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PENNROCK FINANCIAL SERVICES CORP.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Or
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-15040
PENNROCK FINANCIAL SERVICES CORP.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2400021
(State of incorporation) (IRS Employer Identification Number)
1060 Main Street
Blue Ball, Pennsylvania 17506
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (717) 354-4541
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $2.50 per share
(Title of class)
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, 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 is not contained herein, and will not be contained, to the
best of the 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 | |
The aggregate market value of the shares of Common Stock of the Registrant held
by non-affiliates of the Registrant as of February 14, 2003 was $165.9 million.
As of February 14, 2003, there were 6,909,009 shares of Common Stock, Par Value
$2.50 Per Share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Pertinent extracts from the Registrant's definitive Proxy Statement for its 2003
Annual Stockholders Meeting to be filed with the Securities and Exchange
Commission are incorporated into Part III of this report.
PENNROCK FINANCIAL SERVICES CORP.
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business................................................................................... 3
Item 2. Properties................................................................................. 11
Item 3. Legal Proceedings.......................................................................... 11
Item 3A. Executive Officers of the Registrant....................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders........................................ 12
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................... 13
Item 6. Selected Financial Data.................................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................................. 36
Item 8. Financial Statements and Supplementary Data................................................ 40
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures...... 65
PART III
Item 10. Directors and Executive Officers of the Registrant......................................... 65
Item 11. Executive Compensation..................................................................... 65
Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 65
Item 13. Certain Relationships and Related Transactions............................................. 65
Item 14. Controls and Procedures.................................................................... 65
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................ 66
SIGNATURES................................................................................................ 68
Certification of Chief Executive Officer as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002...................................................... 69
Certification of Chief Financial Officer as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002...................................................... 70
FORWARD LOOKING STATEMENTS
In our Annual Report, we may include 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 PennRock'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. The risks and uncertainties that may affect the
operations, performance, development and results of PennRock's business include:
- - Changes in market interest rates;
- - Changes in monetary and fiscal policies of the U.S. Treasury and Federal
Reserve;
- - Local and national economic trends and conditions;
- - Competition for products and services among community, regional and
national financial institutions;
- - New services and product offerings by competitors;
- - Changes in customer preferences;
- - Changes in technology;
- - Legislative and regulatory changes;
- - Delinquency rates on loans;
- - Changes in accounting principles, policies or guidelines;
You should consider these factors in evaluating any forward-looking statements
and not place undue reliance on such statements.
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PENNROCK FINANCIAL SERVICES CORP.
PART I
ITEM 1. BUSINESS
PENNROCK FINANCIAL SERVICES CORP.
PennRock Financial Services Corp. ("PennRock" or the "Registrant") is a
Pennsylvania business corporation organized on March 5, 1986. It became a bank
holding company when it acquired all of the common stock of Blue Ball National
Bank (the "Bank") on August 1, 1986. Effective November 6, 2000, PennRock became
a financial holding company as provided by the Gramm-Leach-Bliley Act of 1999.
PennRock is a financial holding company that operates through its subsidiaries
to deliver financial and related services to its customers. PennRock's primary
function is to direct the policies and coordinate the financial resources of its
subsidiaries as well as provide various advisory services. PennRock primarily
obtains the cash necessary to pay dividends to stockholders from the dividends
paid to it by its subsidiaries.
PennRock is a registered bank holding company under the Bank Holding Company Act
of 1956, as amended. It is also subject to regulation by the Federal Reserve
Board and by the Pennsylvania Department of Banking.
BLUE BALL NATIONAL BANK
Blue Ball National Bank began operations in 1906. The Bank provides a full range
of general commercial and retail banking services to its customers, including
several types of checking and savings accounts, certificates of deposit, and
commercial, consumer and mortgage loans through 17 full service community
offices in Lancaster, Berks and Chester Counties in southeastern and
south-central Pennsylvania. The Bank also provides personal and corporate trust
and agency services to individuals, corporations and others, including trust
investment accounts, investment advisory services, mutual funds, estate
planning, and management and administration of pension and profit sharing plans.
