UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
COMMISSION FILE NUMBER 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
SCRANTON, PENNSYLVANIA
COMMONWEALTH OF PENNSYLVANIA
I.R.S. EMPLOYER IDENTIFICATION NUMBER 23-2939222
150 NORTH WASHINGTON AVENUE
SCRANTON, PENNSYLVANIA 18503-1848
TELEPHONE NUMBER 570-346-7741
SECURITIES REGISTERED UNDER
SECTION 12(g) OF THE ACT
Common Stock, Par Value $ .01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes ( ) No (X)
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes ( ) No (X)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer ( ) Accelerated filer (X) Non-accelerated filer ( )
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes ( ) No (X)
The aggregate market value of the Company's voting stock held by non-affiliates
of the registrant on June 30, 2006, based on the closing price of such stock on
that date, equals approximately $79,136,087.
The number of shares of common stock outstanding as of February 9, 2007 equals
2,148,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Corporation's definitive proxy statement relating to the 2007
Annual Meeting of Stockholders are incorporated by reference in Part III.
Penseco Financial Services Corporation / 2006 Annual Report 9
PENSECO FINANCIAL SERVICES CORPORATION
PART I
------
ITEM 1 Business
GENERAL
PENSECO FINANCIAL SERVICES CORPORATION, (the "Company"), which is headquartered
in Scranton, Pennsylvania, was formed under the general corporation laws of the
State of Pennsylvania in 1997 and is registered as a financial holding company.
The Company became a holding company upon the acquisition of all of the
outstanding shares of Penn Security Bank and Trust Company (the "Bank"), a
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, central loan
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.
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.
ITEM 1A Risk Factors
RISKS RELATED TO OUR BUSINESS
Credit Risk
Changes in the credit quality of our loan portfolio may impact the level of our
allowance for loan losses.
We make various judgments about the collectibility of our loans, including the
creditworthiness of our borrowers and the value of the real estate and other
assets serving as collateral for our loans. In determining the amount of the
allowance for loan losses, we review our loans and our loan loss and delinquency
experience, and we evaluate economic conditions. If our judgments are incorrect,
our allowance for loan losses may not be sufficient to cover future losses,
which will result in additions to our allowance through increased provisions for
loan losses. In addition, bank regulators periodically review our allowance for
loan losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs. Increased provisions for loan losses would
increase our expenses and reduce our profits.
10 Penseco Financial Services Corporation / 2006 Annual Report
Nonetheless, to the best of management's knowledge, there are also no
particular risk elements in the local economy that put a group or category of
loans at increased risk. Also the Company is not dependent upon a single
customer, or a few customers, the loss of one or more of which would have a
material adverse effect on its operations. The operations and earnings of the
Corporation are also not materially affected by seasonal changes
Market Risk
Changes in interest rates could affect our investment values and net interest
income.
At December 31, 2006, the Company owned approximately $91.7 million of
marketable securities available for sale. These securities are carried at fair
value on the consolidated balance sheet. Unrealized gains or losses on these
securities, that is, the difference between the fair value and the amortized
cost of these securities, is reflected in stockholders' equity, net of deferred
taxes. As of December 31, 2006, the Company's available for sale marketable
securities portfolio had a net unrealized gain, net of taxes, of $1,011. The
fair value of the Company's available for sale marketable securities is subject
to interest rate change, which would not affect recorded earnings, but would
increase or decrease comprehensive income and stockholders' equity.
The principal component of the Company's earnings is net interest income,
which is the difference between interest and fees earned on interest-earning
assets and interest paid on deposits and other borrowings. The most significant
impact on net interest income between periods is derived from the interaction of
changes in the volume of and rates earned or paid on interest-earning assets and
interest-bearing liabilities. The volume of earning dollars in loans and
investments, compared to the volume of interest-bearing liabilities represented
by deposits and borrowings, combined with the spread, produces the changes in
net interest income between periods.
The Company continually monitors the relationship of its interest rate
sensitive assets and liabilities through its Asset/Liability Committee.
Strong competition within our market could affect our profits and growth.
The Bank operates in a competitive environment in which it must share its market
with many local independent banks as well as several banks which are affiliates
or branches of very large regional holding companies. The Bank encounters
competition from diversified financial institutions, ranging in size from small
banks to the nationwide banks operating in its region. The competition includes
commercial banks, savings and loan associations, credit unions, other lending
institutions and mortgage originators.
The principal competitive factors among the Company's competitors can be
grouped into two categories: pricing and services. In the Company's primary
service area, interest rates on deposits, especially time deposits, and interest
rates and fees charged to customers on loans are very competitive. From a
service perspective, the Bank competes in areas such as convenience of location,
types of services, service costs and banking hours.
Compliance
We operate in a highly regulated environment and may be affected by changes in
laws and regulations.
The Company is registered as a financial holding company under the Bank Holding
Company Act of 1956, as amended, and, as such, is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System ("FRB"). The
Company is required to file 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.
Our banking subsidiary, Penn Security Bank and Trust Company, as a
Pennsylvania state-chartered financial institution, is subject to supervision,
regulation and examination by the Commonwealth of Pennsylvania Department of
Banking and by the Federal Deposit Insurance Corporation (the "FDIC"), which
insures the Bank's deposits to the maximum extent permitted by law.
Operational Risk
The Company needs to continually attract and retain qualified personnel for its
operations. High quality customer service, as well as efficient and profitable
operations, are dependent on the Company's ability to attract and retain
qualified individuals for key positions within the organization. As of December
31, 2006, the Company employed 171 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.
Penseco Financial Services Corporation / 2006 Annual Report 11
Our operations could be affected if we do not have access to modern and reliable
technology.
The Company operates in a highly-automated environment, wherein almost all
transactions are processed by computer software to produce results. To remain
competitive, the Company must continually evaluate the adequacy of its data
processing capabilities and make revisions as needed. The Company has recently
upgraded its computer technology at a total cost of $1.5 million.
The Company regularly tests its ability to restore data capabilities in the
event of a natural disaster, sustained power failure or other inability to
utilize its primary systems.
Liquidity Risk
Increased needs for disbursement of funds on loans and deposits can affect our
liquidity.
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
Our future pension plan costs and contributions could be unfavorably impacted by
the factors that are used in the actuarial calculations.
Our costs of providing non-contributory defined benefit pension plans are
dependent upon a number of factors, such as the rates of return on plan assets,
discount rates, the level of interest rates used to measure the required minimum
funding levels of the plans, future government regulation and our required or
voluntary contributions made to the plans. Without sustained growth in the
pension investments over time to increase the value of our plan assets and
depending upon the other factors impacting our costs as listed above, we could
be required to fund our plans with higher amounts of cash than are anticipated
by our actuaries. Such increased funding obligations could have a material
impact on our liquidity by reducing our cash flows.
ITEM 1B Unresolved Staff Comments
Not applicable
ITEM 2 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.
ITEM 3 Legal Proceedings
There are no material pending legal proceedings, other than ordinary routine
litigation incidental to the business of the Company, as to which the Company or
subsidiary is a party or of which any of their property is subject.
ITEM 4 Submission of Matters to a Vote of Security Holders
No matter was submitted by the Company to its shareholders through the
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year covered by this report.
12 Penseco Financial Services Corporation / 2006 Annual Report
Part II
-------
ITEM 5 Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
This Form 10-K is the Company's annual disclosure statement as required under
Section 13 or 15(d) of the Securities Exhchange Act of 1934. 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:
Boenning & Scattergood, Inc. Jefferies & Company, Inc.
Ferris, Baker, Watts, Inc. Knight Equity Markets, LP
Hill Thompson Magid & Company, Inc. Monroe Securities, Inc.
Hudson Securities, Inc.. Ryan, Beck & 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
2006 High Low Per Share
- ---------------------------------------------
First Quarter $ 46 $ 41 $ .35
Second Quarter 45 42 .35
Third Quarter 43 41 .35
Fourth Quarter 44 41 .45
------
$ 1.50
======
Dividends Paid
2005 High Low Per Share
- ---------------------------------------------
First Quarter $ 48 $ 39 $ .33
Second Quarter 47 42 .33
Third Quarter 44 41 .33
Fourth Quarter 43 41 .45
------
$ 1.44
======
A graph depicts Dividends Paid (in millions) Year
- -------------------------------------------------------
$ 3,222 2006
3,094 2005
2,900 2004
2,900 2003
2,899 2002
As of February 9, 2007 there were approximately 895 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 23 and 46.
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
2006 Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------
Net Interest Income $ 5,171 $ 5,212 $ 5,214 $ 5,271
Provision for Loan Losses 127 27 143 136
Other Income 2,038 1,655 2,452 2,060
Other Expenses and Taxes 5,508 5,279 5,650 6,195
Net Income 1,574 1,561 1,873 1,000
Earnings Per Share $ .73 $ .73 $ .87 $ .47
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 $ .58 $ .71 $ .79 $ .65
Penseco Financial Services Corporation / 2006 Annual Report 13
PENSECO FINANCIAL SERVICES CORPORATION
The following line graph sets forth comparative information regarding the
Company's cumulative shareholder return on its Common Stock over the last five
fiscal years. Total shareholder return is measured by dividing total dividends
(assuming dividend reinvestment) plus share price change for a period by the
share price at the beginning of the investment period. The Company's cumulative
shareholder return based on an investment of $100 at the beginning of the
five-year period begining December 31, 2001 is compared to the cumulative total
return of the Russell 2000 Index ("Russell 2000") and the SNL Securities
Northeast Quadrant Pink Sheet Banks Index ("Pink Banks"), which more closely
reflects the Company's peer group. The yearly points marked on the horizontal
axis of the graph correspond to December 31st of that year.
Total Return Performance Graph
Period Ending
---------------------------------------------------------------
Index 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
- ------------------------------------------------------------------------------------------------------
Penseco Financial Services Corporation 100.00 123.66 150.02 159.18 164.69 173.59
Russell 2000 100.00 79.52 117.09 138.55 144.86 171.47
SNL Northeast OTC-BB and Pink Banks 100.00 121.20 176.77 205.94 205.31 212.18
14 Penseco Financial Services Corporation / 2006 Annual Report
ITEM 6 Selected Financial Data
(in thousands, except per share amounts)
RESULTS OF OPERATIONS:
2006 2005 2004 2003 2002
- ---------------------------------------------------------------------------------------------
Interest Income $ 31,922 $ 28,170 $ 25,385 $ 26,014 $ 27,899
Interest Expense 11,054 8,580 7,579 8,228 8,011
- ---------------------------------------------------------------------------------------------
Net Interest Income 20,868 19,590 17,806 17,786 19,888
Provision for Loan Losses 433 263 144 476 813
- ---------------------------------------------------------------------------------------------
Net Interest Income after
Provision for Loan Losses 20,435 19,327 17,662 17,310 19,075
Other Income 8,205 8,874 9,594 10,743 11,032
Other Expenses 21,037 20,719 20,584 20,454 21,098
Income Taxes 1,595 1,613 1,071 1,628 2,256
- ---------------------------------------------------------------------------------------------
Net Income $ 6,008 $ 5,869 $ 5,601 $ 5,971 $ 6,753
=============================================================================================
BALANCE SHEET AMOUNTS:
Assets $ 569,821 $ 575,688 $ 563,708 $ 584,590 $ 496,956
Investment Securities $ 166,080 $ 229,957 $ 262,678 $ 293,125 $ 139,132
Net Loans $ 365,722 $ 317,562 $ 276,576 $ 236,882 $ 285,509
Deposits $ 413,800 $ 397,867 $ 395,301 $ 407,944 $ 414,664
Long-Term Borrowings $ 65,853 $ 75,401 $ 84,620 $ 93,523 $ -
Stockholders' Equity $ 66,571 $ 63,799 $ 62,376 $ 60,807 $ 58,975
PER SHARE AMOUNTS:
Earnings per Share $ 2.80 $ 2.73 $ 2.61 $ 2.78 $ 3.14
Dividends per Share $ 1.50 $ 1.44 $ 1.35 $ 1.35 $ 1.35
Book Value per Share $ 30.99 $ 29.70 $ 29.04 $ 28.31 $ 27.46
Common Shares Outstanding 2,148,000 2,148,000 2,148,000 2,148,000 2,148,000
FINANCIAL RATIOS:
Net Interest Margin 3.89% 3.57% 3.18% 3.24% 4.21%
Return on Average Assets 1.07% 1.03% .96% 1.05% 1.37%
Return on Average Equity 9.15% 9.23% 9.11% 9.87% 11.79%
Average Equity to Average Assets 11.68% 11.19% 10.57% 10.59% 11.58%
Dividend Payout Ratio 53.57% 52.75% 51.72% 48.56% 42.99%
Penseco Financial Services Corporation / 2006 Annual Report 15
ITEM 7 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 2006 totalled $6,008, an increase of $139 or 2.4% from the
$5,869 earned in 2005, which was an increase of $268 or 4.8% from the $5,601
earned in 2004. Net earnings per share were $2.80 in 2006, compared with $2.73
in 2005 and $2.61 in 2004. Core after tax earnings for 2006, excluding a
Voluntary Early Retirement Initiative (VERI) and security gains, increased by
$658 or 11.2% compared with 2005. The Company recorded an expense of $1,119 in
the 4th quarter of 2006 in connection with the VERI. The Company anticipates
after tax cost savings of approximately $1,571 over the next three years. Net
earnings for 2006 increased from 2005 mainly from higher interest income from
strong loan demand experienced during 2006. This was offset by a higher
provision for loan losses and lower non-interest income, as well as, increased
operating expenses. Income taxes were slightly lower than year ago levels. Core
after tax earnings for 2005, excluding one time securities gains or losses
increased by $513 or 9.6% compared with 2004. 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.
