Exhibit 13
Financial Highlights
--------------------
In thousands, except per share amounts 2005 2004 2003
- --------------------------------------------------------------------------------
Earnings per share $ 2.73 $ 2.61 $ 2.78
Dividends per share $ 1.44 $ 1.35 $ 1.35
Total Capital $ 63,799 $ 62,376 $ 60,807
Total Deposits $ 397,867 $ 395,301 $ 407,944
Total Assets $ 575,688 $ 563,708 $ 584,590
Contents
--------
Management's Letter............................................................2
Board of Directors.............................................................3
Promotions and Appointments....................................................4
Community Projects and Sponsorships............................................5
Business.......................................................................6
Properties.....................................................................7
Investor Information...........................................................8
Selected Financial Data........................................................9
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................................10
Management's Report on Internal Control Over Financial Reporting..............21
Reports of Independent Registered Public Accounting Firm......................22
Financial Statements and Supplementary Data...................................25
Consolidated Balance Sheets...............................................25
Consolidated Statements of Income.........................................26
Consolidated Statements of Stockholders' Equity...........................27
Consolidated Statements of Cash Flows.....................................28
General Notes to Financial Statements.........................................29
Executive Officers............................................................41
Company Officers..............................................................42
Company Board Members.........................................................43
Customer Services.............................................................44
Penseco Financial Services Corporation / 2005 Annual Report 1
Management's Letter
-------------------
Dear Shareholder:
This past year was one of significant progress for Penseco Financial Services
Corporation. Total earnings increased 4.8%, with core earnings from operations
increasing a healthy 9.6%. Loans grew 14.8% in 2005 while asset quality remained
strong, as we continued to emphasize a strong risk management process.
Earnings for the twelve months ended December 31, 2005 increased $268,000
or 4.8% to $5,869,000 compared to $5,601,000 for the twelve months ended
December 31, 2004. Corresponding earnings per share increased to $2.73 for 2005
compared to $2.61 for 2004. Core after-tax earnings from operations (excluding
one-time security gains of $357,000 in 2004 and losses of $13,000 in 2005)
increased $513,000 or 9.6% in 2005.
The major component of our increased earnings was an increase in net
interest income to $19.6 million in 2005 from $17.8 million for 2004. This 10.1%
increase in net interest income, and the corresponding increase in our tax
equivalent percentage margin to 3.57% in 2005 from 3.18% in 2004, was driven by
an increase in net loans to $317.6 million at year end 2005. This marked the
second consecutive year of double digit loan growth. Loan growth in 2005 was
primarily in our residential real estate portfolio.
Asset quality continues to be strong. Provision for loan losses in 2005
ended at $3.8 million or 1.2% of total loans compared to $3.6 million or 1.3% in
2004. Net charge offs as a percentage of average loans were .02% in both 2005
and 2004. Given the historical performance of our loan portfolio and our low
levels of charge offs, management feels the level of loan loss reserve is
adequate.
Penseco dedicated significant resources during 2005 to the implementation
of Section 404 of the Sarbanes-Oxley Act. Section 404 requires management to
establish a series of documented internal controls. Our independent auditors
then test the effectiveness of these controls. Both management and the
independent auditors' attestations to the effectiveness of these controls are
contained in this annual report.
In June of 2005, Penseco contracted with Information Technology, Inc. to
provide state of the art application software to run on our existing IBM AS400
platform. The conversion to the new software is occurring during the first
quarter of 2006 and will provide efficiencies that will enable us to keep our
customer service fees low, greatly reduce account opening time and provide a
much improved internet banking and bill payment product.
In July, our Board of Directors appointed Penseco Financial Service
Corporation's first Nominating and Corporate Governance Committee. The Committee
is comprised of independent directors and is charged with developing effective
Corporate Governance procedures for our company. Our Boards' commitment to
strong corporate governance will help ensure continued confidence in your
investment in the company.
As you know, our President and CEO, Otto P. Robinson, Jr., had announced
his intentions to retire at the end of 2005. Mr. Robinson had been President and
CEO of our company for the last 30 years. During that time, our company has
thrived as one of the strongest financial institutions under $1.0 billion in
assets in the country. Our shareholders, employees and customers are greatly
appreciative for his 30 years of leadership and dedication to our organization.
Mr. Robinson will continue to serve as a member of our Board of Directors.
The past year's successes are attributed to the hard work of our employees.
During the year, the following employees were promoted and appointed: Melissa
McLain was named Assistant Branch Operations Officer of the Mount Pocono Office;
Sheila Caprario was named Branch Operations Officer of the East Stroudsburg
Office; Paul J. Macknosky, III was appointed Trust Investment Officer. We are
pleased to announce that George F. Edwards, Jr., a long time resident and
businessman in the borough of Moscow, was named to the Advisory Board of our
North Pocono Office.
As we transition into 2006, our emphasis will be on improving our
competitive position in our primary markets in an effort to grow our balance
sheet, increase revenues and improve earnings for the years ahead.
Sincerely yours,
Craig W. Best, President and CEO and D. William Hume, Chairman of the Board
2 Penseco Financial Services Corporation / 2005 Annual Report
Board of Directors
------------------
This page of the 2005 Annual Report to Shareholders contains one picture. A
description of the picture follows:
Seated left to right:
Emily S. Perry, Edwin J. Butler, P. Frank Kozik, Secretary, D. William Hume,
Chairman of the Board, Craig W. Best, President and CEO, Attorney Otto P.
Robinson, Jr., Russell C. Hazelton, and Sandra C. Phillips
Standing left to right:
Robert W. Naismith, Ph.D., James B. Nicholas, Richard E. Grimm, Executive
Vice-President and Treasurer, Steven L. Weinberger, and James G. Keisling
Penseco Financial Services Corporation / 2005 Annual Report 3
Promotions & Appointments
-------------------------
This page of the 2005 Annual Report to Shareholders contains six pictures. A
description of each picture follows, starting at the top, from left to right:
Craig W. Best
President and CEO
D. William Hume
Chairman of the Board
George F. Edwards, Jr.
North Pocono Advisory Board
Sheila Caprario
Branch Operations Officer
Paul J. Macknosky III
Trust Investment Officer
Melissa McLain
Assistant Branch Operations Officer
4 Penseco Financial Services Corporation / 2005 Annual Report
Community Projects and Sponsorships
-----------------------------------
This page depicts the Company's involvement in Community Events.
Penseco Financial Services Corporation / 2005 Annual Report 5
PENSECO FINANCIAL SERVICES CORPORATION
Business
GENERAL
PENSECO FINANCIAL SERVICES CORPORATION, (the "Company"), which is headquartered
in Scranton, Pennsylvania, was formed under the general corporation laws of the
State of Pennsylvania in 1997 and is registered as a financial holding company.
The Company became a holding company upon the acquisition of all of the
outstanding shares of Penn Security Bank and Trust Company (the "Bank"), a
state-chartered bank, on December 31, 1997. The Company is subject to
supervision by the Federal Reserve Board. The Bank, as a state-chartered
financial institution, is subject to supervision, regulation and examination by
the Federal Deposit Insurance Corporation and the Pennsylvania Department of
Banking.
The Company's principal banking office is located at 150 North Washington
Avenue, Scranton, Pennsylvania, containing trust, investor services, marketing,
audit, credit card, human resources, executive, data processing and central
bookkeeping offices. There are eight additional offices.
Through its banking subsidiary, the Company generates interest income from
its outstanding loans receivable and its investment portfolio. Other income is
generated primarily from merchant transaction fees, trust fees and service
charges on deposit accounts. The Company's primary costs are interest paid on
deposits and borrowings and general operating expenses. The Bank provides a
variety of commercial and retail banking services to business and professional
customers, as well as retail customers, on a personalized basis. The Bank's
primary lending products are real estate, commercial and consumer loans. The
Bank also offers ATM access, credit cards, active investment accounts, trust
department services and other various lending, depository and related financial
services. The Bank's primary deposit products are savings and demand deposit
accounts and certificates of deposit. The Company also offers collateralized
repurchase agreements, that have a one day maturity, as an alternative deposit
option for its customers.
The Bank has a third party marketing agreement with National Financial
Services (formerly Fiserv Investor Services, Inc.) that allows the bank to offer
a full range of securities, brokerage and annuity sales to its customers. The
Investor Services division is located in the headquarters building and the
services are offered throughout the entire branch system.
The Company is not dependent upon a single customer, or a few customers,
the loss of one or more of which would have a material adverse effect on its
operations. The operations and earnings of the Corporation are not materially
affected by seasonal changes or by Federal, state or local environmental laws or
regulations.
COMPETITION
The Bank operates in a competitive environment in which it must share its market
with many local independent banks as well as several banks which are affiliates
or branches of very large regional holding companies. The Bank encounters
competition from diversified financial institutions, ranging in size from small
banks to the nationwide banks operating in its region. The competition includes
commercial banks, savings and loan associations, credit unions, other lending
institutions and mortgage originators.
The principal competitive factors among the Bank's competitors can be
grouped into two categories: pricing and services. In the Bank's primary service
area, interest rates on deposits, especially time deposits, and interest rates
and fees charged to customers on loans are very competitive. From a service
perspective, the Bank competes in areas such as convenience of location, types
of services, service costs and banking hours.
6 Penseco Financial Services Corporation / 2005 Annual Report
EMPLOYEES
As of December 31, 2005, the Company employed 189 full-time equivalent
employees. The employees of the Company are not represented by any collective
bargaining group. Management of the Company considers relations with its
employees to be good.
SUPERVISION AND REGULATION
The Company is registered as a bank holding company under the Bank Holding
Company Act of 1956, as amended, and, as such, is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board" or "FRB"). The Company is required to file quarterly reports of
its operations with the FRB.
As a financial holding company, the Company is permitted to engage in
banking-related activities as authorized by the Federal Reserve Board, directly
or through subsidiaries or by acquiring companies already established in such
activities subject to the FRB regulations relating to those activities.
The Bank, as a Pennsylvania state-chartered financial institution, is
subject to supervision, regulation and examination by the Commonwealth of
Pennsylvania Department of Banking and by the Federal Deposit Insurance
Corporation (the "FDIC"), which insures the Bank's deposits to the maximum
extent permitted by law.
FORWARD LOOKING INFORMATION
This Form 10-K 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 risks 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.
Properties
There are nine offices positioned throughout the greater Northeastern
Pennsylvania region. They are located in the South Scranton, East Scranton,
Green Ridge, and Central City sections of Scranton, the Borough of Moscow, the
Town of Gouldsboro, South Abington Township, the Borough of Mount Pocono and the
Borough of East Stroudsburg at Eagle Valley Corners. Through these offices, the
Company provides a full range of banking and trust services primarily to
Lackawanna, Wayne, Monroe and the surrounding counties. All offices are owned by
the Bank or through a wholly owned subsidiary of the Bank, Penseco Realty, Inc.,
with the exception of the Mount Pocono Office, which is owned by the Bank but is
located on land occupied under a long-term lease. The Company also owns property
in the Borough of Dalton, Lackawanna County, to use for potential future
expansion.
The principal office, located at the corner of North Washington Avenue and
Spruce Street in the "Central City" of Scranton's business district, houses the
operations, trust, investor services, marketing, credit card and audit
departments as well as the Company's executive offices. Several remote ATM
locations are leased by the Bank, which are located throughout Northeastern
Pennsylvania. All branches and ATM locations are equipped with closed circuit
television monitoring.
Penseco Financial Services Corporation / 2005 Annual Report 7
Investor Information
Stockholders may obtain, without charge, a copy of the Company's Form 10-K by
writing to the Controller's office or accessing the Company's website at
www.pennsecurity.com. Questions may be directed to any branch location of the
Company or by contacting the Controller's office at:
Patrick Scanlon, Controller
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, Pennsylvania 18503-1848
1-800-327-0394
Management of the Company is aware of the following securities dealers who make
a market in the Company stock:
Archipelago Trading Services, Inc. Knight Equity Markets, LP
Boenning & Scattergood, Inc. Monroe Securities, Inc.
Ferris, Baker, Watts, Inc. Ryan, Beck & Company, Inc.
Hill Thompson Magid & Company, Inc. UBS Capital Markets, LP
Jefferies & Company, Inc.
The Company's capital stock is traded on the "Over-the-Counter" BULLETIN BOARD
under the symbol "PFNS". The following table sets forth the price range together
with dividends paid for each of the past two years. These quotations do not
necessarily reflect the value of actual transactions.
Dividends Paid
2005 High Low Per Share
- ---------------------------------------------
First Quarter $ 41 $ 41 $ .33
Second Quarter 47 42 .33
Third Quarter 44 41 .33
Fourth Quarter 43 41 .45
------
$ 1.44
======
Dividends Paid
2004 High Low Per Share
- ---------------------------------------------
First Quarter $ 41 $ 38 $ .30
Second Quarter 41 35 .30
Third Quarter 41 34 .30
Fourth Quarter 42 40 .45
------
$ 1.35
======
A graph depicts Dividends Paid (in millions) Year
- -----------------------------------------------------------
$ 3,094 2005
2,900 2004
2,900 2003
2,899 2002
2,685 2001
As of February 10, 2006 there were approximately 921 stockholders of the Company
based on the number of holders of record.
Reference should be made to the information about the Company's dividend policy
and regulatory guidelines on pages 17 and 39.
TRANSFER AGENT
Penn Security Bank and Trust Company, Trust Department, 150 North Washington
Avenue, Scranton, Pennsylvania 18503-1848. Stockholders' questions should be
directed to the Bank's Trust Department at 570-346-7741.
