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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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
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Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by 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 July 29, 2005 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
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Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
June 30, 2005........................................ 3
December 31, 2004.................................... 3
Statements of Income:
Three Months Ended June 30, 2005..................... 4
Three Months Ended June 30, 2004..................... 4
Six Months Ended June 30, 2005....................... 5
Six Months Ended June 30, 2004....................... 5
Statements of Cash Flows:
Six Months Ended June 30, 2005....................... 6
Six Months Ended June 30, 2004....................... 6
Notes to Financial Statements........................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 25
Item 4. Controls and Procedures......................................... 26
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................... 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..... 26
Item 3. Defaults Upon Senior Securities................................. 26
Item 4. Submission of Matters to a Vote of Security Holders............. 26
Item 5. Other Information............................................... 26
Item 6. Exhibits........................................................ 27
Signatures.............................................................. 27
Certifications.......................................................... 28
2
PART I. FINANCIAL INFORMATION, Item 1 -- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
June 30, December 31,
2005 2004
--------------- ---------------
ASSETS
Cash and due from banks $ 11,315 $ 7,763
Interest bearing balances with banks 9,603 534
Federal funds sold 3,550 -
--------------- ---------------
Cash and Cash Equivalents 24,468 8,297
Investment securities:
Available-for-sale, at fair value 148,122 167,410
Held-to-maturity (fair value of $ 91,287
and $97,791, respectively) 88,790 95,268
--------------- ---------------
Total Investment Securities
236,912 262,678
Loans, net of unearned income 294,476 280,176
Less: Allowance for loan losses 3,722 3,600
--------------- ---------------
Loans, Net 290,754 276,576
Bank premises and equipment 8,960 9,233
Other real estate owned 100 176
Accrued interest receivable 3,229 3,406
Other assets 3,406 3,342
--------------- ---------------
Total Assets $ 567,829 $ 563,708
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 87,062 $ 82,938
Interest bearing 307,195 312,363
--------------- ---------------
Total Deposits 394,257 395,301
Other borrowed funds:
Repurchase agreements 27,762 18,398
Short-term borrowings 254 886
Long-term borrowings 80,051 84,620
Accrued interest payable 998 886
Other liabilities 996 1,241
--------------- ---------------
Total Liabilities 504,318 501,332
--------------- ---------------
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 52,180 50,832
Accumulated other comprehensive income 491 704
--------------- ---------------
Total Stockholders' Equity 63,511 62,376
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 567,829 $ 563,708
=============== ===============
3
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
June 30, 2005 June 30, 2004
------------------ ------------------
INTEREST INCOME
Interest and fees on loans $ 4,516 $ 3,192
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 1,622 2,047
States & political subdivisions 643 957
Other securities 51 27
Interest on Federal funds sold 63 6
Interest on balances with banks 57 21
------------------ ------------------
Total Interest Income 6,952 6,250
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INTEREST EXPENSE
Interest on time deposits of $100,000 or more 178 167
Interest on other deposits 1,002 812
Interest on other borrowed funds 884 908
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Total Interest Expense 2,064 1,887
------------------ ------------------
Net Interest Income 4,888 4,363
Provision for loan losses - 3
------------------ ------------------
Net Interest Income After Provision for Loan Losses 4,888 4,360
------------------ ------------------
OTHER INCOME
Trust department income 362 322
Service charges on deposit accounts 237 268
Merchant transaction income 1,056 970
Other fee income 292 292
Other operating income 179 154
Realized (losses) gains on securities, net - -
------------------ ------------------
Total Other Income 2,126 2,006
------------------ ------------------
OTHER EXPENSES
Salaries and employee benefits 2,303 2,258
Expense of premises and fixed assets 593 600
Merchant transaction expenses 868 816
Other operating expenses 1,333 1,153
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Total Other Expenses 5,097 4,827
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Income before income taxes 1,917 1,539
Applicable income taxes 397 176
------------------ ------------------
Net Income 1,520 1,363
Other comprehensive income, net of taxes:
Unrealized securities gains (losses) 484 (2,190)
------------------ ------------------
Comprehensive Income $ 2,004 $ (827)
================== ==================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.71 $ 0.64
Cash Dividends Declared Per Common Share $ 0.33 $ 0.30
4
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004
------------------ ------------------
INTEREST INCOME
Interest and fees on loans $ 8,667 $ 6,348
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 3,332 4,212
States & political subdivisions 1,337 1,728
Other securities 86 51
Interest on Federal funds sold 86 43
Interest on balances with banks 94 37
------------------ ------------------
Total Interest Income 13,602 12,419
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INTEREST EXPENSE
Interest on time deposits of $100,000 or more 340 337
Interest on other deposits 1,903 1,663
Interest on other borrowed funds 1,774 1,840
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Total Interest Expense 4,017 3,840
