 $581,714
- --------------------------------------------------------------------------------------------------------------------------------
Interest Spread 4.09% 3.75% 3.56%
- --------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 30,571 $ 23,068 $ 21,590
- --------------------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 4.11% 3.93% 3.92%
Return on average assets 1.04% 1.40% 1.15%
Return on average equity 7.93% 11.89% 9.75%
Average equity to average assets 13.12% 11.76% 11.81%
Dividend payout ratio 60.00% 41.40% 50.64%
</Table>
14
<Page>
<Table>
<Caption>
CHANGE
DOLLAR AMOUNT CHANGE IN CHANGE IN IN RATE-
2009 COMPARED TO 2008 OF CHANGE VOLUME RATE VOLUME
------------------------------------------------------------------------------------------------------
EARNING Investment Securities:
ASSETS Available-for-Sale
U.S. Agency obligations $ (301) $ 598 $ (713) $ (186)
States & political subdivisions 1,123 1,532 108 (517)
Equity securities (3) (217) 4 (218)
Held to Maturity:
U.S. Agency obligations (340) (355) 18 (3)
States & political subdivisions (108) (162) (3) 57
Loans, net of unearned income:
Real estate mortgages 3,557 6,506 (2,274) (675)
Commercial (9) (61) 91 (143)
Consumer and other 2,685 1,806 512 367
Federal funds sold (29) 29 (29) (29)
Interest bearing balances with banks (56) 1 (1) (56)
------------------------------------------------------------------------------------------------------
Total Interest Income 6,253 9,990 (2,798) (939)
------------------------------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand-Interest Bearing 16 76 (11) (49)
LIABILITIES Savings (3) 137 (107) (33)
Money markets (752) 428 (985) (195)
Time-Over $100 275 1,126 (479) (372)
Time-Other 32 1,737 (1,021) (684)
Repurchase agreements (509) (215) (393) 99
Short-term borrowings (98) 178 (137) (139)
Long-term borrowings (211) (194) 5 (22)
------------------------------------------------------------------------------------------------------
Total Interest Expense (1,250) 3,273 (3,193) (1,330)
------------------------------------------------------------------------------------------------------
Net Interest Income $ 7,503 $ 6,717 $ 395 $ 391
------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
2008 compared to 2007
------------------------------------------------------------------------------------------------------
EARNING Investment Securities:
ASSETS Available-for-Sale
U.S. Agency obligations $ 446 $ 400 $ 39 $ 7
States & political subdivisions 433 402 25 6
Equity securities (28) (148) (3) (117)
Held to Maturity:
U.S. Agency obligations (6) (230) (278) 54
States & political subdivisions 3 (1) 4 -
Loans, net of unearned income:
Real estate mortgages 648 2,645 (2,291) 294
Commercial (22) (316) 105 (399)
Consumer and other (543) (329) (241) 27
Federal funds sold (427) (366) (309) 248
Interest bearing balances with banks (297) (171) (238) 112
------------------------------------------------------------------------------------------------------
Total Interest Income (431) 2,404 (3,473) 638
------------------------------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand-Interest Bearing (193) (19) (179) 5
LIABILITIES Savings (468) (52) (446) 30
Money markets (720) 656 (1,117) (259)
Time-Over $100 (559) (166) (432) 39
Time-Other (462) (184) (300) 22
Repurchase agreements 9 272 (199) (64)
Short-term borrowings 113 287 (31) (143)
Long-term borrowings 371 502 (110) (21)
------------------------------------------------------------------------------------------------------
Total Interest Expense (1,909) 1,296 (2,814) (391)
------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $ 1,478 $ 1,108 $ (659) $ 1,029
------------------------------------------------------------------------------------------------------
</Table>
15
<Page>
PROVISION FOR LOAN LOSSES
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio.
The provision for loan losses was $2,260 in 2009, an increase of 162.5% compared
to $861 for 2008. The increase in the provision was due to the Company's
increased loan portfolio resulting from the Merger, as well as management's
viewpoint in valuing the loan portfolio for loan losses as the national and
local economies have slowed down. The allowance for loan losses at December 31,
2009 was $6,300 or 1.04% of total loans compared to $5,275 or 1.20% of total
loans at December 31, 2008.
The allowance for loan loss as a percentage of loans was 1.04% at December 31,
2009, compared to 1.20% at December 31, 2008. The decrease is a result of
eliminating the allowance for loan loss and incorporating a credit fair value
adjustment on purchased loans due to the merger with Old Forge Bank as of April
1, 2009. As a result, the allowance for credit losses, which included the
allowance for loan loss and the credit fair value adjustment on loans purchased,
provides an allowance for credit loss as a percentage of period end loans of
1.98% at December 31, 2009. The evaluation of the credit fair value adjustment
on purchased loans was made in accordance with current accounting standards for
business combinations.
The following table presents the components of the allowance for credit losses
for the past five years are as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007 2006 2005
- ------------------------------------------------------------------------------------------------------------
Allowance for loan losses $ 6,300 $5,275 $ 4,700 $ 4,200 $ 3,800
Credit fair value adjustment on purchased loans 5,795 - - - -
- ------------------------------------------------------------------------------------------------------------
Allowance for credit losses $12,095 $ 5,275 $ 4,700 $ 4,200 $ 3,800
- ------------------------------------------------------------------------------------------------------------
Allowance for credit losses to period end loans 1.98% 1.20% 1.16% 1.14% 1.18%
</Table>
The Company believes that the judgments used in establishing the allowance for
loan losses are based on reliable information. In assessing the sufficiency of
the allowance for loan losses, management considers how well prior estimates
have related to actual experience. The Company continually monitors the risk
elements, historical rates and other data used in establishing the allowance on
a periodic basis.
Although management uses available information to establish the appropriate
level of the allowance for loan losses, future additions or reductions to the
allowance may be necessary based on estimates that are susceptible to change as
a result of changes in economic conditions and other factors. As a result, our
allowance for loan losses may not be sufficient to cover actual loan losses, and
future provisions for loan losses could materially adversely affect the
Company's operating results. 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
adjustments to the allowance based on their judgments about information
available to them at the time of their examination.
There are also no particular risk elements in the local economy that put a group
or category of loans at increased risk, however, the Company has increased its
portfolio of commercial loans, which typically bear a higher risk. These loans
are typically secured by real estate to minimize this risk. At December 31, 2009
management feels the loan loss reserve is adequate to manage the risk inherent
in the loan portfolio due to today's economic environment.
The process of determining the adequacy of the allowance is necessarily
judgmental and subject to changes in external conditions. Accordingly, there can
be no assurance that existing levels of the allowance will ultimately prove
adequate to cover actual loan losses.
16
<Page>
NON-INTEREST INCOME
The following table sets forth information by category of non-interest income
for the Company for the past three years:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007
- ---------------------------------------------------------------------------------
Trust department income $ 1,392 $ 1,474 $ 1,535
Service charges on deposit accounts 1,939 1,477 1,014
Merchant transaction income 4,379 4,502 4,256
Brokerage fee income 348 596 261
Other fee income 1,392 1,279 1,211
Bank-owned life insurance 470 316 314
Other operating income 363 167 80
VISA mandatory share redemption - 1,213 -
Impairment losses on investment securities (787) - -
Realized gains on securities, net 873 12 49
- ---------------------------------------------------------------------------------
Total Non-Interest Income $10,369 $11,036 $ 8,720
- ---------------------------------------------------------------------------------
</Table>
Total non-interest income decreased $667 or 6.0% to $10,369 during 2009, from
$11,036 for the same period of 2008. Trust department income decreased $82 or
5.6% from $1,474 at December 31, 2008 to $1,392 at December 31, 2009 due to a
lower market value of trust assets. Service charges on deposit accounts
increased $462 or 31.3% primarily due to the increased number of accounts and
increased service charge activity. Merchant transaction income decreased $123 or
2.7%, mainly due to lower transaction volume from continued softness in the
economy. Brokerage fee income decreased $248 or 41.6% mostly due to the decline
in the overall volume of transactions. Other operating income increased $196 or
117.4% largely due to gains on the sale of low yielding long-term fixed rate
real estate loans. In the first quarter of 2008, the Company realized a gain of
$1,213 related to VISA, Inc.'s Initial Public Offering, which consisted of a
mandatory partial share redemption. The Company recognized an impairment loss on
bank equity investment securities of $787 during 2009. Realized gains on
securities increased $861 to $873 during 2009 from $12 for 2008 largely due to
gains on the sale of the majority of the Old Forge Bank securities portfolio,
with the proceeds reinvested into higher quality securities.
Total non-interest income increased $2,316 or 26.6% to $11,036 during 2008, from
$8,720 for the same period of 2007. Trust department income decreased $61 due to
the decrease in market value of trust assets. Service charges on deposit
accounts increased $463 or 45.7% primarily due to the increased number of
accounts and increased service charge activity. Merchant transaction income
increased $246 or 5.8%, mainly due to higher transaction volume and new
business. Brokerage fee income increased $335 or 128.4% due to new and increased
business in the wealth management area. Other operating income increased $87 or
108.7% due to a gain on the sale of other real estate owned of $69, along with
an increase in general operating income. The Company realized a gain of $1,213
related to VISA, Inc.'s Initial Public Offering, which consisted of a mandatory
partial share redemption, during the first quarter of 2008, discussed earlier.
Realized gains on securities decreased $37 to $12 during 2008 from $49 for 2007.
NON-INTEREST EXPENSES
VISA CONTINGENCY
In October 2007, Penn Security Bank & Trust Company, as a member of VISA U.S.A.
Inc. received shares of restricted stock in VISA, Inc.(VISA) as a result of a
global restructuring of VISA in preparation for an initial public offering in
2008.
In connection with this, VISA member banks were required to recognize a
contingent obligation to indemnify VISA under its revised bylaws for potential
losses arising from certain antitrust litigation, at the estimated fair value of
such obligation. The Company, accordingly, recorded a $497 charge or $328, net
of tax, in the fourth quarter of 2007. Upon successful completion of the public
offering in 2008, VISA established an escrow account for the litigation, funded
by a partial redemption of member shares allowing the Company to reverse the
$497 litigation accrual during the first quarter of 2008.
17
<Page>
The following table sets forth information by category of non-interest expenses
for the Company for the past three years:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007
- ---------------------------------------------------------------------------------
Salaries and employee benefits $12,551 $10,157 $ 9,118
Expense of premises and equipment, net 3,246 2,703 2,586
Merchant transaction expenses 3,085 3,403 3,358
Merger related costs 1,550 - -
FDIC insurance assessments 968 59 49
Bank shares tax 1,039 743 695
Outside services 615 770 710
Director fees 568 493 492
Other operating expenses 4,798 3,844 4,323
- ---------------------------------------------------------------------------------
Total Non-Interest Expenses $28,420 $22,172 $21,331
- ---------------------------------------------------------------------------------
</Table>
Total non-interest expenses increased $6,248 or 28.2% to $28,420 during 2009
compared with $22,172 for the same period of 2008. Salaries and employee
benefits expense increased $2,394 or 23.6% mainly due to increased salaries
resulting from additional employees as a result of the merger. Premises and
fixed assets expense increased $543 or 20.1% due to additional depreciation and
increased occupancy expense in part due to the merger. Merchant transaction
expenses decreased $318 or 9.3% due to lower transaction volume. Merger related
costs of $1,550 consist of computer system conversions and equipment upgrades of
$606, investment banking, valuation services, legal and accounting fees of $429,
severance payments of $450 and stay bonuses of $65. FDIC insurance assessments
increased $909 due to a one time FDIC special assessment charge of $385 and
increases in quarterly assessments. Bank shares tax increased $296 or 39.8% as a
result of the Merger. Other operating expenses increased $954 or 24.8% due to
the effect of the reversal in the first quarter of 2008 of the $497 VISA
litigation accrual recorded by the Company in the fourth quarter of 2007, in
addition to an increase of $248 in consulting and advisory expense and $850 of
legal and professional services.
Total non-interest expenses increased $841 or 3.9% to $22,172 during 2008
compared with $21,331 for the same period of 2007. Salaries and employee
benefits expense increased $1,039 or 11.4% largely due to a $356 retirement
contribution to fifty employees negatively impacted by the Company's pension
freeze during the second quarter of 2008, and an additional $70 contribution to
the 401(k) plan benefiting all employees, and increased salaries resulting from
additional employee hires and increased commissions related to our wealth
management division. Premises and fixed assets expense increased $117 or 4.5%
due to computer system upgrades and increased occupancy expense. Merchant
transaction expenses increased $45 or 1.3% due to higher transaction volume.
Other operating expenses decreased $479 or 11.1% largely due to the effect of
the $497 VISA litigation accrual recorded by the Company during the fourth
quarter of 2007(2). Excluding this VISA litigation accrual, other operating
expense increased year over year $515 mostly related to the Company's new brand
and logo expenses of $120, legal fees related to loan collection efforts of
$128, and professional expenses of $134 related to the pension freeze, $82
related to outsourced audit and compliance services, and $78 related to computer
system updates.
INCOME TAXES
Federal income tax expense decreased $570 or 23.2% to $1,888 in 2009 compared to
$2,458 in 2008, primarily due to lower operating income described above and
higher tax-free income.
- ---------------------
(2) See pages 26 and 27 for a reconciliation of GAAP net income excluding the
merger costs incurred during the year ended December 31, 2009 and the gain
related to the VISA, Inc. initial public offering during the year ended
December 31, 2008.
18
<Page>
Federal income tax expense increased $834 or 51.4% to $2,458 in 2008 compared to
$1,624 in 2007, primarily due to the VISA initial public offering and overall
higher income.
The Company's effective income tax rate for 2009, 2008 and 2007 was 18.4%, 22.2%
and 19.5%, respectively.
The Company uses the asset and liability method of accounting for deferred
income taxes. If current available information raises doubt as to the
realization of deferred tax assets, a valuation allowance is established. The
Company evaluates the recoverability of deferred tax assets based on its ability
to generate future profits. The Company employs budgeting and periodic reporting
processes to continually monitor its progress. Historically, the Company has had
sufficient profits for recovery of deferred tax benefits.
For further discussion pertaining to Federal income taxes, see Note 17 to the
Consolidated Financial Statements.
FINANCIAL CONDITION
Total assets increased $254.3 million or 40.4% during 2009 to $883.3 million at
December 31, 2009 compared to $629.0 million at December 31, 2008, including the
acquisition of Old Forge Bank assets at fair value of $212.6 million and the
recording of Goodwill of $26.4 million. Total assets increased $48.2 million or
8.3% during 2008 to $629.0 million at December 31, 2008 compared to $580.8
million at December 31, 2007.
INVESTMENT PORTFOLIO
The Company maintains a portfolio of investment securities to provide income and
serve as a source of liquidity for its ongoing operations.
The following table presents the carrying value, by security type, for the
Company's investment portfolio:
<Table>
<Caption>
December 31, 2009 2008 2007
- -------------------------------------------------------------------------------
U.S. Agency obligations $ 95,962 $ 80,643 $ 69,516
States & political subdivisions 98,584 70,010 68,714
Equity securities 7,786 6,827 7,218
- -------------------------------------------------------------------------------
Total Investment Securities $202,332 $157,480 $145,448
- -------------------------------------------------------------------------------
</Table>
Equity securities at December 31, 2009 and 2008 consisted primarily of other
financial institutions' stock and Federal Home Loan Bank of Pittsburgh (FHLB)
stock, which is a required investment in order to participate in an available
line of credit program. The FHLB stock is stated at par value as 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 December 31, 2009.
In 2009, the Company recorded an other-than-temporary impairment charge of $787
related to the Company's equity investment portfolio containing stock of
financial institutions. Prior to this impairment charge, the decline in value of
the securities was recorded as unrealized losses on securities
available-for-sale and reflected as a reduction in stockholders' equity through
other comprehensive income.
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. 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 businesses, financial conditions 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.