QUARTERLY FINANCIAL AMOUNTS (unaudited)
(in thousands, except per share amounts)
First Second Third Fourth
2005 Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------
Net Interest Income $ 4,697 $ 4,888 $ 4,960 $ 5,045
Provision for Loan Losses 122 - - 141
Other Income 2,346 2,126 2,564 1,838
Other Expenses and Taxes 5,675 5,494 5,827 5,336
Net Income 1,246 1,520 1,697 1,406
Earnings Per Share $ 0.58 $ 0.71 $ 0.79 $ 0.65
First Second Third Fourth
2004 Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------
Net Interest Income $ 4,216 $ 4,363 $ 4,591 $ 4,636
Provision for Loan Losses 18 3 114 9
Other Income 2,414 2,006 2,830 2,344
Other Expenses and Taxes 5,467 5,003 5,692 5,493
Net Income 1,145 1,363 1,615 1,478
Earnings Per Share $ 0.53 $ 0.64 $ 0.75 $ 0.69
8 Penseco Financial Services Corporation / 2005 Annual Report
Selected Financial Data
(in thousands, except per share amounts)
RESULTS OF OPERATIONS:
2005 2004 2003 2002 2001
- ---------------------------------------------------------------------------------------------
Interest Income $ 28,170 $ 25,385 $ 26,014 $ 27,899 $ 31,860
Interest Expense 8,580 7,579 8,228 8,011 12,524
- ---------------------------------------------------------------------------------------------
Net Interest Income 19,590 17,806 17,786 19,888 19,336
Provision for Loan Losses 263 144 476 813 954
- ---------------------------------------------------------------------------------------------
Net Interest Income after
Provision for Loan Losses 19,327 17,662 17,310 19,075 18,382
Other Income 8,874 9,594 10,743 11,032 9,186
Other Expenses 20,719 20,584 20,454 21,098 20,077
Income Taxes 1,613 1,071 1,628 2,256 1,869
- ---------------------------------------------------------------------------------------------
Net Income $ 5,869 $ 5,601 $ 5,971 $ 6,753 $ 5,622
BALANCE SHEET AMOUNTS:
Assets $ 575,688 $ 563,708 $ 584,590 $ 496,956 $ 482,551
Investment Securities $ 229,957 $ 262,678 $ 293,125 $ 139,132 $ 128,623
Net Loans $ 317,562 $ 276,576 $ 236,882 $ 285,509 $ 320,208
Deposits $ 397,867 $ 395,301 $ 407,944 $ 414,664 $ 406,531
Long-Term Borrowings $ 75,401 $ 84,620 $ 93,523 $ - $ -
Stockholders' Equity $ 63,799 $ 62,376 $ 60,807 $ 58,975 $ 54,648
PER SHARE AMOUNTS:
Earnings per Share $ 2.73 $ 2.61 $ 2.78 $ 3.14 $ 2.62
Dividends per Share $ 1.44 $ 1.35 $ 1.35 $ 1.35 $ 1.25
Book Value per Share $ 29.70 $ 29.04 $ 28.31 $ 27.46 $ 25.44
Common Shares Outstanding 2,148,000 2,148,000 2,148,000 2,148,000 2,148,000
FINANCIAL RATIOS:
Net Interest Margin 3.57% 3.18% 3.24% 4.21% 4.30%
Return on Average Assets 1.03% .96% 1.05% 1.37% 1.18%
Return on Average Equity 9.23% 9.11% 9.87% 11.79% 10.57%
Average Equity to Average Assets 11.19% 10.57% 10.59% 11.58% 11.19%
Dividend Payout Ratio 52.75% 51.72% 48.56% 42.99% 47.71%
Penseco Financial Services Corporation / 2005 Annual Report 9
Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion is intended to provide information to facilitate the
understanding and assessment of significant changes and trends related to the
financial condition of the Company and the results of its operations. This
discussion and analysis should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto. All information is
presented in thousands of dollars, except as indicated.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Provision (allowance) for possible loan losses - The provision for loan
losses is based on past loan loss experience, management's evaluation of the
potential loss in the current loan portfolio under current economic conditions
and such other factors as, in management's best 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.
SUMMARY
Net earnings for 2005 totalled $5,869, an increase of $268 or 4.8% from the
$5,601 earned in 2004, which was a decrease of $370 or 6.2% from the $5,971
earned in 2003. Net earnings per share were $2.73 in 2005, compared with $2.61
in 2004 and $2.78 in 2003. Core after tax earnings for 2005, excluding one time
security gains or losses, increased by $513 or 9.6% compared with 2004. Core
after tax earnings for 2004 decreased $381 or 6.6% compared with 2003. Net
earnings for 2005 increased from 2004 mainly due to higher interest income from
strong loan demand experienced during 2005. This was offset by a higher
provision for loan losses and lower non-interest income. Income taxes were
higher largely from increased operating income and lower tax-free income. Net
earnings for 2004 decreased from 2003 mainly due to the reduction of other
operating income from the sale of fixed-rate loans which peaked during the third
quarter of 2003. This was offset by a lower provision for loan losses and lower
income taxes.
The Company's return on average assets was 1.03% in 2005 compared to .96%
in 2004 and 1.05% in 2003. Return on average equity was 9.23%, 9.11% and 9.87%
in 2005, 2004 and 2003, respectively.
A graph depicts Net Income (in millions) Year
- ------------------------------------------------
$ 5,869 2005
5,601 2004
5,971 2003
6,753 2002
5,622 2001
A graph depicts Return on Average Assets Year
- ------------------------------------------------
1.03% 2005
.96% 2004
1.05% 2003
1.37% 2002
1.18% 2001
10 Penseco Financial Services Corporation / 2005 Annual Report
RESULTS OF OPERATIONS
Net Interest Income
The principal component of the Company's earnings is net interest income, which
is the difference between interest and fees earned on interest-earning assets
and interest paid on deposits and other borrowings.
Net interest income increased $1.8 million or 10.1% to $19.6 million for
2005 compared to $17.8 million for 2004. Loan income was higher overall for 2005
due to increases in the volume of new loans and interest rates. Investment
income decreased due in part to the return of principal on the Mortgage-Backed
Securities portfolio and the sale of $10 million long term fixed rate municipal
securities during the first quarter of 2005. Interest expense for 2005 increased
$1.0 million or 13.2% to $8.6 million for 2005 compared to $7.6 million in 2004.
The increase is primarily due to increases in interest rates as the Federal
Reserve continued to raise interest rates through 2005.
Net interest income for 2004 was $17.8 million, which was basically
unchanged from 2003. Loan income was lower overall for 2004 since the volume of
new loans and rate increases occurred primarily in the second half of the year.
Investment income increased due to purchases of tax-exempt securities at
favorable tax-equivalent yields. Interest expense for 2004 remained low as to
deposits, offset by an increase in long-term borrowing costs in 2004 versus
2003, since the long-term debt was not incurred until March 2003.
Net interest income, when expressed as a percentage of average
interest-earning assets, is referred to as net interest margin. The Company's
net interest margin for the year ended December 31, 2005 was 3.6% compared with
3.2% for the year ended December 31, 2004 and 3.2% for the year ended December
31, 2003.
Interest income in 2005 totalled $28.2 million, compared to $25.4 million
in 2004, an increase of $2.8 million or 11.0%. The yield on average
interest-earning assets increased to 5.1% in 2005, compared to 4.5% in 2004.
Average interest-earning assets decreased in 2005 to $548.2 million from $560.3
million in 2004. Average loans, which are typically the Company's highest
yielding earning assets, increased $41.8 million or 16.3% in 2005. Average loans
represented 54.3% of 2005 average interest-earning assets, compared to 45.7% in
2004. Income on loans increased $5.0 million or 36.8% in 2005, compared to a
decrease in loan income of $1.0 million or 6.8% during 2004. Investment
securities decreased on average by $55.1 million or 18.9% to $237.1 million
compared to $292.2 million in 2004. Income on investments declined $2.1 million
or 17.9% to $9.6 million in 2005, from $11.7 million in 2004.
The average rate paid on interest-bearing liabilities during 2005 was 2.1%,
compared to 1.7% in 2004.
Interest income in 2004 totalled $25.4 million, compared to $26.0 million
in 2003, a decrease of 2.3%. The yield on average interest-earning assets was
4.5% in 2004, compared to 4.8% in 2003. Average interest-earning assets
increased in 2004 to $560.3 million from $548.2 million in 2003. Average loans,
which are typically the Company's highest yielding earning assets, decreased
$6.4 million in 2004, while investment securities increased on average by $51.9
million. Average loans represented 45.7% of 2004 average interest-earning
assets, compared to 47.9% in 2003.
Interest expense also decreased in 2004 to $7.6 million from $8.2 million
in 2003, a decrease of $.6 million or 7.3%.
The average rate paid on interest-bearing liabilities during 2004 was 1.7%,
compared to 1.9% in 2003.
The most significant impact on net interest income between periods is derived
from the interaction of changes in the volume of and rates earned or paid on
interest-earning assets and interest-bearing liabilities. The volume of earning
dollars in loans and investments, compared to the volume of interest-bearing
liabilities represented by deposits and borrowings, combined with the spread,
produces the changes in net interest income between periods.
A graph depicts Net Interest Income (in millions) Year
- -----------------------------------------------------------
$ 19,590 2005
17,806 2004
17,786 2003
19,888 2002
19,336 2001
Penseco Financial Services Corporation / 2005 Annual Report 11
Distribution of Assets, Liabilities and Stockholders' Equity/Interest Rates and
Interest Differential
The table below presents average weekly balances, interest income on a fully
taxable equivalent basis and interest expense, as well as average rates earned
and paid on the Company's major asset and liability items for the years 2005,
2004 and 2003.
2005 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investment securities:
Available-for-sale:
U.S. Treasury securities $ 1,849 $ 7 6.87% $ 6,206 $ 370 5.96% $ 30,127 $ 1,250 4.15%
U.S. Agency obligations 116,429 3,650 3.13 133,231 4,340 3.26 79,520 3,660 4.60
States & political subdivisions 23,873 1,006 6.38 41,142 1,931 7.11 20,433 947 7.02
Federal Home Loan Bank stock 4,907 143 2.91 5,704 94 1.65 4,911 97 1.98
Other 1,765 47 2.66 549 13 2.37 435 11 2.53
Held-to-maturity:
U.S. Agency obligations 59,036 2,631 4.46 74,291 3,334 4.49 75,194 3,365 4.48
States & political subdivisions 29,250 1,610 8.34 31,103 1,545 7.53 29,730 1,621 8.26
Loans, net of unearned income:
Real estate mortgages 217,942 13,396 6.15 185,440 10,044 5.42 194,135 11,246 5.79
Commercial 42,820 2,782 6.50 36,312 1,814 5.00 31,288 1,497 4.78
Consumer and other 37,037 2,391 6.46 34,287 1,774 5.17 36,997 1,890 5.11
Federal funds sold 6,011 176 2.93 5,434 58 1.07 35,620 340 .95
Interest on balances with banks 7,302 211 2.89 6,589 68 1.03 9,781 90 .92
- -----------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets/
Total Interest Income 548,221 $ 28,170 5.14% 560,288 $ 25,385 4.53% 548,171 $ 26,014 4.75%
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks 8,961 8,732 8,760
Bank premises and equipment 9,184 9,593 9,984
Accrued interest receivable 2,967 3,225 3,144
Other assets 2,663 3,040 4,482
Less: Allowance for loan losses 3,686 3,523 3,411
- -----------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 568,310 $ 581,355 $ 571,130
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 32,821 $ 190 .58% $ 31,425 $ 115 .37% $ 28,738 $ 144 .50%
Savings 79,262 275 .35 81,812 346 .42 76,983 472 .61
Money markets 84,115 1,246 1.48 89,161 707 .79 87,973 737 .84
Time - Over $100 26,088 808 3.10 28,067 806 2.87 32,525 844 2.59
Time - Other 86,995 2,501 2.87 92,752 1,985 2.14 105,858 2,873 2.71
Repurchase agreements 27,546 415 1.51 22,817 167 .73 22,266 183 .82
Short-term borrowings 378 19 5.03 595 10 1.68 699 11 1.57
Long-term borrowings 79,919 3,126 3.91 88,955 3,443 3.87 76,401 2,964 3.88
- -----------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 417,124 $ 8,580 2.06% 435,584 $ 7,579 1.74% 431,443$ 8,228 1.91%
- -----------------------------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 86,302 82,757 76,421
All other liabilities 1,270 1,545 2,763
Stockholders' equity 63,614 61,469 60,503
- -----------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 568,310 $ 581,355 $ 571,130
Interest Spread 3.08% 2.79% 2.84%
- -----------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 19,590 $ 17,806 $ 17,786
FINANCIAL RATIOS
Net interest margin 3.57% 3.18% 3.24%
Return on average assets 1.03% .96% 1.05%
Return on average equity 9.23% 9.11% 9.87%
Average equity to average assets 11.19% 10.57% 10.59%
Dividend payout ratio 52.75% 51.72% 48.56%
12 Penseco Financial Services Corporation / 2005 Annual Report
DOLLAR AMOUNT OF CHANGE IN INTEREST INCOME AND INTEREST EXPENSE
Dollar Change
Amount Change in Change in in Rate-
2005 compared to 2004 of Change Volume Rate Volume
----------------------------------------------------------------------------------
EARNING Investment securities:
ASSETS Available-for-sale:
U.S. Treasury securities $ (243) $ (260) $ 56 $ (39)
U.S. Agency obligations (690) (548) (173) 31
States & political subdivisions (925) (810) (197) 82
Equity securities 83 7 71 5
Held-to-maturity:
U.S. Agency obligations (703) (685) (22) 4
States & political subdivisions 65 (92) 165 (8)
Loans, net of unearned income:
Real estate mortgages 3,352 1,762 1,354 236
Commercial 968 325 545 98
Consumer and other 617 142 442 33
Federal funds sold 118 6 101 11
Interest bearing balances with banks 143 7 123 13
----------------------------------------------------------------------------------
Total Interest Income 2,785 (146) 2,465 466
----------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand - Interest bearing 75 5 66 4
LIABILITIES Savings (71) (11) (57) (3)
Money markets 539 (40) 615 (36)
Time - Over $100 2 (57) 65 (6)
Time - Other 516 (123) 677 (38)
Repurchase agreements 248 35 178 35
Short-term borrowings 9 (4) 20 (7)
Long-term borrowings (317) (350) 36 (3)
----------------------------------------------------------------------------------
Total Interest Expense 1,001 (545) 1,600 (54)
----------------------------------------------------------------------------------
Net Interest Income $ 1,784 $ 399 $ 865 $ 520
==================================================================================
Dollar Change
Amount Change in Change in in Rate-
2004 compared to 2003 of Change Volume Rate Volume
----------------------------------------------------------------------------------
EARNING Investment securities:
ASSETS Available-for-sale:
U.S. Treasury securities $ (880) $ (993) $ 545 $ (432)
U.S. Agency obligations 680 2,471 (1,066) (725)
States & political subdivisions 984 959 12 13
Equity securities (1) 19 (17) (3)
Held-to-maturity:
U.S. Agency obligations (31) (40) 9 -
States & political subdivisions (76) 75 (169) 18
Loans, net of unearned income:
Real estate mortgages (1,202) (503) (718) 19
Commercial 317 240 69 8
Consumer and other (116) (138) 22 -
Federal funds sold (282) (287) 43 (38)
Interest bearing balances with banks (22) (29) 11 (4)
----------------------------------------------------------------------------------
Total Interest Income (629) 1,774 (1,259) (1,144)
----------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand - Interest bearing (29) 13 (37) (5)
LIABILITIES Savings (126) 29 (146) (9)
Money markets (30) 10 (44) 4
Time - Over $100 (38) (115) 91 (14)
Time - Other (888) (355) (603) 70
Repurchase agreements (16) 5 (20) (1)
Short-term borrowings (1) (2) 1 -
Long-term borrowings 479 487 (7) (1)
----------------------------------------------------------------------------------
Total Interest Expense (649) 72 (765) 44
----------------------------------------------------------------------------------
Net Interest Income $ 20 $ 1,702 $ (494) $(1,188)
==================================================================================
Penseco Financial Services Corporation / 2005 Annual Report 13
Provision for Loan Losses
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio.