------------------ ------------------
Net Interest Income 9,585 8,579
Provision for loan losses 122 21
------------------ ------------------
Net Interest Income After Provision for Loan Losses 9,463 8,558
------------------ ------------------
OTHER INCOME
Trust department income 715 642
Service charges on deposit accounts 461 539
Merchant transaction income 2,412 2,399
Other fee income 565 559
Other operating income 332 281
Realized (losses) gains on securities, net (13) -
------------------ ------------------
Total Other Income 4,472 4,420
------------------ ------------------
OTHER EXPENSES
Salaries and employee benefits 4,596 4,557
Expense of premises and fixed assets 1,268 1,281
Merchant transaction expenses 1,948 1,937
Other operating expenses 2,691 2,367
------------------ ------------------
Total Other Expenses 10,503 10,142
------------------ ------------------
Income before income taxes 3,432 2,836
Applicable income taxes 666 328
------------------ ------------------
Net Income 2,766 2,508
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (213) (2,912)
------------------ ------------------
Comprehensive Income $ 2,553 $ (404)
================== ==================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 1.29 $ 1.17
Cash Dividends Declared Per Common Share $ 0.66 $ 0.60
5
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004
-------------------- -------------------
OPERATING ACTIVITIES
Net Income $ 2,766 $ 2,508
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 374 424
Provision for loan losses 122 21
Deferred income tax provision (benefit) 3 10
Amortization of securities, (net of accretion) 721 790
Net realized losses (gains) on securities 13 -
(Gain) loss on other real estate (7) -
Decrease (increase) in interest receivable 177 (361)
(Increase) decrease in other assets (64) (1,557)
Increase (decrease) in income taxes payable 80 91
Increase (decrease) in interest payable 112 (261)
(Decrease) increase in other liabilities (218) 1,663
-------------------- ------------------
Net cash provided by operating activities 4,079 3,328
-------------------- -------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (11,289) (49,543)
Proceeds from sales and maturities of investment securities available-for-sale 20,911 18,155
Purchase of investment securities to be held-to-maturity - -
Proceeds from repayments of investment securities available-for-sale 8,873 7,817
Proceeds from repayments of investment securities held-to-maturity 6,214 11,050
Net loans (originated) repaid (14,479) (11,600)
Proceeds from other real estate 262 121
Investment in premises and equipment (101) (59)
-------------------- -------------------
Net cash provided (used) by investing activities 10,391 (24,059)
-------------------- -------------------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 175 4,569
Net (payments) proceeds on time deposits (1,219) (5,699)
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 9,364 (558)
Net (decrease) increase in short-term borrowings (632) 3,016
Repayments of long-term borrowings (4,569) (4,412)
Cash dividends paid (1,418) (1,289)
-------------------- -------------------
Net cash provided (used) by financing activities 1,701 (4,373)
-------------------- -------------------
Net increase (decrease) in cash and cash equivalents 16,171 (25,104)
Cash and cash equivalents at January 1 8,297 38,355
-------------------- -------------------
Cash and cash equivalents at June 30 $ 24,468 $ 13,251
==================== ===================
The Company paid interest and income taxes of $3,905 and $575 and $4,101 and
$226, for the six month periods ended June 30, 2005 and 2004, respectively.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended June 30, 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 June 30, 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 June 30, 2005 and June 30, 2004 and for the six months ended June 30, 2005
and June 30, 2004, with respect to the Company's net interest income, capital
requirements and liquidity, (2) Part II, Item 6, Exhibits and (3) the Company's
Annual Report - Form 10-K for the year ended December 31, 2004, incorporated
herein by reference.
FORWARD LOOKING INFORMATION
This Form 10-Q contains forward-looking informational statements, in addition to
the historical financial information required by the Securities and Exchange
Commission. There are certain risks and uncertainties associated with these
forward-looking statements which could cause actual results to differ materially
from those stated herein. Such differences are discussed in the section entitled
"Management Discussion and Analysis of Financial Condition and Results of
Operations". These forward-looking statements reflect management's analysis as
of this point in time. Readers should review the other documents the Company
periodically files with the Securities and Exchange Commission in order to keep
apprised of any material changes.
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
7
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 June 30, 2005 and
December 31, 2004 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 2005 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ - $ - $ - $ -
U.S. Agency securities 65,429 38 396 65,071
Mortgage-backed securities 54,794 94 172 54,716
States & political subdivisions 20,693 827 - 21,520
- --------------------------------------------------------------------------------
Total Debt Securities 140,916 959 568 141,307
Equity securities 6,460 370 15 6,815
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 147,376 $ 1,329 $ 583 $ 148,122
- --------------------------------------------------------------------------------
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
June 30, 2005 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 59,540 $ 8 $ 348 $ 59,200
States & political subdivisions 29,250 2,837 - 32,087
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 88,790 $ 2,845 $ 348 $ 91,287
- --------------------------------------------------------------------------------
8
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 June 30, 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.