A summary of transactions involving available-for-sale debt securities in 2009,
2008 and 2007 are as follows:
19
<Page>
<Table>
<Caption>
December 31, 2009 2008 2007
- ------------------------------------------------------------
Proceeds from sales $25,568 $11,798 $ -
Gross realized gain 1,029 11 -
Gross realized losses 142 - -
</Table>
LOAN PORTFOLIO
Details regarding the Company's loan portfolio for the past five years are as
follows:
<Table>
<Caption>
December 31, 2009 2008 2007 2006 2005
- ----------------------------------------------------------------------------------------------
Real estate - construction
and land development $ 32,910$ $ 21,949 $ 25,858 $ 23,714 $ 13,132
Real estate mortgages 470,093 355,528 318,437 284,323 227,853
Commercial 30,743 27,793 24,505 26,265 42,894
Credit card and related plans 3,365 3,272 3,324 3,282 3,152
Installment 59,986 28,135 26,542 25,532 26,293
Obligations of states &
political subdivisions 6,873 4,471 5,973 6,806 8,038
- ----------------------------------------------------------------------------------------------
Loans, net of unearned income 603,970 441,148 404,639 369,922 321,362
Less: Allowance for loan losses 6,300 5,275 4,700 4,200 3,800
- ----------------------------------------------------------------------------------------------
Loans, net $597,670 $435,873 $399,939 $365,722 $317,562
- ----------------------------------------------------------------------------------------------
</Table>
LOANS
Total net loans increased $161.8 million or 37.1% to $597.7 million at December
31, 2009 from $435.9 million at December 31, 2008. This increase is primarily
due to the acquisition of the Old Forge Bank loan portfolio of $159.9 million.
Total net loans increased $36.0 million or 9.0% to $435.9 million at December
31, 2008 from $399.9 million at December 31, 2007. This increase was due mainly
to strong loan demand with a mix of fixed and variable rate loans backed by
real estate.
LOAN QUALITY
The lending activities of the Company are guided by the comprehensive lending
policy established by the Board of Directors. Loans must meet criteria which
include consideration of the character, capacity and capital of the borrower,
collateral provided for the loan, and prevailing economic conditions. 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.
20
<Page>
The allowance for loan loss as a percentage of loans was 1.04% at December 31,
2009, compared to 1.20% at December 31, 2008. The decrease is a result of
eliminating the allowance for loan loss and incorporating a credit fair value
adjustment on purchased loans due to the merger with Old Forge Bank as of April
1, 2009. As a result, the allowance for credit losses, which included the
allowance for loan loss and the credit fair value adjustment on loans purchased,
provides an allowance for credit loss as a percentage of period end loans of
1.98% at December 31, 2009. The evaluation of the credit fair value adjustment
on purchased loans was made in accordance with current accounting standards for
business combinations.
The following table presents the components of the allowance for credit losses
for the past five years are as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007 2006 2005
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses $ 6,300 $ 5,275 $ 4,700 $ 4,200 $ 3,800
Credit fair value adjustment on purchased loans 5,795 - - - -
- --------------------------------------------------------------------------------------------------------------
Allowance for credit losses $12,095 $ 5,275 $ 4,700 $ 4,200 $ 3,800
- --------------------------------------------------------------------------------------------------------------
Allowance for credit losses to period end loans 1.98% 1.20% 1.16% 1.14% 1.18%
</Table>
In 2009, our local economy began to experience the negative impact of our
nation's economic downturn. The local housing market has slowed and the
unemployment rate in Northeastern Pennsylvania increased to 9.7% by
year-end. To enhance our ability to identify and manage risk throughout our
organization, we created the senior level position of Chief Risk Officer in
December of 2009. This position will facilitate our enterprise wide risk
assessment to identify, monitor and quickly mitigate the inherent risks of a
community bank in today's economic environment.
21
<Page>
NON-PERFORMING ASSETS
Non-performing assets consist of non-accrual loans and other real estate owned
The following table sets forth information regarding non-performing assets and
loans past due 90 days or more and still accuring interest as of the dates
indicated:
<Table>
<Caption>
As of: 2009 2008 2007 2006 2005
- ---------------------------------------------------------------------------------------------------
Non-accrual loans
Secured by real estate $ 1,945 $ 1,098 $ 657 $ 3,005 $ 1,003
Commercial loans 199 201 949 175 609
Consumer loans 195 155 4 - 15
Total non-performing loans $ 2,339 $ 1,454 $1,610 $ 3,180 $1,627
- ----------------------------------------------------------------------------------------------------
Other real estate owned 405 - - - -
- ----------------------------------------------------------------------------------------------------
Total non-performing assets 2,744 1,454 1,610 3,180 1,627
- ----------------------------------------------------------------------------------------------------
Loans past due 90 days or more and accruing:
Secured by real estate 1,456 810 57 177 -
Guaranteed student loans 218 203 408 251 152
Credit card loans 9 17 2 6 21
Commercial loans - 119 - - -
Consumer loans 14 4 12 - -
- ----------------------------------------------------------------------------------------------------
Total loans past due 90 days or
more and accruing 1,697 1,153 479 434 173
- ----------------------------------------------------------------------------------------------------
Non-performing loans to period end loans 0.39% 0.33% 0.40% 0.86% 0.51%
Total loans past due 90 days or more
and accruing to period end loans 0.28% 0.26% 0.12% 0.12% 0.05%
Non-performing assets to period end assets 0.31% 0.23% 0.28% 0.56% 0.28%
</Table>
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 $2,339, $1,454 and $1,610 at December 31, 2009, 2008 and 2007, respectively.
The increase in 2009 was due primarily to several loans which were acquired in
the Old Forge Bank merger, as well as, a single borrowing relationship for which
management feels the Company is sufficiently secured and predicts no significant
loss of principal. The decrease in 2007 was primarily due to the resolution of a
single borrower relationship outstanding in 2006. If interest on those loans had
been accrued, such income would have been $365, $192 and $153 for 2009, 2008 and
2007, respectively. Interest income on those loans, which is recorded only when
received, amounted to $52, $29 and $17 for 2009, 2008 and 2007, respectively.
There are no commitments to lend additional funds to individuals whose loans are
in non-accrual status.
Real estate loans of $1,456 that are past due 90 days or more and still accruing
are primarily 1-4 family residential loans with favorable loan-to-value ratios
and in the process of collection.
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 December 31, 2009 there are no significant loans as to which management
has serious doubt about their collectibility.
22
<Page>
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 $8.0 million of TERI loans. 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 December 31, 2009 there
was $137 of such loans placed on non-accrual status.
At December 31, 2009, 2008 and 2007, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
The Company does not engage in any sub-prime or ALT-A credit lending. Therefore,
the Company is not subject to any credit risks associated with such loans.
LOAN LOSS EXPERIENCE
The following table presents the Company's loan loss experience during the
periods indicated:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007 2006 2005
- ------------------------------------------------------------------------------------------------------
Balance at beginning of year $ 5,275 $ 4,700 $ 4,200 $ 3,800 $ 3,600
- ------------------------------------------------------------------------------------------------------
Charge-offs:
Real estate mortgages 349 83 84 74 31
Commercial and all others 610 - 10 18 -
Credit card and related plans 71 55 66 49 68
Installment loans 270 179 5 26 14
- ------------------------------------------------------------------------------------------------------
Total charge-offs 1,300 317 165 167 113
- ------------------------------------------------------------------------------------------------------
Recoveries:
Real estate mortgages 42 - 5 - 46
Commercial and all others - 14 1 131 -
Credit card and related plans 1 16 1 3 3
Installment loans 22 1 1 - 1
- ------------------------------------------------------------------------------------------------------
Total recoveries 65 31 8 134 50
- ------------------------------------------------------------------------------------------------------
Net charge-offs 1,235 286 157 33 63
- ------------------------------------------------------------------------------------------------------
Provision charged to operations 2,260 861 657 433 263
- ------------------------------------------------------------------------------------------------------
Balance at End of Year $ 6,300 $ 5,275 $ 4,700 $ 4,200 $3,800
- ------------------------------------------------------------------------------------------------------
Ratio of net charge-offs to
average loans outstanding 0.22% 0.07% 0.04% 0.01% 0.02%
- ------------------------------------------------------------------------------------------------------
</Table>
The allowance for loan losses at December 31, 2009 was $6,300 or 1.04% of total
loans compared to $5,275 or 1.20% of total loans at December 31, 2008. The
allowance for credit losses was 1.98% at December 31, 2009 compared to 1.20% at
December 31, 2008.
The overwhelming majority of commercial loans and real estate mortgages
charged-off during 2009 were comprised of one and two borrowing relationships,
respectively.
23
<Page>
The allowance for loan losses is allocated as follows:
<Table>
<Caption>
December 31, 2009 2008 2007 2006 2005
- ---------------------------------------------------------------------------------------------------------------------
Amount %(1) Amount %(1) Amount %(1) Amount %(1) Amount %(1)
- ---------------------------------------------------------------------------------------------------------------------
Real estate mortgages $1,200 83% $1,200 86% $1,200 85% $1,200 83% $1,200 75%
Commercial and all other 4,000 5 3,275 6 2,900 7 2,500 9 2,190 16
Credit card and related plans 350 1 300 1 300 1 250 1 185 1
Personal installment loans 750 11 500 7 300 7 250 7 225 8
- ---------------------------------------------------------------------------------------------------------------------
Total $6,300 100% $5,275 100% $4,700 100% $4,200 100% $3,800 100%
- ---------------------------------------------------------------------------------------------------------------------
</Table>
(1) - Percent of loans in each category to total loans
24
<Page>
DEPOSITS
The primary source of funds to support the Company's operations is its deposit
base. Company deposits increased $220.7 million to $645.4 million at December
31, 2009 from $424.7 million at December 31, 2008. Largely, the Company
experienced growth in transaction accounts and time deposits due to the
acquisition of Old Forge Bank accounts of $177.0 million, as well as growth from
increased marketing efforts. Company deposits increased $8.2 million to $424.7
million at December 31, 2008 from $416.5 million at December 31, 2007. Largely,
the Company experienced growth in transaction accounts and time deposits due to
increased marketing efforts.
The maturities of time deposits of $100,000 or more at December 31, 2009 are as
follows:
<Table>
<Caption>
Three months or less $ 20,649
Over three months through six months 19,826
Over six months through twelve mont 12,611
Over twelve months 25,616
--------
Total $ 78,702
========
</Table>
DIVIDEND POLICY
Payment of future dividends will be subject to the discretion of the Board of
Directors and will depend upon the earnings of the Company, its financial
condition, capital requirements, need for funds and other matters as the
Board deems appropriate.
Dividends on the Company common stock, if approved by the Board of Directors,
are customarily paid on or about March 15, June 15, September 15 and December
15.
ASSET/LIABILITY MANAGEMENT
The Company's policy is to match its level of rate-sensitive assets and
rate-sensitive liabilities within a limited range, thereby reducing its exposure
to interest rate fluctuations. While no single measure can completely identify
the impact of changes in interest rates on net interest income, one gauge of
interest rate-sensitivity is to measure, over a variety of time periods, the
differences in the amounts of the Company's rate-sensitive assets and
rate-sensitive liabilities. These differences, or "gaps", provide an indication
of the extent to which net interest income may be affected by future changes in
interest rates. A positive gap exists when rate-sensitive assets exceed
rate-sensitive liabilities and indicates that a greater volume of assets than
liabilities will reprise during a given period. This mismatch may enhance
earnings in a rising interest rate environment and may inhibit earnings when
interest rates decline. Conversely, when rate-sensitive liabilities exceed
rate-sensitive assets, referred to as a negative gap, it indicates that a
greater volume of liabilities than assets may reprise during the period. In this
case, a rising interest rate environment may inhibit earnings and declining
interest rates may enhance earnings. However, because interest rates for
different asset and liability products offered by financial institutions respond
differently, the gap is only a general indicator of interest rate sensitivity.
LIQUIDITY
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Agency bond portfolios,
additional deposits, 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.
25
<Page>
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. At December 31, 2009 the Company had $227,981
of available borrowing capacity with the FHLB, a Borrower-In-Custody (BIC) line
of credit of $11,171 with the Federal Reserve Bank of Philadelphia and available
borrowing capacity at the Discount Window of $36,625, an overnight Federal funds
line of credit of $19,000 with PNC Bank and an overnight Federal funds line of
credit of $5,000 with Wells Fargo.
The Company is a separate legal entity from the Bank and must provide for its
own liquidity. In addition to its operating expenses, the Company is responsible
for paying any dividends declared to its shareholders. The Company's primary
source of income is dividends received from the Bank. The amount of dividends
that the Bank may declare and pay to the Company is generally restricted under
Pennsylvania law to the retained earnings of the Bank.
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.
Financial instruments whose contract amounts represent credit risk at December
31, 2009 and 2008 are as follows:
<Table>
<Caption>
2009 2008
- --------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 39,576 $ 26,396
Variable rate $ 87,454 $ 92,935
Standby letters of credit $ 16,091 $ 11,173
</Table>
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 December 31, 2009 the Bank has entered into contracts for the building of a
new branch at an existing location, in the amount of $1,909, approximately $675
of which had been disbursed as of December 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 December 31, 2009, the Bank has issued
standby letters of credit for the accounts of related parties in the amount of
$7,802.
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.
26
<Page>
The Company's total risk-based capital ratio was 16.90% at December 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". Under
these rules, the Company could significantly increase its assets and still
comply with these capital requirements without the necessity of increasing its
equity capital.
The following table presents Stockholders' Equity of the Company for the past
two years:
<Table>
<Caption>
Years Ended December 31, 2009 2008
- -------------------------------------------------------------------------
Balance at beginning of year $ 73,642 $ 69,715
Fair value of consideration exchanged in merger 38,058 -
Net income 8,372 8,613
Other comprehensive income 2,356 (1,121)
Cash dividends declared (5,031) (3,565)
- -------------------------------------------------------------------------
Total Stockholders' Equity $117,397 $ 73,642
- -------------------------------------------------------------------------
</Table>
NON-GAAP FINANCIAL MEASURES
Certain financial measures contained in this Form 10-K for 2008 exclude the
income created by the reversal of a 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. These financial measures for
2009 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.
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. The current conversion ratio of 0.5824 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 December 31, 2009, the value of the Class A shares
was $87.46 per share. The value of unredeemed Class A equivalent shares owned by
the Company was $2.3 million as of December 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 a $497 accrual 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 of $1,550 for the year ended December 31, 2009, related to the
merger with Old Forge Bank, consist primarily of investment banking costs,
system conversion costs, valuation services, legal and accounting fees and
severance payments.
27
<Page>
NON-GAAP RECONCILIATION SCHEDULE
PENSECO FINANCIAL SERVICES CORPORATION
(UNAUDITED)
(IN THOUSANDS)
The following tables present the reconciliation of non-GAAP financial measures
to reported GAAP financial measures.
<Table>
<Caption>
Twelve Months Ended
December 31,
2009 2008 Change
- ---------------------------------------------------------------------------------------------
Net interest income after provision for loan losses $ 28,311 $ 22,207 $ 6,104
Non-interest income 10,369 11,036 (667)
Non-interest expense (28,420) (22,172) (6,248)
Income tax benefit (provision) (1,888) (2,458) 570
- ---------------------------------------------------------------------------------------------
Net income 8,372 8,613 (241)
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 1,550 - 1,550
Covered litigation accrual - (497) 497
- ---------------------------------------------------------------------------------------------
Total Adjustments pre-tax 1,550 (1,710) 3,260
Income tax provision (benefit) (25%(3)/34% tax rate) 381 (581) 962
After tax adjustments to GAAP 1,169 (1,129) 2,298
- ---------------------------------------------------------------------------------------------
Adjusted net income $ 9,541 $ 7,484 $ 2,057
- ---------------------------------------------------------------------------------------------
Return on Average Assets 1.18% 1.21%
Return on Average Equity 9.03% 10.33%
Dividend Payout Ratio 52.66% 47.70%
</Table>
Return on average equity (ROE) and return on average assets (ROA) for the year
ended December 31, 2009 was 7.93% (9.03% excluding the Merger costs) and 1.04%
(1.18% excluding the Merger costs), respectively. ROE was 11.89% (10.33%
excluding the VISA IPO impact) and ROA was 1.40% (1.21% excluding the VISA IPO
impact) for the same period last year. The dividend payout ratio for December
31, 2009 was 60.00% (52.66% excluding the Merger costs) and was 41.40% (47.70%
excluding the VISA IPO impact) for the same period last year.
