PENNROCK FINANCIAL SERVICES CORP - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended September 30, 2003 Commission File Number 0-15040
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PennRock Financial Services Corp.
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(Exact name of Registrant as specified in its charter)

Pennsylvania 23-2400021
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1060 Main St.
Blue Ball, Pennsylvania 17506
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(Address of principal executive offices) (Zip code)

(717) 354-4541
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Registrant's telephone number, including area code

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 periods that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes /X/ No

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes /X/ No

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.

Class Outstanding at November 12, 2003
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Common Stock ($2.50 par value) 7,588,846 Shares

PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES
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FORM 10-Q
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For the Quarter Ended September 30, 2003

Contents
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PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements

Consolidated balance sheets - September 30, 2003,
December 31, 2002 and September 30, 2002.

Consolidated statements of income - Three months and nine months ended
September 30, 2003 and 2002.

Consolidated statements of comprehensive income - Three months and
nine months ended September 30, 2003 and 2002.

Consolidated statements of cash flows - Nine months ended
September 30, 2003 and 2002.

Notes to consolidated financial statements.

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Item 4. Controls and Procedures

PART II. OTHER INFORMATION
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Item 6. Exhibits and Reports on Form 8-K

SIGNATURES
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PART I. FINANCIAL INFORMATION

For the Quarter Ended September 30, 2003

Item 1. Financial Statements

PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

Three Months Ended Nine Months Ended
(Amounts in thousands) September 30, September 30,
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2003 2002 2003 2002
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Net income $3,283 $3,042 $10,545 $ 9,531
Other comprehensive income (loss),
net of tax:
Unrealized gains (losses) on
securities available for sale:
Gain (loss) arising during the
period, net of tax (benefit) (1,188) 1,182 238 3,444
Reclassification adjustment
for gains included in net income,
net of tax (60) (202) (227) (131)
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Other comprehensive income (loss) (1,248) 980 11 3,313
------- ------- ------- -------
Comprehensive income $2,035 $4,022 $10,556 $12,844
======= ======= ======= =======

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2003

NOTE 1. BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
PennRock Financial Services Corp. and its subsidiaries. All material
intercompany balances and transactions have been eliminated in consolidation.

The information contained in the financial statements is unaudited. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation of the results of
interim periods have been made. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements.
Operating results for the nine months ended September 30, 2003 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2003.

The accounting policies of PennRock Financial Services Corp. and
Subsidiaries, as applied in the consolidated interim financial statements
presented, are substantially the same as those followed on an annual basis as
presented in the 2002 Annual Report to shareholders.

NOTE 2. BUSINESS

PennRock Financial Services Corp. ("PennRock") is a bank holding company
incorporated in 1986 under the laws of Pennsylvania. Blue Ball National Bank
("the Bank"), The National Advisory Group, Inc. ("National") and Pension
Consulting Services, Inc. ("PCS") are wholly owned subsidiaries of PennRock.
The Bank provides a broad range of banking, trust and other financial
services to consumers, small businesses and corporations in south-central and
southeastern Pennsylvania. PennRock Insurance Group, Inc., a wholly owned
subsidiary of the Bank sells annuity and life insurance products. National,
established in 1984, is the parent company for four corporations: National
Actuarial Consultants, Ltd. which provides consulting, actuarial and
administrative services to retirement and employee benefit plans; National
Financial Advisors, Inc. which offers investment, advisory and asset
management services to retirement plan sponsors and participants, and serves
as an investment advisor to the Dresher Family of Funds; NFA Brokerage
Services, Inc. which is a mutual-funds-only broker dealer; and National
Shareholder Services, Inc. which provides transfer agency services for the
Dresher Family of Funds. The Dresher Family of Funds is an open-end
diversified management investment company (mutual fund) which consists of
three portfolios: The Dresher Comprehensive Growth Fund, The Dresher Classic
Retirement Fund and The Dresher Income Fund. PCS is a third party
administrator of retirement plans.

NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES

The financial statements do not reflect various commitments and contingent
liabilities, such as commitments to extend credit, letters of credit,
guarantees, and liability for assets held in Trust, which arise in the normal
course of business. Commitments under outstanding letters of credit amounted
to $39.5 million and commitments to extend credit totaled $124.7 million as
of September 30, 2003. Management does not anticipate any significant loss
as a result of these transactions.

NOTE 4. STOCKHOLDERS' EQUITY

On July 8, 2003, the Board of Directors declared a 10% stock dividend payable
on August 12, 2003 to shareholders of record on July 22, 2003. All share and
per-share amounts in the accompanying financial statements have been restated
for the 10% stock dividend and for a 10% stock dividend that was paid on
August 13, 2002.

On June 25, 2003, the Board of Directors authorized the repurchase of up to
300,000 shares of common stock to be held as treasury shares to be used in
connection with future stock dividends and stock splits, employee benefit
plans, executive compensation plans, the Dividend Reinvestment Plan and other
corporate purposes.

NOTE 5. STOCK-BASED EMPLOYEE COMPENSATION

In December 2002, the Financial Accounting Standards Board ("the FASB")
issued Statement of Financial Accounting Standard No. 148 ("SFAS No. 148"),
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123." This statement amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change from the intrinsic value method to the fair
value method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method on reported results.

SFAS No. 148 has also amended APB Opinion 28, "Interim Financial Reporting"
to require that public companies provide a tabular presentation similar to
that called for in annual statements in condensed quarterly statements if,
for any period presented, the intrinsic value method is used. PennRock
adopted the provisions of SFAS No. 148 in December 2002 but will continue to
account for stock-based employee compensation under the intrinsic value
method in accordance with APB 25.

Pro forma information regarding net income and earnings per share has been
determined as if we had accounted for all stock-based compensation under the
fair value method of SFAS 123. There were no options granted in the third
quarters of 2003 and 2002. Therefore, no stock-based employee compensation
expense was incurred in those quarters.

Nine Months Ended
(Amounts in thousands except September 30,
per share data) --------------------
2003 2002
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Net income as reported $10,545 $9,531
Deduct: Total stock-based employee
compensation expense determined
under fair value method for all
awards, net of tax effect (243) (165)
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Pro-forma net income $10,302 $9,366
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Earnings per share:
Basic - as reported $1.38 $1.25
Basic - pro-forma 1.35 1.23
Diluted - as reported 1.36 1.23
Diluted - pro-forma 1.33 1.21

We estimate the fair value of each option on the grant date using the Black-
Sholes option-pricing model with the following weighted average assumptions
used for 2003 and 2002:

2003 2002
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Dividend yield 2.62% 3.33%
Expected volatility 40.00% 36.00%
Risk free interest rate 4.89% 5.58%
Expected average life 10 years 7.12 years

NOTE 6. NEW ACCOUNTING STANDARDS

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or asset in some circumstances) rather than
as capital. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective for interim periods
beginning after June 15, 2003. The adoption of this standard on July 1, 2003
did not have a material impact on our financial condition, results of
operations, earnings per share or cash flows.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," resulting in more consistent reporting of contracts
as either derivatives or hybrid instruments. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, and should be applied
prospectively. Implementation issues that have been effective for fiscal
quarters that began prior to June 15, 2003 should continue to be applied in
accordance with their respective effective dates. The adoption of this
standard on July 1, 2003 did not have a material impact on our financial
condition, results of operations, earnings per share or cash flows.