June 30, 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 $ - $ - $ - $ -
U.S. Agency securities 55,332 55,048 - -
After one year through five years:
U.S. Agency securities 10,097 10,023 - -
After ten years:
States & political subdivisions 20,693 21,520 29,250 32,087
- -----------------------------------------------------------------------------------------
Subtotal 86,122 86,591 29,250 32,087
Mortgage-backed securities 54,794 54,716 59,540 59,200
- -----------------------------------------------------------------------------------------
Total Debt Securities $ 140,916 $ 141,307 $ 88,790 $ 91,287
- -----------------------------------------------------------------------------------------
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 June 30, 2005 and
December 31, 2004 are as follows:
Less than twelve months Twelve months or more Totals
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
June 30, 2005 Value Losses Value Losses Value Losses
- ------------------------------------------------------ -------------------------- --------------------------
U.S. Agency securities $ 35,112 $ 235 $ 19,919 $ 161 $ 55,031 $ 396
Mortgage-backed securities 34,893 136 68,457 384 103,350 520
Equities 790 15 - - 790 15
-------------------------- -------------------------- --------------------------
Total $ 70,795 $ 386 $ 88,376 $ 545 $ 159,171 $ 931
========================== ========================== ==========================
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
========================== ========================== ==========================
9
The above table at June 30, 2005, includes sixteen (16) securities that have
unrealized losses for less than twelve months and six (6) 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 June 30, 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 June 30,
2005.
Marketable Equity Securities
The unrealized losses on the Company's investment in marketable equity
securities were caused primarily by recent interest rate increases and other
market conditions. The Company's investments in marketable equity securities
consist primarily of investments in common stock of companies in the financial
services industry. Because the Company has the ability and intent to hold these
investments for a reasonable period of time sufficient for a forecasted recovery
of fair value, the Company does not consider these investments to be
other-than-temporarily impaired at June 30, 2005.
NOTE 5 -- Loan Portfolio
Details regarding the Company's loan portfolio:
June 30, December 31,
As Of: 2005 2004
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 9,114 $ 6,805
Real estate mortgages 205,026 196,149
Commercial 43,131 41,560
Credit card and related plans 2,945 2,872
Installment 26,054 25,679
Obligations of states & political subdivisions 8,206 7,111
- --------------------------------------------------------------------------------
Loans, net of unearned income 294,476 280,176
Less: Allowance for loan losses 3,722 3,600
- --------------------------------------------------------------------------------
Loans, net $ 290,754 $ 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
10
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 June 30, 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. $ 5,102
Note payable, due in monthly installments of $253, including
principal and interest at a fixed rate of 3.22%, maturing March, 2010. 13,353
Note payable, due in monthly installments of $430, including
principal and interest at a fixed rate of 3.74%, maturing March, 2013. 34,674
Note payable, due in monthly installments of $186, including
principal and interest at a fixed rate of 4.69%, maturing March, 2023. 26,922
--------
Total long-term debt $ 80,051
========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at June 30, 2005 are as follows:
June 30, Principal
--------- ---------
2006 $ 9,382
2007 9,716
2008 9,579
2009 8,455
2010 8,011
Thereafter 34,908
---------
$ 80,051
=========
NOTE 8 -- Employee Benefit Plans
The components of the net periodic benefit costs are as follows:
Pension Benefits Other Benefits
------------------ -----------------
Six months ended June 30, 2005 2004 2005 2004
- -----------------------------------------------------------------------------
Service cost $ 208 $ 195 $ 2 $ 1
Interest cost 336 329 4 4
Expected return on plan assets (378) (350) - -
Amortization of prior service cost - - 2 2
Amortization of net (gain) loss 54 64 - -
- -----------------------------------------------------------------------------
Net periodic pension cost $ 220 $ 238 $ 8 $ 7
- -----------------------------------------------------------------------------
11
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 July 15, 2005, $188 has been
contributed to the pension 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 June 30, 2005, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of June 30, 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 June 30, 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.
12
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of June 30, 2005 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 66,360 19.33% > $ 27,470 > 8.0% > $ 34,337 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 62,638 18.24% > $ 13,735 > 4.0% > $ 20,602 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 62,638 11.04% > $ * > * > $ 28,372 > 5.0%
- - - -
*3.0% ($17,023), 4.0% ($22,698) or 5.0% ($28,372) 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.