ITEM 7A 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.
- ------------------------
(3) Income tax effect calculation is 34% except for the portion of the merger
costs that are non-deductible.
28
<Page>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Standby letters of credit are conditional commitments
issued to guarantee the performance of a customer to a third party up to a
stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded as
an asset or liability by the Company until the instrument is exercised.
The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximizing income. Management realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and an interest rate shock simulation report. The Company
has no market risk sensitive instruments held for trading purposes. It appears
the Company's market risk is reasonable at this time.
The following table provides information about the Company's market rate
sensitive instruments used for purposes other than trading that are sensitive to
changes in interest rates. For loans, securities, and liabilities with
contractual maturities, the table presents principal cash flows and related
weighted-average interest rates by contractual maturities as well as the
Company's historical experience of the impact of interest rate fluctuations on
the prepayment of residential and home equity loans and mortgage-backed
securities. For core deposits (e.g., DDA, interest checking, savings and money
market deposits) that have no contractual maturity, the table presents principal
cash flows and, as applicable, related weighted-average interest rates based on
the Company's historical experience, management's judgment, and statistical
analysis, as applicable, concerning their most likely withdrawal behaviors.
29
<Page>
MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2009
The table below presents States and political subdivisions securities on a fully
taxable equivalent basis.
<Table>
<Caption>
NON-RATE FAIR
2010 2011 2012 2013 2014 THEREAFTER SENSITIVE TOTAL VALUE
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed interest rate securities:
U.S. Agency obligations $ 19,375 $ 22,308 $ 28,545 $ 3,050 $ 2,497 $ 12,450 $ - $ 88,225 $ 89,502
Yield 3.47% 3.12% 2.13% 5.31% 5.30% 5.29% - 3.30% -
State & political subdivisions 13,186 14,058 8,120 7,239 7,491 48,490 - 98,584 99,507
Yield 8.44% 7.71% 7.64% 6.69% 6.68% 6.91% - 7.16% -
Variable interest rate securities:
U.S. Agency obligations 7,737 - - - - - - 7,737 7,741
Yield 2.46% - - - - - - 2.46% -
Federal Home Loan Bank stock - - - - - - 6,402 6,402 6,402
Yield - - - - - - - - -
Other 1,384 - - - - - - 1,384 1,384
Yield .95% - - - - - - .95% -
Fixed interest rate loans:
Real estate mortgages 62,471 41,342 32,623 25,767 19,269 33,312 - 214,784 222,021
Yield 6.20% 6.18% 6.13% 6.10% 6.04% 5.80% - 6.10% -
Commercial 7,019 2,129 3,565 993 566 4,809 - 19,081 18,960
Yield 4.70% 6.43% 6.04% 6.52% 6.71% 7.17% - 5.92% -
Consumer and other 18,461 10,327 7,339 4,231 2,048 6,573 - 48,979 50,073
Yield 7.19% 7.99% 7.76% 7.51% 6.97% 6.11% - 7.32% -
Variable interest rate loans:
Real estate mortgages 118,600 29,385 26,525 26,118 17,865 984 - 219,477 222,798
Yield 4.62% 6.00% 6.12% 5.82% 5.34% 6.56% - 5.22% -
Commercial 61,750 8,318 2,175 1,859 2,637 337 - 77,076 74,989
Yield 4.40% 6.88% 6.41% 5.74% 5.87% 3.74% - 4.80% -
Consumer and other 20,736 521 2,497 240 579 - - 24,573 24,273
Yield 4.72% 5.73% 7.94% 6.33% 5.27% - - 5.09% -
Less: Allowance for loan losses - - - - - 6,300 - 6,300 -
Interest bearing balances with banks 2,274 - - - - - - 2,274 2,274
Yield .50% - - - - - - .50% -
Cash surrender life insurance 14,380 - - - - - - 14,380 14,380
Yield 3.94% - - - - - - 3.94% -
Cash and due from banks - - - - - - 11,100 11,100 11,100
Goodwill - - - - - - 26,398 26,398 -
Other assets - - - - - - 29,173 29,173 -
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $347,373 $128,388 $111,389 $69,497 $52,952 $100,655 $73,073 $883,327 $845,404
- --------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
Demand-Interest bearing $ 16,450 $ - $ - $ - $ - $ 56,027 $ - $ 72,477 $ 72,477
Yield 1.72% - - - - .27% - .60% -
Savings 10,527 - - - - 100,467 - 110,994 110,994
Yield .52% - - - - .38% - .39% -
Money markets 146,189 - - - - - - 146,189 146,189
Yield .74% - - - - - - .74% -
Fixed interest rate deposits:
Time-Over $100,000 53,086 16,806 5,595 1,285 1,830 100 - 78,702 79,221
Yield 1.78% 2.99% 2.80% 4.23% 3.37% 3.50% - 2.19% -
Time-Other 90,174 23,039 8,115 2,350 2,934 605 - 127,217 128,984
Yield 1.81% 2.79% 3.68% 4.02% 3.33% 3.68% - 2.25% -
Demand-Non interest bearing - - - - - - 109,855 109,855 109,855
Repurchase agreements 18,168 - - - - - - 18,168 18,168
Yield .97% - - - - - - .97% -
Short-term borrowings 27,430 - - - - - - 27,430 27,430
Yield .40% - - - - - - .40% -
Long-term borrowings 12,825 11,072 10,956 11,151 4,785 17,305 - 68,094 69,853
Yield 3.36% 3.57% 3.66% 3.68% 3.63% 4.42% - 3.78% -
Other liabilities - - - - - - 6,804 6,804 -
Stockholders' equity - - - - - - 117,397 117,397 -
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $374,849 $ 50,917 $24,666 $14,786 $ 9,549 $174,504 $234,056 $883,327 $763,171
- --------------------------------------------------------------------------------------------------------------------------------
EXCESS OF ASSETS(LIABILITIES)
SUBJECT TO INTEREST RATE CHANGE $(27,476) $ 77,471 $86,723 $54,711 $43,403 $(73,849) $(160,983) $ -
- --------------------------------------------------------------------------------------------------------------------------------
</Table>
30
<Page>
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31, 2009 2008
- -------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 11,100 $ 7,246
Interest bearing balances with banks 2,274 2,109
- -------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents 13,374 9,355
Investment securities:
Available-for-sale, at fair value 155,481 94,996
Held-to-maturity (fair value of $49,054 and $64,678, respectively) 46,851 62,484
- -------------------------------------------------------------------------------------------------------------
Total Investment Securities 202,332 157,480
Loans, net of unearned income 603,970 441,148
Less: Allowance for loan losses 6,300 5,275
- -------------------------------------------------------------------------------------------------------------
Loans, Net 597,670 435,873
Bank premises and equipment 12,396 10,391
Other real estate owned 528 -
Accrued interest receivable 4,317 3,518
Goodwill 26,398 -
Cash surrender value of life insurance 14,380 7,684
Other assets 11,932 4,666
- -------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $883,327 $628,967
- -------------------------------------------------------------------------------------------------------------
Deposits:
Non-interest bearing $109,855 $ 72,456
Interest bearing 535,579 352,269
- -------------------------------------------------------------------------------------------------------------
Total Deposits 645,434 424,725
Other borrowed funds:
Repurchase agreements 18,168 29,155
Short-term borrowings 27,430 24,204
Long-term borrowings 68,094 72,720
Accrued interest payable 1,317 1,118
Other liabilities 5,487 3,403
- -------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 765,930 555,325
- -------------------------------------------------------------------------------------------------------------
Common stock; $.01 par value, 15,000,000 shares authorized,
3,276,079 shares issued and outstanding at December 31, 2009 and
2,148,000 shares issued and outstanding at December 31, 2008 33 21
Surplus 48,865 10,819
Retained earnings 68,086 64,745
Accumulated other comprehensive income 413 (1,943)
- -------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 117,397 73,642
- -------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $883,327 $628,967
- -------------------------------------------------------------------------------------------------------------
</Table>
31
<Page>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2009 2008 2007
- ----------------------------------------------------------------------------------------------------
Interest and fees on loans $ 32,399 $ 26,218 $ 26,429
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 3,306 3,947 3,731
States & political subdivisions 4,395 3,380 2,944
Other securities 39 256 404
Interest on Federal funds sold - 29 456
Interest on balances with banks 12 68 365
- ----------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 40,151 33,898 34,329
- ----------------------------------------------------------------------------------------------------
Interest on time deposits of $100,000 or more 1,726 1,451 2,010
Interest on other deposits 4,815 5,522 7,365
Interest on other borrowed funds 3,039 3,857 3,364
- ----------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 9,580 10,830 12,739
- ----------------------------------------------------------------------------------------------------
NET INTEREST INCOME 30,571 23,068 21,590
Provision for loan losses 2,260 861 657
- ----------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 28,311 22,207 20,933
- ----------------------------------------------------------------------------------------------------
Trust department income 1,392 1,474 1,535
Service charges on deposit accounts 1,939 1,477 1,014
Merchant transaction income 4,379 4,502 4,256
Brokerage fee income 348 596 261
Other fee income 1,392 1,279 1,211
Bank-owned life insurance 470 316 314
Other operating income 363 167 80
VISA mandatory share redemption - 1,213 -
Impairment losses on investment securities (787) - -
Realized gains on securities, net 873 12 49
- ----------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST INCOME 10,369 11,036 8,720
- ----------------------------------------------------------------------------------------------------
Salaries and employee benefits 12,551 10,157 9,118
Expense of premises and equipment, net 3,246 2,703 2,586
Merchant transaction expenses 3,085 3,403 3,358
Merger related costs 1,550 - -
FDIC insurance assessments 968 59 49
Bank shares tax 1,039 743 695
Outside services 615 770 710
Director fees 568 493 492
Other operating expenses 4,798 3,844 4,323
- ----------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSES 28,420 22,172 21,331
- ----------------------------------------------------------------------------------------------------
Income before income taxes 10,260 11,071 8,322
Applicable income taxes 1,888 2,458 1,624
- ----------------------------------------------------------------------------------------------------
NET INCOME $ 8,372 $ 8,613 $ 6,698
- ----------------------------------------------------------------------------------------------------
EARNINGS PER SHARE $ 2.80 $ 4.01 $ 3.12
- ----------------------------------------------------------------------------------------------------
</Table>
32
<Page>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
- -------------------------------------------- ACCUMULATED
OTHER TOTAL
COMMON RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK SURPLUS EARNINGS INCOME EQUITY
- -------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2006 $ 21 $ 10,819 $ 56,393 $ (662) $ 66,571
Comprehensive income:
Net income, 2007 - - 6,698 - 6,698
Other comprehensive income, net of tax
Unrealized losses on securities,
net of reclassification adjustment - - - (57) (57)
Unrealized losses on employee benefit plans, net - - - (103) (103)
-------- ---------
Other comprehensive income (160) (160)
---------
Comprehensive income 6,538
Cash dividends declared ($1.58 per share) - - (3,394) - (3,394)
- -------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2007 21 10,819 59,697 69,715
Comprehensive income:
Net income, 2008 - - 8,613 - 8,613
Other comprehensive income, net of tax
Unrealized losses on securities,
net of reclassification adjustment - - - (728) (728)
Unrealized losses on employee benefit plans, net - - - (393) (393)
-------- ---------
Other comprehensive income (1,121) (1,121)
---------
Comprehensive income 7,492
Cash dividends declared ($1.66 per share) - - (3,565) - (3,565)
- -------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2008 21 10,819 64,745 (1,943) 73,642
Fair value of consideration exchanged in merger 12 38,046 - - 38,058
Comprehensive income:
Net income, 2009 - - 8,372 - 8,372
Other comprehensive income, net of tax
Unrealized gains on securities,
net of reclassification adjustment - - - 2,069 2,069
Unrealized gains on employee benefit plans, net - - - 287 287
-------- ---------
Other comprehensive income 2,356 2,356
---------
Comprehensive income 10,728
Cash dividends declared ($1.68 per share) - - (5,031) (5,031)
- -------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2009 $ 33 $ 48,865 $ 68,086 $ 413 $117,397
- -------------------------------------------------------------------------------------------------------------------------
</Table>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
33
<Page>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2009 2008 2007
- --------------------------------------------------------------------------------------------------------
Net income $ 8,372 $ 8,613 $ 6,698
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 997 795 861
Provision for loan losses 2,260 861 657
Deferred income tax provision (benefit) (60) 244 (344)
Amortization of securities (net of accretion) 486 317 366
Accretion of purchase accounting fair value adjustment
(net of amortization) (1,075) - -
Gain on VISA mandatory share redemption - (1,213) -
Increase in cash surrender value of life insurance (469) (316) (314)
Other-than-temporary impairment loss 787 - -
Net realized gains on securities (873) (12) (49)
Loss (gain) on other real estate 25 (69) (19)
Decrease in interest receivable 206 40 74
Increase in other assets (122) (350) (36)
Decrease in income taxes payable (469) (565) (14)
(Decrease) increase in interest payable (140) (380) 26
Increase (decrease) in other liabilities 493 (484) 82
- --------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 10,538 7,481 7,988
- --------------------------------------------------------------------------------------------------------
Purchase of investment securities available-for-sale (63,292) (51,389) (21,412)
Proceeds from sales and maturities of investment
securities available-for-sale 34,792 24,976 21,962
Proceeds from repayments of investment
securities available-for-sale 3,891 7,603 13,779
Proceeds from repayments of investment
securities to be held-to-maturity 15,438 5,369 5,899
Proceeds from VISA mandatory share redemption - 1,213 -
Net loans originated (4,626) (36,817) (34,950)
Proceeds from other real estate 538 91 95
Investment in premises and equipment (1,426) (1,863) (713)
Net cash paid in merger (12,645) - -
- --------------------------------------------------------------------------------------------------------
NET CASH USED BY INVESTING ACTIVITIES (27,330) (50,817) (15,340)
- --------------------------------------------------------------------------------------------------------
Net increase in demand and savings deposits 38,274 2,426 17,781
Net proceeds (payments) on time deposits 4,955 5,766 (15,048)
(Decrease) increase in repurchase agreements (10,987) 8,663 7,051
Net (decrease) increase in short-term borrowings (1,774) 11,003 7,715
Increase in long-term borrowings 8,000 27,000 -
Payments on long-term borrowings (12,626) (10,246) (9,887)
Cash dividends paid (5,031) (3,565) (3,394)
- --------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 20,811 41,047 4,218
- --------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 4,019 (2,289) (3,134)
Cash and cash equivalents at January 1 9,355 11,644 14,778
- --------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 13,374 $ 9,355 $ 11,644
- --------------------------------------------------------------------------------------------------------
</Table>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
34
<Page>
GENERAL NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated in 1997 under the laws of Pennsylvania. It is the parent company of
Penn Security Bank and Trust Company (Bank), a state chartered bank.
The Company operates twelve banking offices under a state bank charter and
provides full banking services, including trust services, to individual and
corporate customers primarily in Northeastern Pennsylvania. The Company's
primary deposit products are savings and demand deposit accounts and
certificates of deposit. Its primary lending products are real estate,
commercial and consumer loans.
The Company's revenues are attributable to a single reportable segment;
therefore segment information is not presented.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
BASIS OF PRESENTATION
The Financial Statements of the Company have been consolidated with those of its
wholly-owned subsidiary, Penn Security Bank and Trust Company, eliminating all
intercompany items and transactions.
The Statements are presented on the accrual basis of accounting.
Effective April 1, 2009, Old Forge Bank (OFB) merged into the Company. The
merger was accounted for as a purchase with the assets and liabilities of OFB
recorded at fair value. The operations of OFB prior to April 1, 2009 are not
included in the accompanying consolidated financial statements.