Commercial lending services provided by the Bank include short and medium term
loans, revolving credit loans, letters and lines of credit, real estate mortgage
and construction loans and agricultural loans. Consumer lending services include
various types of secured and unsecured loans including installment loans, home
equity loans and overdraft protection lines of credit. Residential mortgage
loans are offered in a wide variety of types including fixed and adjustable-rate
loans. The Bank's underwriting guidelines conform to Fannie Mae and Federal Home
Loan Mortgage Corporation ("FHLMC") guidelines. The Bank sells most of the
conforming fixed-rate residential mortgage loans it originates to either Fannie
Mae or FHLMC in the secondary market but retains the servicing. The Bank's
business is not considered seasonal.
PENNROCK INSURANCE GROUP, INC.
PennRock Insurance Group, Inc. ("PIGI") is a Pennsylvania corporation formed as
a wholly owned subsidiary of Blue Ball National Bank on September 22, 1998. PIGI
is an insurance agency organized for the sale of annuities and other types of
insurance.
THE NATIONAL ADVISORY GROUP, INC.
PennRock acquired The National Advisory Group, Inc. ("National") on March 19,
2001. 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) that consists of two portfolios: The Dresher
Comprehensive Growth Fund and The Dresher Classic Retirement Fund.
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PENNROCK FINANCIAL SERVICES CORP.
PENSION CONSULTING SERVICES, INC.
PennRock acquired Pension Consulting Services, Inc. ("PCS") on October 31, 2002.
PCS is a third party administrator of retirement plans for nearly 1,000 small to
medium sized businesses and professional corporations. All operations were
relocated to Dresher, Pennsylvania and will work out of the same offices as
National.
EMPLOYEES
PennRock has no employees. At year-end 2002, the Bank and PIGI employed 261
full-time and 66 part-time employees; National employed 20 full-time and 3
part-time employees; PCS employed 11 full-time and 2 part-time employees.
COMPETITION
Blue Ball National Bank originates most of its loans to, and accepts most of its
deposits from, residents and businesses located in southeastern and
south-central Pennsylvania, primarily Lancaster, Berks and Chester Counties. The
financial services industry in the Bank's service area continues to be extremely
competitive, both among commercial banks and other financial service providers
such as consumer finance companies, thrifts, investment companies, mutual funds
and credit unions. Mortgage banking firms, insurance companies, brokerage
companies, financial affiliates of commercial companies, and government agencies
also provide competition for loans and other financial services. Some of these
competitors are considerably larger and have more resources than the Bank.
However, the Bank has made a significant investment in technological resources
that allows us to offer a wide variety of products and services and enables us
to compete with any size financial institution.
Among the most important factors influencing the Bank's ability to compete
successfully for new loans and deposits are interest rates, convenience of
office locations, and quality of service. We have attempted to differentiate
ourselves from other competitors by emphasizing the local and personalized
nature of our services. In an effort to make our community offices more
convenient to our existing and potential customers, the Bank has, on average,
added one new office per year over the past ten years.
The National Advisory Group, Inc. and Pension Consulting Services, Inc., both
located in Dresher, Montgomery County, Pennsylvania, offer asset management and
retirement plan administration services throughout southeastern Pennsylvania,
New Jersey and Delaware. Numerous financial institutions, accounting and law
firms, as well as other corporations offer similar services as those provided by
National and PCS in the greater Philadelphia metropolitan area.
PennRock is not dependent upon a single customer or a small number of customers,
the loss of which would have a materially adverse effect upon PennRock or its
subsidiaries.