The Company's return on average assets was 1.07% in 2006 compared to 1.03%
in 2005 and .96% in 2004. Return on average equity was 9.15%, 9.23% and 9.11% in
2006, 2005 and 2004, respectively.
A graph depicts Net Income (in millions) Year
- ------------------------------------------------
$ 6,008 2006
5,869 2005
5,601 2004
5,971 2003
6,753 2002
A graph depicts Return on Average Assets Year
- ------------------------------------------------
1.07% 2006
1.03% 2005
.96% 2004
1.05% 2003
1.37% 2002
16 Penseco Financial Services Corporation / 2006 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 $1.3 million or 6.6% to $20.9 million for
2006 compared to $19.6 million for 2005. Loan interest income was higher overall
for 2006 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 maturities of U.S. Agency Securities.
The proceeds were used to fund loan demand. Interest expense for 2006 increased
$2.5 million or 29.1% to $11.1 million for 2006 compared to $8.6 million in
2005. The increase is primarily due to increases in interest rates through 2005.
Net interest income increased $1.8 million or 10.1% to $19.6 million for
2005 compared to $17.8 million for 2004. Loan interest income was higher overall
for 2005 due to increases in 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 in primarily due to increases in interest rates as the Federal
Reserve continued to raise interest rates through 2005.
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, 2006 was 3.9% compared with
3.6% for the year ended December 31, 2005 and 3.2% for the year ended December
31, 2004.
Interest income in 2006 totalled $31.9 million, compared to $28.2 million
in 2005, an increase of $3.7 million or 13.1%. The yield on average
interest-earning assets increased to 6.0% in 2006, compared to 5.1% in 2005.
Average interest-earning assets decreased in 2006 to $536.9 million from $548.2
million in 2005. Average loans, which are typically the Company's highest
yielding earning assets, increased $42.0 million or 14.1% in 2006. Average loans
represented 63.3% of 2006 average interest-earning assets, compared to 54.3% in
2005. Income on loans increased $4.8 million or 25.8% in 2006, compared to an
increase in loan income of $5.0 million or 36.8% during 2005. Investment
securities decreased on average by $43.0 million or 18.1% to $194.1 million
compared to $237.1 million in 2005. Income on investments declined $.8 million
or 8.7% to $8.4 million in 2006, from $9.2 million in 2005.
The average rate paid on interest-bearing liabilities during 2006 was 2.6%,
compared to 2.1% in 2005.
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 was 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. Interest expense also increased $1.0 million or 13.1% in 2005 to $8.6
million from $7.6 million in 2004.
The average rate paid on interest-bearing liabilities during 2005 was 2.1%,
compared to 1.7% in 2004.
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
- -----------------------------------------------------------
$ 20,868 2006
19,590 2005
17,806 2004
17,786 2003
19,888 2002
Penseco Financial Services Corporation / 2006 Annual Report 17
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 2006,
2005 and 2004.
2006 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
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%
U.S. Agency obligations 83,355 3,186 3.82 116,429 3,650 3.13 133,231 4,340 3.26
States & political subdivisions 24,851 1,114 6.79 23,873 1,006 6.38 41,142 1,931 7.11
Federal Home Loan Bank stock 4,738 232 4.90 4,907 143 2.91 5,704 94 1.65
Other 3,119 108 3.46 1,765 47 2.66 549 13 2.37
Held-to-maturity:
U.S. Agency obligations 48,801 2,174 4.45 59,036 2,631 4.46 74,291 3,334 4.49
States & political subdivisions 29,221 1,574 8.16 29,250 1,610 8.34 31,103 1,545 7.53
Loans, net of unearned income:
Real estate mortgages 270,445 18,459 6.83 217,942 13,396 6.15 185,440 10,044 5.42
Commercial 31,690 2,131 6.72 42,820 2,782 6.50 36,312 1,814 5.00
Consumer and other 37,679 2,784 7.39 37,037 2,391 6.46 34,287 1,774 5.17
Federal funds sold - - - 6,011 176 2.93 5,434 58 1.07
Interest on balances with banks 3,047 160 5.25 7,302 211 2.89 6,589 68 1.03
- ------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets/
Total Interest Income 536,946 $ 31,922 5.95% 548,221 $ 28,170 5.14% 560,288 $ 25,385 4.53%
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks 10,534 8,961 8,732
Bank premises and equipment 9,427 9,184 9,593
Accrued interest receivable 3,035 2,967 3,225
Other assets 6,243 2,663 3,040
Less: Allowance for loan losses 3,895 3,686 3,523
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 562,290 $ 568,310 $ 581,355
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 49,753 $ 347 .70% $ 32,821 $ 190 .58% $ 31,425 $ 115 .37%
Savings 71,624 248 .35 79,262 275 .35 81,812 346 .42
Money markets 83,349 2,225 2.67 84,115 1,246 1.48 89,161 707 .79
Time - Over $100 32,692 1,408 4.31 26,088 808 3.10 28,067 806 2.87
Time - Other 88,614 3,384 3.82 86,995 2,501 2.87 92,752 1,985 2.14
Repurchase agreements 19,457 455 2.34 27,546 415 1.51 22,817 167 .73
Short-term borrowings 3,466 189 5.45 378 19 5.03 595 10 1.68
Long-term borrowings 70,592 2,798 3.96 79,919 3,126 3.91 88,955 3,443 3.87
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 419,547 $ 11,054 2.63% 417,124 $ 8,580 2.06% 435,584 $ 7,579 1.74%
- ------------------------------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 72,950 86,302 82,757
All other liabilities 4,141 1,270 1,545
Stockholders' equity 65,652 63,614 61,469
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 562,290 $ 568,310 $ 581,355
Interest Spread 3.32% 3.08% 2.79%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 20,868 $ 19,590 $ 17,806
FINANCIAL RATIOS
Net interest margin 3.89% 3.57% 3.18%
Return on average assets 1.07% 1.03% .96%
Return on average equity 9.15% 9.23% 9.11%
Average equity to average assets 11.68% 11.19% 10.57%
Dividend payout ratio 53.57% 52.75% 51.72%
18 Penseco Financial Services Corporation / 2006 Annual Report
DOLLAR AMOUNT OF CHANGE IN INTEREST INCOME AND INTEREST EXPENSE
Dollar Change
Amount Change in Change in in Rate-
2006 compared to 2005 of Change Volume Rate Volume
----------------------------------------------------------------------------------
EARNING Investment securities:
ASSETS Available-for-sale:
U.S. Treasury securities $ (127) $ (127) $ (127) $ 127
U.S. Agency obligations (464) (1,035) 803 (232)
States & political subdivisions 108 33 64 11
Equity securities 150 34 99 17
Held-to-maturity:
U.S. Agency obligations (457) (456) (6) 5
States & political subdivisions (36) (2) (34) -
Loans, net of unearned income:
Real estate mortgages 5,063 3,229 1,482 352
Commercial (651) (723) 94 (22)
Consumer and other 393 41 344 8
Federal funds sold (176) (176) (176) 176
Interest bearing balances with banks (51) (123) 172 (100)
----------------------------------------------------------------------------------
Total Interest Income 3,752 695 2,715 342
----------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand - Interest bearing 157 98 39 20
LIABILITIES Savings (27) (27) - -
Money markets 979 (11) 1,001 (11)
Time - Over $100 600 205 316 79
Time - Other 883 46 822 15
Repurchase agreements 40 (122) 229 (67)
Short-term borrowings 170 155 2 13
Long-term borrowings (328) (365) 40 (3)
----------------------------------------------------------------------------------
Total Interest Expense 2,474 (21) 2,449 46
----------------------------------------------------------------------------------
Net Interest Income $ 1,278 $ 716 $ 266 $ 296
==================================================================================
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
==================================================================================
Penseco Financial Services Corporation / 2006 Annual Report 19
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 $433 in 2006, an increase of 64.6%
compared to $263 for 2005. The increase in the provision was due to the
Company's increased 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, 2006 2005 2004
- --------------------------------------------------------------------------------
Trust department income $ 1,483 $ 1,479 $ 1,353
Service charges on
deposit accounts 860 940 1,056
Merchant transaction income 3,947 4,521 5,001
Other fee income 1,423 1,575 1,650
Other operating income 173 372 177
Realized gains (losses) on
securities, net 319 (13) 357
- --------------------------------------------------------------------------------
Total Other Income $ 8,205 $ 8,874 $ 9,594
- --------------------------------------------------------------------------------
Other income declined $669 or 7.5% to $8,205 during 2006, from $8,874 for the
same period of 2005. Service charges on deposit accounts decreased $80 or 8.5%,
largely due to the implementation of the free checking program. Merchant
transaction income decreased $574 or 12.7%, mainly due to lower transaction
volume. Other fee income declined $152 or 9.7%, including reduced brokerage
income of $98 or 26.6%. Other operating income decreased $199, mainly from lower
Sunny Day income of $143 from 2005. The Sunny Day income rebate program was
discontinued in 2005. The Company realized a gain on the sale of securities of
$319 which was used to partly offset the cost associated with the VERI discussed
earlier.
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 EXPENSES
The following table sets forth information by category of other expenses for the
Company for the past three years:
Years Ended December 31, 2006 2005 2004
- --------------------------------------------------------------------------------
Salaries and employee
benefits $ 10,315 $ 9,261 $ 9,165
Expense of premises and
equipment, net 2,397 2,455 2,391
Merchant transaction
expenses 3,141 3,646 4,058
Other operating expenses 5,184 5,357 4,970
- --------------------------------------------------------------------------------
Total Other Expenses $ 21,037 $ 20,719 $ 20,584
- --------------------------------------------------------------------------------
Total other expenses increased $318 or 1.5% to $21,037 during 2006 compared with
$20,719 the same period of 2005. Salaries and employee benefits increased $1,054
or 11.4%, primarily due to the $1,119 expense recorded in the fourth quarter of
2006 in connection with the VERI. The Company anticipates after tax cost savings
of approximately $1,571 over the next three years. Merchant transaction expenses
decreased $505 or 13.9%, due to lower transaction volume. Other operating
expenses decreased $173 or 3.2%, mostly from lower professional fees and general
operating expenses.