All information is presented in thousands of dollars, except per share amounts.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2010, the Financial Accounting Standards Board ("FASB") issued
authoritative guidance intended to improve disclosures about fair value
measurements. The guidance requires entities to disclose significant transfers
in and out of fair value hierarchy levels and the reasons for the transfers and
to present information about purchases, sales, issuances and settlements
separately in the reconciliation of fair value measurements using significant
unobservable inputs (Level III). Additionally, the guidance clarifies that a
35
<Page>
reporting entity should provide fair value measurements for each class of assets
and liabilities and disclose the inputs and valuation techniques used for fair
value measurements using significant other observable inputs (Level II) and
significant unobservable inputs (Level III). This guidance is effective for
interim and annual periods beginning after December 15, 2009 except for the
disclosures about purchases, sales, issuances and settlements in the Level III
reconciliation, which will be effective for interim and annual periods beginning
after December 15, 2010. As this guidance provides only disclosure requirements,
the adoption of this standard will not impact the Company's results of
operations, cash flows or financial positions.
In October 2009, the FASB issued new guidance related to the revenue recognition
in situations with multiple-element arrangements. The new guidance requires
companies to allocate revenue in multiple-element arrangements based on an
element's estimated selling price if vendor-specific or other third-party
evidence of value is not available. The accounting guidance will be applied
prospectively and will become effective for annual periods beginning on or after
June 15, 2010. Early adoption is permitted. The Company is currently evaluating
the impact that the adoption of this guidance will have on the consolidated
financial statements.
In August 2009, the FASB issued guidance clarifying the measurement of
liabilities at fair value in the absence of observable market information. The
guidance was effective for the first reporting period, including interim
periods, beginning after August 28, 2009.
The adoption of this guidance did not have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
In June 2009, the FASB issued the FASB Accounting Standards Codification (the
"Codification") for financial statements issued for annual periods ending after
September 15, 2009. The Codification became the single authoritative source for
GAAP. Accordingly, previous references to GAAP accounting standards are no
longer used in the Company's disclosures, including these Notes to the
Consolidated Financial Statements.
The Codification does not affect the Company's consolidated financial position,
cash flows, or results of operations.
In May 2009, the FASB issued guidance establishing standards for and disclosures
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. The new guidance was
effective for interim and annual reporting periods ending after June 15, 2009.
Since the new standards only required additional disclosures, the adoption did
not impact the Company's consolidated financial position, results of operations
or cash flows.
In April 2009, the FASB issued new standards for the recognition and measurement
of other-than-temporary impairments for debt securities which replaced the
pre-existing "intent and ability" indicator. These new standards specify that if
the fair value of a debt security is less than its amortized cost basis, an
other-than-temporary impairment is triggered in circumstances where (1) an
entity has an intent to sell the security, (2) it is more likely than not that
the entity will be required to sell the security before recovery of its
amortized cost basis, or (3) the entity does not expect to recover the entire
amortized cost basis of the security (that is, a credit loss exists).
Other-than-temporary impairments are separated into amounts representing credit
losses which are recognized in earnings and amounts related to all other factors
which are recognized in other comprehensive income (loss). The standards were
effective for interim and annual periods ending after June 15, 2009.
The adoption of these standards did not have a material effect on our
consolidated financial position, results of operations or cash flows.
In April 2009, the FASB issued guidance on how to determine the fair value of
assets and liabilities when the volume and level of activity for the asset or
liability has significantly decreased and on identifying circumstances that
indicate a transaction is not orderly. In addition, the guidance also required
disclosure of the inputs and valuation techniques used to measure fair value and
discussion of changes in valuation techniques. The guidance was effective for
interim and annual periods ending after June 15, 2009.
The adoption of this guidance did not have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
In December 2008, the FASB issued guidance on employers' disclosures about plan
assets of a defined benefit pension or postretirement plan. The guidance
requires more detailed disclosures including employers' investment strategies,
major categories of plan assets, concentrations of risk within plan assets, and
inputs and valuation techniques used to measure the fair value of plan assets.
36
<Page>
The guidance also requires, for fair value measurements using significant
unobservable inputs (Level III), disclosure of the effect of the measurement on
changes in plan assets for the period. The disclosures about plan assets
required by the guidance must be provided for fiscal years ending after December
15, 2009.
Since the guidance only required additional disclosures, the adoption did not
impact the Company's consolidated financial position, results of operations or
cash flows.
In March 2008, the FASB issued new standards which required companies with
derivative instruments to disclose information that should enable financial
statement users to understand how and why a company uses derivative instruments,
how derivative instruments and related hedged items are accounted for and how
derivative instruments and related hedged items affect a company's financial
position, financial performance and cash flows. The new standard was effective
for fiscal years beginning on or after December 15, 2008.
Since the new standards only required additional disclosure, the adoption did
not impact the Company's consolidated financial position, results of operations
or cash flows.
In December 2007, the FASB issued guidance for business combinations and
non-controlling interests. The new standards change how business acquisitions
are accounted for and will impact financial statements both on the acquisition
date and in subsequent periods. The changes also impact the accounting and
reporting for minority interests, which will be recharacterized as
non-controlling interests and classified as a component of equity. The new
standards were effective for fiscal years beginning on or after December 15,
2008.
The adoption of these standards did not have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
INVESTMENT SECURITIES
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, debentures and mortgage-backed
- ---------------------------
securities for which the Company has the positive intent and ability to hold to
maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts computed on the straight-line basis, which approximates
the interest method, over the remaining period to maturity.
Securities Available-for-Sale Bonds, notes, debentures, mortgage-backed
- -----------------------------
securities and certain equity securities not classified as securities to be held
to maturity are carried at fair value with unrealized holding gains and losses,
net of tax, reported as a net amount in a separate component of stockholders'
equity until realized.
The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities, adjusted, when necessary,
for advanced prepayments in excess of those estimates.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific identification method and are reported as a
separate component of other income in the Statements of Income. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
Investments are evaluated periodically to determine whether a decline in their
value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term "other than temporary" is not intended to indicate that the decline is
permanent. It indicates that the prospects for a near term recovery of value are
not necessarily favorable, or that there is a lack of evidence to support fair
values equal to, or greater than, the carrying value of the investment. Once a
decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized.
LOANS AND PROVISION (ALLOWANCE) FOR POSSIBLE LOAN LOSSES
Loans are stated at the principal amount outstanding, net of any unearned
income, deferred loan fees and the allowance for loan losses. Interest is
accrued daily on the outstanding balances.
Loans are generally placed on a non-accrual status when principal or interest is
past due 90 days or when payment in full is not anticipated. When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is charged against current income. Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
37
<Page>
The provision for loan losses is based on past loan loss experience,
management's evaluation of the potential loss in the current loan portfolio
under current economic conditions and such other factors as, in management's
best judgement, deserve current recognition in estimating loan losses. The
annual provision for loan losses charged to operating expense is that amount
which is sufficient to bring the balance of the allowance for possible loan
losses to an adequate level to absorb anticipated losses.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Provision for depreciation and amortization, computed principally on the
straight-line method, is charged to operating expenses over the estimated useful
lives of the assets. Maintenance and repairs are charged to current expense as
incurred.
LOAN SERVICING
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair value
of those rights. Fair values are estimated using discounted cash flows based on
current market rates of interest and current expected future prepayment rates.
For purposes of measuring impairment, the rights must be stratified by one or
more predominant risk characteristics of the underlying loans. The Company
stratifies its capitalized mortgage servicing rights based on the product type,
interest rate and term of the underlying loans. The amount of impairment
recognized is the amount, if any, by which the amortized cost of the rights for
each stratum exceed the fair value.
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expenses for the years
ended December 31, 2009, 2008 and 2007, amounted to $409, $603 and $612,
respectively.
INCOME TAXES
Provisions for income taxes are based on taxes payable or refundable for the
current year (after exclusion of non-taxable income such as interest on state
and municipal securities) as well as deferred taxes on temporary differences,
between the amount of taxable income and pre-tax financial income and between
the tax bases of assets and liabilities and their reported amounts in the
Financial Statements. Deferred tax assets and liabilities are included in the
Financial Statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
Management evaluated the Company's tax positions and concluded that the Company
had taken no uncertain tax positions that require adjustment to the financial
statements. With few exceptions, the Company is no longer subject to income tax
examinations by the U.S. Federal, state or local tax authorities for years
before 2006.
PENSION AND POSTRETIREMENT BENEFITS EXPENSE
The Company sponsors various pension plans covering substantially all employees.
The Company also provides post-retirement benefit plans other than pensions,
consisting principally of life insurance benefits, to eligible retirees. The
liabilities and annual income or expense of the Company's pension and other
post-retirement benefit plans are determined using methodologies that involve
several actuarial assumptions, the most significant of which are the discount
rate, the long-term rate of asset return (based on the market-related value of
assets). The fair values of plan assets are determined based on prevailing
market prices or estimated fair value for investments with no available quoted
prices.
STOCK APPRECIATION RIGHTS EXPENSE
The compensation expense recognized for the Company's stock appreciation rights
(SARs) is recorded over the vesting period (five years). The fair value of the
SARs are estimated using a Black-Scholes option-pricing model.
CASH FLOWS
For purposes of the Statements of Cash Flows, cash and cash equivalents include
cash on hand, due from banks, interest bearing balances with banks and Federal
funds sold for a one-day period.
38
<Page>
The Company paid interest and income taxes during the years ended December 31,
2009, 2008 and 2007 as follows:
<Table>
<Caption>
2009 2008 2007
- ---------------------------------------------------------------
Income taxes paid $ 1,699 $ 2,836 $ 1,730
Interest paid $ 9,389 $11,210 $12,713
</Table>
Non-cash transactions during the years ended December 31, 2009, 2008 and 2007,
comprised entirely of the net acquisition of real estate in the settlement of
loans, amounted to $927, $22 and $76, respectively.
LONG-LIVED ASSETS
The Company reviews the carrying value of long-lived assets for impairment
whenever events or changes in circumstances indicate that carrying amounts of
the assets might not be recoverable.
TRUST ASSETS AND INCOME
Assets held by the Company in a fiduciary or agency capacity for its customers
are not included in the Financial Statements since such items are not assets of
the Company. Trust income is reported on the accrual basis of accounting.
EARNINGS PER SHARE
Basic earnings per share is computed on the weighted average number of common
shares outstanding. For the years ended December 31, 2009, 2008 and 2007, the
weighted average number of common shares outstanding was 2,994,059, 2,148,000,
and 2,148,000, respectively. A calculation of diluted earnings per share is not
applicable to the Company.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
NOTE 2 -- CASH AND DUE FROM BANKS
Cash and due from banks are summarized as follows:
<Table>
<Caption>
December 31, 2009 2008
- -----------------------------------------------------------
Cash items in process of collection $ 4,928 $ 3,026
Non-interest bearing balances 481 735
Cash on hand 5,691 3,485
- -----------------------------------------------------------
Total $11,100 $7,246
- -----------------------------------------------------------
</Table>
The Company may, from time to time, maintain bank balances with other financial
institutions in excess of FDIC limitations. Management is not aware of any
evidence that would indicate that such deposits are at risk.
NOTE 3 -- INVESTMENT SECURITIES
The amortized cost and fair value of investment securities at December 31, 2009
and 2008 are as follows:
AVAILABLE-FOR-SALE
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
2009 Cost Gains Losses Value
- -------------------------------------------------------------------------------------
U.S. Agency securities $ 54,165 $ 595 $ 65 $ 54,695
Mortgage-backed securities 16,999 568 - 17,567
States & political subdivisions 74,060 1,784 411 75,433
- -------------------------------------------------------------------------------------
Total Debt Securities 145,224 2,947 476 147,695
Equity securities 6,780 1,006 - 7,786
- -------------------------------------------------------------------------------------
Total Available-for-Sale $152,004 $ 3,953 $ 476 $155,481
- -------------------------------------------------------------------------------------
</Table>
39
<Page>
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
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
- -------------------------------------------------------------------------------------
</Table>
HELD-TO-MATURITY
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
2009 Cost Gains Losses Value
- -------------------------------------------------------------------------------------
Mortgage-backed securities $ 23,700 $ 1,281 $ - $ 24,981
States & political subdivisions 23,151 922 - 24,073
- -------------------------------------------------------------------------------------
Total Held-to-Maturity $ 46,851 $ 2,203 $ - $ 49,054
- -------------------------------------------------------------------------------------
</Table>
HELD-TO-MATURITY
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
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
- -------------------------------------------------------------------------------------
</Table>
Equity securities at December 31, 2009 and 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
a FHLB 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 indefinitely 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 December 31, 2009.
A summary of transactions involving available-for-sale debt securities in 2009,
2008 and 2007 are as follows:
<Table>
<Caption>
December 31, 2009 2008 2007
- ----------------------------------------------------------------
Proceeds from sales $ 25,568 $ 11,798 $ -
Gross realized gains 1,029 11 -
Gross realized losses 142 - -
</Table>
Investment securities with amortized costs and fair values of $141,193 and
$145,554, respectively, at December 31, 2009 and $125,804 and $128,573,
respectively, at December 31, 2008, were pledged to secure trust funds, public
deposits and for other purposes as required by law.
The amortized cost and fair value of debt securities at December 31, 2009 by
contractual maturity are shown in the following table. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
40
<Page>
<Table>
<Caption>
December 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 $ 11,154 $ 11,355 $ - $ -
States & political subdivisions 45 45 - -
After one year through five years:
U.S. Agency securities 42,008 42,335 - -
States & political subdivisions 320 330 - -
After five year through ten years:
U.S. Agency securities 1,003 1,005 - -
States & political subdivisions 1,468 1,580 10,705 11,180
After ten years:
States & political subdivisions 72,227 73,478 12,446 12,893
- ----------------------------------------------------------------------------------------------
Subtotal 128,225 130,128 23,151 24,073
Mortgage-backed securities 16,999 17,567 23,700 24,981
- ----------------------------------------------------------------------------------------------
Total Debt Securities $145,224 $147,695 $ 46,851 $49,054
- ----------------------------------------------------------------------------------------------
</Table>
The gross fair value and unrealized losses of the Company's investments
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2009 and
2008 are as follows:
<Table>
<Caption>
Less than twelve months Twelve months or more Totals
----------------------- --------------------- ---------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2009 Value Losses Value Losses Value Losses
- ------------------------------------------------------------------------------------------------------------------
U.S. Agency securities $14,259 $ 65 $ - $ - $14,259 $ 65
States & political subdivisions 9,212 383 3,817 28 13,029 411
- ------------------------------------------------------------------------------------------------------------------
Total $23,471 $ 448 $ 3,817 $ 28 $27,288 $ 476
- ------------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
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
- ------------------------------------------------------------------------------------------------------------------
</Table>
The table at December 31, 2009, includes fourteen (14) securities that have
unrealized losses for less than twelve months and ten (10) 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.
In 2009, the Company recorded an other-than-temporary impairment charge of $787
related to the Company's equity investment portfolio containing stock of
financial institutions. Prior to this impairment charge, the decline in value of
the securities was recorded as unrealized losses on securities
available-for-sale and reflected as a reduction in stockholders' equity through
other comprehensive income.
41
<Page>
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 does not intend to
sell the investments and it is not more likely than not that the Company will be
required to sell the investments before recovery of their amortized cost bases,
which may be maturity, the Company does not consider those investments to be
other-than-temporarily impaired at December 31, 2009.
STATES AND POLITICAL SUBDIVISIONS
The unrealized losses on the Company's investments in states and political
subdivisions were caused by interest rate fluctuations and not credit quality.
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 does not intend to sell the investments and it is not more likely than
not that the Company will be required to sell the investments before recovery of
their amortized cost bases, which may be maturity, the Company does not consider
those investments to be other-than-temporarily impaired at December 31, 2009.