The provision for loan losses was $263 in 2005, an increase of 82.6%
compared to $144 for 2004. The increase in the provision was due to the
Company's increased commercial loan portfolio.
The Company believes that the judgments used in establishing the Allowance
for Loan Losses are based on reliable information. In assessing the sufficiency
of the Allowance for Loan Losses, management considers, how well prior estimates
have related to actual experience. The Company continually monitors the risk
elements, historical rates and other data used in establishing the allowance on
a periodic basis. The Company has not found it necessary to change the allowance
by material amounts, which would call into question the reliability of the
judgments used in its calculation.
There are also no particular risk elements in the local economy that put a
group or category of loans at increased risk, however the Company has increased
its portfolio of commercial loans, which typically bear a higher risk. These
loans are typically secured by real estate to minimize this risk.
The process of determining the adequacy of the allowance is necessarily
judgmental and subject to changes in external conditions. Accordingly, there can
be no assurance that existing levels of the allowance will ultimately prove
adequate to cover actual loan losses.
OTHER INCOME
The following table sets forth information by category of other income for the
Company for the past three years:
Years Ended December 31, 2005 2004 2003
- --------------------------------------------------------------------------------
Trust department income $ 1,479 $ 1,353 $ 1,311
Service charges on deposit accounts 940 1,056 1,133
Merchant transaction income 4,521 5,001 5,005
Other fee income 1,575 1,650 1,630
Other operating income 372 177 1,323
Realized (losses) gains on securities, net (13) 357 341
- --------------------------------------------------------------------------------
Total Other Income $ 8,874 $ 9,594 $ 10,743
================================================================================
Other income decreased $720 or 7.5% during 2005 to $8,874 from $9,594 for 2004.
Service charge income decreased $116 or 11.0%. Merchant transaction income
declined $480 or 9.6%, mainly from lower volumes. Other fee income declined $75
or 4.5%, including reduced brokerage income of $140 or 27.5%. The Company
experienced a loss on securities of $13 in 2005 compared to a gain on securities
of $357 in 2004. Offsetting these declines were increases in trust department
income of $126 or 9.3% and other operating income of $195 or 110.2%.
Other income decreased $1,149 or 10.7% during 2004 to $9,594 from $10,743
for 2003. Service charge income decreased $77 or 6.8%. Other operating income
decreased $1,146, mostly due to a reduction of $1,083 in gains on the sale of
refinanced mortgage loans in the secondary market, which peaked during the third
quarter of 2003, while interest rates were falling. Refinancing activity slowed
as interest rates increased during 2004. Offsetting these declines were
increases in other operating income, trust income of $42 or 3.2% and brokerage
income of $85 or 20.0%, mainly from increased business.
OTHER EXPENSES
The following table sets forth information by category of other expenses for the
Company for the past three years:
Years Ended December 31, 2005 2004 2003
- --------------------------------------------------------------------------------
Salaries and employee benefits $ 9,261 $ 9,165 $ 9,010
Occupancy expenses, net 1,377 1,255 1,388
Furniture and equipment expenses 1,078 1,136 1,175
Merchant transaction expenses 3,646 4,058 4,158
Other operating expenses 5,357 4,970 4,723
- --------------------------------------------------------------------------------
Total Other Expenses $ 20,719 $ 20,584 $ 20,454
================================================================================
Other expenses increased $135 or 1% for 2005 to $20,719 from $20,584 for 2004.
Occupancy expense increased $122 or 9.7%. Other operating expenses increased
$387 or 7.8%, mainly due to increased professional services. Merchant
transaction expense declined $412 or 10.2% due to lower volumes.
Other expenses increased $130 or 1% for 2004 to $20,584 from $20,454 for
2003. Salaries and employee benefits increased $155 to $9,165 for 2004 from
$9,010 for 2003, primarily due to merit increases and health care costs. Other
operating expenses increased $247 or 5.2%, mainly due to increased professional
expenses. Occupancy expense decreased $133, largely from lower depreciation
expense.
INCOME TAXES
Federal income tax expense increased $542 or 50.6% to $1,613 in 2005 compared to
$1,071 in 2004, due to increased operating income and decreased tax-free income.
Federal income tax expense decreased $557 or 34.2% to $1,071 in 2004
compared to $1,628 in 2003, due to increased tax free income and decreased
operating income.
The Company's effective income tax rate for 2005, 2004 and 2003 was 21.6%,
16.1% and 21.4%, respectively.
The Company uses the asset and liability method of accounting for deferred
income taxes. If current available information raises doubt as to the
realization of deferred tax assets, a valuation allowance is established. The
Company evaluates the recoverability of deferred tax assets based on its ability
to generate future profits. The Company employs budgeting and periodic reporting
processes to continually monitor its progress. Historically, the Company has had
sufficient profits for recovery of deferred tax benefits.
For further discussion pertaining to Federal income taxes, see Note 14 to
the Consolidated Financial Statements.
FINANCIAL CONDITION
Total assets increased $12.0 million or 2.1% during 2005 to $575.7 million at
December 31, 2005 compared to $563.7 million at December 31, 2004. For the year
ended December 31, 2004, total assets decreased $20.9 million or 3.6% to $563.7
million compared to $584.6 million at December 31, 2003.
INVESTMENT PORTFOLIO
The Company maintains a portfolio of investment securities to provide income and
serve as a source of liquidity for its ongoing operations.
The following table presents the carrying value, by security type, for the
Company's investment portfolio:
December 31, 2005 2004 2003
- --------------------------------------------------------------------------------
U.S. Treasury securities $ - $ 5,077 $ 15,387
U.S. Agency securities 171,308 190,547 221,156
States & political subdivisions 50,887 60,789 50,228
Equity securities 7,762 6,265 6,354
- --------------------------------------------------------------------------------
Total Investment Securities $ 229,957 $ 262,678 $ 293,125
================================================================================
14 Penseco Financial Services Corporation / 2005 Annual Report
LOAN PORTFOLIO
Details regarding the Company's loan portfolio for the past five years are as
follows:
December 31, 2005 2004 2003 2002 2001
- -------------------------------------------------------------------------------------------
Real estate - construction
and land development $ 13,132 $ 6,805 $ 3,078 $ 5,031 $ 9,124
Real estate mortgages 227,853 196,149 172,964 217,883 246,486
Commercial 42,894 41,560 30,056 30,077 30,001
Credit card and related plans 3,152 2,872 2,403 2,320 2,377
Installment 26,293 25,679 25,855 27,306 30,142
Obligations of states &
political subdivisions 8,038 7,111 6,026 6,239 5,678
- -------------------------------------------------------------------------------------------
Loans, net of unearned income
321,362 280,176 240,382 288,856 323,808
Less: Allowance for loan losses 3,800 3,600 3,500 3,347 3,600
- -------------------------------------------------------------------------------------------
Loans, net $ 317,562 $ 276,576 $ 236,882 $ 285,509 $ 320,208
===========================================================================================
LOANS
Total net loans increased $41.0 million to $317.6 million at December 31, 2005
from $276.6 million at December 31, 2004, an increase of 14.8%. This increase is
mainly due to strong loan demand with a mix of fixed and variable rate loans.
Total net loans increased $39.7 million to $276.6 million at December 31,
2004 from $236.9 million at December 31, 2003, an increase of 16.8%. This
increase is mainly due to strong loan demand with a mix of fixed and variable
rate loans.
A graph depicts Net Loans (in millions) Year
- --------------------------------------------------
$ 317,562 2005
276,576 2004
236,882 2003
285,509 2002
320,208 2001
LOAN QUALITY
The lending activities of the Company are guided by the comprehensive
lending policy established by the Board of Directors. Loans must meet criteria
which include consideration of the character, capacity and capital of the
borrower, collateral provided for the loan, and prevailing economic conditions.
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.
Penseco Financial Services Corporation / 2005 Annual Report 15
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:
December 31, 2005 2004 2003 2002 2001
- ---------------------------------------------------------------------------------------------
Non-accrual loans $ 1,627 $ 1,991 $ 1,533 $ 2,245 $ 1,917
Loans past due 90 days or more and accruing:
Guaranteed student loans 152 253 169 394 304
Credit card loans 21 13 3 - 22
- ---------------------------------------------------------------------------------------------
Total non-performing loans 1,800 2,257 1,705 2,639 2,243
Other real estate owned 91 176 121 59 143
- ---------------------------------------------------------------------------------------------
Total non-performing assets $ 1,891 $ 2,433 $ 1,826 $ 2,698 $ 2,386
=============================================================================================
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 $1,627, $1,991 and $1,533 at December 31, 2005, 2004 and 2003,
respectively. If interest on those loans had been accrued, such income would
have been $264, $199 and $198 for 2005, 2004 and 2003, respectively. Interest
income on those loans, which is recorded only when received, amounted to $27,
$16 and $29 for 2005, 2004 and 2003, respectively. There are no commitments to
lend additional funds to borrowers whose loans are on 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 portfolio quality,
and current economic conditions that may affect the borrower's ability to pay.
As of December 31, 2005, there are no significant loans as to which management
has serious doubt about their collectibility.
At December 31, 2005, 2004 and 2003, 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:
Years Ended December 31, 2005 2004 2003 2002 2001
- ---------------------------------------------------------------------------------------
Balance at beginning of year $ 3,600 $ 3,500 $ 3,347 $ 3,600 $ 3,100
- ---------------------------------------------------------------------------------------
Charge-offs:
Real estate mortgages 31 - 11 91 38
Commercial and all others - 12 289 944 389
Credit card and related plans 68 34 51 44 37
Installment loans 14 7 4 22 19
- ---------------------------------------------------------------------------------------
Total charge-offs 113 53 355 1,101 483
- ---------------------------------------------------------------------------------------
Recoveries:
Real estate mortgages 46 3 24 31 20
Commercial and all others - - 6 - -
Credit card and related plans 3 2 2 1 1
Installment loans 1 4 - 3 8
- ---------------------------------------------------------------------------------------
Total recoveries 50 9 32 35 29
- ---------------------------------------------------------------------------------------
Net charge-offs 63 44 323 1,066 454
- ---------------------------------------------------------------------------------------
Provision charged to operations 263 144 476 813 954
- ---------------------------------------------------------------------------------------
Balance at End of Year $ 3,800 $ 3,600 $ 3,500 $ 3,347 $ 3,600
=======================================================================================
Ratio of net charge-offs
to average loans outstanding 0.02% 0.02% 0.12% 0.34% 0.14%
=======================================================================================
16 Penseco Financial Services Corporation / 2005 Annual Report
The allowance for loan losses is allocated as follows:
December 31, 2005 2004 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Amount %1 Amount %1 Amount %1 Amount %1 Amount %1
- ---------------------------------------------------------------------------------------------------------------
Real estate mortgages $ 1,200 75% $ 1,100 72% $ 1,100 73% $ 1,600 77% $ 1,700 79%
Commercial
and all others 2,190 16 2,070 18 1,970 15 1,222 13 1,375 11
Credit card and
related plans 185 1 180 1 180 1 175 1 175 1
Personal installment loans 225 8 250 9 250 11 350 9 350 9
- ---------------------------------------------------------------------------------------------------------------
Total $ 3,800 100% $ 3,600 100% $ 3,500 100% $ 3,347 100% $ 3,600 100%
===============================================================================================================
Note: 1 - Percent of loans in each category to total loans
DEPOSITS
The primary source of funds to support the Company's operations is its deposit
base. Company deposits increased $2.6 million to $397.9 million at December 31,
2005 from $395.3 million at December 31, 2004. Company deposits decreased $12.6
million to $395.3 million at December 31, 2004 from $407.9 million at December
31, 2003, a decrease of 3.1%, mainly due to a decrease in higher rate time
deposits.
The maturities of time deposits of $100,000 or more are as follows:
Three months or less $ 6,100
Over three months through six months 5,789
Over six months through twelve months 5,321
Over twelve months 10,914
--------
Total $ 28,124
========
A graph depicts Deposits (in millions) Year
- -----------------------------------------------
$ 397,867 2005
395,301 2004
407,944 2003
414,664 2002
406,531 2001
DIVIDEND POLICY
Payment of future dividends will be subject to the discretion of the Board of
Directors and will depend upon the earnings of the Company, its financial
condition, its capital requirements, its need for funds and other matters as the
Board deems appropriate.
Dividends on the Company common stock, if approved by the Board of
Directors, are customarily paid on or about March 15, June 15, September 15 and
December 15.