Other expenses increased $135 or 1.0% 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 expenses declined $412 or 10.2% due to lower volumes.
INCOME TAXES
Federal income tax expense decreased $18 or 1.1% to $1,595 in 2006 compared to
$1,613 in 2005, due to increased operating income offset by higher tax-free
income.
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
taxfree income.
The Company's effective income tax rate for 2006, 2005 and 2004 was 21.0%,
21.6% and 16.1%, 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 15 to
the Consolidated Financial Statements.
FINANCIAL CONDITION
Total assets decreased $5.9 million or 1.0% during 2006 to $569.8 million at
December 31, 2006 compared to $575.7 million at December 31, 2005. For the year
ended December 31, 2005, total assets increased $12.0 million or 2.1% to $575.7
million compared to $563.7 million at December 31, 2004.
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, 2006 2005 2004
- --------------------------------------------------------------------------------
U.S.Treasury securities $ - $ - $ 5,077
U.S. Agency obligations 99,247 171,308 190,547
States & political subdivisions 59,471 50,887 60,789
Equity securities 7,362 7,762 6,265
- --------------------------------------------------------------------------------
Total Investment Securities $ 166,080 $ 229,957 $ 262,678
- --------------------------------------------------------------------------------
20 Penseco Financial Services Corporation / 2006 Annual Report
LOAN PORTFOLIO
Details regarding the Company's loan portfolio for the past five years are as
follows:
December 31, 2006 2005 2004 2003 2002
- -------------------------------------------------------------------------------------------
Real estate - construction
and land development $ 23,714 $ 13,132 $ 6,805 $ 3,078 $ 5,031
Real estate mortgages 284,323 227,853 196,149 172,964 217,883
Commercial 26,265 42,894 41,560 30,056 30,077
Credit card and related plans 3,282 3,152 2,872 2,403 2,320
Installment 25,532 26,293 25,679 25,855 27,306
Obligations of states &
political subdivisions 6,806 8,038 7,111 6,026 6,239
- -------------------------------------------------------------------------------------------
Loans, net of unearned income 369,922 321,362 280,176 240,382 288,856
- -------------------------------------------------------------------------------------------
Less: Allowance for loan losses 4,200 3,800 3,600 3,500 3,347
- -------------------------------------------------------------------------------------------
Loans, net $ 365,722 $ 317,562 $ 276,576 $ 236,882 $ 285,509
===========================================================================================
LOANS
Total net loans increased $48.1 million or 15.1% to $365.7 million at December
31, 2006 from $317.6 million at December 31, 2005. This increase is mainly due
to strong loan demand with a mix of fixed and variable rate loans backed by real
estate.
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.
A graph depicts Net Loans (in millions) Year
- --------------------------------------------------
$ 365,722 2006
317,562 2005
276,576 2004
236,882 2003
285,509 2002
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 / 2006 Annual Report 21
NON-PERFORMING ASSETS
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned.
The following table sets forth information regarding non-performing assets as of
the dates indicated:
December 31, 2006 2005 2004 2003 2002
- ---------------------------------------------------------------------------------------------
Non-accrual loans $ 3,180 $ 1,627 $ 1,991 $ 1,533 $ 2,245
Loans past due 90 days or more and accruing:
Guaranteed student loans 251 152 253 169 394
Secured by real estate 177 - - - -
Credit card loans 6 21 13 3 -
- ---------------------------------------------------------------------------------------------
Total non-performing loans 3,614 1,800 2,257 1,705 2,639
Other real estate owned - 91 176 121 59
- ---------------------------------------------------------------------------------------------
Total non-performing assets $ 3,614 $ 1,891 $ 2,433 $ 1,826 $ 2,698
- ---------------------------------------------------------------------------------------------
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 $3,180, $1,627 and $1,991 at December 31, 2006, 2005 and 2004,
respectively. The increase in 2006 was due to a single borrowing relationship
for which managment feels the company is well secured and projects no loss of
principal. If interest on those loans had been accrued, such income would have
been $209, $264 and $199 for 2006, 2005 and 2004, respectively. Interest income
on those loans, which is recorded only when received, amounted to $10, $27 and
$16 for 2006, 2005 and 2004, 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, 2006, there are no significant loans as to which management
has serious doubt about their collectibility.
At December 31, 2006, 2005 and 2004, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
LOAN LOSS EXPERIENCE
The following tables present the Company's loan loss experience during the
periods indicated:
Years Ended December 31, 2006 2005 2004 2003 2002
- ---------------------------------------------------------------------------------------
Balance at beginning of year $ 3,800 $ 3,600 $ 3,500 $ 3,347 $ 3,600
- ---------------------------------------------------------------------------------------
Charge-offs:
Real estate mortgages 74 31 - 11 91
Commercial and all others 18 - 12 289 944
Credit card and related plans 49 68 34 51 44
Installment loans 26 14 7 4 22
- ---------------------------------------------------------------------------------------
Total charge-offs 167 113 53 355 1,101
- ---------------------------------------------------------------------------------------
Recoveries:
Real estate mortgages - 46 3 24 31
Commercial and all others 131 - - 6 -
Credit card and related plans 3 3 2 2 1
Installment loans - 1 4 - 3
- ---------------------------------------------------------------------------------------
Total recoveries 134 50 9 32 35
- ---------------------------------------------------------------------------------------
Net charge-offs 33 63 44 323 1,066
- ---------------------------------------------------------------------------------------
Provision charged to operations 433 263 144 476 813
- ---------------------------------------------------------------------------------------
Balance at End of Year $ 4,200 $ 3,800 $ 3,600 $ 3,500 $ 3,347
=======================================================================================
Ratio of net charge-offs
to average loans outstanding 0.01% 0.02% 0.02% 0.12% 0.34%
=======================================================================================
22 Penseco Financial Services Corporation / 2006 Annual Report
The allowance for loan losses is allocated as follows:
December 31, 2006 2005 2004 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Amount %1 Amount %1 Amount %1 Amount %1 Amount %1
- ---------------------------------------------------------------------------------------------------------------
Real estate mortgages $ 1,200 83% $ 1,200 75% $ 1,100 72% $ 1,100 73% $ 1,600 77%
Commercial
and all others 2,500 9 2,190 16 2,070 18 1,970 15 1,222 13
Credit card and
related plans 250 1 185 1 180 1 180 1 175 1
Personal installment loans 250 7 225 8 250 9 250 11 350 9
- ---------------------------------------------------------------------------------------------------------------
Total $ 4,200 100% $ 3,800 100% $ 3,600 100% $ 3,500 100% $ 3,347 100%
===============================================================================================================
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 $15.9 million to $413.8 million at December 31,
2006 from $397.9 million at December 31, 2005. Largely, the Company experienced
growth in Money Market Accounts as well as Time Deposits. Company deposits
increased $2.6 million to $397.9 million at December 31, 2005 from $395.3
million at December 31, 2004.
The maturities of time deposits of $100,000 or more are as follows:
Three months or less $ 4,166
Over three months through six months 12,617
Over six months through twelve months 8,547
Over twelve months 14,148
--------
Total $ 39,478
========
A graph depicts Deposits (in millions) Year
- -----------------------------------------------
$ 413,800 2006
397,867 2005
395,301 2004
407,944 2003
414,664 2002
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 / 2006 Annual Report 23
LIQUIDITY (CONTINUED)
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 $178,176 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, 2006 and 2005 are as follows:
2006 2005
- --------------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 37,692 $ 41,229
Variable rate $ 74,577 $ 75,100
Standby letters of credit $ 15,061 $ 15,268
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have expiration dates of one year or less or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.
RELATED PARTIES
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. The Bank has issued standby letters of
credit for the accounts of related parties in the amount of $6,248.
A graph depicts Assets (in millions) Year
- -----------------------------------------------
$ 569,821 2006
575,688 2005
563,708 2004
584,590 2003
496,956 2002
CAPITAL RESOURCES
A strong capital position is important to the continued profitability of the
Company and promotes depositor and investor confidence. The Company's capital
provides a basis for future growth and expansion and also provides additional
protection against unexpected losses.
Additional sources of capital would come from retained earnings from the
operations of the Company and from the sale of additional common stock.
Management has no plans to offer additional common stock at this time.
The Company's total risk-based capital ratio was 19.65% at December 31,
2006. 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, 2006 2005
- -----------------------------------------------------------------------
Balance at beginning of year $ 63,799 $ 62,376
Net Income 6,008 5,869
Other comprehensive
income 1,659 (1,352)
Cash dividends declared (3,222) (3,094)
Adjustment to initially apply
FASB Statement No. 158,
net of tax (1,673) -
- -----------------------------------------------------------------------
Total Stockholders' Equity $ 66,571 $ 63,799
=======================================================================
24 Penseco Financial Services Corporation / 2006 Annual Report
A graph depicts Stockholders' Equity (in millions) Year
- -----------------------------------------------------------
$ 66,571 2006
63,799 2005
62,376 2004
60,807 2003
58,975 2002
A graph depicts Return on Average Equity Year
- -----------------------------------------------------------
9.15% 2006
9.23% 2005
9.11% 2004
9.87% 2003
11.79% 2002
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 / 2006 Annual Report 25
MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2006
The table below presents States and political subdivisions securities on a fully
taxable equivalent basis.
