================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
------------------
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
Incorporated pursuant to the laws of Pennsylvania
------------------
Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). | |
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on April 29, 2005 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
----
Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
March 31, 2005............................................ 3
December 31, 2004......................................... 3
Statements of Income:
Three Months Ended March 31, 2005......................... 4
Three Months Ended March 31, 2004......................... 4
Statements of Cash Flows:
Three Months Ended March 31, 2005......................... 5
Three Months Ended March 31, 2004......................... 5
Notes to Financial Statements................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 21
Item 4. Controls and Procedures.......................................... 21
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................ 22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 22
Item 3. Defaults Upon Senior Securities.................................. 22
Item 4. Submission of Matters to a Vote of Security Holders.............. 22
Item 5. Other Information................................................ 22
Item 6. Exhibits......................................................... 22
Signatures............................................................... 22
Certifications........................................................... 23
PART I. FINANCIAL INFORMATION, Item 1 -- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
March 31, December 31,
2005 2004
--------------- ---------------
ASSETS
Cash and due from banks $ 9,749 $ 7,763
Interest bearing balances with banks 10,421 534
Federal funds sold - -
--------------- ---------------
Cash and Cash Equivalents 20,170 8,297
Investment securities:
Available-for-sale, at fair value 146,318 167,410
Held-to-maturity (fair value of $93,279
and $97,791, respectively) 92,011 95,268
--------------- ---------------
Total Investment Securities 238,329 262,678
Loans, net of unearned income 291,359 280,176
Less: Allowance for loan losses 3,700 3,600
--------------- ---------------
Loans, Net 287,659 276,576
Bank premises and equipment 9,098 9,233
Other real estate owned 334 176
Accrued interest receivable 2,944 3,406
Other assets 4,152 3,342
--------------- ---------------
Total Assets $ 562,686 $ 563,708
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 83,988 $ 82,938
Interest bearing 307,694 312,363
--------------- ---------------
Total Deposits 391,682 395,301
Other borrowed funds:
Repurchase agreements 23,472 18,398
Short-term borrowings 759 886
Long-term borrowings 82,345 84,620
Accrued interest payable 930 886
Other liabilities 1,282 1,241
--------------- ---------------
Total Liabilities 500,470 501,332
--------------- ---------------
STOCKHOLDERS' EQUITY
Common stock ($ .01 par value, 15,000,000 shares
authorized, 2,148,000 shares issued and outstanding) 21 21
Surplus 10,819 10,819
Retained earnings 51,369 50,832
Accumulated other comprehensive income 7 704
--------------- ---------------
Total Stockholders' Equity 62,216 62,376
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 562,686 $ 563,708
=============== ===============
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
March 31, 2005 March 31, 2004
-------------------- --------------------
INTEREST INCOME
Interest and fees on loans $ 4,151 $ 3,156
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency
obligations 1,710 2,165
States & political subdivisions 694 771
Other securities 35 24
Interest on Federal funds sold 23 37
Interest on balances with banks 37 16
-------------------- --------------------
Total Interest Income 6,650 6,169
-------------------- --------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 162 170
Interest on other deposits 901 851
Interest on other borrowed funds 890 932
-------------------- --------------------
Total Interest Expense 1,953 1,953
-------------------- --------------------
Net Interest Income 4,697 4,216
Provision for loan losses 122 18
-------------------- --------------------
Net Interest Income After Provision for Loan
Losses 4,575 4,198
-------------------- --------------------
OTHER INCOME
Trust department income 353 320
Service charges on deposit accounts 224 271
Merchant transaction income 1,356 1,429
Other fee income 273 267
Other operating income 153 127
Realized (losses) gains on securities, net (13) -
-------------------- --------------------
Total Other Income 2,346 2,414
-------------------- --------------------
OTHER EXPENSES
Salaries and employee benefits 2,293 2,299
Expense of premises and fixed assets 675 681
Merchant transaction expenses 1,080 1,121
Other operating expenses 1,358 1,214
-------------------- --------------------
Total Other Expenses 5,406
5,315
-------------------- --------------------
Income before income taxes 1,515
1,297
Applicable income taxes 269 152
-------------------- --------------------
Net Income 1,246 1,145
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (697) 722
-------------------- --------------------
Comprehensive Income $ 549 $ 1,867
==================== ====================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.58 $ 0.53
Cash Dividends Declared Per Common Share $ 0.33 $ 0.30
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
March 31, 2005 March 31, 2004
-------------------- -------------------
OPERATING ACTIVITIES
Net Income $ 1,246 $ 1,145
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 188 218
Provision for loan losses 122 18
Deferred income tax provision (benefit) 7 147
Amortization of securities, (net of accretion) 372 410
Net realized losses (gains) on securities 13 -
Loss (gain) on other real estate 10 -
Decrease (increase) in interest receivable 462 (282)
(Increase) decrease in other assets (810) 100
Increase (decrease) in income taxes payable 262 4
Increase (decrease) in interest payable 44 (155)
Increase (decrease) in other liabilities 132 (80)
-------------------- -------------------
Net cash provided by operating activities 2,048 1,525
-------------------- -------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (33) (24,146)
Proceeds from sales and maturities of investment securities available-for-sale 15,757 10,483
Purchase of investment securities to be held-to-maturity - -
Proceeds from repayments of investment securities available-for-sale 4,068 2,523
Proceeds from repayments of investment securities held-to-maturity 3,115 3,394
Net loans (originated) repaid (11,384) (8,850)
Proceeds from other real estate 11 36
Investment in premises and equipment (53) (45)
-------------------- -------------------
Net cash provided (used) by investing activities 11,481 (16,605)
-------------------- -------------------
FINANCING ACTIVITIES
Net (decrease) increase in demand and savings deposits (3,940) 1,378
Net proceeds (payments) on time deposits 321 (3,299)
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 5,074 772
Net (decrease) increase in short-term borrowings (127) (395)
Repayments of long-term borrowings (2,275) (2,196)
Cash dividends paid (709) (645)
-------------------- -------------------
Net cash (used) provided by financing activities (1,656) (4,385)
-------------------- -------------------
Net increase (decrease) in cash and cash equivalents 11,873 (19,465)
Cash and cash equivalents at January 1 8,297 38,355
-------------------- -------------------
Cash and cash equivalents at March 31 $ 20,170 $ 18,890
==================== ===================