13
PART 1. FINANCIAL INFORMATION, Item 2 --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following commentary provides an overview of the financial condition and
significant changes in the results of operations of Penseco Financial Services
Corporation and its subsidiary, Penn Security Bank and Trust Company, for the
three months ended June 30, 2005 and June 30, 2004 and for the six months ended
June 30, 2005 and June 30, 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 for
the three months ended June 30, 2005 of $157 or 11.5% to $1,520 or $.71 per
share compared with $1,363 or $.64 per share from the year ago period. Net
interest income after provision for loan losses increased $528 or 12.1%, to
$4,888 for the three months ended June 30, 2005 compared to $4,360, for the same
quarter of 2004. Largely, the increase resulted from higher interest on loans
($4,516 compared with $3,192 last year, a gain of 41.5%) due to increases in
interest rates as well as an increase in net loans of $42.3 million or 17.1%.
Interest on investments declined by $715 or 23.6%.
Other income increased 6.0% or $120 to $2,126 for the three months ended June
30, 2005 compared with $2,006 for the similar period of 2004. Trust income
increased $40 or 12.4% from new business and market value increases. Merchant
transaction income increased $86 or 8.9% due to increased transaction volume.
Other operating income increased $25 or 16.2% due to gains on the sale of
foreclosed properties. Offsetting these increases was a reduction of service
charge income on deposit accounts of $31 or 11.6%. Other expenses increased $270
or 5.6% mainly due
14
to higher other operating expenses of $180 or 15.6% due mostly to increased
professional fees. Applicable income taxes increased $221 due to higher income
along with lower tax-free income.
For the six months ended June 30, 2005, net income increased $258 or 10.3% to
$2,766 or $1.29 per share compared with the year ago period of $2,508 or $1.17
per share. Net interest income after provision for loan losses increased $905 or
10.6% to $9,463 for the first half of 2005 from $8,558 for the same period of
2004 even though the loan loss provision for the first six months of 2005 was
$101 more than for the same period of 2004. Largely, the increase came from
higher interest on loans of $2,319 or 36.5%, as net loans increased $42.3
million along with the effect of interest rate increases. Interest on
investments declined by $1,236 or 20.6%. Other income was relatively unchanged.
Total other expenses increased $361 or 3.6% mainly due to higher fees for
professional services. Applicable income taxes increased $338 due to higher
income along 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. Average earning assets are composed primarily of
loans and investments while deposits, short-term and long-term borrowings
represent interest-bearing liabilities. Variations in the volume and mix of
these assets and liabilities, as well as changes in the yields earned and rates
paid, are determinants of changes in net interest income.
Net interest income after provision for loan losses increased $528 or 12.1% to
$4,888 for the three months ended June 30, 2005 compared to $4,360 for the three
months ended June 30, 2004. The average yield on earning assets increased 66
basis points, largely due to the growth in our loan portfolio, of $44.2 million
from the comparable period of 2004.
The net interest margin represents the Company's net yield on its average
earning assets and is calculated as net interest income divided by average
earning assets. In the three months ended June 30, 2005, net interest margin was
3.59% increasing 49 basis points from 3.10% in the same period of 2004.
Total average earning assets and average interest bearing funds decreased in the
three months ended June 30, 2005 as compared to 2004. Average earning assets
decreased $18.5 million or 3.3%, from $562.4 million in 2004 to $543.9 million
in 2005 and average interest bearing funds decreased $22.9 million, or 5.2%,
from $438.0 million to $415.1 million for the same period, mainly due to lower
time-deposit savings. As a percentage of average assets, earning assets
increased to 96.5% for the three months ended June 30, 2005 from 96.4% 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 ended June 30, 2005 and 2004. Average loans
as a percentage of average earning assets increased from 44.3% in 2004 to 54.0%
in 2005, due in part to the increase of new and refinanced mortgages as well as
commercial loans; average investments decreased $69.2 million from 53.6% to
42.7%. Average short-term investments, federal funds sold and interest bearing
balances with banks increased $6.5 million to $18.2 from $11.7 and also
increased as a percentage of average earning assets from 2.1% in 2004 to 3.3% in
2005. Average time deposits decreased $13.3 million or 10.7% from 28.4% of
interest bearing liabilities in 2004 to 26.8% in 2005. Average short-term
borrowings, long-term borrowings and repurchase agreements decreased $5.0.
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 12 basis points from 4.68% in the
three months ended June 30, 2004 to 4.56% for 2005. Also, average loan yields
increased 103 basis points, from 5.12% in the three months ended June 30, 2004
to 6.15% in 2005.