Non-Rate
2007 2008 2009 2010 2011 Thereafter Sensitive Total Fair Value
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed interest rate securities:
U.S. Agency obligations $ 19,674 $ 17,891 $ 10,814 $ 4,432 $ 3,428 $ 13,472 - $ 69,711 $ 68,623
Yield 4.79% 4.99% 4.45% 4.89% 4.89% 4.89% - 4.82%
States & political subdivisions - - 7,635 8,885 13,005 29,946 - 59,471 61,286
Yield - - 8.80% 8.50% 7.57% 6.97% - 7.55%
Variable interest rate securities:
U.S. Agency obligations 23,743 5,793 - - - - - 29,536 29,554
Yield 5.63% 5.26% - - - - - 5.56%
Federal Home Loan Bank stock 5,093 - - - - - - 5,093 5,093
Yield 5.25% - - - - - - 5.25%
Other - - - - - 2,269 - 2,269 2,269
Yield - - - - - 2.92% - 2.92%
Fixed interest rate loans:
Real estate mortgages 28,009 21,681 18,515 15,334 12,675 57,940 - 154,154 153,889
Yield 6.30% 6.23% 6.22% 6.25% 6.25% 6.28% - 6.26%
Commercial 5,908 2,352 3,822 1,102 818 4,634 - 18,636 18,422
Yield 6.73% 6.58% 5.88% 7.04% 7.15% 7.36% - 6.73%
Consumer and other 8,077 1,174 990 729 492 4,407 - 15,869 15,813
Yield 5.49% 7.26% 7.18% 7.27% 7.36% 6.50% - 6.15%
Variable interest rate loans:
Real estate mortgages 119,537 14,583 12,631 4,286 1,708 1,138 - 153,883 153,619
Yield 7.73% 5.70% 6.33% 6.47% 7.53% 6.74% - 7.38%
Commercial 7,629 - - - - - - 7,629 7,541
Yield 7.75% - - - - - - 7.75%
Consumer and other 19,751 - - - - - - 19,751 19,679
Yield 8.91% - - - - - - 8.91%
Less: Allowance for loan losses - - - - - - 4,200 - 4,200
Interest bearing deposits with banks 1,779 - - - - - - 1,779 1,779
Yield 4.78% - - - - - - 4.78%
Cash surrender life insurance 7,054 - - - - - - 7,054 7,054
Yield 4.98% - - - - - - 4.98%
Cash and due from banks 12,999 - - - - - - 12,999 12,999
Yield 4.92% - - - - - - 4.92%
Other assets - - - - - - - 16,187 16,187
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 259,253 $ 63,474 $ 54,407 $ 34,768 $ 32,126 $ 109,606 $ 16,187 $ 569,821 $ 557,620
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
Demand - Interest bearing $ - $ - $ - $ - $ - $ 57,309 $ - $ 57,309 $ 57,309
Yield - - - - - 0.24% - 0.24%
Savings 12,633 - - - - 67,695 - 80,328 80,328
Yield 4.82% - - - - 0.36% - 1.05%
Money markets 85,720 - - - - - - 85,720 85,720
Yield 3.18% - - - - - - 3.18%
Fixed interest rate deposits:
Time - Over $100,000 25,330 3,988 4,026 5,447 287 400 - 39,478 39,255
Yield 4.63% 4.44% 5.13% 5.13% 4.63% 5.16% - 4.74%
Time - Other 61,170 8,094 3,261 3,678 2,118 1,059 - 79,380 78,946
Yield 4.11% 4.01% 3.63% 4.24% 4.63% 4.95% - 4.32%
Demand - Non-interest bearing - - - - - - 71,585 71,585 71,585
Repurchase agreements 13,441 - - - - - - 13,441 13,441
Yield 2.48% - - - - - - 2.48%
Short-term borrowings 5,486 - - - - - - 5,486 5,486
Yield 5.40% - - - - - - 5.40%
Long-term borrowings 9,887 8,781 8,612 6,634 6,116 25,823 - 65,853 63,306
Yield 3.59% 3.66% 3.75% 3.85% 3.99% 4.44% - 4.00%
Other liabilities - - - - - - - 4,670 4,670
Stockholders' equity - - - - - - - 66,571 66,571
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 213,667 $ 20,863 $ 15,899 $ 15,759 $ 8,521 $ 152,286 $ 142,826 $ 569,821 $ 495,376
====================================================================================================================================
Excess of assets (liabilities)
subject to interest rate change $ 45,586 $ 42,611 $ 38,508 $ 19,009 $ 23,605 $ (42,680) $(126,639) $ -
====================================================================================================================================
26 Penseco Financial Services Corporation / 2006 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, 2006 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, 2006, 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, 2006 has been audited by
McGrail, Merkel, Quinn & Associates, the Company's independent registered public
accounting firm, as stated in their report appearing on page 28, 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, 2006.
Penseco Financial Services Corporation / 2006 Annual Report 27
MMQ Francis J. Merkel, CPA
Joseph J. Quinn, CPA/ABV, CVA
Daniel J. Gerrity, CPA
Mary Ann E. Novak, CPA
McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
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, 2006, 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.
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
28 Penseco Financial Services Corporation / 2006 Annual Report
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
Because of its inherent limitations, internal control over financial reporting
may misstatements. Also, projections of any evaluation of effectiveness to
future periods the risk that controls may become inadequate because of changes
in conditions, or compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Penseco Financial Services
Corporation subsidiary maintained effective internal control over financial
reporting as of December fairly stated, in all material respects, based on
criteria established in Internal Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion, Penseco
Financial Services Corporation and subsidiary all material respects, effective
internal control over financial reporting as of based on criteria established in
Internal Control-Integrated Framework issued by Sponsoring Organizations of the
Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Board (United States), the consolidated financial statements of
Penseco Financial Corporation and subsidiary and our report dated February 26,
2006 expressed an unqualified opinion.
/s/ McGrail Merkel Quinn & Associates
Scranton, Pennsylvania
February 26, 2006
Penseco Financial Services Corporation / 2006 Annual Report 29
MMQ Francis J. Merkel, CPA
Joseph J. Quinn, CPA/ABV, CVA
Daniel J. Gerrity, CPA
Mary Ann E. Novak, CPA
McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
Scranton, Pennsylvania
We have audited the accompanying consolidated balance sheets of Penseco
Financial Services Corporation and subsidiary as of December 31, 2006 and 2005,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2006. 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, 2006 and 2005, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006, 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, 2006, 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 26, 2007
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.
/s/ McGrail Merkel Quinn & Associates
Scranton, Pennsylvania
February 26, 2006
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
30 Penseco Financial Services Corporation / 2006 Annual Report
ITEM 8 Financial Statements and Supplementary Data
Consolidated Balance Sheets
(in thousands, except per share amounts)
December 31, 2006 2005
---------------------------------------------------------------
ASSETS Cash and due from banks $ 12,999 $ 11,310
Interest bearing balances with banks 1,779 263
---------------------------------------------------------------
Cash and Cash Equivalents 14,778 11,573
Investment securities:
Available-for-sale, at fair value 91,705 147,942
Held-to-maturity (fair value of $75,120
and $83,130, respectively) 74,375 82,015
Total Investment Securities 166,080 229,957
Loans, net of unearned income 369,922 321,362
Less: Allowance for loan losses 4,200 3,800
---------------------------------------------------------------
Loans, Net 365,722 317,562
Bank premises and equipment 9,471 9,453
Other real estate owned - 91
Accrued interest receivable 3,632 3,473
Cash surrender value of life insurance 7,054 -
Other assets 3,084 3,579
---------------------------------------------------------------
Total Assets $ 569,821 $ 575,688
===============================================================
LIABILITIES Deposits:
Non-interest bearing $ 71,585 $ 91,713
Interest bearing 342,215 306,154
---------------------------------------------------------------
Total Deposits 413,800 397,867
Other borrowed funds:
Repurchase agreements 13,441 30,414
Short-term borrowings 5,486 4,626
Long-term borrowings 65,853 75,401
Accrued interest payable 1,472 1,261
Other liabilities 3,198 2,320
---------------------------------------------------------------
Total Liabilities 503,250 511,889
===============================================================
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 56,393 53,607
Accumulated other comprehensive income (662) (648)
---------------------------------------------------------------
Total Stockholders' Equity 66,571 63,799
---------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 569,821 $ 575,688
===============================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
Penseco Financial Services Corporation / 2006 Annual Report 31
Consolidated Statements of Income
(in thousands, except per share amounts)
Years Ended December 31, 2006 2005 2004
------------------------------------------------------------------------
INTEREST Interest and fees on loans $ 23,374 $ 18,569 $ 13,632
INCOME Interest and dividends on investments:
U.S. Treasury securities and U.S.
Agency obligations 5,360 6,408 8,044
States & political subdivisions 2,688 2,616 3,476
Other securities 340 190 107
Interest on Federal funds sold - 176 58
Interest on balances with banks 160 211 68
------------------------------------------------------------------------
Total Interest Income 31,922 28,170 25,385
------------------------------------------------------------------------
INTEREST Interest on time deposits
EXPENSE of $100,000 or more 1,408 808 806
Interest on other deposits 6,204 4,212 3,153
Interest on other borrowed funds 3,442 3,560 3,620
Total Interest Expense 11,054 8,580 7,579
------------------------------------------------------------------------
Net Interest Income 20,868 19,590 17,806
Provision for loan losses 433 263 144
------------------------------------------------------------------------
Net Interest Income After Provision
for Loan Losses 20,435 19,327 17,662
------------------------------------------------------------------------
OTHER Trust department income 1,483 1,479 1,353
INCOME Service charges on deposit accounts 860 940 1,056
Merchant transaction income 3,947 4,521 5,001
Other fee income 1,423 1,575 1,650
Other operating income 173 372 177
Realized gains (losses) on securities, net 319 (13) 357
------------------------------------------------------------------------
Total Other Income 8,205 8,874 9,594
------------------------------------------------------------------------
OTHER Salaries and employee benefits 10,315 9,261 9,165
EXPENSES Expense of premises and equipment, net 2,397 2,455 2,391
Merchant transaction expenses 3,141 3,646 4,058
Other operating expenses 5,184 5,357 4,970
------------------------------------------------------------------------
Total Other Expenses 21,037 20,719 20,584
------------------------------------------------------------------------
Income before income taxes 7,603 7,482 6,672
Applicable income taxes 1,595 1,613 1,071
------------------------------------------------------------------------
NET INCOME Net Income $ 6,008 $ 5,869 $ 5,601
========================================================================
PER SHARE Earnings Per Share $ 2.80 $ 2.73 $ 2.61
========================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
32 Penseco Financial Services Corporation / 2006 Annual Report
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2006, 2005 and 2004
- --------------------------------------------
Accumulated
Other Total
Common Retained Comprehensive Stockholders'
(in thousands except per share data) Stock Surplus Earnings Income Equity
- ----------------------------------------------------------------------------------------------------------
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
Comprehensive income:
Net income, 2006 - - 6,008 - 6,008
Other comprehensive income, net of tax
Unrealized gains on securities
net of reclassification adjustment - - - 648 648
Minimum pension liability adjustment - - - 1,011 1,011
------- -------
Other comprehensive income 1,659 1,659
Comprehensive income 7,667
Cash dividends declared ($1.50 per share) - - (3,222) - (3,222)
Adjustment to initially apply FASB Statement
No. 158, net of tax. - - - (1,673) (1,673)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2006 $ 21 $ 10,819 $ 56,393 $ (662) $ 66,571
==========================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
Penseco Financial Services Corporation / 2006 Annual Report 33
Consolidated Statements of Cash Flows
(in thousands) Years Ended December 31, 2006 2005 2004
--------------------------------------------------------------------------------------------
OPERATING Net Income $ 6,008 $ 5,869 $ 5,601
ACTIVITIES Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 723 704 813
Provision for loan losses 433 263 144
Deferred income tax (benefit) provision (254) 166 (119)
Amortization of securities
(net of accretion) 419 1,379 1,573
Increase cash surrender value of life insurance (54) - -
Net realized (gains) losses on securities (319) 13 (357)
Loss (gain) on other real estate 10 (46) (2)
Gain on disposition of fixed asset - (5) -
Increase in interest receivable (159) (67) (108)
(Increase) decrease in other assets (304) 313 366
(Decrease) increase in income taxes payable (4) (442) 117
Increase (decrease) in interest payable 211 375 (272)
Increase (decrease) in other liabilities 940 (29) 110
--------------------------------------------------------------------------------------------
Net cash provided by
operating activities 7,650 8,493 7,866
--------------------------------------------------------------------------------------------
INVESTING Purchase of investment securities
ACTIVITIES available-for-sale (25,770) (47,526) (49,975)
Proceeds from sales and maturities of investment
securities available-for-sale 68,287 46,451 41,938
Proceeds from repayments of investment
securities available-for-sale 15,028 19,140 17,893
Proceeds from repayments of investment
securities to be held-to-maturity 7,213 12,746 17,661
Net loans originated (48,676) (41,550) (40,015)
Proceeds from other real estate 164 432 124
Proceeds from sale of fixed assets - 10 -
Investment in premises and equipment (741) (929) (111)
Purchase of life insurance policies (7,000) - -
--------------------------------------------------------------------------------------------
Net cash provided (used) by
investing activities 8,505 (11,226) (12,485)
--------------------------------------------------------------------------------------------
FINANCING Net (decrease) increase in demand and savings deposits (1,374) (3,984) 5,977
ACTIVITIES Net proceeds (payments) on time deposits 17,307 6,550 (18,620)
(Decrease) increase in repurchase agreements (16,973) 12,016 (1,056)
Net increase (decrease) in short-term borrowings 860 3,740 63
Payments on long-term borrowings (9,548) (9,219) (8,903)
Cash dividends paid (3,222) (3,094) (2,900)
--------------------------------------------------------------------------------------------
Net cash (used) provided by
financing activities (12,950) 6,009 (25,439)
--------------------------------------------------------------------------------------------
Net increase (decrease) in cash
and cash equivalents 3,205 3,276 (30,058)
Cash and cash equivalents at January 1 11,573 8,297 38,355
--------------------------------------------------------------------------------------------
Cash and cash equivalents at December 31 $ 14,778 $ 11,573 $ 8,297
============================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
34 Penseco Financial Services Corporation / 2006 Annual Report
General Notes To Financial Statements
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 a public 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 Company adopted this Statement on January 1, 2006.