NOTE 4 -- LOANS
Major classifications of loans are as follows:
<Table>
<Caption>
December 31, 2009 2008
- -------------------------------------------------------------------------------
Loans secured by real estate:
Construction and land development $ 32,910 $ 21,949
Secured by 1-4 family residential properties:
Revolving, open-end loans 31,674 28,738
Secured by first liens 240,615 200,920
Secured by junior liens 21,840 23,107
Secured by multi-family properties 3,969 3,795
Secured by non-farm, non-residential properties 171,995 98,968
Commercial and industrial loans to U.S. addressees 30,743 27,793
Loans to individuals for household, family
and other personal expenditures:
Credit card and related plans 3,365 3,272
Other (installment and student loans, etc.) 56,426 25,009
Obligations of states & political subdivisions 6,873 4,471
All other loans 3,562 3,126
- -------------------------------------------------------------------------------
Gross Loans 603,972 441,148
Less: Unearned income on loans 2 -
- -------------------------------------------------------------------------------
Loans, Net of Unearned Income $603,970 $441,148
- -------------------------------------------------------------------------------
</Table>
Loans on which the accrual of interest has been discontinued or reduced amounted
to $2,339, $1,454 and $1,610 at December 31, 2009, 2008 and 2007, respectively.
If interest on those loans had been accrued, such income would have been $365,
$192 and $153 for 2009, 2008 and 2007, respectively. Interest income on those
loans, which is recorded only when received, amounted to $52, $29 and $17 for
2009, 2008 and 2007, respectively. Also, at December 31, 2009 and 2008, the Bank
had loans totaling $1,697 and $1,153, respectively, which were past due 90 days
or more and still accruing interest.
42
<Page>
The Company does not engage in any sub-prime or Alt-A credit lending. Therefore,
the Company is not subject to any credit risks associated with such loans. The
Company's lending is primarily residential and commercial secured mortgage
loans, in Northeastern Pennsylvania, based upon conservative underwriting
standards.
NOTE 5 -- ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007
- -------------------------------------------------------------------
Balance at beginning of year $ 5,275 $ 4,700 $ 4,200
Provision charged to operations 2,260 861 657
Recoveries credited to allowance 65 31 8
- --------------------------------------------------------------------
7,600 5,592 4,865
Losses charged to allowance (1,300) (317) (165)
- --------------------------------------------------------------------
Balance at End of Year $ 6,300 $ 5,275 $ 4,700
- --------------------------------------------------------------------
</Table>
A comparison of the provision for loan losses for Financial Statement purposes
with the allowable bad debt deduction for tax purposes is as follows:
<Table>
<Caption>
Years Ended December 31, Book Provision Tax Deduction
- ------------------------ -------------- -------------
2009 $ 2,260 $ 1,178
2008 $ 861 $ 286
2007 $ 657 $ 157
</Table>
The balance of the Reserve for Bad Debts as reported for Federal income tax
purposes was $514, $0 and $0 at December 31, 2009, 2008 and 2007, respectively.
NOTE 6 --LOAN SERVICING
The Company services $54,497 in mortgage loans for Freddie Mac which are not
included in the accompanying Consolidated Balance Sheets.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in deposits, were approximately $496 and $586, at
December 31, 2009 and 2008, respectively. The balance of the servicing rights
was $163 and $41 at December 31, 2009 and 2008, respectively, net of
amortization.
The Company has recorded new mortgage servicing rights of $169 and $9 at
December 31, 2009 and 2008, respectively. Amortization expense of $47 and $59
was recorded for the years ended December 31, 2009 and 2008, respectively.
There was no allowance for impairment recorded at December 31, 2009 or 2008.
NOTE 7 -- BANK PREMISES AND EQUIPMENT
<Table>
<Caption>
December 31, 2009 2008
- -------------------------------------------------------
Land $ 3,471 $ 3,117
Buildings and improvements 17,667 15,970
Furniture and equipment 16,300 15,350
37,438 34,437
Less: Accumulated depreciation 25,042 24,046
- -------------------------------------------------------
Net Bank Premises and Equipment $12,396 $10,391
- -------------------------------------------------------
</Table>
Buildings and improvements are being depreciated over 10 to 39.5 year periods
and equipment over 3 to 10 year periods. Depreciation expense amounted to $997
in 2009, $795 in 2008 and $861 in 2007.
Occupancy expenses were reduced by rental income received in the amount of $196,
$154 and $64 in the years ended December 31, 2009, 2008 and 2007, respectively.
43
<Page>
NOTE 8 -- OTHER REAL ESTATE OWNED
Real estate acquired through foreclosure is recorded at the lower of cost or
market at the time of acquisition. Any subsequent write-downs are charged
against operating expenses. The other real estate owned, which includes real
estate sales contracts, was $528 and $0 as of December 31, 2009 and 2008,
respectively.
NOTE 9 -- INVESTMENT IN AND LOAN TO, INCOME FROM DIVIDENDS AND EQUITY IN
EARNINGS OR LOSSES OF SUBSIDIARY
Penseco Realty, Inc. is a wholly-owned subsidiary of the Bank which owns
certain banking premises. Selected financial information is presented below:
<Table>
<Caption>
Equity in
Percent underlying Bank's
of voting Total net assets at Amount proportionate
stock investment balance of part of loss for
Year owned and loan sheet date dividends the period
- -------------------------------------------------------------------------------------------------
2009 100% $ 3,250 $ 3,234 None $ -
2008 100% $ 3,250 $ 3,235 None $ -
2007 100% $ 3,250 $ 3,235 None $ -
</Table>
NOTE 10 -- GOODWILL
Goodwill represents the excess of the purchase price over the underlying fair
value of merged entities. Goodwill is assessed for impairment at least annually
and as triggering events occur. In making this assessment, management considers
a number of factors including, but not limited to, operating results, business
plans, economic projections, anticipated future cash flows, and current market
data. There are inherent uncertainties related to these factors and management's
judgment in applying them to the analysis of Goodwill impairment. Changes in
economic and operating conditions, as well as other factors, could result in
Goodwill impairment in future periods. Management has determined that the
carrying value of Goodwill is not impaired at December 31, 2009.
NOTE 11 -- CASH SURRENDER VALUE OF LIFE INSURANCE
The Company has purchased BOLI policies on certain officers. The value of such
policies totaled $14,380 and $7,684 at December 31, 2009 and 2008, respectively.
The policies are split-dollar life insurance policies which provide for the
Company to receive the cash value of the policy and to split the residual
proceeds with the officer's designated beneficiary upon the death of the
insured, while the officer is employed at the Company. The majority of the
residual proceeds are retained by the Company per the individual agreements with
the insured officers.
NOTE 12 -- OTHER INTANGIBLE ASSETS
Intangible assets include the premium assigned to the core deposit relationships
acquired in the Merger. The core deposit intangible is being amortized over ten
years on a sum-of-the-years-digits basis. Amortization expense is expected to be
as follows:
2010 $ 341
2011 304
2012 267
2013 230
2014 194
2015 and thereafter 415
- ------------------------------
Total $1,751
- ------------------------------
44
<Page>
NOTE 13 -- DEPOSITS
<Table>
<Caption>
December 31, 2009 2008
- ----------------------------------------------------------
Demand - Non-interest bearing $109,855 $ 72,456
Demand - Interest bearing 72,477 51,975
Savings 110,994 74,907
Money markets 146,189 115,811
Time - Over $100,000 78,702 37,960
Time - Other 127,217 71,616
- ----------------------------------------------------------
Total $645,434 $424,725
- ----------------------------------------------------------
</Table>
Scheduled maturities of time deposits are as follows:
2010 $143,300
2011 36,587
2012 12,685
2013 5,528
2014 7,114
2015 and thereafter 705
- --------------------------------
Total $205,919
- --------------------------------
NOTE 14 -- OTHER BORROWED FUNDS
At December 31, 2009 and 2008, other borrowed funds consisted of demand notes to
the U.S. Treasury, Federal Reserve Bank overnight borrowings, Federal Home Loan
Bank overnight borrowings and repurchase agreements.
Short-term borrowings generally have original maturity dates of thirty days or
less.
Investment securities with amortized costs and fair values of $27,256 and
$28,546, respectively, at December 31, 2009 and $49,599 and $50,869,
respectively, at December 31, 2008, were pledged to secure repurchase
agreements.
<Table>
<Caption>
Year Ended December 31, 2009 2008
- --------------------------------------------------------------------------
Amount outstanding at year end $45,598 $53,359
Average interest rate at year end 0.44% 0.68%
Maximum amount outstanding at any month end $65,389 $53,359
Average amount outstanding $44,951 $43,421
Weighted average interest rate during the year
Federal funds purchased 0.48% 2.47%
Federal Home Loan Bank borrowings 0.51% -
Repurchase agreements 1.33% 2.48%
Demand notes to U.S. Treasury - 2.60%
</Table>
The Company has an available credit facility with the Federal Reserve Bank of
Philadelphia in the amount of $36,625, secured by pledged securities with
amortized costs and fair values of $36,678 and $37,699, respectively, at
December 31, 2009 and $10,088 and $10,290, respectively, at December 31, 2008
and with interest rates of .50% at December 31, 2009 and .50% at December 31,
2008. There is no stated expiration date for the credit facility as long as the
Company maintains the pledged securities at the Federal Reserve Bank. There was
no outstanding balance as of December 31, 2009 and 2008.
45
<Page>
The Company has a $11.2 million Borrower In Custody (BIC) line of credit with
the Federal Reserve Bank of Philadelphia, secured by commercial loans with an
outstanding principal of $22,559 and a collateral value of $11,171 at December
31, 2009. There was no outstanding balance as of December 31, 2009 and 2008.
The Company has the availability of a $5,000 overnight Federal funds line of
credit with Wells Fargo. Also, the Company has a $19,000 overnight Federal Funds
line with PNC Bank. There was no balance outstanding as of December 31, 2009 and
2008.
The Company maintains a collateralized maximum borrowing capacity of $316,075
with the Federal Home Loan Bank of Pittsburgh. There was a balance of $88,094
outstanding as of December 31, 2009, including $20,000 in short-term borrowings.
NOTE 15 -- LONG-TERM DEBT
The loans from the Federal Home Loan Bank of Pittsburgh, which were borrowed to
purchase mortgage-backed securities, are secured by a general collateral pledge
of the Company's assets.
<Table>
<Caption>
A summary of long-term debt, including amortizing principal Aggregate maturities of long-term debt at
and interest payments, at December 31, 2009 is as follows: December 31, 2009 are as follows:
Monthly Installment Fixed Rate Maturity Date Balance December 31, Principal
- --------------------------------------------------------------- --------------------------------------
Amortizing Loans
$ 253 3.22% 03/15/10 $ 755 2010 $12,059
29 1.84% 08/28/12 892 2011 10,615
90 3.10% 02/28/13 3,256 2012 10,823
430 3.74% 03/13/13 15,770 2013 11,094
16 2.66% 08/28/14 937 2014 4,670
67 3.44% 03/02/15 3,804 Thereafter 18,833
-------
13 3.48% 03/31/15 772 $68,094
-------
10 3.83% 04/02/18 859
186 4.69% 03/13/23 22,049
- ---------------------------------------------------------------
Total amortizing 49,094
- ---------------------------------------------------------------
Non-amortizing loans
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
2.89% 11/28/14 2,000
3.32% 11/27/15 3,000
- ---------------------------------------------------------------
Total non-amortizing 19,000
- ---------------------------------------------------------------
Total long term-debt $68,094
- ---------------------------------------------------------------
</Table>
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
46
<Page>
NOTE 16 -- BENEFIT PLANS
The Company provides an Employee Stock Ownership Plan (ESOP), a Retirement
Profit Sharing 401(k) Plan, an Employees' Pension Plan, unfunded supplemental
executive defined benefit and defined contribution plans, a Postretirement Life
Insurance Plan, a Stock Appreciation Rights Plan (SAR), and a Long-Term
Incentive Plan.
Under the ESOP, amounts voted by the Board of Directors are paid into the ESOP
and each employee is credited with a share in proportion to their annual
compensation. All contributions to the ESOP are invested in or will be invested
primarily in Company stock. Distribution of a participant's ESOP account occurs
upon retirement, death or termination in accordance with the plan provisions.
At December 31, 2009 and 2008, the ESOP held 70,604 and 67,754 shares,
respectively, of the Company's stock, all of which were acquired as described
above and allocated to specific participant accounts. These shares are treated
the same for dividend purposes and earnings per share calculations as are any
other outstanding shares of the Company's stock. The Company contributed $90, $0
and $70 to the ESOP plan during the years ended December 31, 2009, 2008 and
2007, respectively.
Under the Retirement Profit Sharing Plan, amounts approved by the Board of
Directors have been paid into a fund and each employee was credited with a share
in proportion to their annual compensation. Upon retirement, death or
termination, each employee is paid the total amount of their credits in the fund
in one of a number of optional ways in accordance with the plan provisions. The
Company contributed $70 to the plan during the years ended December 31, 2007.
Effective July 1, 2008, the Retirement Profit Sharing Plan became a 401(k)
Deferred Compensation and Profit Sharing Plan for eligible employees. Eligible
employees may elect deferrals of up to the maximum amounts permitted by law. The
Bank's contributions included a Safe Harbor contribution of $290 and $202,
during the years ended December 31, 2009 and 2008, respectively, and a
discretionary match of $204 and $119 during the years ended December 31, 2009
and 2008, respectively, equal to one-half of employee deferrals, up to a maximum
match of 3%. In 2008, the Company also provided a benefit of $356, allocated to
fifty employees who were negatively impacted by the Employees' Pension Plan
freeze in the second quarter of 2008. A portion of this benefit was rolled into
the 401(k) plan and the balance used to fund individual Supplemental Employee
Retirement Plans (SERP) for the impacted employees.
Under the Employees' Pension Plan (currently under curtailment), amounts
computed on an actuarial basis were being paid by the Company into a trust fund.
The plan provided for fixed benefits payable for life upon retirement at the age
of 65, based on length of service and compensation levels as defined in the
plan. As of June 22, 2008 no further benefits are being accrued in this plan.
Plan assets of the trust fund are invested and administered by the Trust
Department of Penn Security Bank and Trust Company.
The Unfunded Supplemental Executive Pension Plan (currently under curtailment)
provided certain officers with additional retirement benefits to replace
benefits lost due to limits imposed on qualified plans by Federal tax law.
Benefits under this plan were actuarially computed and recorded as a liability.
As of June 22, 2008 no further benefits are being accrued in this plan.
Effective July 1, 2008, the Company established an Unfunded Supplemental
Executive Defined Contribution Plan to replace 401(k) plan benefits lost due to
compensation limits imposed on qualified plans by Federal tax law. The annual
benefit is a maximum of 6% of the executive compensation in excess of Federal
limits.
The Postretirement Life Insurance Plan is an unfunded, non-vesting defined
benefit plan. The plan is non-contributory and provides for a reducing level of
term life insurance coverage following retirement. Annual expense amounts are
calculated on an actuarial basis and are recorded as a liability.
47
<Page>
The Company granted 10,000 SAR's to an executive on January 3, 2006 at a strike
price of $43.00 per share. The Company also granted 8,500 SAR's to an executive
on February 29, 2008 at a strike price of $37.50 per share. All rights vest on a
straight-line basis over a five year period and are expected to be settled in
cash when exercised. The Company calculates the value of the vested rights using
the Black-Scholes method and has recorded an expense of $13 in 2009 and $14 in
2008.
Under the 2008 Long-Term Incentive Plan (the "2008" Plan"), the Compensation
Committee of the Board of Directors has broad authority with respect to awards
granted under the 2008 plan, including, without limitation, the authority to:
|X| Designate the individuals eligible to receive awards under the 2008 plan.
|X| Determine the size, type and date of grant for individual awards, provided
that awards approved by the Committee are not effective unless and until
ratified by the Board of Directors.
|X| Interpret the 2008 plan and award agreements issued with respect to
individual participants.
Persons eligible to receive awards under the 2008 Plan include directors,
officers, employees, consultants and other service providers of the Company and
its subsidiaries, except that incentive stock option may be granted only to
individuals who are employees on the date of grant.
The total number of shares of the Company's common stock available for grant
awards under the 2008 plan shall not exceed in the aggregate five percent of the
outstanding shares of the Company's common stock as of February 15, 2008, or
107,400 shares of the Company's common stock.
The 2008 plan authorizes grants of stock options, stock appreciation rights,
dividend equivalents, performance awards, restricted stock and restricted stock
units. There was an award of $75 made during 2009 under this 2008 plan.