The Company paid interest and income taxes of $1,909 and $284 and $2,108 and
$211, for the three month periods ended March 31, 2005 and 2004, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended March 31, 2005
(unaudited)
These Notes to Financial Statements reflect events subsequent to December 31,
2004, the date of the most recent Report of Independent Registered Public
Accounting Firm, through the date of this Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005. These Notes to Financial Statements should be read
in conjunction with Financial Information and Other Information required to be
furnished as part of this Report, in particular, (1) Management's Discussion and
Analysis of Financial Condition and Results of Operations for the three months
ended March 31, 2005 and March 31, 2004, with respect to the Company's net
interest income, capital requirements and liquidity, (2) Part II, Item 6,
Exhibits and Reports on Form 8-K and (3) the Company's Annual Report - Form 10-K
for the year ended December 31, 2004, incorporated herein by reference.
NOTE 1 -- Principles of Consolidation
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated under the laws of Pennsylvania. It is the parent company of Penn
Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.
Intercompany transactions have been eliminated in preparing the consolidated
financial statements.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
NOTE 2 -- Basis of Presentation
The unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
In the opinion of management, all adjustments that are of a normal recurring
nature and are considered necessary for a fair presentation have been included.
They are not, however, necessarily indicative of the results of consolidated
operations for a full year.
For further information, refer to the consolidated financial statements and
accompanying notes included in the Company's Annual Report - Form 10-K for the
year ended December 31, 2004.
NOTE 3 -- Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
NOTE 4 -- Investment Securities
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, debentures and mortgage-backed
securities for which the Company has the positive intent and ability to hold to
maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts computed on the straight-line basis, which approximates
the interest method, over the remaining period to maturity.
Securities Available-for-Sale Bonds, notes, debentures, mortgage-backed
securities and certain equity securities not classified as securities to be held
to maturity are carried at fair value with unrealized holding gains and losses,
net of tax, reported as a net amount in a separate component of stockholders'
equity until realized.
The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities, adjusted, when necessary,
for advanced prepayments in excess of those estimates.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific identification method and are reported as a
separate component of other income in the Statements of Income. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
The amortized cost and fair value of investment securities at March 31, 2005 and
December 31, 2004 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2005 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 5,000 $ 23 $ - $ 5,023
U.S. Agency securities 65,605 124 514 65,215
Mortgage-backed securities 49,653 - 222 49,431
States & political subdivisions 20,691 435 130 20,996
- --------------------------------------------------------------------------------
Total Debt Securities 140,949 582 866 140,665
Equity securities 5,358 295 - 5,653
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 146,307 $ 877 $ 866 $ 146,318
================================================================================
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 5,000 $ 77 $ - $ 5,077
U.S. Agency securities 70,777 510 541 70,746
Mortgage-backed securities 53,782 36 36 53,782
States & political subdivisions 30,910 686 56 31,540
- --------------------------------------------------------------------------------
Total Debt Securities 160,469 1,309 633 161,145
Equity securities 5,873 392 - 6,265
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 166,342 $ 1,701 $ 633 $ 167,410
================================================================================
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2005 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 62,761 $ 8 $ 986 $ 61,783
States & political subdivisions 29,250 2,246 - 31,496
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 92,011 $ 2,254 $ 986 $ 93,279
================================================================================
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 66,019 $ 10 $ 357 $ 65,672
States & political subdivisions 29,249 2,870 - 32,119
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 95,268 $ 2,880 $ 357 $ 97,791
================================================================================
The amortized cost and fair value of debt securities at March 31, 2005 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
March 31, 2005 Available-for-Sale Held-to-Maturity
- -----------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -----------------------------------------------------------------------------------------
Due in one year or less:
U.S. Treasury securities $ 5,000 $ 5,023 $ - $ -
U.S. Agency securities 40,396 40,251 - -
After one year through five years:
U.S. Agency securities 25,209 24,964 - -
After ten years:
States & political subdivisions 20,691 20,996 29,250 31,496
- -----------------------------------------------------------------------------------------
Subtotal 91,296 91,234 29,250 31,496
Mortgage-backed securities 49,653 49,431 62,761 61,783
- -----------------------------------------------------------------------------------------
Total Debt Securities $ 140,949 $ 140,665 $ 92,011 $ 93,279
=========================================================================================
The gross fair value and unrealized losses of the Company's investments,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at March 31, 2005 and
December 31, 2004 are as follows:
Less than twelve months Twelve months or more Totals
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
March 31, 2005 Value Losses Value Losses Value Losses
- ------------------------------------------------------ -------------------------- --------------------------
U.S. Agency securities $ 55,084 $ 514 $ - $ - $ 55,084 $ 514
Mortgage-backed securities 110,709 1,208 - - 110,709 1,208
States & political
subdivisions 6,557 58 4,496 72 11,053 130
-------------------------- -------------------------- --------------------------
Total $ 172,350 $ 1,780 $ 4,496 $ 72 $ 176,846 $ 1,852
========================== ========================== ==========================
Less than twelve months Twelve months or more Totals
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2004 Value Losses Value Losses Value Losses
- ------------------------------------------------------ -------------------------- --------------------------
U.S. Agency securities $ 35,064 $ 541 $ - $ - $ 35,064 $ 541
Mortgage-backed securities 93,527 393 - - 93,527 393
States & political
subdivisions 3,257 24 4,889 32 8,146 56
-------------------------- -------------------------- --------------------------
Total $ 131,848 $ 958 $ 4,889 $ 32 $ 136,737 $ 990
========================== ========================== ==========================
The above table at March 31, 2005, includes twenty-eight (28) securities that
have unrealized losses for less than twelve months and nine (9) securities that
has been in an unrealized loss position for twelve or more months.