The adoption of this Statement had no effect on the Company's results of
operations or financial position.
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 was
effective for fiscal periods beginning after June 15, 2005.
The adoption of this Statement had no effect on the Company's results of
operations or financial position.
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 was effective for accounting changes or corrections of
errors made in fiscal periods beginning after December 15, 2005.
The adoption of this Statement had no effect on the Company's results of
operations or financial position.
In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115- 1 and
FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments. The FSP addresses the determination of when an investment
is considered impaired and whether that impairment is other than temporary, and
provides guidance on measuring an impairment loss. The FSP requires certain
disclosures about unrealized losses not recognized as other-than-temporary
impairments. The guidance in the FSP amends FASB Statements No. 115, Accounting
for Certain Investments in Debt and Equity Securities, and No. 124, Accounting
for Certain Investments Held by Not-For-Profit Organizations, and APB Opinion
No. 18, The Equity Method of Accounting for Investments in Common Stock. The
Company has considered the requirements of this FSP in its assessment of the
investment portfolio.
In February 2006, FASB issued Statement No. 155, Accounting for Certain
Hybrid Financial Instruments - An Amendment of FASB Statements No. 133 and 140.
Statement No. 155 eliminates the exception from applying Statement 133 to
interests in securitized financial assets so that similar instruments are
accounted for similarly regardless of the form of the instruments. The Statement
is effective for all financial instruments acquired or issued after the
beginning of the first fiscal year that begins after September 15, 2006.
The Company believes that the adoption of this Statement will not have a
significant impact on its results of operations or financial position.
In March 2006, FASB issued Statement No. 156, Accounting for Servicing of
Financial Instruments - An Amendment of FASB Statement No. 140. Statement No.
156 requires the recognition of the fair value of a servicing asset or servicing
liability each time an obligation to service a financial asset by entering into
a servicing contract is undertaken, if practicable.
Penseco Financial Services Corporation / 2006 Annual Report 35
1 NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
It also allows the entity to subsequently measure the asset or liability under
an amortization or fair value method. The Statement is effective for all
financial instruments acquired or issued after the beginning of the first fiscal
year that begins after September 15, 2006.
The Company believes that the adoption of this Statement will not have a
significant impact on its results of operations or financial position.
In July 2006, FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109.
Interpretation No. 48 clarifies the application of Statement No. 109 by
establishing a threshold condition that a tax position must meet for any part of
that position to be recognized in the financial statements. In addition to
recognition, the Interpretation provides guidance on the measurement,
derecognition, classification and disclosure of tax positions. The
Interpretation is effective for fiscal years beginning after December 15, 2006.
The Company believes that the adoption of this Statement will not have a
significant impact on its results of operations or financial position.
In September 2006, FASB issued Statement No. 157, Fair Value Measurements.
Statement No. 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements. The Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years.
The Company believes that the adoption of this Statement will not have a
significant impact on its results of operations or financial position.
In September 2006, FASB issued Statement No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB
Statements No. 87, 88, 106, and 132(R). Statement No. 158 requires an employer
to recognize the overfunded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income. The
Statement was effective for financial statements issued for fiscal years ending
after December 31, 2006.
The effects of the adoption of this Statement are included in Note 14 to
these Consolidated Financial Statements and relate to the Company's financial
position. The adoption of the Statement had no effect on the Company's results
of operations.
In the September 2006 EITF meeting, a consensus was reached on EITF 06-4,
Accounting for Deferred Compensation and Postretirement Benefit Aspects of
Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 requires the
recognition of a liability related to the postretirement benefits covered by an
endorsement split-dollar life insurance arrangement based on the substantive
agreement with the employee. The issue is effective for fiscal years beginning
after December 15, 2007, with early adoption permitted.
The Company is evaluating the potential impact of this statement on its
results of operations and financial position.
In the September 2006 EITF meeting, a consensus was reached on EITF 06-5,
Accounting for Purchases of Life Insurance - Determining the Amount That Could
be Realized in accordance with FASB Technical Bulletin No. 85-4, "Accounting for
Purchases of Life Insurance". EITF 06-5 requires that the amount that could be
realized under the insurance contract as of the date of the statement of
financial position should be reported as an asset net of any potential surrender
charges. The issue is effective for fiscal years beginning after December 15,
2006.
The Company believes the adoption of this Statement will not have a
significant impact on its results of operations and financial position.
In September 2006, the SEC staff issued SEC Staff Accounting Bulletin No.
108 (SAB No. 108) Topic 1N, Financial Statements - Considering the Effects of
Prior Year Misstatements When Quantifying Misstatements in Current Year
Financial Statements. SAB No. 108 addresses how a registrant should quantify the
effect of an error on the financial statements. The SEC staff concluded in that
a dual approach should be used to compute the amount of a misstatement.
Specifically, the amount should be computed using both the "rollover" (current
year income statement perspective) and "iron curtain" (year-end balance sheet
perspective) methods. This SAB was effective for annual financial statements
covering the first fiscal year ending after November 15, 2006.
The adoption of this SAB had no effect on the Company's 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.
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.
36 Penseco Financial Services Corporation / 2006 Annual Report
1 NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
The provision for loan losses is based on past loan loss experience,
management's evaluation of the potential loss in the current loan portfolio
under current economic conditions and such other factors as, in management's
best judgement, deserve current recognition in estimating loan losses. The
annual provision for loan losses charged to operating expense is that amount
which is sufficient to bring the balance of the allowance for possible loan
losses to an adequate level to absorb anticipated losses.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Provision for depreciation and amortization, computed principally on the
straight-line method, is charged to operating expenses over the estimated useful
lives of the assets. Maintenance and repairs are charged to current expense as
incurred.
LOAN SERVICING
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair
value of those rights. Fair values are estimated using discounted cash flows
based on current market rates of interest and current expected future prepayment
rates. For purposes of measuring impairment, the rights must be stratified by
one or more predominant risk characteristics of the underlying loans. The
Company stratifies its capitalized mortgage servicing rights based on the
product type, interest rate and term of the underlying loans. The amount of
impairment recognized is the amount, if any, by which the amortized cost of the
rights for each stratum exceed the fair value.
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expenses for the years
ended December 31, 2006, 2005 and 2004, amounted to $379, $472 and $476,
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).
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).
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,
2006, 2005 and 2004 as follows:
2006 2005 2004
- -----------------------------------------------------------------
Income taxes paid $ 1,752 $ 1,886 $ 802
Interest paid $ 10,843 $ 8,205 $ 7,851
Non-cash transactions during the years ended December 31, 2006, 2005 and 2004,
comprised entirely of the net acquisition of real estate in the settlement of
loans, amounted to $83, $301 and $177, 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 2006
presentation.
Penseco Financial Services Corporation / 2006 Annual Report 37
2 CASH AND DUE FROM BANKS
Cash and due from banks are summarized as follows:
December 31, 2006 2005
- ----------------------------------------------------------------
Cash items in process of collection $ 31 $ 6,568
Non-interest bearing balances 9,102 1,544
Cash on hand 3,866 3,198
- ----------------------------------------------------------------
Total $ 12,999 $ 11,310
================================================================
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.
- --------------------------------------------------------------------------------
3 INVESTMENT SECURITIES
The amortized cost and fair value of investment securities at December 31, 2006
and 2005 are as follows:
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
2006 Cost Gains Losses Value
- ---------------------------------------------------------------------------
U.S. Agency securities $ 24,897 $ 9 $ 23 $ 24,883
Mortgage-backed securities 29,231 91 82 29,240
States & political
subdivisions 29,281 939 - 30,220
- ---------------------------------------------------------------------------
Total Debt Securities 83,409 1,039 105 84,343
Equity securities 6,764 628 30 7,362
- ---------------------------------------------------------------------------
Total Available-
for-Sale $ 90,173 $ 1,667 $ 135 $ 91,705
===========================================================================
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
===========================================================================
Equity securities at December 31, 2006 and 2005, 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 2006,
2005 and 2004 are as follows:
December 31, 2006 2005 2004
- ---------------------------------------------------------------------------
Proceeds from sales $ - $ 10,250 $ 18,380
Gross realized gains - 51 385
Gross realized losses - 64 28
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
2006 Cost Gains Losses Value
- ---------------------------------------------------------------------------
Mortgage-backed
securities $ 45,124 $ 4 $ 1,074 $ 44,054
States & political
subdivisions 29,251 1,815 - 31,066
- ---------------------------------------------------------------------------
Total Held-to-
Maturity $ 74,375 $ 1,819 $ 1,074 $ 75,120
===========================================================================
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
===========================================================================
Investment securities with amortized costs and fair values of $98,949 and
$99,898 at December 31, 2006 and $106,280 and $107,914 at December 31, 2005,
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, 2006
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 $ 9,999 $ 9,985 $ - $ -
After one year through
five years:
U.S. Agency
securities 14,898 14,898 - -
After five years through
ten years:
States & political
subdivisions - - 1,041 1,114
After ten years:
States & political
subdivisions 29,281 30,220 28,210 29,952
- --------------------------------------------------------------------------------
Subtotal 54,178 55,103 29,251 31,066
Mortgage-backed
securities 29,231 29,240 45,124 44,054
- --------------------------------------------------------------------------------
Total Debt Securities $ 83,409 $ 84,343 $ 74,375 $ 75,120
================================================================================
38 Penseco Financial Services Corporation / 2006 Annual Report
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, 2006 and
2005 are as follows:
Less than twelve months Twelve months or more Totals
- ------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2006 Value Losses Value Losses Value Losses
- ------------------------------------------------------------------------------------------------------------
U.S. Agency securities $ 9,868 $ 9 $ 9,985 $ 14 $ 19,853 $ 23
Mortgage-backed securities - - 50,379 1,156 50,379 1,156
Equities 160 1 541 29 701 30
- ------------------------------------------------------------------------------------------------------------
Total $ 10,028 $ 10 $ 60,905 $ 1,199 $ 70,933 $ 1,209
============================================================================================================
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
============================================================================================================
The table above at December 31, 2006, includes five (5) 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, 2006.
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,
2006.
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, 2006.
Penseco Financial Services Corporation / 2006 Annual Report 39
4 LOANS
Major classifications of loans are as follows:
December 31, 2006 2005
- ------------------------------------------------------------------------------
Loans secured by real estate:
Construction and land development $ 23,714 $ 13,132
Secured by 1-4 family residential
properties:
Revolving, open-end loans 17,691 15,070
Secured by first liens 156,944 125,950
Secured by junior liens 30,108 22,649
Secured by multi-family properties 2,870 355
Secured by non-farm, non-residential
properties 76,710 63,829
Commercial and industrial loans
to U.S. addressees 26,265 42,894
Loans to individuals for household, family
and other personal expenditures:
Credit card and related plans 3,282 3,152
Other (installment and
student loans, etc.) 24,647 24,773
Obligations of states &
political subdivisions 6,806 8,038
All other loans 885 1,520
- ------------------------------------------------------------------------------
Gross Loans 369,922 321,362
Less: Unearned income on loans - -
- ------------------------------------------------------------------------------
Loans, Net of Unearned Income $ 369,922 $ 321,362
==============================================================================
Loans on which the accrual of interest has been discontinued or reduced amounted
to $3,180, $1,627 and $1,991 at December 31, 2006, 2005 and 2004, respectively.