ASSET/LIABILITY MANAGEMENT
The Company's policy is to match its level of rate-sensitive assets and
rate-sensitive liabilities within a limited range, thereby reducing its exposure
to interest rate fluctuations. While no single measure can completely identify
the impact of changes in interest rates on net interest income, one gauge of
interest rate-sensitivity is to measure, over a variety of time periods, the
differences in the amounts of the Company's rate-sensitive assets and
rate-sensitive liabilities. These differences, or "gaps", provide an indication
of the extent to which net interest income may be affected by future changes in
interest rates. A positive gap exists when rate-sensitive assets exceed
rate-sensitive liabilities and indicates that a greater volume of assets than
liabilities will reprice during a given period. This mismatch may enhance
earnings in a rising interest rate environment and may inhibit earnings when
interest rates decline. Conversely, when rate-sensitive liabilities exceed
rate-sensitive assets, referred to as a negative gap, it indicates that a
greater volume of liabilities than assets may reprice during the period. In this
case, a rising interest rate environment may inhibit earnings and declining
interest rates may enhance earnings. However, because interest rates for
different asset and liability products offered by financial institutions respond
differently, the gap is only a general indicator of interest rate sensitivity.
LIQUIDITY
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
Penseco Financial Services Corporation / 2005 Annual Report 17
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Agency bond portfolios,
additional deposits, earnings, overnight loans to and from other companies
(Federal Funds) and lines of credit at the Federal Reserve Bank and the Federal
Home Loan Bank. 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 $171,053 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.
Financial instruments whose contract amounts represent credit risk at
December 31, 2005 and 2004 are as follows:
2005 2004
- --------------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 41,229 $ 21,152
Variable rate $ 75,100 $ 67,502
Standby letters of credit $ 15,268 $ 17,662
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.
The Company is upgrading its computer technology at an estimated total cost
of $1.5 million of which $.7 million has been incurred through December 31, 2005
and is included in fixed assets, but not yet placed in service. The project is
expected to be completed in the first quarter of 2006.
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 $6,545.
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 18.62% at December 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.
The following table presents Stockholders' Equity of the Company for the past
two years:
Years Ended December 31, 2005 2004
- -----------------------------------------------------------------------
Balance at beginning of year $ 62,376 $ 60,807
Net Income 5,869 5,601
Less:
Other comprehensive income 1,352 1,132
Cash dividends declared 3,094 2,900
- -----------------------------------------------------------------------
Total Stockholders' Equity $ 63,799 $ 62,376
=======================================================================
18 Penseco Financial Services Corporation / 2005 Annual Report
A graph depicts Stockholders' Equity (in millions) Year
- -----------------------------------------------------------
$ 63,799 2005
62,376 2004
60,807 2003
58,975 2002
54,648 2001
A graph depicts Return on Average Equity Year
- -----------------------------------------------------------
9.23% 2005
9.11% 2004
9.87% 2003
11.79% 2002
10.57% 2001
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk
The Company currently does not enter into derivative financial instruments,
which include futures, forwards, interest rate swaps, option contracts and other
financial instruments with similar characteristics. However, the Company is
party to traditional financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, financial guarantees
and letters of credit. These traditional instruments involve to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the Consolidated Balance Sheets. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Standby letters of credit
are conditional commitments issued to guarantee the performance of a customer to
a third party up to a stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded
as an asset or liability by the Company until the instrument is exercised.
The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximizing income. Management realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and an interest rate shock simulation report. The Company
has no market risk sensitive instruments held for trading purposes. It appears
the Company's market risk is reasonable at this time.
The following table provides information about the Company's market rate
sensitive instruments used for purposes other than trading that are sensitive to
changes in interest rates. For loans, securities, and liabilities with
contractual maturities, the table presents principal cash flows and related
weighted-average interest rates by contractual maturities as well as the
Company's historical experience of the impact of interest rate fluctuations on
the prepayment of residential and home equity loans and mortgage-backed
securities. For core deposits (e.g., DDA, interest checking, savings and money
market deposits) that have no contractual maturity, the table presents principal
cash flows and, as applicable, related weighted-average interest rates based on
the Company's historical experience, management's judgment, and statistical
analysis, as applicable, concerning their most likely withdrawal behaviors.
Penseco Financial Services Corporation / 2005 Annual Report 19
MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2005
The table below presents States and political subdivisions securities on a fully
taxable equivalent basis.
Non-Rate
2006 2007 2008 2009 2010 Thereafter Sensitive Total Fair Value
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed interest rate securities:
U.S. Treasury securities $ - $ - $ - $ - $ - $ - $ - $ - $ -
Yield - - - - - - - -
U.S. Agency obligations 66,280 11,688 1,840 1,930 2,025 43,153 - 126,916 125,642
Yield 3.47% 4.25% 4.82% 4.82% 4.82% 4.82% - 4.06%
States & political subdivisions - - - 7,612 8,347 34,928 - 50,887 53,273
Yield - - - 8.21% 8.22% 6.99% - 7.37%
Variable interest rate securities:
U.S. Agency obligations 13,001 13,008 13,418 2,443 2,522 - - 44,392 44,395
Yield 3.16% 3.13% 3.14% 3.23% 3.23% - - 3.15%
Federal Home Loan Bank stock - - - - - 4,699 - 4,699 4,699
Yield - - - - - 3.00% - 3.00%
Other - - - - - 3,063 - 3,063 3,063
Yield - - - - - 1.71% - 1.71%
Fixed interest rate loans:
Real estate mortgages 9,397 9,561 7,654 9,927 7,283 90,767 - 134,589 133,060
Yield 6.10% 6.43% 6.24% 5.92% 6.26% 6.14% - 6.15%
Consumer and other 1,942 1,747 1,636 1,253 1,030 2,572 - 10,180 10,206
Yield 6.94% 6.80% 6.74% 6.81% 7.00% 6.61% - 6.79%
Variable interest rate loans:
Real estate mortgages 19,763 9,465 8,771 8,686 9,024 50,687 - 106,396 102,367
Yield 7.17% 6.92% 6.90% 6.89% 6.88% 6.50% - 6.76%
Commercial 42,894 - - - - - - 42,894 42,894
Yield 6.50% - - - - - - 6.50%
Consumer and other 12,990 3,734 3,304 2,818 3,025 1,432 - 27,303 27,693
Yield 7.50% 8.84% 8.55% 8.07% 8.08% 8.13% - 7.97%
Less: Allowance for loan losses 602 334 292 309 278 1,985 - 3,800
Interest bearing deposits with banks 263 - - - - - - 263 263
Yield 4.00% - - - - - - 4.00%
Cash and due from banks - - - - - - 11,310 11,310 11,310
Other assets - - - - - - 16,596 16,596
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 165,928 $ 48,869 $ 36,331 $ 34,360 $ 32,978 $ 229,316 $ 27,906 $ 575,688 $ 558,865
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
Demand - Interest bearing $ - $ 33,094 $ - $ - $ - $ - $ - $ 33,094 $ 33,094
Yield - .61% - - - - - .61%
Savings - 86,013 - - - - - 86,013 86,013
Yield - .77% - - - - - .77%
Money markets 80,463 - - - - - - 80,463 80,463
Yield 2.11% - - - - - - 2.11%
Fixed interest rate deposits:
Time - Over $100,000 17,210 6,047 3,841 200 726 100 - 28,124 28,877
Yield 3.37% 3.94% 4.06% 3.75% 4.33% 5.00% - 3.62%
Time - Other 44,975 18,031 6,549 3,247 4,908 750 - 78,460 78,917
Yield 2.87% 3.95% 3.69% 3.42% 4.24% 4.41% - 3.31%
Demand - Non-interest bearing - - - - - - 91,713 91,713 91,713
Repurchase agreements 30,414 - - - - - - 30,414 30,414
Yield 1.75% - - - - - - 1.75%
Short-term borrowings 4,626 - - - - - - 4,626 4,626
Yield 2.46% - - - - - - 2.46%
Long-term borrowings 9,547 9,887 8,781 8,612 6,635 31,939 - 75,401 75,710
Yield 3.50% 3.50% 3.63% 3.69% 3.86% 4.36% - 3.93%
Other liabilities - - - - - - 3,581 3,581
Stockholders' equity - - - - - - 63,799 63,799
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 187,235 $ 153,072 $ 19,171 $ 12,059 $ 12,269 $ 32,789 $ 159,093 $ 575,688 $ 509,827
====================================================================================================================================
Excess of (liabilities) assets subject
to interest rate change $ (21,307) $ (104,203) $ 17,160 $ 22,301 $ 20,709 $ 196,527 $(131,187) $ -
====================================================================================================================================
20 Penseco Financial Services Corporation / 2005 Annual Report
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Penseco Financial Services Corporation is responsible for
establishing and maintaining adequate internal control over financial reporting.
Penseco Financial Services Corporation's internal control system was designed to
provide reasonable assurance to the Company's management and Board of Directors
regarding the preparation and fair presentation of published financial
statements in accordance with U.S. generally accepted accounting principles. All
internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
Management maintains a comprehensive system of controls intended to ensure
that transactions are executed in accordance with management's authorization,
assets are safeguarded, and financial records are reliable. Management also
takes steps to see that information and communication flows are effective and to
monitor performance, including performance of internal control procedures.
Penseco Financial Services Corporation management assessed the
effectiveness of the Company's internal control over financial reporting as of
December 31, 2005 based on the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework. Based on this assessment, management believes that, as of December
31, 2005, the Company's internal control over financial reporting is effective.
Management's assessment of the effectiveness of the Company's internal
control over financial reporting as of December 31, 2005 has been audited by
McGrail, Merkel, Quinn & Associates, the Company's independent registered public
accounting firm, as stated in their report appearing on page 22, which expresses
unqualified opinions on management's assessment and on the effectiveness of the
Company's internal control over financial reporting as of December 31, 2005.
Penseco Financial Services Corporation / 2005 Annual Report 21
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
Scranton, Pennsylvania
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Penseco
Financial Services Corporation and subsidiary maintained effective internal
control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Penseco Financial
Services Corporation and subsidiary's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
22 Penseco Financial Services Corporation / 2005 Annual Report
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
[2]
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Penseco Financial Services
Corporation and subsidiary maintained effective internal control over financial
reporting as of December 31, 2005, is fairly stated, in all material respects,
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Also in our opinion, Penseco Financial Services Corporation and subsidiary
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated financial
statements of Penseco Financial Services Corporation and subsidiary and our
report dated February 3, 2006 expressed an unqualified opinion.
Scranton, Pennsylvania
February 3, 2006
Penseco Financial Services Corporation / 2005 Annual Report 23
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
Scranton, Pennsylvania
We have audited the accompanying consolidated balance sheets of Penseco
Financial Services Corporation and subsidiary as of December 31, 2005 and 2004,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2005. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provided a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Penseco
Financial Services Corporation and subsidiary as of December 31, 2005 and 2004,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2005, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Penseco
Financial Services Corporation and subsidiary's internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO) and our report dated February 3, 2006
expressed an unqualified opinion on management's assessment of the effectiveness
of Penseco Financial Services Corporation and subsidiary's internal control over
financial reporting and an unqualified opinion on the effectiveness of Penseco
Financial Services Corporation and subsidiary's internal control over financial
reporting.
Scranton, Pennsylvania
February 3, 2006
24 Penseco Financial Services Corporation / 2005 Annual Report
ITEM 8 Financial Statements and Supplementary Data
Consolidated Balance Sheets
(in thousands, except per share amounts)
December 31, 2005 2004
---------------------------------------------------------------
ASSETS Cash and due from banks $ 11,310 $ 7,763
Interest bearing balances with banks 263 534
---------------------------------------------------------------
Cash and Cash Equivalents 11,573 8,297
Investment securities:
Available-for-sale, at fair value 147,942 167,410
Held-to-maturity (fair value of $83,130
and $97,791, respectively) 82,015 95,268
---------------------------------------------------------------
Total Investment Securities 229,957 262,678
Loans, net of unearned income 321,362 280,176
Less: Allowance for loan losses 3,800 3,600
---------------------------------------------------------------
Loans, Net 317,562 276,576
Bank premises and equipment 9,453 9,233
Other real estate owned 91 176
Accrued interest receivable 3,473 3,406
Other assets 3,579 3,342
---------------------------------------------------------------
Total Assets $ 575,688 $ 563,708
===============================================================
LIABILITIES Deposits:
Non-interest bearing $ 91,713 $ 82,938
Interest bearing 306,154 312,363
---------------------------------------------------------------
Total Deposits 397,867 395,301
Other borrowed funds:
Repurchase agreements 30,414 18,398
Short-term borrowings 4,626 886
Long-term borrowings 75,401 84,620
Accrued interest payable 1,261 886
Other liabilities 2,320 1,241
---------------------------------------------------------------
Total Liabilities 511,889 501,332
===============================================================
STOCKHOLDERS' Common stock, $.01 par value, 15,000,000
EQUITY shares authorized, 2,148,000
shares issued and outstanding 21 21
Surplus 10,819 10,819
Retained earnings 53,607 50,832
Accumulated other comprehensive income (648) 704
---------------------------------------------------------------
Total Stockholders' Equity 63,799 62,376
===============================================================
Total Liabilities and
Stockholders' Equity $ 575,688 $ 563,708
===============================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
Penseco Financial Services Corporation / 2005 Annual Report 25
Consolidated Statements of Income
(in thousands, except per share amounts)
Years Ended December 31, 2005 2004 2003
-------------------------------------------------------------------------
INTEREST Interest and fees on loans $ 18,569 $ 13,632 $ 14,632
INCOME Interest and dividends on investments:
U.S. Treasury securities and U.S.