U.S. Agency Securities
The unrealized losses on the Company's investments in these obligations were
caused by recent interest rate increases. The contractual terms of these
investments do not permit the issuer to settle the securities at a price less
than the par value of the investment. Because the Company has the ability to
hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at March 31, 2005.
Mortgage-Backed Securities
The unrealized losses on the Company's investment in mortgage-backed securities
were caused by recent interest rate increases. The contractual cash flows of
these investments are guaranteed by an agency of the U.S. government.
Accordingly, it is expected that these securities would not be settled at a
price less than the amortized cost of the Company's investment. Because the
decline in market value is attributable to changes in interest rates and not
credit quality and because the Company has the ability to hold these investments
until a recovery of fair value, which may be maturity, the Company does not
consider these investments to be other-than-temporarily impaired at March 31,
2005.
State and Political Subdivisions
The unrealized losses on the Company's investments in these obligations were
caused by recent interest rate increases. The contractual terms of these
investments do not permit the issuer to settle the securities at a price less
than the par value of the investment. Because the Company has the ability to
hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at March 31, 2005.
NOTE 5 -- Loan Portfolio
Details regarding the Company's loan portfolio:
March 31, December 31,
As Of: 2005 2004
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 9,690 $ 6,805
Real estate mortgages 201,062 196,149
Commercial 44,117 41,560
Credit card and related plans 2,831 2,872
Installment 26,394 25,679
Obligations of states & political subdivisions 7,265 7,111
- --------------------------------------------------------------------------------
Loans, net of unearned income 291,359 280,176
Less: Allowance for loan losses 3,700 3,600
- --------------------------------------------------------------------------------
Loans, net $ 287,659 $ 276,576
================================================================================
NOTE 6 -- Loan Servicing
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair value
of those rights. Fair values are estimated using discounted cash flows based on
current market rates of interest and 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.
NOTE 7 -- Long-Term Debt
During 2003, the Bank borrowed $100,000 from the Federal Home Loan Bank, in four
loans with various maturity dates, to finance the purchase of a mortgaged-backed
security.
The loans are secured by a general collateral pledge of the Company.
A summary of the long-term debt at March 31, 2005 is as follows:
Note payable, due in monthly installments of $161, including
principal and interest at a fixed rate of 2.73%, maturing March, 2008. $ 5,547
Note payable, due in monthly installments of $253, including
principal and interest at a fixed rate of 3.22%, maturing March, 2010. 14,000
Note payable, due in monthly installments of $430, including
principal and interest at a fixed rate of 3.74%, maturing March, 2013. 35,634
Note payable, due in monthly installments of $186, including
principal and interest at a fixed rate of 4.69%, maturing March, 2023. 27,164
--------
Total long-term debt $ 82,345
========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at March 31, 2005 are as follows:
March 31, Principal
--------- ---------
2006 $ 9,300
2007 9,631
2008 9,974
2009 8,377
2010 8,692
Thereafter 36,371
---------
$ 82,345
=========
NOTE 8 -- Employee Benefit Plans
The components of the net periodic benefit costs are as follows:
Pension Benefits Other Benefits
------------------ -----------------
Three months ended March 31, 2005 2004 2005 2004
- -----------------------------------------------------------------------------
Service cost $ 104 $ 94 $ 2 $ 1
Interest cost 168 167 4 4
Expected return on plan assets (189) (175) - -
Amortization of prior service cost - - 2 2
Amortization of net (gain) loss 27 34 - -
- -----------------------------------------------------------------------------
Net periodic pension cost $ 110 $ 120 $ 8 $ 7
=============================================================================
Contributions
The Company previously disclosed in its financial statements for the year ended
December 31, 2004, that it expected to contribute $375 to its pension plan and
$13 to its postretirement plan in 2005. As of March 31, 2005, there has been no
contributions made to either plan. The pension and postretirement contribution
estimates have not changed since December 31, 2004.