Forward Looking Statements

In this report, we may have included certain forward looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products and similar matters. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward looking statements. In order to comply with the terms of the safe
harbor, we must inform you that a variety of factors could cause the
Company's actual results and experiences to differ materially from the
anticipated results or other expectations expressed in these forward looking
statements. Our ability to predict the results or the effect of future plans
and strategies is inherently uncertain. Factors that could affect future
results include changes in market interest rates, local and national economic
trends and conditions, competition for products and services, changes in
customer preferences, legislative and regulatory changes, delinquency rates
on loans, changes in accounting principles, policies or guidelines, or the
failure of major customers, vendors or suppliers. You should consider these
factors in evaluating any forward looking statements and not place undue
reliance on such statements. We are not obligated to publicly update any
forward looking statements we may make in this report to reflect the impact
of subsequent events.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total assets of PennRock increased $74.3 million or 7.3% since September 30
last year and by $83.7 million or 8.3% from year-end 2002. Loans grew $78.2
million from year-end 2002 and by $93.4 million from September last year.
Securities available for sale increased $603,000 from the end of 2002 and
decreased by $31.0 million from last September. Deposits increased $4.6
million from last year and by $4.7 million from year-end. Borrowed funds
increased $69.0 million from year-end and by $62.1 million from last year.

Net income for the quarter was $3.3 million or $.43 per share compared with
$3.0 million or $.40 per share for the third quarter of 2002, an increase of
$241,000 or 7.9%. Dividends paid in the third quarter of 2003 totaled $1.4
million or $.19 per share and $1.3 million or $.17 per share for the third
quarter of 2002.

For the first nine months of 2003, net income totaled $10.5 million or $1.38
per share compared with $9.5 million or $1.25 per share for the first nine
months of 2002, an increase of 10.6%. Net interest income increased $1.7
million, non-interest income excluding security gains and losses increased
$1.8 million and non-interest expenses increased $1.9 million. Dividends of
$4.2 million or $.55 per share were paid in the first nine months of 2003
compared with $4.0 million or $.52 per share in 2002. The dividend payout
ratio was 40% in 2003 and 42% in 2002.

NET INTEREST INCOME

Net interest income is the product of the volume of average earning assets
and the average rates earned on them, less the volume of average interest
bearing liabilities and the average rates paid on them. The amount of net
interest income is affected by changes in interest rates, volumes and the mix
of earning assets and paying liabilities. For analytical purposes, net
interest income is adjusted to a taxable equivalent basis. This adjustment
allows for a more accurate comparison among taxable and tax-exempt assets by
increasing tax-exempt income by an amount equivalent to the federal income
tax that would have been paid if this income were taxable at the statutory
rate of 35%.

Table 1 presents net interest income on a fully taxable equivalent basis for
the third quarter and first nine months of 2003 and 2002. For the third
quarter of 2003, net interest income on a fully taxable equivalent basis
totaled $9.3 million, an increase of $935,000 or 11.1% from $8.4 million
earned for the same period of 2002. For the first nine months of 2003 and
2002, net interest income on a fully taxable equivalent basis totaled $27.8
million and $26.5 million, respectively.

TABLE 1 - NET INTEREST INCOME
Three Months Ended Nine Months Ended
(Amounts in thousands) September 30, September 30,
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2003 2002 2003 2002
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Total interest income $13,070 $13,769 $39,972 $42,662
Total interest expense 4,258 5,845 13,518 17,923
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Net interest income 8,812 7,924 26,454 24,739
Tax equivalent adjustment 513 466 1,338 1,735
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Net interest income
(fully taxable equivalent) $ 9,325 $ 8,390 $27,792 $26,474
======= ======= ======== ========

Table 2 presents the average balances, taxable equivalent interest income and
expense and rates for PennRock's assets and liabilities for the three and
nine months ended September 30, 2003 and 2002.

Net interest income for the third quarter of 2003 benefited from increases in
both the interest rate spread and margin relative to the third quarter of
last year. For the first nine months of 2003, spreads and margins
essentially unchanged relative to the first nine months of 2002.