48
<Page>
Obligations and funded status of the plans:
<Table>
<Caption>
Pension Benefits Other Benefits
---------------- --------------
December 31, 2009 2008 2009 2008
- ------------------------------------------------------------------ -----------------------
Change in benefit obligation:
Benefit obligation, beginning $11,782 $13,558 $ 327 $ 292
Service cost - 209 5 5
Interest cost 701 752 19 18
Amendments - (1,969 - -
Change in assumptions 24 (159 22 30
Actuarial (gain) loss 244 - - -
Benefits paid (614) (609) (19) (18)
- ------------------------------------------------------------------ -----------------------
Benefit obligation, ending 12,137 11,782 354 327
- ------------------------------------------------------------------ -----------------------
Change in plan assets:
Fair value of plan assets, beginning 9,971 12,255 - -
Actual return on plan assets 1,328 (1,775 - -
Employer contribution - 100 - -
Benefits paid (614) (609) - -
- ------------------------------------------------------------------ -----------------------
Fair value of plan assets, ending 10,685 9,971 - -
- ------------------------------------------------------------------ -----------------------
Funded status at end of year $(1,452) $(1,811) $ (354) $ (327)
- ------------------------------------------------------------------ -----------------------
</Table>
Amounts recognized in the balance sheet consist of:
<Table>
<Caption>
Pension Benefits Other Benefits
---------------- --------------
December 31, 2009 2008 2009 2008
- ------------------------------------------------------------------ -----------------------
Non Current Assets $ 494 $ 616 $ - $ -
Non Current Liabilities $ 1,452 $ 1,811 $ 354 $ 327
</Table>
Amounts recognized in the accumulated other comprehensive income consist of:
<Table>
<Caption>
Pension Benefits Other Benefits
---------------- --------------
December 31, 2009 2008 2009 2008
- ------------------------------------------------------------------ -----------------------
Prior service costs $ - $ - $ 20 $ 20
Net actuarial loss (gain) 2,845 3,280 (16) (16)
Deferred taxes (967) (1,115) (1) (1)
- ------------------------------------------------------------------ -----------------------
Net amount recognized $ 1,878 $ 2,165 $ 3 $ 3
- ------------------------------------------------------------------ -----------------------
</Table>
The accumulated benefit obligation for all defined benefit pension plans was
$12,137 and $11,782 at December 31, 2009 and 2008, respectively.
49
<Page>
Information for pension plans with an accumulated benefit obligation in excess
of plan assets is as follows:
<Table>
<Caption>
Pension Benefits
-----------------
2009 2008
- ----------------------------------------------------------
Projected benefit obligation $ 4 $ 4
Accumulated benefit obligation 4 4
Fair value of plan assets - -
</Table>
Components of net periodic pension cost and other amounts recognized in other
comprehensive income:
<Table>
<Caption>
Pension Benefits
----------------
Years Ended December 31, 2009 2008 2007
- ----------------------------------------------------------------------------------------------
Components of net periodic pension cost:
Service cost $ - $ 209 $ 438
Interest cost 701 752 738
Expected return on plan assets (819) (985) (962)
Amortization of prior service cost - - 1
Amortization of unrecognized net loss 194 86 141
Curtailment loss - 30 -
- ----------------------------------------------------------------------------------------------
Net periodic pension cost $ 76 $ 92 $ 356
- ----------------------------------------------------------------------------------------------
</Table>
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
<Table>
<Caption>
Net (gain) loss (435) 624 175
Prior service cost - (52) -
Deferred tax 148 (194) (60)
- ----------------------------------------------------------------------------------------------
Total recognized in other comprehensive income (287) 378 115
- ----------------------------------------------------------------------------------------------
Total recognized in net period pension
cost and other comprehensive income $ (211) $ 470 $ 471
- ----------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
Other Benefits
--------------
Years Ended December 31, 2008 2008 2007
- ----------------------------------------------------------------------------------------------
Components of net periodic pension cost:
Service Cost $ 5 $ 5 $ 5
Interest Cost 19 18 18
Amortization of prior service cost 7 7 7
Amortization of unrecognized net gain - - -
- ----------------------------------------------------------------------------------------------
Net periodic other benefit cost 31 30 30
- ----------------------------------------------------------------------------------------------
</Table>
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
<Table>
<Caption>
Net loss (gain) 21 29 (11)
Prior service cost (7) (7) (7)
Deferred tax (5) (7) 6
- ----------------------------------------------------------------------------------------------
Total recognized in other comprehensive income 9 15 (12)
- ----------------------------------------------------------------------------------------------
Total recognized in net period pension
cost and other comprehensive income $ 40 $ 45 $ 18
- ----------------------------------------------------------------------------------------------
</Table>
50
<Page>
The estimated net loss for the defined benefit pension plans that will be
amortized from accumulated other comprehensive income into net periodic benefit
cost over the next fiscal year is $56. There is no estimated amortization of net
loss for the defined benefit postretirement plan that will be amortized from
accumulated other comprehensive income over the next fiscal year.
Weighted-average assumptions used to determine benefit obligations were as
follows:
<Table>
<Caption>
Pension Benefits Other Benefits
---------------- --------------
December 31, 2009 2008 2009 2008
- -----------------------------------------------------------------------------
Discount rate 6.00% 6.00% 5.75% 6.00%
Expected long-term return
on plan assets 8.50% 8.50% - -
Rate of compensation increase - 3.50% 3.50% 3.50%
</Table>
The expected long-term return on plan assets was determined using average
historical returns of the Company's plan assets.
The Company's pension plan weighted-average asset allocations at December 31,
2009 and 2008, by asset category are as follows:
<Table>
<Caption>
Plan Assets at December 31,
- ---------------------------
2009 2008
- --------------------------------------------------
Asset Category
- --------------
Equity securities 50.3% 45.3%
Corporate bonds 28.9 30.8
U.S. Government securities 18.7 21.6
Cash and cash equivalents 2.1 2.3
- --------------------------------------------------
100.0% 100.0%
- --------------------------------------------------
</Table>
51
<Page>
Fair Value Measurement at December 31, 2009
<Table>
<Caption>
Quoted Prices
in Active Significant Significant
Markets for Observable Observable
Identical Assets Inputs Inputs
Asset Category Total (Level I) (Level II) (Level III)
- ---------------------------------------------------------------------------------------------------------
Cash $ 219 $ 219 $ - $ -
Equity securities:
U.S. large cap 5,019 5,019 - -
International 355 355 - -
Fixed income securities:
U.S. Treasuries 783 - 783 -
U.S. Government Agencies 1,220 - 1,220 -
Corporate bonds 3,089 - 3,089 -
- ---------------------------------------------------------------------------------------------------------
Total 10,685 5,593 5,092 -
- ---------------------------------------------------------------------------------------------------------
</Table>
The Company investment policies and strategies include:
1.) The Trust and Investment Division's equity philosophy is Large-Cap Core with
a value bias. We invest in individual high-grade common stocks that are selected
from our approved list.
2.) Diversification is maintained by having no more than 20% in any industry
sector and no individual equity representing more than 10% of the portfolio.
3.) The fixed income style is conservative but also responsive to the various
needs of our individual clients. For our "Fixed Income" securities, we buy U.S.
Government bonds and Agencies or high-grade Corporate rated "A" or better. The
Company targets the following allocation percentages: cash equivalents 10%,
fixed income 40% and equities 50%.
There is no Company stock included in equity securities at December 31, 2009
or 2008.
Contributions
- -------------
The Company does not expect to contribute to the Employees' Pension Plan in 2010
due to the curtailment of the Plan in June 2008. The Company expects to
contribute $35 to its Postretirement Life Insurance Plan in 2010.
Estimated Future Benefit Payments
- ---------------------------------
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid in the next five years and in the aggregate
for the five years thereafter:
<Table>
52
<Page>
Pension Benefits Other Benefits
---------------- --------------
2010 $ 616 $ 18
2011 620 18
2012 631 18
2013 689 19
2014 711 20
2015-2019 3,976 111
</Table>
NOTE 17 -- INCOME TAXES
The total income taxes in the Statements of Income are as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007
- ----------------------------------------------------------------------
Currently payable $ 1,828 $ 2,214 $ 1,968
Deferred provision (benefit) 60 244 (344)
- ----------------------------------------------------------------------
Total $ 1,888 $ 2,458 $ 1,624
- ----------------------------------------------------------------------
</Table>
A reconciliation of income taxes at statutory rates to applicable income taxes
reported in the Statements of Income is as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007
- ----------------------------------------------------------------------
Tax at statutory rate $ 3,488 $ 3,764 $ 2,829
Reduction for non-taxable interest (1,855) (1,409) (1,301)
Disallowed merger costs 146 - -
Other additions 109 103 96
- ----------------------------------------------------------------------
Applicable Income Taxes $ 1,888 $ 2,458 $ 1,624
- ----------------------------------------------------------------------
</Table>
The components of the deferred income tax (benefit) provision, which result from
temporary differences, are as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008 2007
- ----------------------------------------------------------------------
Accretion of discount on bonds $ (42) $ (6) $ 18
Accelerated depreciation 355 316 21
Supplemental benefit plans (8) (46) -
Allowance for loan losses (368) (196) (192)
Purchase accounting accretion, net 390 - -
Other-than-temporary impariment loss (267) - -
Prepaid pension cost - 7 (22)
Accrued liabilities - 169 (169)
- ----------------------------------------------------------------------
Total $ 60 $ 244 $ (344)
- ----------------------------------------------------------------------
</Table>
53
<Page>
The significant components of deferred tax assets and liabilities are as
follows:
<Table>
<Caption>
December 31, 2009 2008
- ----------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 1,967 $ 1,794
Accrued pension costs 494 616
Accrued supplemental benefit plans 54 46
Purchase accounting 1,627 -
Other-than-temporary impairment loss 267 -
AMT 79 -
Post retirement losses 2 1
- ----------------------------------------------------------------
Total Deferred Tax Assets 4,490 2,457
- ----------------------------------------------------------------
Deferred tax liabilities:
Unrealized securities gains 1,183 116
Accumulated accretion 10 52
Accumulated depreciation 490 28
- ----------------------------------------------------------------
Total Deferred Tax Liabilities 1,683 196
- ----------------------------------------------------------------
Net Deferred Tax Assets $ 2,807 $ 2,261
- ----------------------------------------------------------------
</Table>
In management's opinion, the deferred tax assets are realizable in as much as
there is a history of strong earnings and a carryback potential greater than the
deferred tax assets. Management is not aware of any evidence that would preclude
the realization of the benefit in the future and, accordingly, has not
established a valuation allowance against the deferred tax assets.
NOTE 18 -- ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income was $413, ($1,943) and ($822) at December
31, 2009, 2008 and 2007, respectively.
OTHER COMPREHENSIVE INCOME
Other comprehensive income (comprehensive income, excluding net income),
beginning with the 2007 period, includes two components, the change in
unrealized holding gains and losses on available for sale securities and the
change in the unfunded pension liability. The components of other comprehensive
income are reported net of related tax effects in the Consolidated Statements of
Changes in Stockholders' Equity.
54
<Page>
A reconciliation of other comprehensive income for the years ended December 31,
2009, 2008 and 2007 is as follows:
<Table>
<Caption>
Tax
Before-Tax Benefit Net-of-Tax
2009 Amount (Expense) Amount
- ------------------------------------------------------------------------------------------------
Unrealized gains on available-for-sale securities:
Unrealized gains arising during the year $ 3,221 $ (1,096) $ 2,125
Less: Reclassification adjustment for gains
realized in income 873 (297) 576
Recognition of other-than-temporary
impairment losses (787) 267 (520)
--------------------------------------
Net unrealized gains 3,135 (1,066) 2,069
Change in funded status of employee benefit plans 435 (148) 287
- ------------------------------------------------------------------------------------------------
Other Comprehensive Income $ 3,570 $ (1,214) $ 2,356
- ------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
Tax
Before-Tax Benefit Net-of-Tax
2008 Amount (Expense) Amount
- ------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (1,092) $ 371 $ (721)
Less: Reclassification adjustment for gains
realized in income 12 (5) 7
- ------------------------------------------------------------------------------------------------
Net unrealized losses (1,104) 376 (728)
Change in funded status of employee benefit plans (595) 202 (393)
- ------------------------------------------------------------------------------------------------
Other Comprehensive Income $ (1,699) $ 578 $ (1,121)
- ------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
Tax
Before-Tax Benefit Net-of-Tax
2007 Amount (Expense) Amount
- ------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (38) $ 13 $ (25)
Less: Reclassification adjustment for gains
realized in income 49 (17) 32
- ------------------------------------------------------------------------------------------------
Net unrealized losses (87) 30 (57)
Change in funded status of employee benefit plans (157) 54 (103)
- ------------------------------------------------------------------------------------------------
Other Comprehensive Income $ (244) $ 84 $ (160)
- ------------------------------------------------------------------------------------------------
</Table>
55
<Page>
NOTE 19 -- 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.
Financial instruments whose contract amounts represent credit risk at December
31, 2009 and 2008 are as follows:
<Table>
<Caption>
2009 2008
- -------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 39,576 $ 26,396
Variable rate $ 87,454 $ 92,935
Standby letters of credit $ 16,091$ $ 11,173
</Table>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
Various actions and proceedings are presently pending to which the Company is a
party. Management is of the opinion that the aggregate liabilities, if any,
arising from such actions would not have a material adverse effect on the
financial position of the Company.
NOTE 20 -- FAIR VALUE MEASUREMENTS
The following table sets forth the Company's financial assets that were
accounted for at fair value and are classified in their entirety based on the
lowest level of input that is significant to the fair value measurement.
Level I - Quoted prices (unadjusted) in active markets for identical assets or
liabilities that the Company has the ability to access at the measurement date.
Level II- Observable inputs other than Level I prices, such as quoted prices for
similar assets or liabilities in active markets; quoted prices in markets that
are not active for identical or similar assets or liabilities; or other inputs
that are observable or can be corroborated by observable market data for
substantially the full term of the assets or liabilities.
56
<Page>
Level III- Unobservable inputs that are supported by little or no market
activity and significant to the fair value of the assets or liabilities that are
developed using the reporting entities' estimates and assumptions, which reflect
those that market participants would use.
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS
A description of the valuation methodologies used for financial assets measured
at fair value on a recurring basis, as well as the classification of the assets
pursuant to the valuation hierarchy, are as follows:
Securities Available-for-Sale
Securities classified as available-for-sale are reported using Level I, Level II
and Level III inputs. Level I instruments generally include equity securities
valued in accordance with quoted market prices in active markets. Level II
instruments include U.S. government agency obligations, state and municipal
bonds, mortgage-backed securities and corporate bonds. For these securities, the
Company obtains fair value measurements from an independent pricing service. The
fair value measurements consider observable data that may include dealer quotes,
market spreads, cash flows, the U.S. Treasury yield curve, live trading levels,
trade execution data, market consensus prepayment speeds, credit information and
the bond's terms and conditions, among other things. Level III instruments
include certain non-public equity securities and real estate sold under
contract. See Note 3 - Investment Securities for additional information.
Assets and liabilities measured at fair value on a recurring basis are
summarized below.
<Table>
<Caption>
December 31, 2009
-------------------------------------------
Level I Level II Level III Total
----------- ------------ ------------- ----------
Financial Assets:
Securities available-for-sale $ 7,786 $147,695 $ - $155,481
</Table>
During 2009, the Company recognized a $50 other-than-temporary impairment charge
to an available-for-sale security that was in Level III at $50 during the year
ended December 31, 2008.
ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
Disclosure of non-financial assets and non-financial liabilities became
effective January 1, 2009. Certain non-financial assets and non-financial
liabilities, measured at fair value on a non-recurring basis, include foreclosed
assets, goodwill and intangible assets.
A description of the valuation methodologies and classification levels used for
non-financial assets and non-financial liabilities measured at fair value on a
nonrecurring basis are listed below.
Goodwill and Other Identifiable Intangibles
The Company employs general industry practices in evaluating the fair value of
its goodwill and other identifiable intangibles. The Company calculates the fair
value, with the assistance of a third party specialist, using a combination of
the following valuation methods: dividend discount analysis under the income
approach, which calculates the present value of all excess cash flows plus the
present value of a terminal value and market multiples (pricing ratios) under
the market approach. Management has performed its initial review of goodwill and
other identifiable intangibles and concluded no impairment had occurred.