NOTE 9 -- Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgements 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 below) 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. The
Bank's actual capital amounts and ratios are substantially identical to the
Company's. Management believes, as of March 31, 2005, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of March 31, 2005, the most recent notification from the Federal Deposit
Insurance Corporation (FDIC) categorized the Company as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"well capitalized", the Company must maintain minimum Tier I Capital, Total
Capital and Leverage ratios as set forth in the Capital Adequacy table. There
are no conditions or events since that notification that management believes
have changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels, which could
limit the payment of dividends, although the Company and Bank currently have
capital levels, which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the Retained Earnings of the Bank. Accordingly, at March 31, 2005,
the balances in the Capital Stock and Surplus accounts totalling $10,840 are
unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of March 31, 2005 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 65,490 19.40% > $ 27,012 > 8.0% > $ 33,764 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 61,790 18.30% > $ 13,506 > 4.0% > $ 20,258 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 61,790 10.82% > $ * > * > $ 28,549 > 5.0%
- - - -
*3.0% ($17,130), 4.0% ($22,839) or 5.0% ($28,549) depending on the bank's CAMELS
Rating and other regulatory risk factors.
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
December 31, 2004 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 64,822 20.03% > $ 25,890 > 8.0% > $ 32,362 > 10.0%
- - -
Tier I Capital
(to Risk Weighted Assets) $ 61,222 18.92% > $ 12,945 > 4.0% > $ 19,417 > 6.0%
- - -
Tier I Capital
(to Average Assets) $ 61,222 10.53% > * > * > $ 29,068 > 5.0%
- - -
*3.0% ($17,441), 4.0% ($23,254) or 5.0% ($29,068) depending on the bank's CAMELS
Rating and other regulatory risk factors.
PART 1. FINANCIAL INFORMATION, Item 2 --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following commentary provides an overview of the financial condition and
significant changes in the results of operations of Penseco Financial Services
Corporation and its subsidiary, Penn Security Bank and Trust Company, for the
three months ended March 31, 2005 and March 31, 2004. Throughout this review,
the subsidiary of Penseco Financial Services Corporation, Penn Security Bank and
Trust Company, is referred to as the "Company". All intercompany accounts and
transactions have been eliminated in preparing the consolidated financial
statements. 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 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.
Actuarial assumptions associated with pension, post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan assets.
Provision for income taxes - Management believes that the assumptions and
judgements used to record tax related assets or liabilities have been
appropriate.
Fair value of certain investment securities - Fair value of investment
securities are based on quoted market prices.
Loan servicing rights - Mortgage servicing rights are evaluated for impairment
based on the fair value of those rights. Fair values are estimated using
discounted cash flows based on current market rates of interest and current
expected future prepayment rates. For purposes of measuring impairment, the
rights must be stratified by one or more predominant risk characteristics of the
underlying loans. The Company stratifies its capitalized mortgage servicing
rights based on the product type, interest rate and term of the underlying
loans. The amount of impairment recognized is the amount, if any, by which the
amortized cost of the rights for each stratum exceed the fair value.
Premium amortization - The amortization of premiums on mortgage-backed
securities is done based on management's estimate of the lives of the
securities, adjusted, when necessary, for advanced prepayments in excess of
those estimates.
Executive Summary
Penseco Financial Services Corporation reported an increase in net income of
$101 or 8.8% to $1,246 or $.58 per share for the three months ended March 31,
2005 compared with $1,145 or $.53 per share reported for the year earlier
period. Net interest income increased $481 or 11.4% to $4,697 for the first
quarter of 2005 compared to $4,216 for the same quarter of 2004. Largely, the
increase came from higher interest on loans of $995 or 31.5% as loans grew $42
million on a year over year comparison and interest rate increases. The
Company's loan loss provision increased $104 to $122 from $18 from the year ago
period as an act of prudence as the loan portfolio increased 17.1%. However, the
Company experienced a decrease in other income of $68, primarily due to lower
service charge income along with a reduction in merchant transaction income due
to the loss of service to a university merchant. During the first quarter of
2005 the Company realized a loss of $13 from the sale of $10 million long-term
fixed rate municipal securities. The proceeds will be redeployed into loans at
higher rates. Total other expenses increased $91 or 1.7%. Contributing to this
increase was higher operating costs, largely professional fees and general
operating expenses. Merchant transaction expense decreased by $41 or 3.7% due to
lower transaction volume. Applicable income taxes increased $117 or 77.0% due to
higher net income with lower tax-free income.
Net Interest Income and Net Interest Margin
Net interest income, the largest contributor to the Company's earnings, is
defined as the difference between interest income on assets and the cost of
funds supporting those assets. Earning assets are composed primarily of loans
and investments while deposits, short-term and long-term borrowings represent
interest-bearing liabilities. Variations in the volume and mix of these assets
and liabilities, as well as changes in the yields earned and rates paid, are
determinants of changes in net interest income.
Net interest income after provision for loan losses increased $377 or 9.0% to
$4,575 for the three months ended March 31, 2005 compared to $4,198 for the
three months ended March 31, 2004. Earning assets increased 45 basis points,
largely due to the growth in our loan portfolio, of $41.2 million from the
comparable period of 2004. Offsetting this increase in yield was the provision
for loan losses which increased from $18 to $122 for the three months ended
March 31, 2005 versus the comparable period of 2004.