The average time deposit costs increased 57 basis points from 2.23% in 2004 to
2.80% in 2005, along with money market accounts increasing 66 basis points from
..71% in 2004 to 1.37% in 2005.
The most significant change in net interest income has been the growth in our
average loan portfolio of $44.2 million mostly in commercial and real estate
loans which will have a significant positive impact on our net interest margin.
15
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 June
30, 2005 and June 30, 2004.
- ----------------------------------------------------------------------------------------------------------
June 30, 2005 June 30, 2004
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 2,320 $ 43 7.41% $ 5,300 $ 85 6.42%
U.S. Agency obligations 113,078 892 3.16% 135,368 1,105 3.27%
States & political subdivisions 20,997 237 6.84% 48,843 571 7.09%
Federal Home Loan Bank stock 4,966 48 3.87% 5,831 25 1.72%
Other 633 3 1.90% 527 2 1.52%
Held-to-maturity:
U.S. Agency obligations 60,992 687 4.51% 76,275 858 4.50%
States & political subdivisions 29,250 406 8.41% 29,249 385 7.98%
Loans, net of unearned income:
Real estate mortgages 212,429 3,199 6.02% 180,327 2,328 5.16%
Commercial 44,055 673 6.11% 34,986 420 4.80%
Consumer and other 37,021 644 6.96% 33,999 444 5.22%
Federal funds sold 9,365 63 2.69% 2,333 6 1.03%
Interest on balances with banks 8,798 57 2.59% 9,367 21 0.90%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income 543,904 $ 6,952 5.11% 562,405 $ 6,250 4.45%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 8,847 8,661
Bank premises and equipment 9,052 9,682
Accrued interest receivable 2,957 3,208
Other assets 2,879 3,069
Less: Allowance for loan losses 3,733 3,500
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 563,906 $ 583,525
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 33,664 $ 46 0.55% $ 31,262 $ 26 0.33%
Savings 80,661 70 0.35% 82,317 102 0.50%
Money markets 83,440 285 1.37% 88,902 158 0.71%
Time - Over $100 24,847 178 2.87% 29,419 167 2.27%
Time - Other 86,364 601 2.78% 95,076 526 2.21%
Federal funds purchased - - - - - -
Repurchase agreements 24,831 89 1.43% 20,437 37 0.72%
Short-term borrowings 230 2 3.48% 553 1 0.72%
Long-term borrowings 81,053 793 3.91% 90,078 870 3.86%
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 415,090 $ 2,064 1.99% 438,044 $ 1,887 1.72%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 85,344 80,933
All other liabilities 843 2,340
Stockholders' equity 62,629 62,208
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 563,906 $ 583,525
- ----------------------------------------------------------------------------------------------------------
Interest Spread 3.12% 2.73%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,888 $ 4,363
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.59% 3.10%
Return on average assets 1.08% 0.93%
Return on average equity 9.71% 8.76%
Average equity to average assets 11.11% 10.66%
Dividend payout ratio 46.48% 46.88%
- ----------------------------------------------------------------------------------------------------------
16
Net interest income after provision for loan losses increased $905 or 10.6% to
$9,463 for the first half of 2005 compared to $8,558 for the first half of 2004.
The average yield on earning assets increased 56 basis points, largely due to
the growth in our average loan portfolio of $42.7 million from the similar
period of 2004.
The net interest margin represents the Company's net yield on its average
earning assets and is calculated as net interest income divided by average
earning assets. In the first six months of 2005, net interest margin was 3.50%
increasing 46 basis points from 3.04% in the same period of 2004.
Total average earning assets and average interest bearing funds decreased in the
first half of 2005 as compared to 2004. Average earning assets decreased $15.9
million or 2.8%, from $563.7 million in 2004 to $547.8 million in 2005 and
average interest bearing funds decreased $20.8 million, or 4.7%, from $439.6
million to $418.8 million for the same period. As a percentage of average
assets, earning assets increased to 96.5% for the first half of 2005 from 96.4%
for the year ago period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the first half of 2005 and 2004. Average loans as a
percentage of average earning assets increased from 43.8% in 2004 to 52.9% in
2004, due in part to the increase of new and refinanced mortgages as well as
commercial loans. Average investments decreased $55.6 million from 53.0% to
44.4%. Average short-term investments, federal funds sold and interest bearing
balances with banks decreased $3.1 million to $14.7 from $17.8 and also
decreased as a percentage of average earning assets from 3.2% in 2004 to 2.7% in
2005. Average time deposits decreased $14.7 million or 11.7% from 28.6% of
interest bearing liabilities in 2004 to 26.5% in 2005. Average short-term
borrowings, long-term borrowings and repurchase agreements decreased $5.2,
however remained the same 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 13 basis points from 4.61% for the
first half of 2004 to 4.48% for 2005. Also, average loan yields increased 84
basis points, from 5.14% for the first half of 2004 to 5.98% in 2005.