Agency obligations 6,408 8,044 8,275
States & political subdivisions 2,616 3,476 2,569
Other securities 190 107 108
Interest on Federal funds sold 176 58 340
Interest on balances with banks 211 68 90
-------------------------------------------------------------------------
Total Interest Income 28,170 25,385 26,014
-------------------------------------------------------------------------
INTEREST Interest on time deposits
EXPENSE of $100,000 or more 808 806 844
Interest on other deposits 4,212 3,153 4,226
Interest on other borrowed funds 3,560 3,620 3,158
-------------------------------------------------------------------------
Total Interest Expense 8,580 7,579 8,228
-------------------------------------------------------------------------
Net Interest Income 19,590 17,806 17,786
Provision for loan losses 263 144 476
-------------------------------------------------------------------------
Net Interest Income After Provision
for Loan Losses 19,327 17,662 17,310
-------------------------------------------------------------------------
OTHER Trust department income 1,479 1,353 1,311
INCOME Service charges on deposit accounts 940 1,056 1,133
Merchant transaction income 4,521 5,001 5,005
Other fee income 1,575 1,650 1,630
Other operating income 372 177 1,323
Realized (losses) gains on securities, net (13) 357 341
-------------------------------------------------------------------------
Total Other Income 8,874 9,594 10,743
-------------------------------------------------------------------------
OTHER Salaries and employee benefits 9,261 9,165 9,010
EXPENSES Occupancy expenses, net 1,377 1,255 1,388
Furniture and equipment expenses 1,078 1,136 1,175
Merchant transaction expenses 3,646 4,058 4,158
Other operating expenses 5,357 4,970 4,723
-------------------------------------------------------------------------
Total Other Expenses 20,719 20,584 20,454
-------------------------------------------------------------------------
Income before income taxes 7,482 6,672 7,599
Applicable income taxes 1,613 1,071 1,628
-------------------------------------------------------------------------
NET INCOME Net Income $ 5,869 $ 5,601 $ 5,971
=========================================================================
PER SHARE Earnings Per Share $ 2.73 $ 2.61 $ 2.78
=========================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
26 Penseco Financial Services Corporation / 2005 Annual Report
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2005, 2004 and 2003
Accumulated
Other Total
Common Retained Comprehensive Stockholders'
(in thousands except per share data) Stock Surplus Earnings Income Equity
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 $ 21 $ 10,819 $ 45,060 $ 3,075 $ 58,975
Comprehensive income:
Net income, 2003 - - 5,971 - 5,971
Unrealized losses on securities,
net of reclassification adjustment
and taxes - - - (1,239) (1,239)
-------
Comprehensive income 4,732
Cash dividends declared ($1.35 per share) - - (2,900) - (2,900)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 21 10,819 48,131 1,836 60,807
Comprehensive income:
Net income, 2004 - - 5,601 - 5,601
Unrealized losses on securities,
net of reclassification adjustment
and taxes - - - (1,132) (1,132)
-------
Comprehensive income 4,469
Cash dividends declared ($1.35 per share) - - (2,900) - (2,900)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2004 21 10,819 50,832 704 62,376
Comprehensive income:
Net income, 2005 - - 5,869 - 5,869
Other comprehensive income, net of tax
Unrealized losses on securities,
net of reclassification adjustment - - - (341) (341)
Minimum pension liability adjustment - - - (1,011) (1,011)
------- -------
Other comprehensive income (1,352) (1,352)
Comprehensive income 4,517
Cash dividends declared ($1.44 per share) - - (3,094) - (3,094)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2005 $ 21 $ 10,819 $ 53,607 $ (648) $ 63,799
==========================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
Penseco Financial Services Corporation / 2005 Annual Report 27
Consolidated Statements of Cash Flows
(in thousands)
(in thousands) Years Ended December 31, 2005 2004 2003
------------------------------------------------------------------------------------------
OPERATING Net Income $ 5,869 $ 5,601 $ 5,971
ACTIVITIES Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 704 813 1,119
Provision for loan losses 263 144 476
Deferred income tax provision (benefit) 166 (119) (182)
Amortization of securities (net of accretion) 1,379 1,573 1,050
Net realized losses (gains) on securities 13 (357) (341)
(Gain) loss on other real estate (46) (2) 15
Gain on disposition of fixed asset (5) - -
(Increase) decrease in interest receivable (67) (108) 101
Decrease in other assets 313 366 1,441
(Decrease) increase in income taxes payable (442) 117 252
Increase (decrease) in interest payable 375 (272) (159)
(Decrease) increase in other liabilities (29) 110 (239)
------------------------------------------------------------------------------------------
Net cash provided by
operating activities 8,493 7,866 9,504
------------------------------------------------------------------------------------------
INVESTING Purchase of investment securities
ACTIVITIES available-for-sale (47,526) (49,975) (122,157)
Proceeds from sales and maturities of investment
securities available-for-sale 46,451 41,938 41,407
Purchase of investment securities
to be held-to-maturity - - (103,031)
Proceeds from repayments of investment
securities available-for-sale 19,140 17,893 7,308
Proceeds from repayments of investment
securities to be held-to-maturity 12,746 17,661 19,894
Net loans (originated) repaid (41,550) (40,015) 47,677
Proceeds from other real estate 432 124 397
Proceeds from sale of fixed asset 10 - -
Investment in premises and equipment (929) (111) (1,134)
------------------------------------------------------------------------------------------
Net cash used by investing activities (11,226) (12,485) (109,639)
------------------------------------------------------------------------------------------
FINANCING Net increase in demand and savings deposits (3,984) 5,977 6,862
ACTIVITIES Net (payments) proceeds on time deposits 6,550 (18,620) (13,582)
Increase (decrease) in repurchase agreements 12,016 (1,056) 35
Net increase (decrease) in short-term borrowings 3,740 63 (67)
Proceeds from long-term borrowings - - 100,000
Payments on long-term borrowings (9,219) (8,903) (6,477)
Cash dividends paid (3,094) (2,900) (2,900)
------------------------------------------------------------------------------------------
Net cash provided (used) by
financing activities 6,009 (25,439) 83,871
------------------------------------------------------------------------------------------
Net increase (decrease) in cash and
cash equivalents 3,276 (30,058) (16,264)
Cash and cash equivalents at January 1 8,297 38,355 54,619
------------------------------------------------------------------------------------------
Cash and cash equivalents at December 31 $ 11,573 $ 8,297 $ 38,355
==========================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
28 Penseco Financial Services Corporation / 2005 Annual Report
General Notes To Financial Statements
NOTE 1 -- NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated in 1997 under the laws of Pennsylvania. It is the parent company of
Penn Security Bank and Trust Company (Bank), a state chartered bank.
The Company operates from nine banking offices under a state bank charter
and provides full banking services, including trust services, to individual and
corporate customers primarily in Northeastern Pennsylvania. The Company's
primary deposit products are savings and demand deposit accounts and
certificates of deposit. Its primary lending products are real estate,
commercial and consumer loans.
The Company's revenues are attributable to a single reportable segment,
therefore segment information is not presented.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
BASIS OF PRESENTATION
The Financial Statements of the Company have been consolidated with those of its
wholly-owned subsidiary, Penn Security Bank and Trust Company, eliminating all
intercompany items and transactions.
The Statements are presented on the accrual basis of accounting.
All information is presented in thousands of dollars, except per share
amounts.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
EMERGING ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123 (Revised 2004), Share-Based Payment. Statement No. 123
(Revised 2004) is a revision of FASB Statement 123, Accounting for Stock-Based
Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and its related implementation guidance. The Statement focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. Statement No. 123 (Revised 2004)
requires an entity to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award, except in certain circumstances. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award. The statement is effective as of the beginning of the first annual
reporting period that begins after December 15, 2005.
The Company has not issued any share-based payments that will be required
to be accounted for under Statement No. 123 (Revised 2004).
In December 2004, FASB issued Statement No. 153, Exchanges of Nonmonetary
Assets, An Amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions. Statement No. 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets in paragraph
21(b) of APB Opinion No. 29 and replaces it with an exception for exchanges that
do not have commercial substance. Statement No. 153 specifies that a nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. The statement is
effective for fiscal periods beginning after June 15, 2005.
The Company has not been a party to any nonmonetary exchanges that would be
impacted by application of Statement No. 153.
In May 2005, FASB issued Statement No. 154, Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20, Accounting Changes, and FASB
Statement No. 3, Reporting Accounting Changes in Interim Financial Statements -
An Amendment of APB Opinion No. 28. Statement No. 154 provides guidance on the
accounting for and reporting of accounting changes and error corrections. It
establishes retrospective application, or earliest date practicable, as the
required method for reporting a change in accounting principle or correction of
an error. The Statement is effective for accounting changes or corrections of
errors made in fiscal periods beginning after December 15, 2005.
The Company believes that the adoption of this statement will not have a
significant impact on its results of operations or financial position.
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.
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.
Penseco Financial Services Corporation / 2005 Annual Report 29
NOTE 1 -- NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
LOANS AND PROVISION (ALLOWANCE) FOR POSSIBLE LOAN LOSSES
Loans are stated at the principal amount outstanding, net of any unearned
income, deferred loan fees and the allowance for loan losses. Interest is
accrued daily on the outstanding balances.
Loans are generally placed on a non-accrual status when principal or
interest is past due 90 days or when payment in full is not anticipated. When a
loan is placed on non-accrual status, all interest previously accrued but not
collected is charged against current income. Loans are returned to accrual
status when past due interest is collected and the collection of principal is
probable.
The provision for loan losses is based on past loan loss experience,
management's evaluation of the potential loss in the current loan portfolio
under current economic conditions and such other factors as, in management's
best judgement, deserve current recognition in estimating loan losses. The
annual provision for loan losses charged to operating expense is that amount
which is sufficient to bring the balance of the allowance for possible loan
losses to an adequate level to absorb anticipated losses.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Provision for depreciation and amortization, computed principally on the
straight-line method, is charged to operating expenses over the estimated useful
lives of the assets. Maintenance and repairs are charged to current expense as
incurred.
LONG-LIVED ASSETS
The Company reviews the carrying value of long-lived assets for impairment
whenever events or changes in circumstances indicate that carrying amounts of
the assets might not be recoverable, as prescribed in Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144).
LOAN SERVICING
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair
value of those rights. Fair values are estimated using discounted cash flows
based on current market rates of interest and current expected future prepayment
rates. For purposes of measuring impairment, the rights must be stratified by
one or more predominant risk characteristics of the underlying loans. The
Company stratifies its capitalized mortgage servicing rights based on the
product type, interest rate and term of the underlying loans. The amount of
impairment recognized is the amount, if any, by which the amortized cost of the
rights for each stratum exceed the fair value.
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expenses for the years
ended December 31, 2005, 2004 and 2003, amounted to $472, $476 and $473,
respectively.
INCOME TAXES
Provisions for income taxes are based on taxes payable or refundable for the
current year (after exclusion of non-taxable income such as interest on state
and municipal securities) as well as deferred taxes on temporary differences,
between the amount of taxable income and pre-tax financial income and between
the tax bases of assets and liabilities and their reported amounts in the
Financial Statements. Deferred tax assets and liabilities are included in the
Financial Statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled as prescribed in Statement of Financial Accounting Standards
No. 109, Accounting for Income Taxes (SFAS 109). As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
PENSION EXPENSE
Pension expense has been determined in accordance with Statement of Financial
Accounting Standards No. 87, Employers Accounting for Pensions (SFAS 87).
POSTRETIREMENT BENEFITS EXPENSE
Postretirement benefits expense has been determined in accordance with Statement
of Financial Accounting Standards No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions (SFAS 106).
CASH FLOWS
For purposes of the Statements of Cash Flows, cash and cash equivalents include
cash on hand, due from banks, interest bearing balances with banks and Federal
funds sold for a one-day period.
The Company paid interest and income taxes during the years ended December 31,
2005, 2004 and 2003 as follows:
2005 2004 2003
- --------------------------------------------------------------------
Income taxes paid $ 1,886 $ 802 $ 1,698
Interest paid $ 8,205 $ 7,851 $ 8,387
Non-cash transactions during the years ended December 31, 2005, 2004 and 2003,
comprised entirely of the net acquisition of real estate in the settlement of
loans, amounted to $301, $177 and $474, respectively.
TRUST ASSETS AND INCOME
Assets held by the Company in a fiduciary or agency capacity for its customers
are not included in the Financial Statements since such items are not assets of
the Company. Trust income is reported on the accrual basis of accounting.
EARNINGS PER SHARE
Basic earnings per share is computed on the weighted average number of common
shares outstanding during each year (2,148,000) as prescribed in Statement of
Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). A
calculation of diluted earnings per share is not applicable to the Company.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 2005
presentation.
30 Penseco Financial Services Corporation / 2005 Annual Report
NOTE 2 -- CASH AND DUE FROM BANKS
Cash and due from banks are summarized as follows:
December 31, 2005 2004
- ------------------------------------------------------------------
Cash items in process of collection $ 6,568 $ 2,951
Non-interest bearing balances 1,544 1,952
Cash on hand 3,198 2,860
- ------------------------------------------------------------------
Total $ 11,310 $ 7,763
==================================================================
The Company may, from time to time, maintain bank balances with other financial
institutions in excess of $100,000 each. Management is not aware of any evidence
that would indicate that such deposits are at risk.
NOTE 3 -- INVESTMENT SECURITIES
The amortized cost and fair value of investment securities at December 31, 2005
and 2004 are as follows:
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
2005 Cost Gains Losses Value
- ---------------------------------------------------------------------------
U.S. Agency securities $ 74,852 $ - $ 308 $ 74,544
Mortgage-backed securities 44,408 - 407 44,001
States & political
subdivisions 20,698 937 - 21,635
- ---------------------------------------------------------------------------
Total Debt Securities 139,958 937 715 140,180
Equity securities 7,433 402 73 7,762
- ---------------------------------------------------------------------------
Total Available-
for-Sale $ 147,391 $ 1,339 $ 788 $ 147,942
===========================================================================
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
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
===========================================================================
Equity securities at December 31, 2005 and 2004, consisted primarily of other
financial institutions stock and Federal Home Loan Bank (FHLB) stock, which is a
required investment in order to participate in an available line of credit
program. The FHLB stock is stated at par value as there is no readily
determinable fair value.
A summary of transactions involving available-for-sale debt securities in 2005,
2004 and 2003 are as follows:
December 31, 2005 2004 2003
- -----------------------------------------------------------------------
Proceeds from sales $ 10,250 $ 18,380 $ 15,640
Gross realized gains 51 385 341
Gross realized losses 64 28 -
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
2005 Cost Gains Losses Value
- ---------------------------------------------------------------------------
Mortgage-backed
securities $ 52,763 $ 3 $ 1,274 $ 51,492
States & political
subdivisions 29,252 2,386 - 31,638
- ---------------------------------------------------------------------------
Total Held-to-
Maturity $ 82,015 $ 2,389 $ 1,274 $ 83,130
===========================================================================
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
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
===========================================================================
Investment securities with amortized costs and fair values of $106,280 and
$107,914 at December 31, 2005 and $104,700 and $107,574 at December 31, 2004,
were pledged to secure trust funds, public deposits and for other purposes as
required by law.