The net interest margin represents the Company's net yield on its earning assets
and is calculated as net interest income divided by average earning assets. In
the three months ended March 31, 2005, net interest margin was 3.41% increasing
42 basis points from 2.99% in the same period of 2004.
Total average earning assets and average interest bearing funds decreased in the
three months ended March 31, 2005 as compared to 2004. Average earning assets
decreased $13.3 million or 2.4%, from $565.0 million in 2004 to $551.7 million
in 2005 and average interest bearing funds decreased $18.5 million, or 4.2%,
from $441.1 million to $422.6 million for the same period, mainly due to lower
time-deposit savings. As a percentage of average assets, earning assets
increased to 96.6% for the three months ended March 31, 2005 from 96.5% for the
year ago period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the three months of 2005 and 2004. Average loans as a
percentage of average earning assets increased from 43.4% in 2004 to 51.9% in
2005, due in part to the increase of new and refinanced fixed rate mortgages;
average investments decreased $41.9 million from 52.4% to 46.1%. Average
short-term investments, federal funds sold and interest bearing balances with
banks decreased $12.6 million to $11.3 from $23.9 and also decreased as a
percentage of average earning assets from 4.1% in 2004 to 2.0% in 2005. Average
time deposits decreased $16.3 million or 12.9% from 28.7% of interest bearing
liabilities in 2004 to 26.2% in 2005. Average short-term borrowings, long-term
borrowings and repurchase agreements decreased $5.5 from 26.0% in 2004 to 25.9%
in 2005, as a percentage of funding sources.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. The investment
securities tax equivalent yield decreased 14 basis points from 4.54% in the
three months ended March 31, 2004 to 4.40% for 2005. Also, average loan yields
increased 65 basis points, from 5.15% in the three months ended March 31, 2004
to 5.80% in 2005.
The average time deposit costs increased 22 basis points from 2.34% in 2004 to
2.56% in 2005, along with money market accounts increasing 40 basis points from
..71% in 2004 to 1.11% in 2005.
The most significant change in net interest income has been the growth in our
loan portfolio of $41.2 million mostly in commercial and real estate loans.
Distribution of Assets, Liabilities and Stockholders' Equity / Interest Rates
and Interest Differential
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the three months ended
March 31, 2005 and March 31, 2004.
- ----------------------------------------------------------------------------------------------------------
March 31, 2005 March 31, 2004
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 5,077 $ 83 6.54% $ 9,225 $ 115 4.99%
U.S. Agency obligations 118,480 918 3.10% 135,763 1,123 3.31%
States & political
subdivisions 31,430 298 5.75% 33,477 362 6.55%
Federal Home Loan Bank stock 5,166 31 2.40% 5,417 18 1.33%
Other 662 4 2.42% 517 5 3.87%
Held-to-maturity:
U.S. Agency obligations 64,190 709 4.42% 82,414 927 4.50%
States & political
subdivisions 29,249 396 8.21% 29,387 410 8.46%
Loans, net of unearned income:
Real estate mortgages 206,930 3,020 5.84% 177,092 2,329 5.26%
Commercial 42,899 616 5.74% 33,047 389 4.71%
Consumer and other 36,352 515 5.67% 34,818 438 5.03%
Federal funds sold 4,008 23 2.30% 15,631 37 0.95%
Interest on balances with banks 7,264 37 2.04% 8,217 16 0.78%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest
Income 551,707 $ 6,650 4.82% 565,005 $ 6,169 4.37%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 7,891 8,249
Bank premises and equipment 9,179 9,867
Accrued interest receivable 2,834 2,916
Other assets 2,967 3,116
Less: Allowance for loan losses 3,594 3,496
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 570,984 $ 585,657
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 31,219 $ 33 0.42% $ 30,191 $ 25 0.33%
Savings 80,099 69 0.34% 80,471 99 0.49%
Money markets 91,457 253 1.11% 88,945 157 0.71%
Time - Over $100 24,143 162 2.68% 29,505 170 2.30%
Time - Other 86,370 546 2.53% 97,260 570 2.34%
Federal funds purchased - - - - - -
Repurchase agreements 25,407 76 1.20% 22,118 41 0.74%
Short-term borrowings 482 2 1.66% 349 1 1.15%
Long-term borrowings 83,397 812 3.89% 92,286 890 3.86%
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense $ 422,574 1,953 1.85% $ 441,125 1,953 1.77%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 84,131 81,394
All other liabilities 1,473 2,052
Stockholders' equity 62,806 61,086
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 570,984 $ 585,657
- ----------------------------------------------------------------------------------------------------------
Interest Spread 2.97% 2.60%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,697 $ 4,216
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.41% 2.99%
Return on average assets 0.87% 0.78%
Return on average equity 7.94% 7.50%
Average equity to average assets 11.00% 10.43%
Dividend payout ratio 56.90% 56.60%
- ----------------------------------------------------------------------------------------------------------
Investments
The Company's investment portfolio consists primarily of two functions: To
provide liquidity and to contribute to earnings. To provide liquidity the
Company may invest in short-term securities such as Federal funds sold, interest
bearing deposits with banks, U.S. Treasury securities and U.S. Agency securities
all with maturities of one year or less. These funds are invested short-term to
ensure the availability of funds to meet customer demand for credit needs. The
Company enhances interest income by securing long-term investments within its
investment portfolio, by means of U.S. Treasury securities, U.S. Agency
securities, municipal securities and mortgage-backed securities generally with
maturities greater than one year.