SUPERVISION AND REGULATION
GENERAL
PennRock is registered as a bank holding company and is subject to supervision
and regulation by the Board of Governors of the Federal Reserve System under the
Bank Holding Act of 1956, as amended. PennRock has also made an effective
election to be treated as a "financial holding company." Financial holding
companies are bank holding companies that meet certain minimum capital and other
standards and are therefore entitled to engage in financially related activities
on an expedited basis; see further discussion below. As a financial holding
company, PennRock's activities and those of its bank subsidiary are limited to
the business of banking activities closely related or incidental to banking, and
activities that have been determined by statute or the Federal Reserve Board to
be financial in nature. Bank holding companies are required to file periodic
reports with and are subject to examination by the Federal Reserve Board. The
Federal Reserve Board has issued regulations under the Bank Holding Company Act
that require a bank holding company to serve as a source of financial and
managerial strength to its subsidiary banks. As a result, the Federal Reserve
Board, pursuant to such regulations, may require PennRock to stand ready to use
its resources to provide adequate capital funds to its bank subsidiary during
periods of financial stress or adversity.
The Bank Holding Company Act prohibits PennRock from acquiring direct or
indirect control of more than 5% of the outstanding shares of any class of
voting stock, or substantially all of the assets of, any bank, or from merging
or
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PENNROCK FINANCIAL SERVICES CORP.
consolidating with another bank holding company, without prior approval of the
Federal Reserve Board. Additionally, the Bank Holding Company Act prohibits
PennRock from engaging in or from acquiring ownership or control of more than 5%
of the outstanding shares of any class of voting stock of any company engaged in
a non-banking business, unless such business has been determined by the Federal
Reserve Board to be so closely related to banking as to be a proper incident
thereto or, for financial holding companies, to be financial in nature or
incidental thereto.
As a Pennsylvania bank holding company for purposes of the Pennsylvania Banking
Code, PennRock is also subject to regulation and examination by the Pennsylvania
Department of Banking.
The Bank is a national bank and a member of the Federal Reserve System, and its
deposits are insured (up to applicable limits) by the Federal Deposit Insurance
Corporation (the "FDIC"). The Bank is subject to regulation and examination by
the Office of the Comptroller of the Currency (the "OCC"), and to a much lesser
extent, the Federal Reserve Board and the FDIC. The primary supervisory
authority of the Bank is the OCC, who regularly examines the Bank. The OCC has
authority to prevent a national bank from engaging in unsafe or unsound
practices in conducting its business. The Bank is also subject to requirements
and restrictions under federal and state law, including requirements to maintain
reserves against deposits, restrictions on the types and amounts of loans that
may be granted and the interest that may be charged thereon, limitations on the
types of investments that may be made and the types of services that may be
offered, and the activities of a bank with respect to mergers and consolidations
and the establishment of branches.
As a subsidiary bank of a bank holding company, the Bank is subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank holding company or its subsidiaries, or investments in the stock or
other securities as collateral for loans. The Federal Reserve Act and Federal
Reserve regulations also place certain limitations and reporting requirements on
extensions of credit by a bank to principal shareholders of its parent holding
company, among others, and to related interests of such principal shareholders.
In addition, such legislation and regulations may affect the terms upon which
any person becoming a principal shareholder of a holding company may obtain
credit from banks with which the subsidiary bank maintains a correspondent
relationship.
Under the Federal Deposit Insurance Act, the OCC possesses the power to prohibit
institutions regulated by it (such as the Bank) from engaging in any activity
that would be an unsafe and unsound banking practice or would otherwise be in
violation of the law.
Under the Community Reinvestment Act of 1977 (the "CRA"), the OCC is required to
assess the record of all financial institutions regulated by it to determine if
these institutions are meeting the credit needs of the community, including low
and moderate income neighborhoods, which they serve and to take this record into
account in its evaluation of any application made by any of such institutions
for, among other things, approval of a branch or other deposit facility, office
relocation, a merger or an acquisition of bank shares. The Financial
Institutions Reform, Recovery and Enforcement Act of 1989 amended the CRA to
require, among other things, that the OCC make publicly available the evaluation
of a bank's record of meeting the credit needs of its entire community,
including low and moderate income neighborhoods. This evaluation will include a
descriptive rating like "outstanding", "satisfactory", "needs to improve" or
"substantial noncompliance" and a statement describing the basis for the rating.