The average time deposit costs increased 40 basis points from 2.28% in 2004 to
2.68% in 2005, along with money market accounts increasing 52 basis points from
..71% in 2004 to 1.23% in 2005.
The most significant change in net interest income has been the growth of our
loan portfolio due to the refinancing of fixed-rate real estate loans and
commercial loans which will have a significant positive impact on the net
interest margin.
17
Distribution of Assets, Liabilities and Stockholders' Equity / Interest Rates
and Interest Differential
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the six months ended June
30, 2005 and June 30, 2004.
- ----------------------------------------------------------------------------------------------------------
June 30, 2005 June 30, 2004
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 3,698 $ 127 6.87% $ 7,262 $ 200 5.51%
U.S. Agency obligations 115,780 1,809 3.12% 135,566 2,228 3.29%
States & political subdivisions 26,213 534 6.17% 41,160 932 6.86%
Federal Home Loan Bank stock 5,066 79 3.12% 5,624 43 1.53%
Other 647 7 2.16% 522 8 3.07%
Held-to-maturity:
U.S. Agency obligations 62,591 1,396 4.46% 79,344 1,785 4.50%
States & political subdivisions 29,250 803 8.32% 29,318 795 8.22%
Loans, net of unearned income:
Real estate mortgages 209,679 6,220 5.93% 178,710 4,657 5.21%
Commercial 43,477 1,288 5.92% 34,016 809 4.76%
Consumer and other 36,687 1,159 6.32% 34,408 882 5.13%
Federal funds sold 6,687 86 2.57% 8,982 43 0.96%
Interest on balances with banks 8,031 94 2.34% 8,792 37 0.84%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income $ 547,806 13,602 4.97% $ 563,704 12,419 4.41%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 8,369 8,455
Bank premises and equipment 9,116 9,774
Accrued interest receivable 2,895 3,062
Other assets 2,923 3,093
Less: Allowance for loan losses 3,664 3,498
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 567,445 $ 584,590
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 32,442 $ 79 0.49% $ 30,726 $ 51 0.33%
Savings 80,380 138 0.34% 81,394 201 0.49%
Money markets 87,449 538 1.23% 88,923 315 0.71%
Time - Over $100 24,494 340 2.78% 29,462 337 2.29%
Time - Other 86,367 1,148 2.66% 96,168 1,096 2.28%
Federal funds purchased - - - - - -
Repurchase agreements 25,119 164 1.31% 21,278 78 0.73%
Short-term borrowings 356 6 3.37% 451 2 0.89%
Long-term borrowings 82,224 1,604 3.90% 91,182 1,760 3.86%
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 418,831 $ 4,017 1.92% 439,584 $ 3,840 1.75%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 84,738 81,163
All other liabilities 1,158 2,196
Stockholders' equity 62,718 61,647
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 567,445 $ 584,590
- ----------------------------------------------------------------------------------------------------------
Interest Spread 3.05% 2.66%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 9,585 $ 8,579
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.50% 3.04%
Return on average assets 0.97% 0.86%
Return on average equity 8.82% 8.14%
Average equity to average assets 11.05% 10.55%
Dividend payout ratio 51.16% 51.28%
- ----------------------------------------------------------------------------------------------------------
18
Investments
The Company's investment portfolio consists primarily of two functions: To
provide liquidity and to contribute to earnings. To provide liquidity the
Company may invest in short-term securities such as Federal funds sold, interest
bearing deposits with banks, U.S. Treasury securities and U.S. Agency securities
all with maturities of one year or less. These funds are invested short-term to
ensure the availability of funds to meet customer demand for credit needs. The
Company enhances interest income by securing long-term investments within its
investment portfolio, by means of U.S. Treasury securities, U.S. Agency
securities, municipal securities and mortgage-backed securities generally with
maturities greater than one year.
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 June 30, 2005, the provision for loan losses
decreased to $0 from $3 in the three months ended June 30, 2004. Loans charged
off totaled $26 and recoveries were $48 for the three months ended June 30,
2005. In the same period of 2004, loans charged off were $7 and recoveries were
$4. In the first half of 2005, the provision for loan losses was $122, an
increase from $21 in the first six months of 2004. Loans charged-off totaled $50
and recoveries of $50 for the six months ended June 30, 2005. In the same period
of 2004 loans charged off were $28, offset by recoveries of $7. At June 30, 2005
the allowance for loan losses was set at $3,722 or 1.26% of loans based upon the
bank's analysis.