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 determined based
on management's estimate of the lives of the securities, adjusted, when
necessary, for advanced prepayments in excess of those estimates.
Gains and losses on the sale of securities available-for-sale are determined
using the specific identification method and are reported as a separate
component of other income in the Statements of Income.
Deposits
The Company is largely dependent on its core deposit base to fund operations.
Management has competitively priced its deposit products in checking, savings,
money market and time deposits to provide a stable source of funding.
As the economy shows strength and improves, migration of some deposits may
return to the equity markets as consumers become more prone to increased yields.
Historically, such changes in the Company's deposit base have been minimal.
Provision for Loan Losses
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio. The process of determining the adequacy of the
allowance is necessarily judgmental and subject to changes in external
conditions. The allowance for loan losses reflects management's judgment as to
the level considered appropriate to absorb such losses based upon a review of
many factors, including historical loss experience, adverse situations that may
affect the borrower's ability to repay (including the timing of future
payments), economic conditions and trends, loan portfolio volume and mix, loan
performance trends, the value and adequacy of collateral, and the Company's
internal credit review process. Accordingly, there can be no assurance that
existing levels of the allowance will ultimately prove adequate to cover actual
loan losses. The quarterly provision for loan losses charged to operating
expense is that amount which is sufficient to bring the balance of the allowance
for possible loan losses to an adequate level to absorb anticipated losses.
Based on this ongoing evaluation, management determines the provision necessary
to maintain an appropriate allowance.
For the three months ended March 31, 2005, the provision for loan losses
increased to $122 from $18 in the three months ended March 31, 2004. Loans
charged off totaled $24 and recoveries were $2 for the three months ended March
31, 2005. In the same period of 2004, loans charged off were $21 and recoveries
were $3. At March 31, 2005 the allowance for loan losses was set at $3,700 or
1.27% of loans based upon the bank's analysis methodology as an act of prudence
by management.
Other Income
The following table sets forth information by category of other income for the
Company for three months ended March 31, 2005 and March 31, 2004, respectively:
March 31, March 31,
Three Months Ended: 2005 2004
- -----------------------------------------------------------------------
Trust department income $ 353 $ 320
Service charges on deposit accounts 224 271
Merchant transaction income 1,356 1,429
Other fee income 273 267
Other operating income 153 127
Realized (losses) gains on securities, net (13) -
- -----------------------------------------------------------------------
Total Other Income $ 2,346 $ 2,414
=======================================================================
Other income decreased $68 or 2.8% to $2,346 for the three months ended March
31, 2005 compared with $2,414 for the similar period of 2004. Trust income
increased $33 or 10.3% largely due to new business. Service charges on deposit
accounts decreased $47 or 17.3%. Merchant transaction income decreased $73 or
5.1% mainly due to the loss of service to a university merchant. Other operating
income increased $26 or 20.5% mainly from increased collection efforts on a
previously written off cash item. During the first quarter, the Company realized
a loss of $13 from the sale of $10 million long-term fixed rate municipal
securities. The proceeds will be redeployed into loans at higher rates.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended March 31, 2005 and March 31, 2004,
respectively:
March 31, March 31,
Three Months Ended: 2005 2004
- -----------------------------------------------------------------------
Salaries and employee benefits $ 2,293 $ 2,299
Expense of premises and fixed assets 675 681
Merchant transaction expenses 1,080 1,121
Other operating expenses 1,358 1,214
- -----------------------------------------------------------------------
Total Other Expenses $ 5,406 $ 5,315
=======================================================================
Total other expenses increased $91 or 1.7% to $5,406 for the first quarter of
2005 compared with $5,315 for the same period of 2004. Merchant transaction
expense decreased by $41 or 3.7% due to lower transaction volume. Other
operating expenses increased $144 or 11.9%, mostly from increased professional
fees and general operating expenses.
Applicable income taxes increased $117 or 77.0% due to higher net income with
lower tax-free income.
Loan Portfolio
Details regarding the Company's loan portfolio:
March 31, December 31,
As Of: 2005 2004
- ---------------------------------------------------------------------------
Real estate - construction
and land development $ 9,690 $ 6,805
Real estate mortgages 201,062 196,149
Commercial 44,117 41,560
Credit card and related plans 2,831 2,872
Installment 26,394 25,679
Obligations of states & political subdivisions 7,265 7,111
- ---------------------------------------------------------------------------
Loans, net of unearned income 291,359 280,176
Less: Allowance for loan losses 3,700 3,600
- ---------------------------------------------------------------------------
Loans, net $ 287,659 $ 276,576
===========================================================================
Loan Quality
The comprehensive lending policy established by the Board of Directors guides
the lending activities of the Company. Loans must meet criteria, which include
consideration of the character, capacity and capital of the borrower, collateral
provided for the loan, and prevailing economic conditions.
Regardless of credit standards, there is risk of loss inherent in every loan
portfolio. The allowance for loan losses is an amount that management believes
will be adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of the loans. The
evaluations take into consideration such factors as change in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, industry experience, collateral value and current economic
conditions that may affect the borrower's ability to pay. Management believes
that the allowance for loan losses is adequate. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
The allowance for loan losses is increased by periodic charges against earnings
as a provision for loan losses, and decreased periodically by charge-offs of
loans (or parts of loans) management has determined to be uncollectible, net of
actual recoveries on loans previously charged-off.