These ratings are publicly disclosed.
Under the Bank Secrecy Act, banks and other financial institutions are required
to report to the Internal Revenue Service currency transactions of more than
$10,000 or multiple transactions of which a bank is aware in any one day that
aggregate in excess of $10,000. Civil and criminal penalties are provided under
the Bank Secrecy Act for failure to file a required report, for failure to
supply information required by the Bank Secrecy Act or for filing a false or
fraudulent report.
CAPITAL ADEQUACY GUIDELINES AND THE PROMPT CORRECTIVE ACTION RULES
Bank holding companies are required to comply with the Federal Reserve Board's
risk-based capital guidelines. The required minimum ratio of total capital to
risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) is 8%. At least half of the total capital is required
to be "Tier 1 capital," consisting principally of common shareholders' equity,
less certain intangible assets. The remainder ("Tier 2 capital") may consist of
certain preferred stock, a limited amount of subordinated debt, certain hybrid
capital instruments and other debt securities, and a limited amount of the
general allowance for loan losses. The risk-based capital guidelines are
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PENNROCK FINANCIAL SERVICES CORP.
required to take adequate account of interest rate risk, concentration of credit
risk, and risks of nontraditional activities.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires that institutions must be classified, based on their risk-based capital
ratios into one of five defined categories, as illustrated below, "well
capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized" and "critically undercapitalized".
Total Risk Tier 1 Risk Tier 1
Based Ratio Based Ratio Leverage Ratio
----------- ----------- --------------
Well capitalized > 10.0% > 6.0% > 5.0%
Adequately capitalized > 8.0% > 4.0% > 4.0%
Undercapitalized < 8.0% < 4.0% < 4.0%
Significantly undercapitalized < 6.0% < 3.0% < 3.0%
Critically undercapitalized < 2.0%
In the event an institution's capital deteriorates to the undercapitalized
category or below, FDICIA prescribes an increasing amount of regulatory
intervention, including: the institution of a capital restoration plan and a
guarantee of the plan by a parent institution; and the placement of a hold on
increases in assets, number of branches or lines of business. If capital has
reached the significantly or critically undercapitalized levels, further
material restrictions can be imposed, including restrictions on interest payable
on accounts, dismissal of management and, in critically undercapitalized
situations, appointment of a receiver. For well capitalized institutions, FDICIA
provides authority for regulatory intervention where the institution is deemed
to be engaging in unsafe or unsound practices or receives a less than
satisfactory examination report rating for asset quality, management, earnings
or liquidity. All but well capitalized institutions are prohibited from
accepting brokered deposits without prior regulatory approval. Under FDICIA,
financial institutions are subject to increased regulatory scrutiny and must
comply with certain operational, managerial and compensation standards to be
developed by Federal Reserve Board regulations. FDICIA also requires the
regulators to issue new rules establishing certain minimum standards to which an
institution must adhere including standards requiring a minimum ratio of
classified assets to capital, minimum earnings necessary to absorb losses and
minimum ratio of market value to book value for publicly held institutions.
Additional regulations are required to be developed relating to internal
controls, loan documentation, credit underwriting, interest rate exposure, asset
growth and excessive compensation, fees and benefits.
REGULATORY EXAMINATIONS AND INDEPENDENT AUDITS
Annual full-scope, on site regulatory examinations are required for all the
FDIC-insured institutions except institutions with assets under $100 million
which are well capitalized, well-managed and not subject to a recent change in
control, in which case, the examination period is every 18 months. Banks with
total assets of $500 million or more, as of the beginning of fiscal year 1993,
are required to submit to their supervising federal and state banking agencies a
publicly available annual audit report. The independent auditors of such banks
are required to attest to the accuracy of management's report regarding the
internal control structure of the bank. In addition, such banks also are
required to have an independent audit committee composed of outside directors
who are independent of management, to review with management and the independent
accountants, the reports that must be submitted to the bank regulatory agencies.