The amortized cost and fair value of debt securities at December 31, 2005
by contractual maturity, are shown in the following table. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
- --------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- --------------------------------------------------------------------------------
Due in one year or less:
U.S. Agency securities $ 64,860 $ 64,610 $ - $ -
After one year through
five years:
U.S. Agency securities 9,992 9,934 - -
After five years through
ten years:
States & political
subdivisions - - 240 266
After ten years:
States & political
subdivisions 20,698 21,635 29,012 31,372
- --------------------------------------------------------------------------------
Subtotal 95,550 96,179 29,252 31,638
Mortgage-backed securities 44,408 44,001 52,763 51,492
- --------------------------------------------------------------------------------
Total Debt Securities $ 139,958 $ 140,180 $ 82,015 $ 83,130
================================================================================
Penseco Financial Services Corporation / 2005 Annual Report 31
NOTE 3 -- INVESTMENT SECURITIES (CONTINUED)
The gross fair value and unrealized losses of the Company's investments,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2005 and
2004 are as follows:
Less than twelve months Twelve months or more Totals
- ------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2005 Value Losses Value Losses Value Losses
- ------------------------------------------------------------------------------------------------------------
U.S. Agency securities $ 39,870 $ 227 $ 34,674 $ 81 $ 74,544 $ 308
Mortgage-backed securities 8,598 104 86,501 1,577 95,099 1,681
Equities 1,298 73 - - 1,298 73
- ------------------------------------------------------------------------------------------------------------
Total $ 49,766 $ 404 $ 121,175 $ 1,658 $ 170,941 $ 2,062
============================================================================================================
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 table above at December 31, 2005, includes twenty-one (21) securities that
have unrealized losses for less than twelve months and ten (10) securities that
have been in an unrealized loss position for twelve or more months.
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 December 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 December 31,
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 December 31, 2005.
32 Penseco Financial Services Corporation / 2005 Annual Report
NOTE 4 -- LOANS
Major classifications of loans are as follows:
December 31, 2005 2004
- -------------------------------------------------------------------------------
Loans secured by real estate:
Construction and land development $ 13,132 $ 6,805
Secured by 1-4 family residential properties:
Revolving, open-end loans 15,070 19,356
Secured by first liens 125,950 102,583
Secured by junior liens 22,649 17,761
Secured by multi-family properties 355 411
Secured by non-farm, non-residential properties 63,829 56,038
Commercial and industrial loans to U.S. addressees 42,894 41,560
Loans to individuals for household, family
and other personal expenditures:
Credit card and related plans 3,152 2,872
Other (installment and student loans, etc.) 24,773 24,091
Obligations of states & political subdivisions 8,038 7,111
All other loans 1,520 1,588
- -------------------------------------------------------------------------------
Gross Loans 321,362 280,176
Less: Unearned income on loans - -
- -------------------------------------------------------------------------------
Loans, Net of Unearned Income $ 321,362 $ 280,176
===============================================================================
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,627, $1,991 and $1,533 at December 31, 2005, 2004 and 2003, respectively.
If interest on those loans had been accrued, such income would have been $264,
$199 and $198 for 2005, 2004 and 2003, respectively. Interest income on those
loans, which is recorded only when received, amounted to $27, $16 and $29 for
2005, 2004 and 2003, respectively. Also, at December 31, 2005 and 2004, the Bank
had loans totalling $173 and $266, respectively, which were past due 90 days or
more and still accruing interest (credit card and guaranteed student loans).
NOTE 5 -- ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
Years Ended December 31, 2005 2004 2003
- ----------------------------------------------------------------
Balance at beginning of year $ 3,600 $ 3,500 $ 3,347
Provision charged to operations 263 144 476
Recoveries credited to allowance 50 9 32
- ----------------------------------------------------------------
3,913 3,653 3,855
Losses charged to allowance (113) (53) (355)
- ----------------------------------------------------------------
Balance at End of Year $ 3,800 $ 3,600 $ 3,500
================================================================
A comparison of the provision for loan losses for Financial Statement purposes
with the allowable bad debt deduction for tax purposes is as follows:
Years Ended December 31, Book Provision Tax Deduction
- ------------------------ -------------- -------------
2005 $ 263 $ 63
2004 $ 144 $ 44
2003 $ 476 $ 323
The balance of the Reserve for Bad Debts as reported for Federal income tax
purposes was $380, $664 and $948 at December 31, 2005, 2004 and 2003,
respectively.
NOTE 6 --LOAN SERVICING
The Company services $54,682 in mortgage loans for Freddie Mac which are not
included in the accompanying Consolidated Balance Sheets.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in deposits, were approximately $562 and $620, at
December 31, 2005 and 2004, respectively. The balance of the servicing rights
was $314 and $450 at December 31, 2005 and 2004, respectively, net of
amortization.
The Company has not recorded any new mortgage servicing rights during 2005
or 2004. Amortization expense of $136 and $197 was recorded for the years ended
December 31, 2005 and 2004, respectively.
There was no allowance for impairment recorded at December 31, 2005 or
2004.
NOTE 7 -- BANK PREMISES AND EQUIPMENT
December 31, 2005 2004
- ------------------------------------------------------------------
Land $ 3,117 $ 3,122
Buildings and improvements 14,623 14,550
Furniture and equipment 13,406 12,550
- ------------------------------------------------------------------
31,146 30,222
Less: Accumulated depreciation 21,693 20,989
- ------------------------------------------------------------------
Net Bank Premises and Equipment $ 9,453 $ 9,233
==================================================================
Buildings and improvements are being depreciated over 10 to 39.5 year periods
and equipment over 3 to 10 year periods. Depreciation expense amounted to $704
in 2005, $813 in 2004 and $1,119 in 2003.
Occupancy expenses were reduced by rental income received in the amount of
$61, $63 and $64 in the years ended December 31, 2005, 2004 and 2003,
respectively.
NOTE 8 -- OTHER REAL ESTATE OWNED
Real estate acquired through foreclosure is recorded at the lower of cost or
market at the time of acquisition. Any subsequent write-downs are charged
against operating expenses. The other real estate owned as of December 31, 2005
and 2004 was $91 and $176, respectively, supported by appraisals of the real
estate involved.
NOTE 9 -- INVESTMENT IN AND LOAN TO, INCOME FROM DIVIDENDS AND EQUITY IN
EARNINGS OR LOSSES OF SUBSIDIARY
Penseco Realty, Inc. is a wholly-owned subsidiary of the Bank which owns certain
banking premises. Selected financial information is presented below:
Equity in
underlying Bank's
Percent Total net assets Amount proportionate
of voting investment at balance of part of loss
Year stock owned and loan sheet date dividends for the period
- --------------------------------------------------------------------------
2005 100% $ 3,250 $ 3,235 None $ -
2004 100% $ 3,350 $ 3,335 None $ -
2003 100% $ 3,450 $ 3,435 None $ -
Penseco Financial Services Corporation / 2005 Annual Report 33
NOTE 10 -- DEPOSITS
December 31, 2005 2004
- -----------------------------------------------------------------------
Demand - Non-interest bearing $ 91,713 $ 82,512
Demand - Interest bearing 33,094 31,161
Savings 86,013 89,990
Money markets 80,463 91,604
Time - Over $100,000 28,124 23,779
Time - Other 78,460 76,255
- -----------------------------------------------------------------------
Total $ 397,867 $ 395,301
=======================================================================
Scheduled maturities of time deposits are as follows:
2006 $ 62,185
2007 24,078
2008 10,390
2009 3,447
2010 5,634
2011 and thereafter 850
- --------------------------------------------
Total $ 106,584
============================================
NOTE 11 -- OTHER BORROWED FUNDS
At December 31, 2005 and 2004, other borrowed funds consisted of demand notes to
the U.S. Treasury and Repurchase agreements.
Short-term borrowings generally have original maturity dates of thirty days
or less.
Investment securities with amortized costs and fair values of $35,209 and
$35,026 at December 31, 2005 and $28,007 and $28,360 at December 31, 2004, were
pledged to secure repurchase agreements.
Years Ended December 31, 2005 2004
- --------------------------------------------------------------------------------
Amount outstanding at year end $ 35,040 $ 19,284
Average interest rate at year end 2.01% .75%
Maximum amount outstanding at any month end $ 35,040 $ 30,176
Average amount outstanding $ 27,638 $ 22,776
Weighted average interest rate during the year:
Federal funds purchased 3.96% 2.21%
Repurchase agreements 1.46% .75%
Demand notes to U.S. Treasury 2.99% 1.11%
The Company has an available credit facility with the Federal Reserve Bank in
the amount of $10,000, secured by pledged securities with amortized costs and
fair values of $10,257 and $10,008 at December 31, 2005 and $10,287 and $10,231
at December 31, 2004 and with interest rates of 5.25% and 3.25% at December 31,
2005 and December 31, 2004, respectively. There is no stated expiration date for
the credit facility as long as the Company maintains the pledged securities at
the Federal Reserve Bank. There was no outstanding balance as of December 31,
2005 and 2004, respectively.
The Company has the availability of a $5,000 overnight Federal funds line
of credit with Wachovia Bank, N.A. There was no balance outstanding as of
December 31, 2005 and 2004, respectively.
The Company maintains a collateralized maximum borrowing capacity of
$171,053 with the Federal Home Loan Bank of Pittsburgh.
NOTE 12 -- LONG-TERM DEBT
The loans from the Federal Home Loan Bank, which were borrowed to purchase a
mortgage-backed security, are secured by a general collateral pledge of the
Company's assets.
A summary of long-term debt, including amortizing principal and interest
payments, at December 31, 2005 is as follows:
Monthly Fixed Maturity
Installment Rate Date Balance
$ 161 2.73% 03/13/08 $ 4,202
253 3.22% 03/13/10 12,041
430 3.74% 03/13/13 32,728
186 4.69% 03/13/23 26,430
- ---------------------------------------------------
Total $ 75,401
===================================================
The Company has agreed to maintain sufficient qualifying collateral to
fully secure the above borrowings.
Aggregate maturities of long-term debt at December 31, 2005 are as follows:
2006 $9,547, 2007 $9,887, 2008 $8,781, 2009 $8,612, 2010 $6,635 and thereafter
$31,939 for a total of $75,401.
NOTE 13 -- EMPLOYEE BENEFIT PLANS
The Company provides an Employee Stock Ownership Plan (ESOP), a Retirement
Profit Sharing Plan, an Employees' Pension Plan, as well as an unfunded
supplemental executive pension plan and a Postretirement Life Insurance Plan,
all non-contributory, covering all eligible employees.
Under the Employee Stock Ownership Plan (ESOP), amounts voted by the Board
of Directors are paid into the ESOP and each employee is credited with a share
in proportion to their annual compensation. All contributions to the ESOP are
invested in or will be invested primarily in Company stock. Distribution of a
participant's ESOP account occurs upon retirement, death or termination in
accordance with the plan provisions.
At December 31, 2005 and 2004, the ESOP held 87,840 and 89,316 shares,
respectively of the Company's stock, all of which were acquired as described
above and allocated to specific participant accounts. These shares are treated
the same for dividend purposes and earnings per share calculations as are any
other outstanding shares of the Company's stock. The Company contributed $70, $0
and $0 to the plan during the years ended December 31, 2005, 2004 and 2003,
respectively.
Under the Retirement Profit Sharing Plan, amounts voted by the Board of
Directors are paid into a fund and each employee is credited with a share in
proportion to their annual compensation. Upon retirement, death or termination,
each employee is paid the total amount of their credits in the fund in one of a
number of optional ways in accordance with the plan provisions. The Company
contributed $70, $60 and $70 to the plan during the years ended December 31,
2005, 2004 and 2003, respectively.
Under the Pension Plan, amounts computed on an actuarial basis are paid by
the Company into a trust fund. Provision is made for fixed benefits payable for
life upon retirement at the age of 65, based on length of service and
compensation levels as defined in the plan. Plan assets of the trust fund are
invested and administered by the Trust Department of Penn Security Bank and
Trust Company.
The unfunded supplemental executive pension plan provides certain officers
with additional retirement benefits to replace benefits lost due to limits
imposed on qualified plans by Federal tax law.
The postretirement life insurance plan is an unfunded, non-vesting defined
benefit plan. The plan is non-contributory and provides for a reducing level of
term life insurance coverage following retirement.
For the unfunded plans above, amounts calculated on an actuarial basis are
recorded as a liability.
34 Penseco Financial Services Corporation / 2005 Annual Report
NOTE 13 -- EMPLOYEE BENEFIT PLANS (CONTINUED)
A reconciliation of the funded status of the plans with amounts reported on the
Consolidated Balance Sheets is as follows:
Pension Benefits Other Benefits
---------------- ---------------
December 31, 2005 2004 2005 2004
- --------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation, beginning $ 11,800 $ 10,884 $ 285 $ 269
Service cost 415 385 6 6
Interest cost 678 664 16 16
Change in assumptions 947 256 (10) 3
Actuarial (gain) loss (223) (59) - -
Benefits paid (350) (330) (10) (9)
- --------------------------------------------------------------------------------
Benefit obligation, ending 13,267 11,800 287 285
- --------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets, beginning 9,469 8,713 - -
Actual return on plan assets 213 713 - -
Employer contribution 377 373 - -
Benefits paid (350) (330) - -
- -------------------------------------------------------------------------------
Fair value of plan assets, ending 9,709 9,469 - -
- --------------------------------------------------------------------------------
Funded status (3,558) (2,331) (287) (285)
Unrecognized net actuarial loss (gain) 3,933 2,775 (33) (23)
Unrecognized prior service cost 53 54 41 49
- --------------------------------------------------------------------------------
Net amount recognized $ 428 $ 498 $ (279) $ (259)
================================================================================
Amounts recognized in the balance sheet consist of:
Pension Benefits Other Benefits
---------------- --------------
December 31, 2005 2004 2005 2004
- --------------------------------------------------------------------------------
Prepaid benefit cost $ 580 $ 643 $ 0 $ 0
Accrued benefit cost (1,683) (145) (279) (259)
Deferred tax asset 520 0 0 0
Accumulated other comprehensive income 1,011 0 0 0
- --------------------------------------------------------------------------------
Net amount recognized $ 428 $ 498 $ (279) $ (259)
================================================================================
The accumulated benefit obligation for all defined benefit pension plans was
$10,866 and $9,510 at December 31, 2005 and 2004, respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets is as follows:
Pension Benefits
----------------
2005 2004
- -------------------------------------------------------------------
Projected benefit obligation $ 13,267 $ 142
Accumulated benefit obligation 10,866 142
Fair value of plan assets 9,709 0
The principal portion of the unfunded pension liability of $1,157 at December
31, 2005 relates to the Company's Defined Benefit Pension Plan for employees.