Non-Performing Assets
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned. The following
table sets forth information regarding non-performing assets as of the dates
indicated:
March 31, December 31, March 31,
As Of: 2005 2004 2004
- -----------------------------------------------------------------------------------------
Non-accrual loans $ 1,534 $ 1,999 $ 1,729
Loans past due 90 days or more and accruing:
Guaranteed student loans 268 253 165
Credit card loans 4 5 3
- -----------------------------------------------------------------------------------------
Total non-performing loans 1,806 2,257 1,897
Other real estate owned 334 176 85
- -----------------------------------------------------------------------------------------
Total non-performing assets $ 2,140 $ 2,433 $ 1,982
=========================================================================================
Loans are generally placed on a non-accrual status when principal or interest is
past due 90 days or when payment in full is not anticipated. When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is charged against current income. Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,534 and $1,729 at March 31, 2005 and March 31, 2004, respectively. If
interest on those loans had been accrued, such income would have been $208 and
$223 for the three months ended March 31, 2005 and March 31, 2004, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $0 and $2 for March 31, 2005 and March 31, 2004, respectively. There are no
commitments to lend additional funds to individuals whose loans are in
non-accrual status.
The management process for evaluating the adequacy of the allowance for loan
losses includes reviewing each month's loan committee reports, which list all
loans that do not meet certain internally developed criteria as to collateral
adequacy, payment performance, economic conditions and overall credit risk.
These reports also address the current status and actions in process on each
listed loan. From this information, adjustments are made to the allowance for
loan losses. Such adjustments include both specific loss allocation amounts and
general provisions by loan category based on present and past collection
experience, nature and volume of the loan portfolio, overall quality, and
current economic conditions that may affect the borrower's ability to pay. As of
March 31, 2005 there are no significant loans as to which management has serious
doubt about their collectibility other than what is included above.
At March 31, 2005 and December 31, 2004, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
Loan Loss Experience
The following tables present the Company's loan loss experience during the
periods indicated:
March 31, March 31,
Three Months Ended: 2005 2004
- -------------------------------------------------------------------------
Balance at beginning of period $ 3,600 $ 3,500
Charge-offs:
Real estate mortgages 10 -
Commercial and all others - 11
Credit card and related plans 7 10
Installment loans 7 -
- -------------------------------------------------------------------------
Total charge-offs 24 21
- -------------------------------------------------------------------------
Recoveries:
Real estate mortgages - 3
Commercial and all others - -
Credit card and related plans 1 -
Installment loans 1 -
- -------------------------------------------------------------------------
Total recoveries 2 3
- -------------------------------------------------------------------------
Net charge-offs (recoveries) 22 18
- -------------------------------------------------------------------------
Provision charged to operations 122 18
- -------------------------------------------------------------------------
Balance at End of Period $ 3,700 $ 3,500
=========================================================================
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.008% 0.007%
=========================================================================
Due to the continuing economic uncertainties, management believes the allowance
for loan losses is considered adequate based on its methodology. The allowance
for loan losses, as a percentage of total loans, stands at 1.27% at March 31,
2005 and 1.40% at March 31, 2004.
The allowance for loan losses is allocated as follows:
As Of: March 31, 2005 December 31, 2004 March 31, 2004
- ------------------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- ------------------------------------------------------------------------------------------
Real estate mortgages $ 1,100 72% $ 1,100 72% $ 1,100 73%
Commercial and all others 2,170 15% 2,070 18% 1,970 13%
Credit card and related plans 180 1% 180 1% 180 1%
Personal installment loans 250 12% 250 9% 250 13%
- ------------------------------------------------------------------------------------------
Total $ 3,700 100% $ 3,600 100% $ 3,500 100%
==========================================================================================
* Percent of loans in each category to total loans
Liquidity
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Treasury and 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. The Company is not a party to any commitments,
guarantees or obligations that could materially affect its liquidity.
The Company offers collateralized repurchase agreements that have a one day
maturity, as an alternative deposit option for its customers. The Company also
has long-term debt outstanding to the FHLB, which was used to purchase a Freddie
Mac pool of residential mortgages, as described earlier in this report. The
Company continues to have $181,617 of available borrowing capacity with the
FHLB.
Commitments and Contingent Liabilities
In the normal course of business, there are outstanding commitments and
contingent liabilities, created under prevailing terms and collateral
requirements such as commitments to extend credit, financial guarantees and
letters of credit, which are not reflected in the accompanying Financial
Statements. The Company does not anticipate any losses as a result of these
transactions. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
Related Parties
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. The Bank has issued standby letters of
credit for the accounts of related parties in the amount of $6,932.
Capital Resources
A strong capital position is important to the continued profitability of the
Company and promotes depositor and investor confidence. The Company's capital
provides a basis for future growth and expansion and also provides additional
protection against unexpected losses.
Additional sources of capital would come from retained earnings from the
operations of the Company and from the sale of additional common stock.
Management has no plans to offer additional common stock at this time.