Other Real Estate Owned
Foreclosed real estate of $405 were adjusted to fair values with any impairment
charge, included in earnings for the year. Foreclosed real estate, which are
considered to be non-financial assets, have been valued using a market approach.
The values were determined using market prices of similar real estate assets,
which the Company considered to be Level II inputs.
57
<Page>
Certain assets measured at fair value on a non-recurring basis are presented
below:
<Table>
<Caption>
Fair Value Measurement Using
----------------------------------------------------------------------
Quoted Prices in Significant Significant Balance
Active Markets for Other
Identical Observable Unobservable December 31,
Assets/Liabilities Inputs Inputs 2009
--------------------- --------------- -------------- --------------
Level I Level II Level III Total
--------------------- --------------- -------------- --------------
ASSETS
Core deposit intangible $ - $ - $ 1,751 $ 1,751
Goodwill - - 26,398 26,398
Other real estate owned - 405 123 528
--------------------- --------------- -------------- --------------
Total non-financial assets - 405 28,272 28,677
--------------------- --------------- -------------- --------------
</Table>
A reconciliation of items in Level III is as follows:
<Table>
<Caption>
Non-Financial Assets
----------------------------------------------------------------
Core Real estate
deposit sold under
intangible Goodwill contract Total
----------------------------------------------------------------
Balance December 31, 2008 $ - $ - $ - $ -
Additions due to the Merger 2,027 26,398 129 28,554
Amortization of core deposit intangible (276) - - (276)
Payments received on real estate sold - - (6) (6)
----------------------------------------------------------------
Balance December 31, 2009 $ 1,751 $26,398 $ 123 $28,272
----------------------------------------------------------------
</Table>
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
General Accepted Accounting Principals (GAAP) requires disclosure of the
estimated fair value of an entity's assets and liabilities considered to be
financial instruments. For the Company, as for most financial institutions, the
majority of its assets and liabilities are considered financial instruments.
However, many such instruments lack an available trading market, as
characterized by a willing buyer and seller engaging in an exchange transaction.
Also, it is the Company's general practice and intent to hold its financial
instruments to maturity and not to engage in trading or sales activities, except
for certain loans and investments. Therefore, the Company had to use significant
estimates and present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair values may
materially affect the estimated amounts. Also, management is concerned that
there may not be reasonable comparability between institutions due to the wide
range of permitted assumptions and methodologies in the absence of active
markets. This lack of uniformity gives rise to a high degree of subjectivity in
estimating financial instrument fair values.
Estimated fair values have been determined by the Company using the best
available data and an estimation methodology suitable for each category of
financial instruments. The estimation methodologies used at December 31, 2009
and December 31, 2008 are outlined below. The methodologies for estimating the
fair value of financial assets and financial liabilities that are measured at
fair value on a recurring or non-recurring basis are discussed in the fair value
measurements section above. The estimated fair value approximates carrying value
for cash and cash equivalents, accrued interest and the cash surrender value of
life insurance policies. The methodologies for other financial assets and
financial liabilities are discussed below:
58
<Page>
Short-term financial instruments
The carrying value of short-term financial instruments including cash and due
from banks, federal funds sold, interest-bearing deposits in banks and other
short-term investments and borrowings, approximates the fair value of these
instruments. These financial instruments generally expose the Company to limited
credit risk and have no stated maturities or have short-term maturities with
interest rates that approximate market rates.
Investment securities held-to-maturity
The estimated fair values of investment securities held to maturity are based on
quoted market prices, provided by independent third parties that specialize in
those investment sectors. If quoted market prices are not available, estimated
fair values are based on quoted market prices of comparable instruments.
Loans
The loan portfolio, net of unearned income, has been valued by a third party
specialist using quoted market prices, if available. When market prices were not
available, a credit risk based present value discounted cash flow analysis was
utilized. The primary assumptions utilized in this analysis are the discount
rate based on the libor curve, adjusted for credit risk, and prepayment
estimates based on factors such as refinancing incentives, age of the loan and
seasonality. These assumptions were applied by loan category and different
spreads were applied based upon prevailing market rates by category.
Deposits
The estimated fair values of demand deposits (i.e., interest and non-interest
bearing checking accounts, savings and money market accounts) are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). The fair value for certificates of deposit was
calculated by an independent third party by discounting contractual cash flows
using current market rates for instruments with similar maturities, using a
credit based risk model. The carrying amount of accrued interest receivable and
payable approximates fair value.
Long-term borrowings
The amounts assigned to long-term borrowings was based on quoted market prices,
when available, or were based on discounted cash flow calculations using
prevailing market interest rates for debt of similar terms.
The carrying and fair values of certain financial instruments were as follows.
<Table>
<Caption>
December 31, 2009 December 31, 2008
------------------------ ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ---------- ----------- ----------
Cash and cash equivalents $ 13,374 $ 13,374 $ 9,355 $ 9,355
Investment securities available- for-sale 155,481 155,481 94,996 94,996
Investment securities held-to-maturity 46,851 49,054 62,484 64,678
Loans, net 597,670 606,814 435,873 441,369
Cash surrender value of life insurance 14,380 14,380 7,684 7,684
Demand deposits 439,515 439,515 315,149 315,149
Time deposits 205,919 208,205 109,576 110,661
Short-term borrowings 45,598 45,598 53,359 53,359
Long-term borrowings 68,094 69,853 72,720 75,415
Standby Letters of Credit (161) (161) (112) (112)
</Table>
NOTE 21 -- OPERATING LEASES
The Company leases the land upon which the Mount Pocono Office was built and the
land upon which a drive-up ATM was built on Meadow Avenue, Scranton. The Company
also leases space at several locations which are being used as remote banking
facilities. Rental expense was $87 in 2009, $85 in 2008 and $83 in 2007. All
leases contain renewal options. The Mount Pocono and the Meadow Avenue leases
contain the right of first refusal for the purchase of the properties and
provisions for annual rent adjustments based upon the Consumer Price Index.
59
<Page>
Future minimum rental commitments under these leases at December 31, 2009 are as
follows:
<Table>
<Caption>
Mount Meadow ATM
Pocono Avenue Sites Total
- ----------------------------------------------------------------------------
2010 $ 58 $ 23 $ 6 $ 87
2011 25 8 6 39
2012 - - - -
2013 - - - -
2014 and beyond - - - -
- ----------------------------------------------------------------------------
Total minimum payments required $ 83 $ 31 $ 12 $ 126
- ----------------------------------------------------------------------------
</Table>
NOTE 22 -- LOANS TO DIRECTORS, PRINCIPAL OFFICERS AND RELATED PARTIES
The Company has had, and may be expected to have in the future, banking
transactions in the ordinary course of business with directors, principal
officers, their immediate families and affiliated companies in which they are
principal stockholders (commonly referred to as related parties), on the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with others. A summary of loans to directors,
principal officers and related parties is as follows:
<Table>
<Caption>
Years Ended December 31, 2009 2008
- ----------------------------------------------------
Beginning Balance $ 10,016 $ 9,703
Additions 4,083 3,584
Reclassifications (20) -
Collections (1,012) (3,271)
- -----------------------------------------------------
Ending Balance $ 13,067 $ 10,016
- -----------------------------------------------------
</Table>
In addition to the loan amounts shown above, the Bank has issued standby letters
of credit for the accounts of related parties in the amount of $7,802.
NOTE 23 -- REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table on the following page) of Tier I and Total
Capital to risk-weighted assets and of Tier I Capital to average assets
(Leverage ratio). The table also presents the Company's actual capital amounts
and ratios. Management believes, as of December 31, 2009, that the Company and
the Bank meet all capital adequacy requirements to which they are subject.
As of June 30, 2009, the most recent notification from the Bank's regulators
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. The balances in the capital
stock and surplus accounts are unavailable for dividends.
60
<Page>
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
<Table>
<Caption>
ACTUAL REGULATORY REQUIREMENTS
- -------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of December 31, 2009 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $95,492 16.90% > $45,198 > 8.0% > $56,497 > 10.0%
- - - -
PSB (Bank) $92,077 16.31% > $45,170 > 8.0% > $56,463 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company) $89,192 15.79% > $22,599 > 4.0% > $33,898 > 6.0%
- - - -
PSB (Bank) $85,777 15.19% > $22,585 > 4.0% > $33,878 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC (Company) $89,192 11.48% > $ * > * > $38,846 > 5.0%
- - - -
PSB (Bank) $85,777 11.09% > $ * > * > $38,658 > 5.0%
- - - -
</Table>
PFSC - *3.0% ($22,308), 4.0% ($31,077) or 5.0% ($38,846) depending on the bank's
CAMELS Rating and other regulatory risk factors.
PSB - *3.0% ($23,195), 4.0% ($30,926) or 5.0% ($38,658) depending on the bank's
CAMELS Rating and other regulatory risk factors.
<Table>
<Caption>
ACTUAL REGULATORY REQUIREMENTS
- -------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of December 31, 2009 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%
- - - -
</Table>
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.
61
<Page>
NOTE 24 -- PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)
The condensed Company-only information follows:
BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31, 2009 2008
- -------------------------------------------------------------------
Cash $ 16 $ 16
Interest bearing balances with banks 2,240 2,085
- -------------------------------------------------------------------
Cash and Cash Equivalents 2,256 2,101
Investment in bank subsidiary 113,840 70,300
Equity investments 1,352 1,239
Other assets 23 2
- -------------------------------------------------------------------
TOTAL ASSETS $117,471 $ 73,642
- -------------------------------------------------------------------
TOTAL LIABILITIES $ 74 $ -
TOTAL STOCKHOLDERS' EQUITY 117,397 73,642
- -------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $117,471 $ 73,642
- -------------------------------------------------------------------
</Table>
STATEMENTS OF INCOME
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2009 2008 2007
- ---------------------------------------------------------------------------
Dividends from bank subsidiary $ 5,031 $ 3,565 $ 3,394
Dividends on investment securities 40 91 99
Interest on balances with banks 11 19 40
Impairment losses on investment securities (787) - -
Gain on sale of equities 4 1 49
- ---------------------------------------------------------------------------
Total income 4,299 3,676 3,582
Other non-interest expense 13 18 40
(Benefit) provision for income taxes (294) 26 48
- ---------------------------------------------------------------------------
Net income before undistributed earnings
of bank subsidiary 4,580 3,632 3,494
Undistributed earnings of bank subsidiary 3,792 4,981 3,204
- ---------------------------------------------------------------------------
NET INCOME $ 8,372 $ 8,613 $ 6,698
- ---------------------------------------------------------------------------
</Table>
62
<Page>
STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2009 2008 2007
- ------------------------------------------------------------------------------------
Operating Activities:
Net income $ 8,372 $ 8,613 $ 6,698
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income tax benefit (268) - -
Gain on sale of equities (4) (1) (49)
Other-than-temporary impairment loss 787 - -
Equity in undistributed net income of
bank subsidiary (3,792) (4,981) (3,204)
Increase in other assets (23) - -
(Decrease) increase in other liabilities (4) (48) 23
- ------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 5,068 3,583 3,468
- ------------------------------------------------------------------------------------
Investing Activities:
Purchase of equity investments - - (1,055)
Proceeds from sales of equity securities 118 1,158 351
Special dividend received from subsidiary 17,405 - -
Cash paid in merger (17,405) - -
- ------------------------------------------------------------------------------------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 118 1,158 (704)
- ------------------------------------------------------------------------------------
Financing Activities:
Cash dividends paid (5,031) (3,565) (3,394)
- ------------------------------------------------------------------------------------
NET CASH USED BY FINANCING ACTIVITIES (5,031) (3,565) (3,394)
- ------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash
equivalents 155 1,176 (630)
Cash and cash equivalents at January 1 2,101 925 1,555
- ------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 2,256 $ 2,101 $ 925
- ------------------------------------------------------------------------------------
</Table>
NOTE 25 -- 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
Merger). The Company consummated the acquisition of Old Forge Bank on April 1,
2009, at which time Old Forge Bank was merged with and into the Bank. Following
the Merger, the Bank continues 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 of the
Company's common stock over a fixed period of time, as provided for 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 Merger, the Company is now an $883 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 Merger, largely
based on the Company's evaluation of the business growth opportunities inherent
in the Old Forge Bank customer base, as well as operating synergies and economy
of scale resulting from the Merger. None of the goodwill is expected to be
deductible for income tax purposes.
63
<Page>
The following table summarizes the consideration paid for Old Forge Bank and the
identifiable assets acquired and liabilities assumed at acquisition date.
<Table>
<Caption>
April 1, 2009
-------------
Consideration
Cash $ 17,405
Common Stock issued - 1,128,079 shares
of the Company, net of issuance costs of $184 38,058
-------------
Fair value of consideration transferred $ 55,463
=============
</Table>
The fair value of the 1,128,079 common shares of the Company issued as part of
the consideration paid to former Old Forge Bank shareholders was $38,058,
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
statement of the acquirer for the year ended
December 31, 2009. $ 1,550
Acquisition-related costs recorded as an offset to
surplus of the acquirer as of December 31, 2009. $ 184
Recognized amounts of identifiable assets acquired
and liabilities assumed on April 1, 2009 are:
Cash $ 4,760
Investments 32,095
Loans 159,949
Property and equipment 1,576
Core Deposit Intangible 2,027
All other assets 12,193
-----------
Identifiable Assets 212,600
Deposits 177,018
Borrowings 5,000
All other liabilities 1,517
------------
Identifiable Liabilities 183,535
Identifiable net assets 29,065
Goodwill 26,398
------------
Total consideration transferred $ 55,463
------------
The fair value of the financial assets acquired included loans receivable with a
gross amortized cost basis of $166,348 at April 1, 2009.
64
<Page>
The table below illustrates the fair value adjustments made to the amortized
cost basis in order to present the fair value of the loans acquired.