This unfunded liability was caused primarily by the use of a 5.5% discount rate
at December 31, 2005. In 2006, the Company made an additional contribution of
$1,005 which was recorded as a Prepaid Benefit Cost. The contribution will not
have a negative impact on 2006 earnings. The remaining $152 relates to the
Supplemental Executive Pension Plan which will be paid out to a retiring officer
during 2006.
A reconciliation of net periodic pension and other benefit costs is as follows:
Pension Benefits
----------------
Years Ended December 31, 2005 2004 2003
- ------------------------------------------------------------------------
Components of net periodic pension cost:
Service cost $ 415 $ 385 $ 385
Interest cost 678 664 635
Expected return on plan assets (755) (700) (624)
Amortization of prior service cost - - -
Amortization of unrecognized net loss 114 114 175
- ------------------------------------------------------------------------
Net periodic pension cost $ 452 $ 463 $ 571
========================================================================
Other Benefits
--------------
Years Ended December 31, 2005 2004 2003
- -----------------------------------------------------------------------------
Components of net periodic other benefit cost:
Service cost $ 6 $ 6 $ 6
Interest cost 16 16 15
Amortization of prior service cost 7 7 8
Amortization of unrecognized net gain - - (1)
- -----------------------------------------------------------------------------
Net periodic other benefit cost $ 29 $ 29 $ 28
=============================================================================
The projected benefit obligation, accumulated benefit obligation and fair value
of plan assets for the pension plan with accumulated benefit obligations in
excess of plan assets were $152, $152 and $0, respectively at December 31, 2005
and $142, $142 and $0, respectively at December 31, 2004.
Penseco Financial Services Corporation / 2005 Annual Report 35
NOTE 13 -- EMPLOYEE BENEFIT PLANS (CONTINUED)
Weighted-average assumptions used to determine benefit obligations were as
follows:
Pension Benefits Other Benefits
---------------- --------------
December 31, 2005 2004 2005 2004
- --------------------------------------------------------------------------------
Discount rate 5.50%-6.00% 6.00% 6.00% 6.00%
Rate of compensation increase 4.00% 4.00% 4.50% 4.50%
Pension Benefits Other Benefits
---------------- --------------
Years Ended December 31, 2005 2004 2005 2004
- --------------------------------------------------------------------------------
Discount rate 5.50%-6.00% 6.00% 6.00% 6.00%
Expected long-term return
on plan assets 8.00% 8.00% - -
Rate of compensation increase 4.00% 4.00% 4.50% 4.50%
The expected long-term return on plan assets was determined using average
historical returns of the Company's plan assets.
The Company's pension plan weighted-average asset allocations at December
31, 2005 and 2004 by asset category are as follows:
Plan Assets at December 31,
---------------------------
2005 2004
- --------------------------------------------------------------
Asset Category
- --------------
Equity securities 55.7% 54.4%
Corporate bonds 24.6% 35.1%
U.S. Government securities 19.4% 8.1%
Cash and cash equivalents .3% 2.4%
- --------------------------------------------------------------
100.0% 100.0%
==============================================================
The Company investment policies and strategies include:
1.) The Trust and Investment Division's equity philosophy is Large-Cap Core with
a value bias. We invest in individual high-grade common stocks that are selected
from our approved list.
2.) Diversification is maintained by having no more than 20% in any industry
sector and no individual equity representing more than 10% of the portfolio.
3.) The fixed income style is conservative but also responsive to the various
needs of our individual clients. For our "Fixed Income" securities, we buy U.S.
Government bonds and Agencies or high-grade Corporate rated "A" or better. The
Company targets the following allocation percentages: cash equivalents 10%,
fixed income 40% and equities 50%.
There is no Company stock included in equity securities at December 31,
2005 or 2004.
Contributions
- -------------
The Company expects to contribute $246, in addition to the $1,005 disclosed
above, to its pension plan and $13 to its other postretirement plan in 2006.
Estimated Future Benefit Payments
- ---------------------------------
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid in the next five years and in the aggregate
for the five years thereafter:
Pension Benefits Other Benefits
---------------- --------------
2006 $ 481 $ 13
2007 482 13
2008 488 13
2009 485 13
2010 494 13
2011-2015 3,412 87
NOTE 14 -- INCOME TAXES
The total income taxes in the Statements of Income are as follows:
Years Ended December 31, 2005 2004 2003
- -------------------------------------------------------------------------------
Currently payable $ 1,447 $ 1,190 $ 1,810
Deferred provision (benefit) 166 (119) (182)
- -------------------------------------------------------------------------------
Total $ 1,613 $ 1,071 $ 1,628
===============================================================================
A reconciliation of income taxes at statutory rates to applicable income taxes
reported in the Statements of Income is as follows:
Years Ended December 31, 2005 2004 2003
- -------------------------------------------------------------------------------
Tax at statutory rate $ 2,544 $ 2,268 $ 2,584
Reduction for non-taxable interest (1,012) (1,262) (978)
Other additions 81 65 22
- -------------------------------------------------------------------------------
Applicable Income Taxes $ 1,613 $ 1,071 $ 1,628
===============================================================================
The components of the deferred income tax provision (benefit), which result from
temporary differences, are as follows:
Years Ended December 31, 2005 2004 2003
- -------------------------------------------------------------------------------
Accretion of discount on bonds $ 18 $ 24 $ (121)
Accelerated depreciation (4) 21 67
Supplemental benefit plan (3) (1) (16)
Allowance for loan losses (165) (130) (53)
Prepaid pension cost 320 (33) (59)
- -------------------------------------------------------------------------------
Total $ 166 $ (119) $ (182)
===============================================================================
The significant components of deferred tax assets and liabilities are as
follows:
December 31, 2005 2004
- ------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 1,163 $ 998
Minimum pension liability 520 -
Accumulated depreciation 322 318
Accrued supplemental benefit plan 51 48
- ------------------------------------------------------------------
Total Deferred Tax Assets 2,056 1,364
==================================================================
Deferred tax liabilities:
Prepaid pension costs 571 251
Unrealized securities gains 187 364
Accumulated accretion 69 51
- ------------------------------------------------------------------
Total Deferred Tax Liabilities 827 666
- ------------------------------------------------------------------
Net Deferred Tax Assets $ 1,229 $ 698
==================================================================
In management's opinion, the deferred tax assets are realizable in as much as
there is a history of strong earnings and a carryback potential greater than the
deferred tax assets. Management is not aware of any evidence that would preclude
the realization of the benefit in the future and, accordingly, has not
established a valuation allowance against the deferred tax assets.
36 Penseco Financial Services Corporation / 2005 Annual Report
NOTE 15 -- ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income of ($648), $704 and $1,836 at December
31, 2005, 2004 and 2003.
Other Comprehensive Income
Other Comprehensive Income (Comprehensive income, excluding net income),
beginning with the 2005 period, includes two components, the change in
unrealized holding gains and losses on available for sale securities and the
change in the minimum pension liability. The components of other comprehensive
income are reported net of related tax effects in the Consolidated Statements of
Changes in Stockholders' Equity. Prior to 2005, other comprehensive income
included only one component, the change in unrealized holding gains and losses
on available for sale securities, net of related tax effects.
A reconciliation of other comprehensive income for the years ended December
31, 2005, 2004 and 2003 is as follows:
Tax
Before-Tax (Expense) Net-of-Tax
2005 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (531) $ 181 $ (350)
Less: Reclassification adjustment for losses realized in income (13) 4 (9)
----------------------- --------
Net unrealized losses (518) 177 (341)
Change in minimum pension liability (1,531) 520 (1,011)
- ------------------------------------------------------------------------------------------------------
Other Comprehensive Income $ (2,049) $ 697 $ (1,352)
======================================================================================================
Tax
Before-Tax (Expense) Net-of-Tax
2004 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (1,357) $ 461 $ (896)
Less: Reclassification adjustment for gains realized in income 357 (121) 236
- ------------------------------------------------------------------------------------------------------
Net unrealized losses $ (1,714) $ 582 $ (1,132)
=====================================================================================================
Tax
Before-Tax (Expense) Net-of-Tax
2003 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (1,536) $ 522 $ (1,014)
Less: Reclassification adjustment for gains realized in income 341 (116) 225
- ------------------------------------------------------------------------------------------------------
Net unrealized losses $ (1,877) $ 638 $ (1,239)
======================================================================================================
NOTE 16 --COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, there are outstanding commitments and
contingent liabilities, created under prevailing terms and collateral
requirements such as commitments to extend credit, financial guarantees and
letters of credit, which are not reflected in the accompanying Financial
Statements. The Company does not anticipate any losses as a result of these
transactions. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
Financial instruments whose contract amounts represent credit risk at
December 31, 2005 and 2004 are as follows:
2005 2004
- --------------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 41,229 $ 21,152
Variable rate $ 75,100 $ 67,502
Standby letters of credit $ 15,268 $ 17,662
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have expiration dates of one year or less or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.
Various actions and proceedings are presently pending to which the Company
is a party. Management is of the opinion that the aggregate liabilities, if any,
arising from such actions would not have a material adverse effect on the
financial position of the Company.
The Company is upgrading its computer technology at an estimated total cost
of $1.5 million of which $.7 million has been incurred through December 31, 2005
and is included in fixed assets, but not yet placed in service. The project is
expected to be completed in the first quarter of 2006.
Penseco Financial Services Corporation / 2005 Annual Report 37
NOTE 17 -- FAIR VALUE DISCLOSURE
GENERAL
Statement of Financial Accounting Standards No.107, "Disclosures about Fair
Value of Financial Instruments" (SFAS 107), requires the disclosure of the
estimated fair value of on and off-balance sheet financial instruments.
VALUATION METHODS AND ASSUMPTIONS
Estimated fair values have been determined using the best available data, an
estimation methodology suitable for each category of financial instruments. For
those loans and deposits with floating interest rates it is presumed that
estimated fair values generally approximate the carrying amount balances.
Financial instruments actively traded in a secondary market have been
valued using quoted available market prices. Those with stated maturities have
been valued using a present value discounted cash flow with a discount rate
approximating current market for similar assets and liabilities. Those
liabilities with no stated maturities have an estimated fair value equal to both
the amount payable on demand and the carrying amount balance. The net loan
portfolio has been valued using a present value discounted cash flow. The
discount rate used in these calculations is the current loan rate adjusted for
non-interest operating costs, credit loss and assumed prepayment risk. Off
balance sheet carrying amounts and fair value of letters of credit represent the
deferred income fees arising from those unrecognized financial instruments.
Changes in assumptions or estimation methodologies may have a material
effect on these estimated fair values.
All assets and liabilities which are not considered financial instruments
have not been valued differently than has been customary with historical cost
accounting.
December 31, 2005 December 31, 2004
Carrying Fair Carrying Fair
Amount Value Amount Value
- -------------------------------------------------------------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 11,310 $ 11,310 $ 7,763 $ 7,763
Interest bearing balances with banks 263 263 534 534
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 11,573 11,573 8,297 8,297
Investment Securities:
Available-for-sale:
U.S. Treasury securities - - 5,077 5,077
U.S. Agency obligations 118,545 118,545 124,528 124,528
States & political subdivisions 21,635 21,635 31,540 31,540
Federal Home Loan Bank stock 4,699 4,699 5,604 5,604
Other securities 3,063 3,063 661 661
Held-to-maturity:
U.S. Agency obligations 52,763 51,492 66,019 65,672
States & political subdivisions 29,252 31,638 29,249 32,119
- -------------------------------------------------------------------------------------------------------------------
Total investment securities 229,957 231,072 262,678 265,201
Loans, net of unearned income:
Real estate mortgages 240,985 235,427 202,954 198,244
Commercial 42,894 42,894 41,560 41,560
Consumer and other 37,483 37,899 35,662 35,891
Less: Allowance for loan losses 3,800 3,600
- -------------------------------------------------------------------------------------------------------------------
Loans, net 317,562 316,220 276,576 275,695
- -------------------------------------------------------------------------------------------------------------------
Total Financial Assets 559,092 $ 558,865 547,551 $ 549,193
Other assets 16,596 16,157
- -------------------------------------------------------------------------------------------------------------------
Total Assets $ 575,688 $ 563,708
===================================================================================================================
Financial Liabilities:
Demand - Non-interest bearing $ 91,713 $ 91,713 $ 82,938 $ 82,938
Demand - Interest bearing 33,094 33,094 31,161 31,161
Savings 86,013 86,013 80,307 80,307
Money markets 80,463 80,463 91,604 91,604
Time 106,584 107,794 109,291 110,953
- -------------------------------------------------------------------------------------------------------------------
Total Deposits 397,867 399,077 395,301 396,963
Repurchase agreements 30,414 30,414 18,398 18,398
Short-term borrowings 4,626 4,626 886 886
Long-term borrowings 75,401 75,710 84,620 84,655
- -------------------------------------------------------------------------------------------------------------------
Total Financial Liabilities 508,308 $ 509,827 499,205 $ 500,902
Other Liabilities 3,581 2,127
Stockholders' Equity 63,799 62,376
- -------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 575,688 $ 563,708
===================================================================================================================
Standby Letters of Credit $ (153) $ (153) $ (177) $ (177)
38 Penseco Financial Services Corporation / 2005 Annual Report
NOTE 18 -- OPERATING LEASES
The Company leases the land upon which the Mount Pocono Office was built and the
land upon which a drive-up ATM was built on Meadow Avenue, Scranton. The Company
also leases space at several locations which are being used as remote banking
facilities. Rental expense was $94 in 2005, $90 in 2004 and $86 in 2003. All
leases contain renewal options. The Mount Pocono and the Meadow Avenue leases
contain the right of first refusal for the purchase of the properties and
provisions for annual rent adjustments based upon the Consumer Price Index.