19
Other Income
The following table sets forth information by category of other income for the
Company for three months ended June 30, 2005 and June 30, 2004, respectively:
June 30, June 30,
Three Months Ended: 2005 2004
- -----------------------------------------------------------------------
Trust department income $ 362 $ 322
Service charges on deposit accounts 237 268
Merchant transaction income 1,056 970
Other fee income 292 292
Other operating income 179 154
Realized (losses) gains on securities, net - -
- -----------------------------------------------------------------------
Total Other Income $ 2,126 $ 2,006
- -----------------------------------------------------------------------
Other income increased 6.0% or $120 to $2,126 for the three months ended June
30, 2005 compared with $2,006 for the similar period of 2004. Trust income
increased $40 or 12.4% from new business and market value increases. Service
charges on deposit accounts decreased $31 or 11.6%. Merchant transaction income
increased $86 or 8.9% due to increased transaction volume. Other operating
income increased $25 or 16.2% due to gains on the sale of foreclosed properties.
The following table sets forth information by category of other income for the
Company for six months ended June 30, 2005 and June 30, 2004, respectively:
June 30, June 30,
Six Months Ended: 2005 2004
- -----------------------------------------------------------------------
Trust department income $ 715 $ 642
Service charges on deposit accounts 461 539
Merchant transaction income 2,412 2,399
Other fee income 565 559
Other operating income 332 281
Realized gains (losses) on securities, net (13) -
- -----------------------------------------------------------------------
Total Other Income $ 4,472 $ 4,420
- -----------------------------------------------------------------------
Other income increased $52 or 1.2% to $4,472 during the first half of 2005 from
$4,420 for the same period of 2004. Trust income increased $73 or 11.4% from new
business and market value increases. Service charges on deposit accounts
decreased $78 or 14.5%. Other operating income increased $51 or 18.1% mainly
from increased collection efforts on a previously written off cash item and
gains on the sale of foreclosed properties.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended June 30, 2005 and June 30, 2004,
respectively:
June 30, June 30,
Three Months Ended: 2005 2004
- -----------------------------------------------------------------------
Salaries and employee benefits $ 2,303 $ 2,258
Expense of premises and fixed assets 593 600
Merchant transaction expenses 868 816
Other operating expenses 1,333 1,153
- -----------------------------------------------------------------------
Total Other Expenses $ 5,097 $ 4,827
- -----------------------------------------------------------------------
Total other expenses increased $270 or 5.6% to $5,097 for the first half of 2005
compared with $4,827 for the same period of 2004. Merchant transaction expense
increased by $52 or 6.4% due to higher transaction volume. Other operating
expenses increased $180 or 15.6%, mostly from increased professional fees to
comply with the Sarbanes-Oxley Act and general operating expenses.
Applicable income taxes increased $221 due to higher net income with lower
tax-free income.
20
The following table sets forth information by category of other expenses for the
Company for the six months ended June 30, 2005 and June 30, 2004, respectively:
June 30, June 30,
Six Months Ended: 2005 2004
- -----------------------------------------------------------------------
Salaries and employee benefits $ 4,596 $ 4,557
Expense of premises and fixed assets 1,268 1,281
Merchant transaction expenses 1,948 1,937
Other operating expenses 2,691 2,367
- -----------------------------------------------------------------------
Total Other Expenses $ 10,503 $ 10,142
- -----------------------------------------------------------------------
Total other expenses increased $361 or 3.6% to $10,503 during the first half of
2005 compared with $10,142 for the same period of 2004. Other operating expenses
increased $324 or 13.7% mostly from increased professional fees to comply with
the Sarbanes-Oxley Act and general operating expenses.
Applicable income taxes increased $338 due to higher income along with lower
tax-free income.
Loan Portfolio
Details regarding the Company's loan portfolio:
June 30, December 31,
As Of: 2005 2004
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 9,114 $ 6,805
Real estate mortgages 205,026 196,149
Commercial 43,131 41,560
Credit card and related plans 2,945 2,872
Installment 26,054 25,679
Obligations of states & political subdivisions 8,206 7,111
- --------------------------------------------------------------------------------
Loans, net of unearned income 294,476 280,176
Less: Allowance for loan losses 3,722 3,600
- --------------------------------------------------------------------------------
Loans, net $ 290,754 $ 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.