PROVISION AND ALLOWANCE FOR LOAN LOSSES

The provision for loan losses charged to earnings was $460,000 for the third
quarter of 2003 compared with $226,000 for the third quarter of last year.
The provision totaled $1.4 million for the first nine months of 2003 compared
with $1.0 million for the first nine months of 2002. The provision is based
on management's estimate of the amount needed to maintain an adequate
allowance for loan losses. The adequacy of the allowance will be examined in
light of past loan loss experience, current economic conditions, volume of
non-performing and delinquent loans and other relevant factors. The
allowance is established at a level considered by management to be adequate
to absorb potential losses contained in the portfolio and is monitored on a
continuous basis with independent formal reviews conducted semiannually.
The allowance is increased by provisions charged to expense and decreased by
net charge-offs. Table 3 reflects an analysis of the allowance for loan
losses for the third quarter and first nine months of 2003 and 2002.

NON-PERFORMING ASSETS

Table 4 reflects PennRock's non-performing assets at September 30, 2003,
December 31, 2002 and September 30, 2002. PennRock's policy is to
discontinue the accrual of interest on loans for which the principal or
interest is past due 90 days or more unless the loan is well secured and
corrective action has begun or the loan is in the process of collection.
When a loan is placed on non-accrual status, any unpaid interest is charged
against income. Other real estate owned represents property acquired through
foreclosure.

Total non-performing loans decreased $2.4 million from September 30 last year
and by $1.4 million from year-end. Non-accrual loans represented 0.16% of
total loans as of September 30, 2003 compared with 0.60% a year ago and 0.41%
at year-end.

LIQUIDITY

The purpose of liquidity management is to ensure that there are sufficient
cash flows available to meet a variety of needs. These include financial
commitments such as satisfying the credit needs of our borrowers and
withdrawals by our depositors, the ability to capitalize on investment and
business opportunities as they occur, and the funding of PennRock's own
operations. Liquidity is provided by maturities and sales of investment
securities, loan payments and maturities and liquidating money market
investments such as federal funds sold. Liquidity is also provided by short-
term lines of credit with various correspondents and fixed and variable rate
advances from the Federal Home Loan Bank of Pittsburgh ("the FHLB") and other
correspondent banks. However, PennRock's primary source of liquidity lies in
PennRock's ability to renew, replace and expand its base of core deposits
(consisting of demand, NOW, money market, savings and time deposits less than
$100,000).

Total deposits increased $4.6 million or 0.6% since last year and by $4.7
million or 0.6% from year-end. Non-interest bearing deposits increased $15.7
million from September 30 last year and by $8.2 million from year-end. Core
deposits (deposits other than time deposits of $100,000 or more) decreased by
$2.0 million from last year but increased by $27.2 million from year-end.
However most balance sheet growth is being funded by short-term borrowings,
primarily overnight advances from the FHLB. Short-term borrowings increased
by $87.1 million from last year and by $94.0 million from year-end 2002.

One fixed rate advance from the FHLB totaling $25 million matured during the
second quarter of 2003 but was not replaced. Also during the second quarter
of 2003, two advances totaling $40 million were paid off and replaced by new
advances at lower interest rates. The prepayment penalty assessed by the
FHLB is being amortized over the life of the new advances in accordance with
EITF 96-19 ("Debtor's Accounting for a Modification or Exchange of Debt
Instruments") issued by the FASB in 1996.

Table 5 reflects the changes in the major classifications of deposits and
borrowed funds by comparing the balances at the end of the third quarter of
2003 with year-end 2002 and the third quarter of 2002.

CAPITAL RESOURCES

Total stockholders' equity increased $7.0 million or 8.0% from September 30,
2002 and by $6.8 million or 7.8% since year end. Stockholders' equity is
impacted by changes in the unrealized market gains and losses of the
securities available for sale portfolio, net of deferred taxes and is shown
on the consolidated balance sheets as a component of stockholders' equity as
accumulated other comprehensive loss, net of tax. The net unrealized loss
increased by $1.5 million from September 30, 2002 and declined by $11,000
from year-end 2002. The net unrealized gains and losses of the securities
available for sale portfolio are excluded from computations of regulatory
ratios.