If interest on those loans had been accrued, such income would have been $209,
$264 and $199 for 2006, 2005 and 2004, respectively. Interest income on those
loans, which is recorded only when received, amounted to $10, $27 and $16 for
2006, 2005 and 2004, respectively. Also, at December 31, 2006 and 2005, the Bank
had loans totalling $434 and $173, respectively, which were past due 90 days or
more and still accruing interest.
- --------------------------------------------------------------------------------
5 ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
Years Ended December 31, 2006 2005 2004
- ----------------------------------------------------------------
Balance at beginning of year $ 3,800 $ 3,600 $ 3,500
Provision charged to operations 433 263 144
Recoveries credited to allowance 134 50 9
- ----------------------------------------------------------------
4,367 3,913 3,653
Losses charged to allowance (167) (113) (53)
- ----------------------------------------------------------------
Balance at End of Year $ 4,200 $ 3,800 $ 3,600
================================================================
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
- ------------------------ -------------- -------------
2006 $ 433 $ 33
2005 $ 263 $ 63
2004 $ 144 $ 44
The balance of the Reserve for Bad Debts as reported for Federal income tax
purposes was $0, $380 and $664 at December 31, 2006, 2005 and 2004,
respectively.
- --------------------------------------------------------------------------------
6 LOAN SERVICING
The Company services $49,116 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 $595 and $562, at
December 31, 2006 and 2005, respectively. The balance of the servicing rights
was $197 and $314 at December 31, 2006 and 2005, respectively, net of
amortization.
The Company has not recorded any new mortgage servicing rights during 2006
or 2005. Amortization expense of $116 and $136 was recorded for the years ended
December 31, 2006 and 2005, respectively.
There was no allowance for impairment recorded at December 31, 2006 or
2005.
- --------------------------------------------------------------------------------
7 BANK PREMISES AND EQUIPMENT
December 31, 2006 2005
- ------------------------------------------------------------------
Land $ 3,117 $ 3,117
Buildings and improvements 14,752 14,623
Furniture and equipment 14,018 13,406
- ------------------------------------------------------------------
31,887 31,146
Less: Accumulated depreciation 22,416 21,693
- ------------------------------------------------------------------
Net Bank Premises
and Equipment $ 9,471 $ 9,453
==================================================================
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 $723
in 2006, $704 in 2005 and $813 in 2004.
Occupancy expenses were reduced by rental income received in the amount of
$64, $61 and $63 in the years ended December 31, 2006, 2005 and 2004,
respectively.
- --------------------------------------------------------------------------------
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, 2006
and 2005 was $0 and $91, respectively, supported by appraisals of the real
estate involved.
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------
2006 100% $ 3,250 $ 3,235 None $ -
2005 100% $ 3,250 $ 3,235 None $ -
2004 100% $ 3,350 $ 3,335 None $ -
- --------------------------------------------------------------------------------
10 CASH SURRENDER VALUE OF LIFE INSURANCE
The Company has purchased Bank Owned Life Insurance (BOLI) policies on certain
officers.
The policies are split-dollar life insurance policies which provide for the
Company to receive the cash value of the policy and to split the residual
proceeds with the officer's designated beneficiary upon the death of the
insured. The majority of the residual proceeds are retained by the Company per
the individual agreements with the insured officers.
40 Penseco Financial Services Corporation / 2006 Annual Report
11 DEPOSITS
December 31, 2006 2005
- -----------------------------------------------------------------------
Demand - Non-interest bearing $ 71,585 $ 91,713
Demand - Interest bearing 57,309 33,094
Savings 80,328 86,013
Money markets 85,720 80,463
Time - Over $100,000 39,478 28,124
Time - Other 79,380 78,460
- -----------------------------------------------------------------------
Total $ 413,800 $ 397,867
=======================================================================
Scheduled maturities of time deposits are as follows:
2007 $ 86,500
2008 12,082
2009 7,287
2010 9,125
2011 2,405
2012 and thereafter 1,459
- -----------------------------------------------------
Total $ 118,858
=====================================================
- --------------------------------------------------------------------------------
12 OTHER BORROWED FUNDS
At December 31, 2006 and 2005, 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 $31,109 and
$31,062 at December 31, 2006 and $35,209 and $35,026 at December 31, 2005, were
pledged to secure repurchase agreements.
Years Ended December 31, 2006 2005
- --------------------------------------------------------------------------------
Amount outstanding at year end $ 18,927 $ 35,040
Average interest rate at year end 2.91% 2.01%
Maximum amount outstanding at
any month end $ 29,285 $ 35,040
Average amount outstanding $ 22,775 $ 27,638
Weighted average interest rate
during the year:
Federal funds purchased 5.28% 3.96%
Repurchase agreements 2.34% 1.46%
Demand notes to U.S. Treasury 4.96% 2.99%
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 $10,202 and $9,958 at December 31, 2006 and $10,257 and $10,008
at December 31, 2005 and with an interest rate of 5.25% at both December 31,
2006 and December 31, 2005. 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, 2006 and 2005,
respectively.
The Company has the availability of a $5,000 overnight Federal funds line
of credit with Wachovia Bank, N.A. Also, the Company has a $16,000 overnight
Federal Funds line with PNC Bank. There was no balance outstanding as of
December 31, 2006 and 2005, respectively.
The Company maintains a collateralized maximum borrowing capacity of
$178,176 with the Federal Home Loan Bank of Pittsburgh.
- --------------------------------------------------------------------------------
13 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, 2006 is as follows:
Monthly Fixed Maturity
Installment Rate Date Balance
- ---------------------------------------------------
$ 161 2.73% 03/13/08 $ 2,366
253 3.22% 03/13/10 9,354
430 3.74% 03/13/13 28,722
186 4.69% 03/13/23 25,411
- ---------------------------------------------------
Total $ 65,853
===================================================
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at December 31, 2006 are as follows:
2007, $9,887, 2008 $8,781, 2008 $8,612, 2010 $6,634, 2011 $6,116 and thereafter
$25,823 for a total of $65,853.
- --------------------------------------------------------------------------------
14 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, 2006 and 2005, the ESOP held 73,591 and 87,840 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,
$70 and $0 to the plan during the years ended December 31, 2006, 2005 and 2004,
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, $70 and $60 to the plan during the years ended December 31,
2006, 2005 and 2004, 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.
Penseco Financial Services Corporation / 2006 Annual Report 41
14 EMPLOYEE BENEFIT PLANS (CONTINUED)
Obligations and funded status of the plans:
Pension Benefits Other Benefits
---------------- ---------------
December 31, 2006 2005 2006 2005
- --------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation, beginning $ 13,267 $ 11,800 $ 287 $ 285
Service cost 436 415 6 6
Interest cost 673 678 17 16
Change in assumptions (1,167) 947 1 (10)
Actuarial (gain) loss (55) (223) - -
Benefits paid (554) (350) (12) (10)
- --------------------------------------------------------------------------------
Benefit obligation, ending $ 12,600 13,267 299 287
- --------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan
assets, beginning 9,709 9,469 - -
Actual return on plan assets 954 213 - -
Employer contribution 1,439 377 - -
Benefits paid (554) (350) - -
- --------------------------------------------------------------------------------
Fair value of plan
assets, ending 11,548 9,709 - -
- --------------------------------------------------------------------------------
Funded status $ (1,052) (3,558) $ (299) (287)
========= =======
Unrecognized net actuarial
loss (gain) 3,933 (33)
Unrecognized prior service
cost 53 41
- --------------------------------------------------------------------------------
Net amount recognized $ 428 $ (279)
- --------------------------------------------------------------------------------
Amounts recognized in the balance sheets consist of:
Pension Benefits Other Benefits
---------------- ---------------
December 31, 2006 2005 2006 2005
- --------------------------------------------------------------------------------
Prepaid benefit cost $ 580 $ -
Accrued benefit cost (1,683) (279)
Intangible assets 520 -
Accumulated other
comprehensive income 1,011 -
- --------------------------------------------------------------------------------
Net amount recognized $ 428 $ (279)
- --------------------------------------------------------------------------------
Non Current Assets $ 358 $ -
Non Current Liabilities $ 1,052 $ 299
Amounts recognized in the accumulated other comprehensive income consist of:
Pension Benefits Other Benefits
---------------- ---------------
December 31, 2006 2005 2006 2005
- --------------------------------------------------------------------------------
Prior service costs $ 52 $ 34
Net actuarial loss (gain) 2,482 (34)
Deferred taxes (861) -
- --------------------------------------------------------------------------------
Net amount recognized $ 1,673 $ -
- --------------------------------------------------------------------------------
The accumulated benefit obligation for all defined benefit pension plans was
$10,915 and $10,866 at December 31, 2006 and 2005 respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets is as follows:
Pension Benefits
----------------
2006 2005
- -------------------------------------------------------------------
Projected benefit obligation $ - $ 13,267
Accumulated benefit obligation - 10,866
Fair value of plan assets - 9,709
Components of net periodic pension cost and other amounts recognized in other
comprehensive income:
Pension Benefits
----------------
Years Ended December 31, 2006 2005 2004
- ------------------------------------------------------------------------
Components of net periodic
pension cost:
Service cost $ 436 $ 415 $ 385
Interest cost 673 678 664
Expected return on plan assets (890) (755) (700)
Amortization of prior service cost - - -
Amortization of unrecognized
net loss 166 114 114
- ------------------------------------------------------------------------
Net periodic pension cost $ 385 $ 452 $ 463
- ------------------------------------------------------------------------
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
FASB 158 recognition of deferred cost, net $1,673
Reverse effect of additional minimum
liability (1,011)
- ------------------------------------------------------------------------
Total recognized in other comprehensive
income $ 662
- ------------------------------------------------------------------------
Total recognized in net period pension
cost and other comprehensive income $1,047
- ------------------------------------------------------------------------
Other Benefits
----------------
Years Ended December 31, 2006 2005 2004
- ------------------------------------------------------------------------
Components of net periodic
other benefit cost:
Service cost $ 6 $ 6 $ 6
Interest cost 17 16 16
Amortization of prior service cost 7 7 7
Amortization of unrecognized
net gain - - -
- ------------------------------------------------------------------------
Net periodic other benefit cost $ 30 $ 29 $ 29
- ------------------------------------------------------------------------
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
FASB 158 recognition of deferred cost, net $ -
- ------------------------------------------------------------------------
Total recognized in other comprehensive
income $ -
- ------------------------------------------------------------------------
Total recognized in net periodic pension
cost and other comprehensive income $ 30
- ------------------------------------------------------------------------
The estimated net loss and prior service cost for the defined benefit pension
plan(s) that will be amortized from accumulated other comprehensive income into
net periodic benefit cost over the next fiscal year are $102 and $0,
respectively. The estimated prior service cost for the other defined benefit
postretirement plan will be amortized from accumulated other comprehensive
income into net periodic benefit cost over the next fiscal year is $7.
42 Penseco Financial Services Corporation / 2006 Annual Report
14 EMPLOYEE BENEFIT PLANS (CONTINUED)
Weighted-average assumptions used to determine benefit obligations were as
follows:
Pension Benefits Other Benefits
---------------- ---------------
December 31, 2006 2005 2006 2005
- --------------------------------------------------------------------------------
Discount rate 5.75%-6.00% 5.5%-6.00% 6.00% 6.00%
Rate of compensation
increase 3.00% 4.00% 4.50% 4.50%
Pension Benefits Other Benefits
---------------- ---------------
December 31, 2006 2005 2006 2005
- --------------------------------------------------------------------------------
Discount rate 5.75%-6.00% 5.5%-6.00% 6.00% 6.00%
Expected long-term
return on plan assets 8.50% 8.00% - -
Rate of compensation
increase 3.00% 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, 2006 and 2005 by asset category are as follows:
Plan Assets at December 31,
---------------------------
2006 2005
- --------------------------------------------------------------
Asset Category
- --------------
Equity securities 55.9% 55.7%
Corporate bonds 20.1% 24.6%
U.S. Government securities 23.2% 19.4%
Cash and cash equivalents .8% .3%
- --------------------------------------------------------------
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,
2006 or 2005.