Future minimum rental commitments under these leases at December 31, 2005
are as follows:
Mount Meadow ATM
Pocono Avenue Sites Total
- -----------------------------------------------------------------------
2006 $ 52 $ 14 $ 13 $ 79
2007 52 - 10 62
2008 52 - 4 56
2009 52 - - 52
2010 53 - - 53
2011 22 - - 22
- -----------------------------------------------------------------------
Total minimum payments required $ 283 $ 14 $ 27 $ 324
=======================================================================
NOTE 19 -- LOANS TO DIRECTORS, PRINCIPAL OFFICERS AND RELATED PARTIES
The Company has had, and may be expected to have in the future, banking
transactions in the ordinary course of business with directors, principal
officers, their immediate families and affiliated companies in which they are
principal stockholders (commonly referred to as related parties), on the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with others. A summary of loans to directors,
principal officers and related parties is as follows:
Years Ended December 31, 2005 2004
- -------------------------------------------------------------
Beginning Balance $ 9,632 $ 5,265
Additions 5,387 4,899
Reclassifications (217) -
Collections (4,312) (532)
- -------------------------------------------------------------
Ending Balance $ 10,490 $ 9,632
=============================================================
In addition to the loan amounts shown above, the Bank has issued standby letters
of credit for the accounts of related parties in the amount of $6,545.
NOTE 20 -- 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 on the following page) of Tier I and Total
Capital to risk-weighted assets and of Tier I Capital to average assets
(Leverage ratio). The table also presents the Company's actual capital amounts
and ratios. The Bank's actual capital amounts and ratios are substantially
identical to the Company's. Management believes, as of December 31, 2005, that
the Company and the Bank meet all capital adequacy requirements to which they
are subject.
As of December 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 December 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.
Penseco Financial Services Corporation / 2005 Annual Report 39
NOTE 20 -- REGULATORY MATTERS (CONTINUED)
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of December 31, 2005 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 67,933 18.62% > $ 29,188 > 8.0% > $ 36,486 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 64,133 17.58% > $ 14,594 > 4.0% > $ 21,892 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 64,133 11.28% > * > * > $ 28,415 > 5.0%
- - - -
*3.0% ($17,049), 4.0% ($22,732) or 5.0% ($28,415) 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.
NOTE 21 -- PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)
The condensed Company-only information follows:
BALANCE SHEETS
December 31, 2005 2004
- ------------------------------------------------------------------
Cash $ 5 $ 8
Interest bearing balances with banks 76 -
- ------------------------------------------------------------------
Cash and Cash Equivalents 81 8
Investment in bank subsidiary 60,787 61,859
Equity Investments 3,043 642
- ------------------------------------------------------------------
Total Assets $ 63,911 $ 62,509
==================================================================
Total Liabilities $ 112 $ 133
Total Stockholders' Equity 63,799 62,376
- ------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 63,911 $ 62,509
==================================================================
STATEMENTS OF INCOME
Years Ended December 31, 2005 2004 2003
- --------------------------------------------------------------------------------
Dividends from bank subsidiary $ 5,594 $ 2,900 $ 2,900
Dividends on investment securities 45 11 10
Interest on balances with banks 3 - -
- --------------------------------------------------------------------------------
Total Income 5,642 2,911 2,910
Other non-interest expense 10 10 10
- --------------------------------------------------------------------------------
Net income before undistributed earnings
of bank subsidiary 5,632 2,901 2,900
Undistributed earnings of bank subsidiary 237 2,700 3,071
- --------------------------------------------------------------------------------
Net Income $ 5,869 $ 5,601 $ 5,971
================================================================================
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2005 2004 2003
- --------------------------------------------------------------------------------
Operating Activities:
Net Income $ 5,869 $ 5,601 $ 5,971
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income
of bank subsidiary (237) (2,700) (3,071)
- --------------------------------------------------------------------------------
Net cash provided by operating activities 5,632 2,901 2,900
- --------------------------------------------------------------------------------
Investing Activities:
Purchase of equity investments (2,465) - -
- --------------------------------------------------------------------------------
Net cash used by investing activities (2,465) - -
- --------------------------------------------------------------------------------
Financing Activities:
Cash dividends paid (3,094) (2,900) (2,900)
- --------------------------------------------------------------------------------
Net cash used by financing activities (3,094) (2,900) (2,900)
- --------------------------------------------------------------------------------
Net increase in cash and cash equivalents 73 1 -
Cash and cash equivalents at January 1 8 7 7
- --------------------------------------------------------------------------------
Cash and cash equivalents at December 31 $ 81 $ 8 $ 7
================================================================================
40 Penseco Financial Services Corporation / 2005 Annual Report
Executive Officers
------------------
Craig W. Best
President and CEO
Richard E. Grimm
Executive Vice-President, Treasurer and Cashier
Peter F. Moylan
Executive Vice-President, Non-Deposit Services and Trust Officer
William J. Calpin, Jr.
Senior Vice-President, Trust Services
Andrew A. Kettel, Jr.
Senior Vice-President
Christe A. Casciano
Vice-President, Director of Marketing
Michael G. Ostermayer
Vice-President, Chief Investment Officer, Trust Services
Richard P. Rossi
Vice-President, Director of Human Resources
Lynn Peters Thiel
Vice-President, Compliance Officer
James Tobin
Vice-President, Charge Card Manager
John H. Warnken
Vice-President, Operations
Robert P. Heim
Director of Internal Audit
Patrick Scanlon
Controller
P. Frank Kozik
Secretary
Penseco Financial Services Corporation / 2005 Annual Report 41
Company Officers
----------------
ASSISTANT VICE-PRESIDENTS
John R. Anderson III
Carl M. Baruffaldi
Mark M. Bennett
and Assistant Secretary
Denise M. Cebular
Carol Curtis McMullen
Assistant Trust Officer and Assistant Secretary
Paula M. DePeters
and Assistant Treasurer
J. Patrick Dietz
Frank Gardner
Lisa A. Kearney
Eleanor Kruk
Thomas J. Malinchak
Caroline Mickelson
Louis J. Rizzo
Aleta Sebastianelli
and Assistant Secretary
Jeffrey Solimine
Jennifer S. Wohlgemuth
Linda Wolf
and Training Officer
Beth S. Wolff
Deborah A. Wright
and Outside Sales
Mark J. Zakoski
ASSISTANT CASHIERS
Pamela Edwards
Barbara Garofoli
Susan T. Holweg
Susan A. Kopp
Jacqueline Lucke
Kristen A. McGoff
and Branch Operations Officer
Candace F. Quick
Nereida Santiago
Sharon Thauer
ACCOUNTING OFFICER
Luree M. Waltz
ASSISTANT BRANCH OPERATIONS OFFICERS
Tanya L. Frable
Melissa McLain
ASSISTANT CHARGE CARD MANAGER
Eileen Yanchak
ASSISTANT CONTROLLER
Susan M. Bray
and Assistant Treasurer
ASSISTANT DIRECTOR OF INTERNAL AUDIT
Paula A. Ralston Nenish
ASSISTANT STUDENT LOAN OFFICER
Jo Ann M. Bevilaqua
ASSISTANT TRUST OFFICER
Dominick P. Gianuzzi
BRANCH OPERATIONS MANAGER
Robin L. Jenkins
BRANCH OPERATIONS OFFICERS
Patricia A. Bruno
Sheila Caprario
Kathleen Griffiths
Stephen A. Hoffman
COLLECTIONS OFFICER
Robert E. Diehl
COMPUTER OPERATIONS OFFICER
Charles Penn
COST ACCOUNTING OFFICER
David R. Weiland
DIRECTOR OF CAMPUS BANKING
Douglas R. Duguay
DIRECTOR OF SYSTEMS / NETWORKING
Robert J. Saslo
LOAN ADMINISTRATION OFFICERS
Susan D. Blascak
Carol J. Ives
LOAN OFFICER
Denise Belton
MERCHANT OFFICER
Jill Ross
OPERATIONS OFFICER
Patricia Pliske
TAX OFFICER
Robert W. McDonald
TRUST ADMINISTRATOR
Kristen R. Noll
TRUST OPERATIONS OFFICER
Carol Trezzi
TRUST INVESTMENT OFFICER
Paul J. Macknosky III
42 Penseco Financial Services Corporation / 2005 Annual Report
Company Board Members
---------------------
PENSECO FINANCIAL SERVICES CORPORATION AND PENN SECURITY BANK AND TRUST COMPANY
BOARD OF DIRECTORS
Craig W. Best
President and CEO
Edwin J. Butler
Retired Bank Officer
Richard E. Grimm
Executive Vice-President, Treasurer and Cashier
Russell C. Hazelton
Retired Captain, Trans World Airlines
D. William Hume
Chairman of the Board, Retired Bank Officer
James G. Keisling
CEO Compression Polymers Corp. and Vycom Corp.,
Manufacturers of Plastic Sheet Products
P. Frank Kozik
President and CEO, Scranton Craftsmen, Inc., Manufacturer of
Ornamental Iron and Precast Concrete Products
Robert W. Naismith, Ph.D.
Chairman and CEO, Life Science Analytics, Inc.
James B. Nicholas
President, D. G. Nicholas Co., Wholesale Auto Parts Company
Emily S. Perry
Retired Insurance Account Executive & Community Volunteer
Sandra C. Phillips
Penn State Master Gardener & Community Volunteer
Otto P. Robinson, Jr.
Attorney-at-Law, Retired Bank Officer
Steven L. Weinberger
President of G. Weinberger Company, Mechanical Contractor
Specializing in Commercial & Industrial Construction
PENN SECURITY BANK AND TRUST COMPANY
ADVISORY BOARDS
ABINGTON OFFICE
Carl M. Baruffaldi
James L. Burne, DDS
Keith Eckel
Richard C. Florey
C. Lee Havey, Jr.
Attorney Patrick J. Lavelle
Sandra C. Phillips
EAST SCRANTON OFFICE
Marie W. Allen
J. Conrad Bosley
Frank Gardner
Judge Carmen Minora
Mark R. Sarno
EAST STROUDSBURG OFFICE
Denise M. Cebular
Robert J. Dillman, Ph.D.
Attorney Kirby Upright
Jeffrey Weichel
GREEN RIDGE OFFICE
Joseph N. Connor
Everett Jones
Caroline Mickelson
George Noone
Jeffrey Solimine
MOUNT POCONO OFFICE
Francis Cappelloni
Robert C. Hay
David Lansdowne
Thomas J. Malinchak
NORTH POCONO OFFICE
Jacqueline A. Carling
Anthony J. Descipio
George F. Edwards, Jr.
James A. Forti
Attorney David Z. Smith
Beth S. Wolff
SOUTH SIDE OFFICE
Attorney Zygmunt R. Bialkowski, Jr.
Michael P. Brown
J. Patrick Dietz
Lois Ferrari
Jeffrey J. Leventhal
Ted M. Stampien, DDS
Penseco Financial Services Corporation / 2005 Annual Report 43
Customer Services
-----------------
A detailed listing of the services offered by the Company is as follows:
DEPOSIT ACCOUNTS
All Purpose Clubs
Certificates of Deposit
Christmas Clubs
Demand Accounts
Individual Retirement Accounts
Money Market Accounts
NOW Accounts
Savings Accounts
Vacation Clubs
LENDING
Automobile Loans
Business Loans
Collateral Loans
Commercial Equipment Leasing
Construction Loans
Cosmic Card (Debit Card)
Credit Lines
Educational Loans
Home Equity Loans
Home Repair and Remodeling Loans
Installment Loans
MasterCard and VISA (Credit Card)
Mortgage Loans (Residential and Commercial)
Personal Loans
OTHER SERVICES
ATM Services
Bank Money Orders
Cash Management
Cashier's Checks
College Campus Card Interface
Direct Deposit of Recurring Payments
Foreign Remittance
Internet Banking
Investor Services
(a) Brokerage
(b) Insurance
Lockbox Services
Merchant Card Service
Night Depository
Repurchase Agreements
Safe Deposit Boxes
Travelers Checks
Trust Department Services
(a) Administrator
(b) Agent
(c) Custodian and Trustee for Pension Plans
(d) Executor
(e) Trustee
(f) Trustee for Public Bond Issues
U.S. Savings Bonds
BRANCH LOCATIONS (Each Have ATMs)
Abington
1100 Northern Boulevard
Clarks Summit, PA 18411
Carl M. Baruffaldi, Manager
(570) 587-4898
East Scranton
Prescott Avenue & Ash Street
Scranton, PA 18510
Frank Gardner, Manager
(570) 342-9101
East Stroudsburg
Route 209 & Route 447
East Stroudsburg, PA 18301
Denise M. Cebular, Manager
(570) 420-0432
Gouldsboro
Main & Second Streets
Gouldsboro, PA 18424
Robin L. Jenkins, Branch Operations Manager
(570) 842-6473
Green Ridge
1901 Sanderson Avenue
Scranton, PA 18509
Jeffrey Solimine, Manager
(570) 346-4695
Central City
150 North Washington Avenue
Scranton, PA 18503
Andrew A. Kettel, Jr., Manager
(570) 346-7741
Mount Pocono
Route 611 & Route 940
Mount Pocono, PA 18344
Thomas J. Malinchak, Manager
(570) 839-8732
North Pocono
Main & Academy Streets
Moscow, PA 18444
Beth S. Wolff, Manager
(570) 842-7626
South Scranton
526 Cedar Avenue
Scranton, PA 18505
J. Patrick Dietz, Manager
(570) 343-1151
OTHER ATM LOCATIONS
-------------------
Acorn Market
Route 611
Swiftwater, PA
Convenient Food Mart
Wyoming & Mulberry Streets
Scranton, PA
Dino & Francesco's Restaurant
Birney Plaza
Moosic, PA
Drive-Up ATM
Meadow Avenue & Hemlock Street
Scranton, PA
Hilton Hotel & Conference Center
Adams Avenue
Scranton, PA
Lackawanna College
501 Vine Street
Scranton, PA
Met Life
Morgan Highway
Clarks Summit, PA
Met Life
Montage Mountain
Moosic, PA
Red Barn Village
Newton Ransom Boulevard
Newton, PA
Skytop Lodge
One Skytop
Skytop, PA
Website: www.pennsecurity.com