Table 6 shows PennRock's capital resources as of September 30, 2003, December
31 and September 30, 2002. PennRock and its subsidiary bank exceed all
minimum capital guidelines.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss from adverse changes in market prices and
rates. Our primary market risk arises from interest-rate risk. We acquire
interest earning assets (loans and securities) and fund them with interest-
bearing and non-interest bearing liabilities (deposits and borrowings).
These financial instruments have varying degrees of sensitivity to changes in
market interest rates. The disparity of sensitivity between these financial
assets and liabilities creates interest rate risk. We believe there have
been no material changes in the levels of interest rate risk exposure since
year-end 2002. Further information on interest rate risk can be found under
the caption "Quantitative and Qualitative Disclosures About Market Risk" on
pages 36-39 in PennRock's 2002 Annual Report on Form 10-K.

Item 4. Controls and Procedures

a. Evaluation of Disclosure Controls and Procedures.

An evaluation of the effectiveness of the design and operation of PennRock's
disclosure controls and procedures (as defined in Section 13(a)-14(c) of the
Securities and Exchange Act of 1934) was carried out by PennRock, as of the
end of the period covered by this report, under the supervision and with the
participation of PennRock's management, including the Chief Executive Officer
and Chief Financial Officer. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that PennRock's disclosure
controls and procedures have been designed and are being operated in a manner
that provides reasonable assurance that the information required to be
disclosed by PennRock in reports filed under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. A controls system, no matter how
well designed and operated, cannot provide absolute assurance that the
objectives of the controls system are met, and no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within a company have been detected.

b. Changes in Internal Control.

Subsequent to the date of the most recent evaluation of PennRock's internal
controls, there were no significant changes in PennRock's internal controls
or in other factors that could significantly affect the internal controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses.

PART II. OTHER INFORMATION
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For the Quarter ended September 30, 2003

Item 1. Legal Proceedings

Various legal actions or proceedings are pending involving PennRock or its
subsidiaries. Management believes that the aggregate liability or loss, if
any, will not be material.

Item 2. Changes in Securities

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits. The following list of exhibits required by Item 601 of
Regulation S-K are filed herewith or incorporated by reference.

(b) Reports on Form 8-K: From July 1, 2003 to the date of this Report,
PennRock filed five Current Reports on Form 8-K.

A current report on Form 8-K dated October 15, 2003 was filed with the
Securities and Exchange Commission on or about October 16, 2003. The
report was filed under Items 9 and 12 which disclosed a press release,
dated October 15, 2003, on PennRock's earnings for the third quarter of
2003.

A current report on Form 8-K dated September 23, 2003 was filed with the
Securities and Exchange Commission on or about September 30, 2003. The
report was filed under Item 4 which disclosed a change in PennRock's
Independent Auditor for fiscal year 2004.

A current report on Form 8-K dated September 9, 2003 was filed with the
Securities and Exchange Commission on or about September 9, 2003. The
report was filed under Item 5 which disclosed that PennRock had declared
a cash dividend.

A current report on Form 8-K dated July 17, 2003 was filed with the
Securities and Exchange Commission on or about July 17, 2003. The report
was filed under Items 9 and 12 which disclosed a press release, dated
July 17, 2003, on PennRock's earnings for the second quarter of 2003.

A current report on Form 8-K dated July 8, 2003 was filed with the
Securities and Exchange Commission on or about July 8, 2003. The report
was filed under Item 5 which disclosed that PennRock had declared a 10%
stock dividend.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

PennRock Financial Services Corp.
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(Registrant)

Date: November 14, 2003 By: /s/Melvin Pankuch
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Melvin Pankuch
Executive Vice President and
Chief Executive Officer

Date: November 14, 2003 By: /s/George B. Crisp
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George B. Crisp
Vice President and Treasurer
(Principal Financial and Accounting Officer)

Exhibit Index
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