If the independent accountants resign or are dismissed, written notification
must be given to the bank's supervising government banking agencies. These
accounting and reporting reforms do not apply to an institution such as a bank
with total assets at the beginning of its fiscal year of less than $500 million.
OTHER PROVISIONS OF FDICIA
FDICIA also requires that banking agencies reintroduce loan-to-value ratio
regulations that were previously repealed by the 1982 Act. Loan-to-values limit
the amount of money a financial institution may lend to a borrower, when the
loan is secured by real estate, to no more than a percentage, set by regulation,
of the value of the real estate.
A separate subtitle within FDICIA, called the "Bank Enterprise Act of 1991",
requires "truth-in-savings" on consumer deposit accounts so that consumers can
make meaningful comparisons between the competing claims of banks with regard to
deposit accounts and products. Under this provision, a bank is required to
provide information to depositors concerning the terms of their deposit
accounts, and in particular, to disclose the annual percentage yield.
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PENNROCK FINANCIAL SERVICES CORP.
REGULATORY RESTRICTIONS ON DIVIDENDS
The Bank may not, under the National Bank Act, declare a dividend without
approval of the Comptroller of the Currency, unless the dividend to be declared
by the Bank's Board of Directors does not exceed the total of:
i. the Bank's net profits for the current year to date, plus
ii. its retained net profits for the preceding two current years, less
any required transfers to surplus.
In addition, the Bank can only pay dividends to the extent that its retained net
profits (including the portion transferred to surplus) exceed its bad debts. The
Federal Reserve Board, the Comptroller and the FDIC have formal and informal
policies which provide that insured banks and bank holding companies should
generally pay dividends only out of current operating earnings, with some
exceptions. The Prompt Corrective Action Rules, described above, further limit
the ability of banks to pay dividends, because banks that are not classified as
well capitalized or adequately capitalized may not pay dividends.
Under these policies and subject to the restrictions applicable to the Bank, the
Bank could declare, during 2003, without prior regulatory approval, aggregate
dividends of approximately $11.3 million, plus net profits earned to the date of
such dividend declaration.
FDIC INSURANCE ASSESSMENTS
The FDIC has implemented a risk-related premium schedule for all insured
depository institutions that results in the assessment of premiums based on
capital and supervisory measures. Under the risk-related premium schedule, the
FDIC assigns, on a semiannual basis, each depository institution to one of three
capital groups (well-capitalized, adequately capitalized or undercapitalized)
and further assigns such institution to one of three subgroups within a capital
group. The institution's subgroup assignment is based upon the FDIC's judgment
of the institution's strength in light of supervisory evaluations, including
examination reports, statistical analyses and other information relevant to
measuring the risk posed by the institution. Only institutions with:
i. a total capital to risk-adjusted assets ratio of 10% or greater;
ii. a Tier 1 capital to risk-based assets ratio of 6% or greater; and
iii. a Tier 1 leverage ratio of 5% or greater,
are assigned to the well-capitalized group. As of December 31, 2002, the Bank
was well capitalized for purposes of calculating insurance assessments.
The Bank Insurance Fund is presently fully funded at more than the minimum
amount required by law. Accordingly, the 2003 Bank Insurance Fund assessment
rates range from zero for those institutions with the least risk, to $0.027 for
every $100 of insured deposits for institutions deemed to have the highest risk.
The Bank is in the category of institutions that presently pay nothing for
deposit insurance. The FDIC adjusts the rates every six months. The FDIC has
indicated that it is possible that all banks will again be required to pay
deposit insurance premiums in the future if the current trend of the size of the
insurance funds relative to all insured deposits continues.