Gross amortized cost basis at April 1, 2009 $166,348
Market rate adjustment 640
Credit fair value adjustment in pools of homogeneous loans (5,648)
Credit fair value adjustment on distressed loans (1,391)
Fair value of purchased loans at April 1, 2009 $159,949
---------
PRO FORMA BALANCE SHEET
As of December 31, 2008
<Table>
<Caption>
Penseco
Financial Services Old Forge
Corporation Bank Pro Forma
12/31/2008 12/31/2008 Eliminations Marks / Costs Adjustments 12/31/2008
- -------------------------------------------------------------------------------------------------------------------------------
Cash and Equivalents $ 9,355 $ 4,275 $ 13,630
Securities 157,480 40,033 197,513
Gross Loans 441,148 169,789 (7,828)(d) 603,109
Loan Loss Reserves (5,275) (1,429) 1,429 (a) (5,275)
Goodwill - - 26,398 (j) 26,398
Other Intangibles 41 150 (150)(b) 2,027 (k) 2,068
Buildings and Furniture,
Fixtures & Equipment 10,391 1,701 (132)(e) 11,960
Other Assets 15,827 8,743 1,853 (f) (17,405)(i) 9,018
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $628,967 $223,262 $858,421
- -------------------------------------------------------------------------------------------------------------------------------
Deposits $424,725 $180,458 929 (g) 606,112
Borrowings 126,079 7,500 133,579
Other Liabilities 4,521 1,825 684 (h) 7,030
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 555,325 189,783 746,721
Common Equity 73,642 33,479 (33,479)(c) 38,058 (l) 111,700
- -------------------------------------------------------------------------------------------------------------------------------
Total Equity 73,642 33,479 111,700
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES & EQUITY $ 628,967 $223,262 $858,421
- -------------------------------------------------------------------------------------------------------------------------------
</Table>
Footnotes:
(a) Elimination of loan loss reserve
(b) Elimination of Old Forge Bank's intangible assets
(c) Elimination of Old Forge Bank's common equity
(d) Fair value adjustment for loans
(e) Buildings and Furniture, Fixtures & Equipment fair value adjustment
(f) Deferred tax adjustments related to fair value adjustment
(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
65
<Page>
PRO FORMA BALANCE SHEET
As of December 31, 2009
<Table>
<Caption>
Penseco
Financial Services Old Forge
Corporation Bank Pro Forma
12/31/2009 12/31/2009 Adjustments 12/31/2009
- ------------------------------------------------------------------------------------------------------------
Interest and fees on loans $ 32,399 $ 2,524 $ 184 (a) $ 35,107
Interest and dividends on investments 7,740 377 (30)(b) 8,087
Interest on Federal funds sold - 1 1
Interest on balances with banks 12 - 12
- ------------------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 40,151 2,902 154 43,207
- ------------------------------------------------------------------------------------------------------------
Interest on deposits 6,541 897 (58)(c) 7,380
Interest on borrowed funds 3,039 9 3,048
TOTAL INTEREST EXPENSE 9,580 906 (58) 10,428
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 30,571 1,996 212 32,779
Provision for loan losses 2,260 75 2,335
Net Interest Income After Provision
for Loan Losses 28,311 1,921 212 30,444
- ------------------------------------------------------------------------------------------------------------
Service charges on deposits 1,939 80 2,019
Other non-interest income 8,344 97 8,441
Impairment losses on investment securities (787) - (787)
Realized gains (losses) on securities 873 - 873
- ------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST INCOME 10,369 177 10,546
- ------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 12,551 696 13,247
Expense of premises and equipment 3,246 146 3,392
Other non-interest expense 11,073 428 61 (d) 11,562
- ------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSES 26,870 1,270 61 28,201
- ------------------------------------------------------------------------------------------------------------
Income before income taxes 11,810 828 151 12,789
Applicable income taxes 2,269 315 51 2,635
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 9,541 (f) $ 513 (f) $ 100 $ 10,154
- ------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE $ 4.44 $ 0.92 (e) $ 3.10
</Table>
FOOTNOTES:
(a) Accretion 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 weighted average shares outstanding of 3,276,079
(f) Excludes merger related costs of $1,550 and $451 and related tax effect
incurred by Penseco and Old Forge Bank, respectively
66
<Page>
PRO FORMA BALANCE SHEET
As of December 31, 2008
<Table>
<Caption>
Penseco
Financial Services Old Forge
Corporation Bank Pro Forma
12/31/2008 12/31/2008 Adjustments 12/31/2008
- ------------------------------------------------------------------------------------------------------------
Interest and fees on loans $ 26,218 $ 10,184 $ 735 (a) $ 37,137
Interest and dividends on investments 7,583 1,779 (122)(b) 9,240
Interest on Federal funds sold 29 33 62
Interest on balances with banks 68 - 68
- ------------------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 33,898 11,996 613 46,507
- ------------------------------------------------------------------------------------------------------------
Interest on deposits 6,973 4,361 (364)(c) 10,970
Interest on borrowed funds 3,857 47 3,904
- ------------------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 10,830 4,408 (364) 14,874
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 23,068 7,588 977 31,633
Provision for loan losses 861 300 1,161
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 22,207 7,288 977 30,472
- ------------------------------------------------------------------------------------------------------------
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 NON-INTEREST INCOME 11,036 799 11,835
- ------------------------------------------------------------------------------------------------------------
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 1,635 243 (d) 11,190
- ------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSES 22,172 5,002 243 27,417
- ------------------------------------------------------------------------------------------------------------
Income before income taxes 11,071 3,085 734 14,890
Applicable income taxes 2,458 565 250 3,273
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 8,613 $ 2,520 $ 484 $ 11,617
- ------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE $ 4.01 $4.51 $ 3.55
</Table>
FOOTNOTES:
(a) Accretion 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
67
<Page>
PRO FORMA INCOME STATEMENT
For the Twelve Months Ended December 31, 2007
<Table>
<Caption>
Penseco
Financial Services Old Forge
Corporation Bank Pro Forma
12/31/2007 12/31/2007 Adjustments 12/31/2007
- ------------------------------------------------------------------------------------------------------------
Interest and fees on loans $ 26,429 $ 10,447 $ 735 (a) $ 37,611
Interest and dividends on investments 7,079 1,820 (122)(b) 8,777
Interest on Federal funds sold 456 71 527
Interest on balances with banks 365 - 365
- ------------------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 34,329 12,338 613 47,280
- ------------------------------------------------------------------------------------------------------------
Interest on deposits 9,375 4,703 (364)(c) 13,714
Interest on borrowed funds 3,364 38 3,402
Total Interest Expense 12,739 4,741 (364) 17,116
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 21,590 7,597 977 30,164
Provision for loan losses 657 150 807
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 20,933 7,447 977 29,357
- ------------------------------------------------------------------------------------------------------------
Service charges on deposits 1,014 594 1,608
Other non-interest income 7,657 546 8,203
Realized gains (losses) on securities 49 (13) 36
- ------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST INCOME 8,720 1,127 9,847
- ------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 9,118 2,947 12,065
Expense of premises and equipment 2,586 493 3,079
Other non-interest expense 9,627 1,417 243 (d) 11,287
- ------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSES 21,331 4,857 243 26,431
- ------------------------------------------------------------------------------------------------------------
Income before income taxes 8,322 3,717 734 12,773
Applicable income taxes 1,624 656 250 2,530
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 6,698 $ 3,061 $ 484 $ 10,243
- ------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE $ 3.12 $ 5.48 $ 3.13
</Table>
FOOTNOTES:
(a) Accretion 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
68
<Page>
NOTE 26 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
First Second Third Fourth
2009 Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------
Net Interest Income $ 5,998 $ 8,040 $ 8,143 $ 8,390
Provision for Loan Losses 996 235 342 687
Non-Interest Income 2,410 2,771 3,143 2,045
Non-Interest Expenses and Taxes 6,971 7,707 7,849 7,781
Net Income 441 2,869 3,095 1,967
Earnings Per Share $ .21 $ .88 $ .94 $ .60
First Second Third Fourth
2009 Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------
Net Interest Income $ 5,577 $ 5,667 $ 5,828 $ 5,996
Provision for Loan Losses 235 216 167 243
Non-Interest Income 3,618 2,364 2,986 2,068
Non-Interest Expenses and Taxes 6,003 5,887 6,405 6,335
Net Income 2,957 1,928 2,242 1,486
Earnings Per Share $ 1.38 $ .90 $ 1.04 $ .69
</Table>
69
MMQ
Francis J. Merkel, CPA
Joseph J. Quinn, CPA/ABV, CVA
Daniel J. Gerrity, CPA
Mary Ann E. Novak, CPA
McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
We have audited the accompanying consolidated balance sheets of Penseco
Financial Services Corporation and subsidiary as of December 31, 2009 and 2008,
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2009.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Penseco Financial
Services Corporation and subsidiary as of December 31, 2009 and 2008, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2009, in conformity with U.S. generally accepted
accounting principles.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Penseco Financial Services
Corporation and subsidiaries' internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission, and our report dated March 12, 2010 expressed an
unqualified opinion on the effectiveness of Penseco Financial Services
Corporation's internal control over financial reporting.
/S/ McGrail Merkel Quinn & Associates
Scranton, Pennsylvania
March 12, 2010
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
70
<Page>
MMQ
Francis J. Merkel, CPA
Joseph J. Quinn, CPA/ABV, CVA
Daniel J. Gerrity, CPA
Mary Ann E. Novak, CPA
McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
We have audited Penseco Financial Services Corporation and subsidiary's internal
control over financial reporting as of December 31, 2009, based on criteria
established in Internal Control -- Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Penseco Financial
Services Corporation and subsidiary's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting included in the
accompanying Management's Report on Internal Control Over Financial Reporting.
Our responsibility is to express an opinion on the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (a) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (b)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (c) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
71
<Page>
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
In our opinion, Penseco Financial Services Corporation and subsidiary
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2009, based on criteria established in Internal
Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of Penseco Financial Services Corporation and subsidiary and our
report dated March 12, 2010 expressed an unqualified opinion.
/S/ McGrail Merkel Quinn & Associates
Scranton, Pennsylvania
March 12, 2010
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
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ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on matters of
accounting principles or practices or financial statement disclosures in 2009 or
2008.
ITEM 9A CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Finance Division Head, 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 Finance Division Head concluded
that our disclosure controls and procedures were effective as of the end of the
period covered by this annual report. Management's annual report on internal
control over financial reporting is included below.
The Company continually assesses the adequacy of its internal control over
financial reporting and enhances its controls in response to internal control
assessments, and internal and external audit and regulatory recommendations. No
change in internal control over financial reporting during the quarter ended
December 31, 2009, or through the date of this Annual Report on Form 10-K, have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
Management maintains a comprehensive system of controls intended to ensure that
transactions are executed in accordance with management's authorization, assets
are safeguarded, and financial records are reliable. Management also takes steps
to see that information and communication flows are effective and to monitor
performance, including performance of internal control procedures.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate due to changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Penseco Financial Services Corporation is responsible for
establishing and maintaining adequate internal control over financial reporting.
Penseco Financial Services Corporation's internal control system over financial
reporting was designed to provide reasonable assurance to the Company's
management and Board of Directors regarding the preparation and fair
presentation of published financial statements in accordance with U.S. generally
accepted accounting principles. All internal control systems, no matter how well
designed, have inherent limitations. Therefore, even those systems determined to
be effective can provide only reasonable assurance with respect to financial
statement preparation and presentation.
The Company's management, under the supervision and with the participation of
the Company's Chief Executive Officer and Finance Division Head, has evaluated
the effectiveness of the Company's internal control over financial reporting as
of December 31, 2009 based on the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Controls-Integrated Framework. Based on this assessment, management believes
that, as of December 31, 2009, the Company's internal control over financial
reporting is effective.
The effectiveness of the Company's internal control over financial reporting as
of December 31, 2009 has been audited by McGrail, Merkel, Quinn & Associates, an
independent registered public accounting firm, as stated in their report
appearing on page 67.
ITEM 9B OTHER INFORMATION
None
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PART III
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Code of Ethical Conduct
-----------------------
The Company has a Code of Ethical Conduct applicable to all employees including
the Company's Principal Executive Officer and Principal Financial Officer
(Finance Division Head). The purpose of the Code is to promote honest and
ethical conduct, full and fair disclosures of financial information, compliance
with laws and regulations and accountability for actions.
A copy of the Code of Ethics may be obtained, without charge, on our website
(www.pennsecurity.com) or by contacting:
Patrick Scanlon, Senior Vice President, Finance Division Head
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, PA 18503-1848
1-800-327-0394
AUDIT COMMITTEE FINANCIAL EXPERT
--------------------------------
The information required by this Item as to Directors of the Company contained
under the headings "Stock Ownership", Item 1 "Election of Directors", "Corporate
Governance" and "Certain Relationships and Related Transactions" within the
Proxy Statement relating to the Company's Annual Meeting of Shareholders, to be
held May 4, 2010, (the "Proxy Statement") is incorporated herein by reference.
The information required by this item as to the Audit Committee's financial
expert (or lack thereof) is incorporated herein by reference to the section
entitled "Corporate Governance-Committees of the Board of Directors" in the
Proxy Statement.
ITEM 11 EXECUTIVE COMPENSATION
The information contained under the headings "Executive Compensation", "Director
Compensation", "Compensation Discussion and Analysis", "Compensation and
Benefits Committee Report" and "Compensation Committee Interlocks and Insider
Participation" in the Proxy Statement is incorporated herein by reference.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information contained under the heading "Stock Ownership" in the Proxy
Statement is incorporated herein by reference.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information contained under the headings "Certain Relationships and Related
Transactions" and "Corporate Governance" and "Item 1- Election of Directors" in
the Proxy Statement is incorporated herein by reference.
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information contained under the heading "Item 2 - Ratification of
Independent Registered Public Accounting Firm" in the Proxy Statement is
incorporated herein by reference.
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PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements - The following financial statements are
incorporated by reference in Part II, Item 8 hereof:
Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
General Notes to Financial Statements
Report of Independent Registered Public Accounting Firm
(2) Financial Statement Schedules - The Financial Statement Schedules are
incorporated by reference in Part II, Item 8 hereof.
(3) Exhibits
The following exhibits are filed herewith or incorporated by reference
as part of this Annual Report.
3(i) Articles of Incorporation (Incorporated herein by reference to
Exhibit 3(i) of Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.)
3(ii) Amended and restated By-Laws (Incorporated herein by reference to
Exhibit 3.2 of Registrant's current report on Form 8-K filed with
the SEC on May 11, 2009.
10 Material contracts (Incorporated herein by reference to Exhibit
10 of Registrant's report on Form 10-K filed with the SEC on
March 16, 2006.)
14 Code of Ethics (Incorporated herein by reference to Exhibit 10 of
Registrant's report on Form 10-K filed with the SEC on March 16,
2006.)
21 Subsidiaries of the registrant (Incorporated herein by reference
to Exhibit 21 of Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.)
31 Certifications required under Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications required under Section 906 of the Sarbanes-Oxley
Act of 2002
(b) The exhibits required to be filed by this Item are listed under Item
15(a)(3), above.
(c) There are no financial statement schedules required to be filed under
this item.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on March 12, 2010.
By: /s/ Craig W. Best
--------------------------------------------
Craig W. Best
President and CEO
By: /s/ Patrick Scanlon
--------------------------------------------
Patrick Scanlon
Senior Vice President, Finance Division Head
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on March 12, 2010.
By: /s/ Craig W. Best By: /s/ Robert J. Mellow
--------------------------------- ------------------------------------
Craig W. Best Robert J. Mellow
President and CEO Director
By: /s/ Edwin J. Butler By: /s/ Robert W. Naismith, Ph.D.
--------------------------------- ------------------------------------
Edwin J. Butler Robert W. Naismith, Ph.D.
Director Director
By: /s/ Joseph G. Cesare, M.D. By: /s/ James B. Nicholas
--------------------------------- ------------------------------------
Josehp G. Cesare, M.D. James B. Nicholas
Director Director
By: /s/ Richard E. Grimm By: /s/ Emily S. Perry
--------------------------------- ------------------------------------
Richard E. Grimm Emily S. Perry
Director Director
By: /s/ Russell C. Hazelton By: /s/ Sandra C. Phillips
--------------------------------- ------------------------------------
Russell C. Hazelton Sandra C. Phillips
Director Director
By: /s/ D. William Hume By: /s/ Otto P. Robinson, Jr.
--------------------------------- ------------------------------------
D. William Hume Otto P. Robinson, Jr.
Director, Chairman of the Board Director
By: /s/ James G. Keisling By: /s/ Jerry J. Weinberger
--------------------------------- ------------------------------------
James G. Keisling Jerry J. Weinberger
Director Director
By: /s/ P. Frank Kozik By: /s/ Steven L. Weinberger
--------------------------------- ------------------------------------
P. Frank Kozik Steven L. Weinberger
Director Director
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CERTIFICATIONS
I, Craig W. Best, certify that:
1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 12, 2010
/s/ Craig W. Best
- -----------------------
Craig W. Best
President and CEO
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I, Patrick Scanlon, certify that:
1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 12, 2010
/s/ Patrick Scanlon
- -----------------------
Patrick Scanlon
Senior Vice President, Finance Division Head
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CERTIFICATION OF PERIODIC FINANCIAL REPORT PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to the best of his knowledge that:
(1) The Annual Report on Form 10-K of the Company for the year ended
December 31, 2009 (the "Form 10-K") fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the
"Act"); and
(2) The information contained in the Form 10-K fairly presents, in all
material respects, the financial condition and results of operations of
the Company as for the dates and for the periods referred to in the Form
10-K.
/s/ Craig W. Best
- -----------------------
Craig W. Best
President and CEO
March 12, 2010
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CERTIFICATION OF PERIODIC FINANCIAL REPORT PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to the best of his knowledge that:
(1) The Annual Report on Form 10-K of the Company for the year ended
December 31, 2009 (the "Form 10-K") fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the
"Act"); and
(2) The information contained in the Form 10-K fairly presents, in all
material respects, the financial condition and results of operations of
the Company as for the dates and for the periods referred to in the Form
10-K.
/s/ Patrick Scanlon
- --------------------------------------------
Patrick Scanlon
Senior Vice President, Finance Division Head
March 12, 2010
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