Contributions
- -------------
The Company expects to contribute $250, to its pension plan and $13 to its other
postretirement plan in 2007.
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
---------------- --------------
2007 $ 499 $ 13
2008 497 13
2009 507 13
2010 540 14
2011 599 15
2012-2016 4,041 93
- --------------------------------------------------------------------------------
15 INCOME TAXES
The total income taxes in the Statements of Income are as follows:
Years Ended December 31, 2006 2005 2004
- -------------------------------------------------------------------------------
Currently payable $ 1,849 $ 1,447 $ 1,190
Deferred (benefit) provision (254) 166 (119)
- -------------------------------------------------------------------------------
Total $ 1,595 $ 1,613 $ 1,071
- -------------------------------------------------------------------------------
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, 2006 2005 2004
- -------------------------------------------------------------------------------
Tax at statutory rate $ 2,585 $ 2,544 $ 2,268
Reduction for non-taxable
interest (1,052) (1,012) (1,262)
Other additions 62 81 65
- -------------------------------------------------------------------------------
Applicable Income Taxes $ 1,595 $ 1,613 $ 1,071
- -------------------------------------------------------------------------------
The components of the deferred income tax (benefit) provision, which result from
temporary differences, are as follows:
Years Ended December 31, 2006 2005 2004
- -------------------------------------------------------------------------------
Accretion of discount on bonds $ (29) $ 18 $ 24
Accelerated depreciation 13 (4) 21
Supplemental benefit plan 51 (3) (1)
Allowance for loan losses (243) (165) (130)
Prepaid pension cost (46) 320 (33)
- -------------------------------------------------------------------------------
Total $ (254) $ 166 $ (119)
- -------------------------------------------------------------------------------
The significant components of deferred tax assets and liabilities are as
follows:
December 31, 2006 2005
- -----------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 1,406 $ 1,163
Minimum pension liability - 520
Accrued pension costs 358 -
Accumulated depreciation 309 322
Accrued supplemental benefit plan - 51
- -----------------------------------------------------------------
Total Deferred Tax Assets 2,073 2,056
- -----------------------------------------------------------------
Deferred tax liabilities:
Prepaid pension costs - 571
Unrealized securities gains 522 187
Accumulated accretion 40 69
- -----------------------------------------------------------------
Total Deferred Tax Liabilities 562 827
- -----------------------------------------------------------------
Net Deferred Tax Assets $ 1,511 $ 1,229
- -----------------------------------------------------------------
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.
Penseco Financial Services Corporation / 2006 Annual Report 43
16 ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income was ($662), ($648) and $704 at December
31, 2006, 2005 and 2004, respectively.
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 unfunded pension liability. The components of other comprehensive
income are reported net of related tax effects in the Consolidated Statements of
Changes in Stockholders' Equity. 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.
In 2006, accumulated other comprehensive income includes the initial
application of FASB No. 158 to record the unrecognized components of net
periodic pension cost. In future years changes in these components will be shown
in other comprehensive income.
A reconciliation of other comprehensive income for the years ended December
31, 2006, 2005 and 2004 is as follows:
Tax
Before-Tax (Expense) Net-of-Tax
2006 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized gains arising during the year $ 1,302 $ (443) $ 859
Less: Reclassification adjustment for gains realized in income 319 (108) 211
---------------------------------
Net unrealized losses 983 (335) 648
Change in minimum pension liability 1,531 (520) 1,011
- ------------------------------------------------------------------------------------------------------
Other Comprehensive Income $ 2,514 $ (855) $ 1,659
======================================================================================================
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)
======================================================================================================
17 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, 2006 and 2005 are as follows:
2006 2005
- --------------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 37,692 $ 41,229
Variable rate $ 74,577 $ 75,100
Standby letters of credit $ 15,061 $ 15,268
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.
44 Penseco Financial Services Corporation / 2006 Annual Report
18 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, 2006 December 31, 2005
- ------------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- ------------------------------------------------------------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 12,999 $ 12,999 $ 11,310 $ 11,310
Interest bearing balances with banks 1,779 1,779 263 263
- ------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 14,778 14,778 11,573 11,573
Investment Securities:
Available-for-sale:
U.S. Agency obligations 54,123 54,123 118,545 118,545
States & political subdivisions 30,220 30,220 21,635 21,635
Federal Home Loan Bank stock 5,093 5,093 4,699 4,699
Other securities 2,269 2,269 3,063 3,063
Held-to-maturity:
U.S. Agency obligations 45,124 44,054 52,763 51,492
States & political subdivisions 29,251 31,066 29,252 31,638
- ------------------------------------------------------------------------------------------------------------------
Total investment securities 166,080 166,825 229,957 231,072
Loans, net of unearned income:
Real estate mortgages 308,037 307,508 240,985 235,427
Commercial 26,265 25,963 42,894 42,894
Consumer and other 35,620 35,492 37,483 37,899
Less: Allowance for loan losses 4,200 - 3,800
- ------------------------------------------------------------------------------------------------------------------
Loans, net 365,722 368,963 317,562 316,220
Cash surrender value of life insurance 7,054 7,054 - -
- ------------------------------------------------------------------------------------------------------------------
Total Financial Assets 553,634 $ 557,620 559,092 $ 558,865
========= =========
Other assets 16,187 16,596
- ------------------------------------------------------------------------------------------------------------------
Total Assets $ 569,821 $ 575,688
- ------------------------------------------------------------------------------------------------------------------
Financial Liabilities:
Demand - Non-interest bearing $ 71,585 $ 71,585 $ 91,713 $ 91,713
Demand - Interest bearing 57,309 57,309 33,094 33,094
Savings 80,328 80,328 86,013 86,013
Money markets 85,720 85,720 80,463 80,463
Time 118,858 118,201 106,584 107,794
- -----------------------------------------------------------------------------------------------------------------
Total Deposits 413,800 413,143 397,867 399,077
Repurchase agreements 13,441 13,441 30,414 30,414
Short-term borrowings 5,486 5,486 4,626 4,626
Long-term borrowings 65,853 63,306 75,401 75,710
- ------------------------------------------------------------------------------------------------------------------
Total Financial Liabilities 498,580 $ 495,376 508,308 $ 509,827
Other Liabilities 4,670 3,581
Stockholders' Equity 66,571 63,799
- ------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 569,821 $ 575,688
- ------------------------------------------------------------------------------------------------------------------
Standby Letters of Credit $ (151) $ (151) $ (153) $ (153)
Penseco Financial Services Corporation / 2006 Annual Report 45
19 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 $90 in 2006, $94 in 2005 and $90 in 2004. 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, 2006
are as follows:
Mount Meadow ATM
Pocono Avenue Sites Total
- -----------------------------------------------------------------------
2007 $ 55 $ 22 $ 6 $ 83
2008 55 22 4 81
2009 55 22 - 77
2010 55 22 - 77
2011 21 9 - 30
- -----------------------------------------------------------------------
Total minimum
payments required $ 241 $ 97 $ 10 $ 348
- -----------------------------------------------------------------------
- --------------------------------------------------------------------------------
20 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, 2006 2005
- -------------------------------------------------------------
Beginning Balance $ 10,490 $ 9,632
Additions 1,042 5,387
Reclassifications 8 (217)
Collections (1,115) (4,312)
- -------------------------------------------------------------
Ending Balance $ 10,425 $ 10,490
- -------------------------------------------------------------
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 $6,248.
21 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, 2006, that
the Company and the Bank meet all capital adequacy requirements to which they
are subject.
As of December 31, 2006, 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,
2006, 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.
46 Penseco Financial Services Corporation / 2006 Annual Report
21 REGULATORY MATTERS (CONTINUED)
Actual Regulatory Requirements
- --------------------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
----------------- ------------------
As of December 31, 2006 Amount Ratio Amount Ratio Amount Ratio
- ---------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $ 71,235 19.65% > $ 28,998 > 8.0% > $ 36,248 > 10.0%
- - - -
PSB (Bank) $ 68,029 18.84% > $ 28,882 > 8.0% > $ 36,103 > 10.0%
- - - -
Tier I Capital (to Risk Weighted Assets)
PFSC $ 67,035 18.49% > $ 14,499 > 4.0% > $ 21,749 > 6.0%
- - - -
PSB $ 63,829 17.68% > $ 14,441 > 4.0% > $ 21,662 > 6.0%
- - - -
Tier I Capital (to Average Assets)
PFSC $ 67,035 11.93% > $ * > * > $ 28,105 > 5.0%
- - -
PSB $ 63,829 11.36% > $ * > * > $ 28,083 > 5.0%
- - - -
PFSC - * 3.0% ($16,863), 4.0% ($22,484) or 5.0% ($28,105) depending on the
bank's CAMELS Rating and other regulatory risk factors.
PSB - * 3.0% ($16,850), 4.0% ($22,466) or 5.0% ($28,083) depending on the bank's
CAMELS Rating and other regulatory risk factors.
Actual Regulatory Requirements
- --------------------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
----------------- ------------------
As of December 31, 2005 Amount Ratio Amount Ratio Amount Ratio
- ---------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $ 66,923 19.78% > $ 27,073 > 8.0% > $ 33,841 > 10.0%
- - - -
PSB $ 64,127 19.10% > $ 26,865 > 8.0% > $ 33,581 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC $ 63,123 18.65% > $ 13,536 > 4.0% > $ 20,304 > 6.0%
- - - -
PSB $ 60,327 17.97% > $ 13,432 > 4.0% > $ 20,148 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC $ 63,123 11.11% > $ * > * > $ 28,400 > 5.0%
- - -
PSB $ 60,327 10.66% > $ * > * > $ 28,297 > 5.0%
- - - -
PFSC - * 3.0% ($17,040), 4.0% ($22,720) or 5.0% ($28,400) depending on the
bank's CAMELS Rating and other regulatory risk factors.
PSB - * 3.0% ($16,978), 4.0% ($22,638) or 5.0% ($28,297) depending on the bank's
CAMELS Rating and other regulatory risk factors.
- --------------------------------------------------------------------------------
22 PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)
The condensed Company-only information follows:
BALANCE SHEETS
December 31, 2006 2005
- ------------------------------------------------------------------
Cash $ 1 $ 5
Interest bearing balances with banks 1,554 76
- ------------------------------------------------------------------
Cash and Cash Equivalents 1,555 81
Investment in bank subsidiary 62,970 60,787
- ------------------------------------------------------------------
Equity Investments 2,249 3,043
- ------------------------------------------------------------------
Total Assets $ 66,774 $ 63,911
- ------------------------------------------------------------------
Total Liabilities $ 203 $ 112
Total Stockholders' Equity 66,571 63,799
- ------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 66,774 $ 63,911
- ------------------------------------------------------------------
STATEMENTS OF INCOME
Years Ended December 31, 2006 2005 2004
- --------------------------------------------------------------------------------
Dividends from bank subsidiary $ 3,222 $ 5,594 $ 2,900
Dividends on investment securities 106 45 11
Interest on balances with banks 5 3 -
Gain on sale of equities 319 - -
- --------------------------------------------------------------------------------
Total Income 3,652 5,642 2,911
Other non-interest expense 21 10 10
- --------------------------------------------------------------------------------
Net income before undistributed
earnings of bank subsidiary 3,631 5,632 2,901
Undistributed earnings of bank
subsidiary 2,377 237 2,700
- --------------------------------------------------------------------------------
Net Income $ 6,008 $ 5,869 $ 5,601
- --------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006 2005 2004
- --------------------------------------------------------------------------------
Operating Activities:
Net Income $ 6,008 $ 5,869 $ 5,601
Adjustments to reconcile net income
to net cash provided by
operating activities:
Gain on sale of equities (319) - -
Equity in undistributed net
income of bank subsidiary (2,377) (237) (2,700)
- --------------------------------------------------------------------------------
Net cash provided by
operating activities 3,312 5,632 2,901
- --------------------------------------------------------------------------------
Investing Activities:
Purchase of equity investments (160) (2,465) -
Proceeds from sales of equity securities 1,544 - -
- --------------------------------------------------------------------------------
Net cash provided (used) by
investing activities 1,384 (2,465) -
- --------------------------------------------------------------------------------
Financing Activities:
Cash dividends paid (3,222) (3,094) (2,900)
- --------------------------------------------------------------------------------
Net cash used by
financing activities (3,222) (3,094) (2,900)
- --------------------------------------------------------------------------------
Net increase in cash and
cash equivalents 1,474 73 1
Cash and cash equivalents at January 1 81 8 7
- --------------------------------------------------------------------------------
Cash and cash equivalents at December 31 $ 1,555 $ 81 $ 8
- --------------------------------------------------------------------------------
Penseco Financial Services Corporation / 2006 Annual Report 47
ITEM 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure
There were no changes in or disagreements with accountants on matters of
accounting principles or practices or financial statement disclosures in 2006.