21
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:
June 30, December 31, June 30,
As Of: 2005 2004 2004
- ----------------------------------------------------------------------------------------
Non-accrual loans $ 1,377 $ 1,999 $ 1,918
Loans past due 90 days or more and accruing:
Guaranteed student loans 246 253 193
Credit card loans 2 5 5
- ----------------------------------------------------------------------------------------
Total non-performing loans 1,625 2,257 2,116
Other real estate owned 100 176 -
- ----------------------------------------------------------------------------------------
Total non-performing assets $ 1,725 $ 2,433 $ 2,116
- ----------------------------------------------------------------------------------------
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 $1,377 and $1,918 at June 30, 2005 and June 30, 2004, respectively. If
interest on those loans had been accrued, such income would have been $220 and
$245 for the six months ended June 30, 2005 and June 30, 2004, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $2 and $9 for June 30, 2005 and June 30, 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
June 30, 2005 there are no significant loans as to which management has serious
doubt about their collectibility other than what is included above.
At June 30, 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.
22
Loan Loss Experience
The following tables present the Company's loan loss experience during the
periods indicated:
June 30, June 30,
Three Months Ended: 2005 2004
- -------------------------------------------------------------------------
Balance at beginning of period $ 3,700 $ 3,500
Charge-offs:
Real estate mortgages - 1
Commercial and all others - 3
Credit card and related plans 26 3
Installment loans - -
- -------------------------------------------------------------------------
Total charge-offs 26 7
- -------------------------------------------------------------------------
Recoveries:
Real estate mortgages 47 -
Commercial and all others - -
Credit card and related plans 1 2
Installment loans - 2
- -------------------------------------------------------------------------
Total recoveries 48 4
- -------------------------------------------------------------------------
Net (recoveries) charge-offs (22) 3
- -------------------------------------------------------------------------
Provision charged to operations - 3
- -------------------------------------------------------------------------
Balance at End of Period $ 3,722 $ 3,500
- -------------------------------------------------------------------------
Ratio of net (recoveries) charge-offs
to average loans outstanding (0.001%) 0.001%
- -------------------------------------------------------------------------
June 30, June 30,
Six Months Ended: 2005 2004
- -------------------------------------------------------------------------
Balance at beginning of period $ 3,600 $ 3,500
Charge-offs:
Real estate mortgages 10 -
Commercial and all others - 12
Credit card and related plans 33 13
Installment loans 7 3
- -------------------------------------------------------------------------
Total charge-offs 50 28
- -------------------------------------------------------------------------
Recoveries:
Real estate mortgages 47 3
Commercial and all others - -
Credit card and related plans 2 2
Installment loans 1 2
- -------------------------------------------------------------------------
Total recoveries 50 7
- -------------------------------------------------------------------------
Net charge-offs (recoveries) - 21
- -------------------------------------------------------------------------
Provision charged to operations 122 21
- -------------------------------------------------------------------------
Balance at End of Period $ 3,722 $ 3,500
- -------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.000% 0.009%
- -------------------------------------------------------------------------
Due to 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 1.26% at June 30, 2005
and 1.39% at June 30, 2004.
23
The allowance for loan losses is allocated as follows:
As Of: June 30, 2005 December 31, 2004 June 30, 2004
- ------------------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- ------------------------------------------------------------------------------------------
Real estate mortgages $ 1,100 73% $ 1,100 72% $ 1,100 73%
Commercial and all others 2,192 15% 2,070 18% 1,975 16%
Credit card and related plans 180 1% 180 1% 175 1%
Personal installment loans 250 11% 250 9% 250 10%
- ------------------------------------------------------------------------------------------
Total $ 3,722 100% $ 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 bond portfolio, 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 $177,327 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.
24
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 19.33% at June 30, 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.
The Company has calculated its public float again as of June 30, 2005 and
determined that it is subject to the accelerated filing rules for the fiscal
year 2005. The 2005 Annual Report on Form 10-K will be required to be filed
within 60 days of December 31, 2005. In addition, as 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 has
caused 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 has spent an enormous amount of time
documenting the internal control processes within the Company utilizing outside
consultants to coordinate the planning and documentation phases of this project.
Although not subject to the accelerated filing dates until December 31, 2005,
the Company intends to file its quarterly reports this year within 40 days of
the end of each quarter and filed its 2004 Form 10K within 75 days of year-end.
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. The
Company continues to evaluate its mix of assets and liabilities in response to
the changing economy.
25
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
June 30, 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
The Annual Meeting of Shareholders of Penseco Financial Services
Corporation was held on May 3, 2005.
The results of the items submitted for a vote are as follows:
The following three Directors, whose term will expire in 2009, were
elected:
number of votes number of votes number of
cast for director cast against director votes not cast
----------------- --------------------- --------------
Richard E. Grimm 1,936,383 65,890 145,727
James B. Nicholas 1,965,317 36,956 145,727
Sandra C. Phillips 1,986,115 16,158 145,727
Item 5 -- Other Information
None.
26
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 /s/ RICHARD E. GRIMM
------------------------------
Richard E. Grimm
Executive Vice-President
Dated: August 3, 2005
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: August 3, 2005
27