The Company's total risk-based capital ratio was 19.40% at March 31, 2005. The
Company's risk-based capital ratio is more than the 10.00% ratio that Federal
regulators use as the "well capitalized" threshold. This is the current criteria
which the FDIC uses in determining the lowest insurance rate for deposit
insurance. The Company's risk-based capital ratio is more than double the 8.00%
limit, which determines whether a company is "adequately capitalized". Under
these rules, the Company could significantly increase its assets and still
comply with these capital requirements without the necessity of increasing its
equity capital.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act, enacted in July of 2002, continues to impact the
Company. A calculation of public float as of June 30, 2004 determined that the
Company was not subject to the accelerated filing deadlines of the Securities
and Exchange Commission (SEC) for 2004, which reduced the number of days
accelerated filers had to issue the 2004 Annual Report (Form 10-K) to 75 days.
Similarly, for accelerated filers, the quarterly reports for 2005 have to be
filed within 40 days of the end of each quarter. Although not subject to the
accelerated filing dates, the Company intends to file its quarterly reports this
year within 40 days of the end of each quarter and have filed our Form 10K
within 75 days of year-end.
The Company will calculate its public float again as of June 30, 2005 to
determine if it is subject to the accelerated filing rules for the fiscal year
2005. If it is determined that the Company is an accelerated filer for 2005, the
2005 Annual Form 10K will be required to be filed within 75 days of December 31,
2005. In addition, if an accelerated
filer, Section 404 of the Act will require that the 2005 Annual Report include
an internal control report that contains management's assertions regarding the
effectiveness of the Company's internal control structure and procedures over
financial reporting. The Company's auditors must also provide an opinion about
whether management's assessment of the effectiveness of its internal control
over financial reporting is fairly stated in all material respects. This
provision will require management to document each type of transaction that
occurs in the Company, the risks involved in the transaction, the internal
controls established to mitigate such risks, information and communication of
the results and finally a monitoring of the controls. Affecting all of this is
the control environment within the Company. Management is already spending an
enormous amount of time documenting the internal control processes within the
Company and has hired outside consultants to coordinate the planning and
documentation phases of this project.
The SEC has ruled that all public companies must provide the Section 404
reporting on internal control, as described above, in Annual Reports (Form 10K)
for year-end 2006.
PART 1. FINANCIAL INFORMATION, Item 3 --
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises principally from interest rate risk inherent in
its lending, deposit and borrowing activities. Management actively monitors and
manages its interest rate risk exposure. Although the Company manages other
risks, such as credit quality and liquidity risk in the normal course of
business, management considers interest rate risk to be its most significant
market risk and the risk that could potentially have the largest material effect
on the Company's financial condition and results of operations. Other types of
market risks such as foreign currency exchange risk and commodity price risk do
not arise in the normal course of community banking activities.
Achieving consistent growth in net interest income is the primary goal of the
Company's asset/liability function. The Company attempts to control the mix and
maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates. The Company seeks to
accomplish this goal while maintaining adequate liquidity and capital. A
continuation of historically low interest rates will most likely affect
negatively the Company's net interest income. The Company continues to evaluate
its mix of assets and liabilities in response to the changing economy.
PART 1. FINANCIAL INFORMATION, Item 4 --
CONTROLS AND PROCEDURES
Based on the evaluations by the Company's principal executive officer, Otto P.
Robinson, Jr., President and the Company's principal financial officer, Patrick
Scanlon, Controller, of the Company's Disclosure Controls and Procedures as of
March 31, 2005, they have concluded that the Company's disclosure controls are
effective, reasonably ensure that material information relating to the Company
and its consolidated subsidiaries is made known to them by others within those
entities, particularly during the period in which this report is being prepared,
and identify significant deficiencies or material weaknesses in internal
controls which could adversely affect the Company's ability to record, process,
summarize and report financial data.
Based on information available to them, they are not aware of significant
deficiencies or material weaknesses in the Company's internal control system.
Based on information available to them, they are not aware of any changes made
in internal controls or in other factors during the reporting period that could
materially affect or is reasonably likely to materially affect the Company's
internal controls over financial reporting.
Based on information available to them, they are not aware of any fraud that
involves management or other employees of the Company.
Despite these and other controls and procedures, the Company's two hundred or so
employees process over 10 million financial transactions every year. The
Company's computer systems consist of some 17 million lines of code used in the
processing of this financial information. Financial accounting rules encompass
thousands of pages of instructions and contain many confusing and "gray" areas.
From time to time honest errors in the entry, processing, or reporting of this
information are discovered or a dishonest or disloyal employee surfaces.
Fortunately, in the past
any such errors or discoveries have not been material and therefore we have
never had to restate the Company's financial results. The probability is that we
won't in the future, but the possibility does exist and the certifications
marked as exhibits 31 and 32 are made subject to these contingencies.
PART II. OTHER INFORMATION
Item 1 -- Legal Proceedings
None.
Item 2 -- Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3 -- Defaults Upon Senior Securities
None.
Item 4 -- Submission of Matters to a Vote of Security Holders
None.
Item 5 -- Other Information
None.
Item 6 -- Exhibits
a. Exhibits
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
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENSECO FINANCIAL SERVICES CORPORATION
By
------------------------------
Richard E. Grimm
Executive Vice-President
Dated: April 29, 2005
By
------------------------------
Patrick Scanlon
Controller
Dated: April 29, 2005