ITEM 9A Controls and Procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Controller, we conducted an evaluation of our
disclosure controls and procedures, as such term is defined under Rule 13a-15(e)
under the Securities Exchange Act of 1934. Based upon this evaluation, our Chief
Executive Officer and our Controller concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this annual
report. Management's annual report on internal control over financial reporting
is included under the heading "Report on Internal Control Over Financial
Reporting" at Item 8 of this Annual Report on Form 10-K. The attestation report
of the registered public accounting firm is included under the heading "Report
of the Independent Registered Public Accounting Firm" at Item 8 of this Annual
Report on Form 10-K.
The Company continually assesses the adequacy of its internal control over
financial reporting and enhances its controls in response to internal control
assessments, and internal and external audit and regulatory recommendations. No
change in internal control over financial reporting during the quarter ended
December 31, 2006 or through the date of this Annual Report on Form 10-K have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate due to changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
ITEM 9B Other Information
There are no items required to be reported
PART III
ITEM 10 Directors, Executive Officers and Corporate
Governance
CODE OF ETHICS
--------------
The Company has had for many years a Code of Ethics applicable to all employees
including the Company's principal Executive Officer and principal Financial
Officer (Controller). The purpose of the Code is to promote honest and ethical
conduct, full and fair disclosures of financial information, compliance with
laws and regulations and accountability for actions.
A copy of the Code of Ethics may be obtained, without charge, on the web
site or by contacting:
Patrick Scanlon, Controller
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, PA 18503-1848
1-800-327-0394
AUDIT COMMITTEE FINANCIAL EXPERT
--------------------------------
The Sarbanes-Oxley Act of 2002 requires the Company to disclose whether or not
its Audit Committee has, as one of its members, an "Audit Committee Financial
Expert", as that term is defined by the U. S. Securities and Exchange Commission
(SEC).
The Board of Directors has determined that the Audit Committee does not
have an "audit committee financial expert" as that term is defined in the
Securities and Exchange Commission's rules and regulations. However, the Board
believes that each of the members of the Audit Committee has demonstrated that
he is capable of analyzing and evaluating the Company's financial statements and
understanding internal controls and procedures for financial reporting. Because
the Board believes that the current members of the Audit Committee are qualified
to carry out all of the duties and responsibilities of the Company's Audit
Committee, the Board does not believe that it is necessary at this time to
actively search for an outside person to serve on the Board who would qualify as
an audit committee financial expert.
Other information required by this Item as to Directors of the Company
contained under the headings "Voting Securities & Principal Holders Thereof",
"Election of Directors", "Board and Committee Meetings" and "Certain
Relationships and Related Transactions" within the definitive proxy statement
relating to the Company's Annual Meeting of Shareholders, to be held May 1,
2007, is incorporated herein by reference thereto.
48 Penseco Financial Services Corporation / 2006 Annual Report
ITEM 11 Executive Compensation
The information contained under the headings "Executive Compensation",
"Directors Compensation", "Compensation Committee Report on Executive
Compensation" and "Compensation Committee Interlocks and Insider Participation"
in the definitive proxy statement relating to the Company's Annual Meeting of
stockholders, to be held May 1, 2007, is incorporated herein by reference
thereto.
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
The information contained under the heading "Voting Securities & Principal
Holders Thereof" in the definitive proxy statement relating to the Company's
Annual Meeting of stockholders, to be held May 1, 2007, is incorporated herein
by reference thereto.
ITEM 13 Certain Relationships and Related Transactions
and Director Independence
The information contained under the heading "Certain Relationships, Related
Transactions" and "Transactions with Directors and Principal Officers" in the
definitive proxy statement relating to the Company's Annual Meeting of
stockholders, to be held May 1, 2007 is incorporated herein by reference
thereto.
ITEM 14 Principal Accounting Fees and Services
The information contained under the heading "Our Relationship with Our Auditors"
in the definitive proxy statement relating to the Company's Annual Meeting of
stockholders, to be held May 1, 2007 is incorporated herein by reference
thereto.
PART IV
ITEM 15 Exhibits and Financial Statement Schedules
(a) (1) Financial Statements - The following financial statements are
incorporated by reference in Part II, Item 8 hereof:
Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
General Notes to Financial Statements
Report of Independent Registered Public Accounting Firm
(2) Financial Statement Schedules - The Financial Statement Schedules
are incorporated by reference in Part II, Item 8 hereof.
(3) Exhibits
The following exhibits are filed herewith or incorporated by reference
as part of this Annual Report.
3(i) Registrant's Articles of Incorporation (Incorporated herein by
reference to Exhibit 3(i) of Registrant's report on Form 10-K
filed with the SEC on March 30, 1998.)
3(ii) Registrant's By-Laws (Incorporated herein by reference to Exhibit
3(ii) of Registrant's report on Form 10-K filed with the SEC on
March 16, 2006.)
10 Material contracts
13 Annual report to security holders (Included herein by reference
on pages 1- 56.)
14 Code of Ethics (Incorporated herein by reference to Exhibit 10 of
Registrant's report on Form 10-K filed with the SEC on March 16,
2006.)
21 Subsidiaries of the registrant (Incorporated herein by reference
to Exhibit 21 of Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.)
31 Certifications required under Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications required under Section 906 of the Sarbanes-Oxley
Act of 2002
(b) A Form 8-K was filed during the fourth quarter of the fiscal year ended
December 31, 2006.
(c) The exhibits required to be filed by this Item are listed under Item
15(a)(3), above.
(d) There are no financial statement schedules required to be filed under
this item.
Penseco Financial Services Corporation / 2006 Annual Report 49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on February 27, 2007.
By: /s/ CRAIG W. BEST
------------------------------
Craig W. Best
President and CEO
By: /s/ RICHARD E. GRIMM
------------------------------
Richard E. Grimm
Executive Vice-President
By: /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on February 27, 2007.
By: /s/ CRAIG W. BEST By: /s/ ROBERT W. NAISMITH, PH.D.
------------------------------ ------------------------------
Craig W. Best Robert W. Naismith, Ph.D.
President and CEO Director
By: /s/ EDWIN J. BUTLER By: /s/ JAMES B. NICHOLAS
------------------------------ ------------------------------
Edwin J. Butler James B. Nicholas
Director Director
By: /s/ RICHARD E. GRIMM By: /s/ EMILY S. PERRY
------------------------------ ------------------------------
Richard E. Grimm Emily S. Perry
Director Director
By: /s/ RUSSELL C. HAZELTON By: /s/ SANDRA C.PHILLIPS
------------------------------ ------------------------------
Russell C. Hazelton Sandra C. Phillips
Director Director
By: /s/ D. WILLIAM HUME By: /s/ OTTO P. ROBINSON,JR.
------------------------------ ------------------------------
D. William Hume Otto P. Robinson, Jr.
Director, Chairman of the Board Director
By: /s/ JAMES G. KEISLING By: /s/ STEVEN L.WEINBERGER
------------------------------ ------------------------------
James G. Keisling Steven L. Weinberger
Director Director
By: /s/ P. FRANK KOZIK
------------------------------
P. Frank Kozik
Director
50 Penseco Financial Services Corporation / 2006 Annual Report
CERTIFICATIONS
I, Craig W. Best, certify that:
1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: February 26, 2007
/s/ Craig W. Best
- -------------------
Craig W. Best
President and CEO
I, Patrick Scanlon, certify that:
1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: February 26, 2007
/s/ Patrick Scanlon
- -------------------
Patrick Scanlon
Controller
Penseco Financial Services Corporation / 2006 Annual Report 51
CERTIFICATION OF PERIODIC FINANCIAL REPORT PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to his knowledge that:
(1) The Annual Report on Form 10-K of the Company for the year ended
December 31, 2006 (the "Form 10-K") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Act");
and
(2) The information contained in the Form 10-K fairly presents, in all
material respects, the financial conditions and results of operations of
the Company as for the dates and for the periods referred to in the Form
10-K.
/s/ Craig W. Best
-------------------
Craig W. Best
President and CEO
February 26, 2007
- --------------------------------------------------------------------------------
CERTIFICATION OF PERIODIC FINANCIAL REPORT PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to his knowledge that:
(1) The Annual Report on Form 10-K of the Company for the year ended
December 31, 2006 (the "Form 10-K") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Act");
and
(2) The information contained in the Form 10-K fairly presents, in all
material respects, the financial conditions and results of operations of
the Company as for the dates and for the periods referred to in the Form
10-K.
/s/ Patrick Scanlon
-------------------
Patrick Scanlon
Controller
February 26, 2007
52 Penseco Financial Services Corporation / 2006 Annual Report
INDEX TO EXHIBITS
Exhibit Number
Referred to
Item 601 of
Regulation S-K DESCRIPTION OF EXHIBIT Prior Filing or Exhibit Page Number Herein
- ----------------------------------------------------------------------------------------------------------------------------
2 Plan of acquisition, reorganization, arrangement, None
liquidation or succession
3 (i) Articles of Incorporation Incorporated herein by reference to Exhibit 3 (i)
of Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.
(ii) By-Laws Incorporated herein by reference to Exhibit 3 (ii)
of Registrant's report on Form 10-K filed with the
SEC on March 16, 2006.
4 Instruments defining the rights of security holders, None
including indentures
9 Voting trust agreement None
10 Material contracts Incorporated herein by reference to Exhibit 10 of
Registrant's report on Form 10-K filed with the SEC
on March 16, 2006
11 Statement re: Computation of per share earnings None
12 Statements re: Computation of ratios None
13 Annual report to security holders, Form 10-Q or Included herein by reference on pages 1-56.
quarterly report to security holders
14 Code of Ethics Incorporated herein by reference to Exhibit 10 of
Registrant's report on Form 10-K filed with the SEC
on March 16, 2006.
16 Letter re: Change in certifying accountant None
18 Letter re: Change in accounting principles None
21 Subsidiaries of the registrant Incorporated herein by reference to Exhibit 21 of
Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.
22 Published report regarding matters submitted to None
vote of security holders
23 Consents of experts and counsel None
24 Power of attorney None
31 (i) Rule 13a-14(a)/15d-14(a) Certifications Included herein by reference on page 51.
(ii) Rule 13a-14(a)/15d-14(a) Certifications Included herein by reference on page 51.
32 Section 1350 Certifications Included herein by reference on page 52.
33 Report on assessment of compliance with None
servicing for asset-backed securities
34 Attestation report on assessment of compliance None
with servicing criteria for asset-backed securities
35 Servicer compliance statement None
99 Additional Exhibits None
Penseco Financial Services Corporation / 2006 Annual Report 53