While the Bank presently pays no premiums for deposit insurance, it is subject
to assessments to pay the interest on Financing Corporation bonds. The Financing
Corporation was created by Congress to issue bonds to finance the resolution of
failed thrift institutions. The FDIC sets the Financing Corporation assessment
rate every quarter. The Financing Corporation assessment for the Bank for the
first quarter of 2003 is an annual rate of $.0168 for each $100 of deposits.
THE GRAMM-LEACH-BLILEY ACT
Landmark legislation in the financial services area was signed into law on
November 12, 1999. The Gramm-Leach-Bliley Act dramatically changes certain
banking laws that have been in effect since the early part of the 20th century.
The most radical changes are that the separation between banking and the
securities businesses mandated by the Glass-Steagall Act has now been removed,
and the provisions of any state law that prohibits affiliation between banking
and insurance entities have been preempted. Accordingly, the new legislation now
permits firms engaged in underwriting and dealing in securities, and insurance
companies, to own banking entities, and permits bank holding companies (and in
some cases, banks) to own securities firms and insurance companies. The
provisions of federal law that preclude banking entities from engaging in
non-financially related activities, such as manufacturing, have not been
changed. For example, a manufacturing company cannot own a bank and become a
bank holding company, and a bank holding company cannot own a subsidiary that is
not engaged in financial activities, as defined by the regulators.
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PENNROCK FINANCIAL SERVICES CORP.
The new legislation creates a new category of bank holding company called a
"financial holding company." In order to avail itself of the expanded financial
activities permitted under the new law, a bank holding company must notify the
Federal Reserve that it elects to be a financial holding company. A bank holding
can make this election if it, and all its bank subsidiaries, are well
capitalized, well managed, and have at least a satisfactory Community
Reinvestment Act rating, each in accordance with the definitions prescribed by
the Federal Reserve and the regulators of the subsidiary banks. Once a bank
holding company makes such an election, and provided that the Federal Reserve
does not object to such election by such bank holding company, the financial
holding company may engage in financial activities (such as securities
underwriting, insurance underwriting, and certain other activities that are
financial in nature as to be determined by the Federal Reserve) by simply giving
a notice to the Federal Reserve within thirty days after beginning such business
or acquiring a company engaged in such business. This makes the regulatory
approval process to engage in financial activities much more streamlined than it
was under prior law.
The new law also permits certain financial activities to be undertaken by a
subsidiary of a national bank. As the Bank is a national bank, some of these
provisions apply directly to the Bank. Generally, for financial activities that
are conducted as a principal, such as an underwriter or dealer of securities
holding an inventory, a national bank must be one of the 100 largest national
banks in the United States and have its debt be rated investment grade. Because
the Bank is not one of the 100 largest national banks in the United States, it
is not authorized under the new law to conduct these financial activities as a
principal. However, the Bank may own a securities broker or an insurance agency
and certain other financial agency entities under the new law. Under prior law,
national banks could only own an insurance agency if it was located in a town of
fewer than 5,000 residents, or under certain other conditions. Under the new
law, there is no longer any restriction on where the insurance agency subsidiary
of a national bank is located or does business.
In addition to the foregoing provisions of the new law that make major changes
to the federal banking laws, the new legislation also makes a number of
additions and revisions to numerous federal laws that affect the business of
banking. For example, there is now a federal law on privacy with respect to
customer information held by banks. The federal banking regulators have adopted
rules implementing the new law regarding privacy for customer information. Banks
must:
i. establish a disclosure policy for non-public customer information;
ii. disclose the policy to their customers; and
iii. give their customers the opportunity to object to non-public
information being disclosed to a third party.
Also, the Community Reinvestment Act has been amended by the new law to provide
that small banks (those under $250 million in assets) that previously received
an "outstanding" on their last CRA exam will not have to undergo another CRA
exam for five years or for four years if their last exam was "satisfactory." In
addition, any CRA agreement entered into between a bank and a community group
must be disclosed, with both the bank and the group receiving any grants from
the bank detailing the amount of funding provided and what it was used for. The
new law also requires a bank's policy on fees for transactions at ATM machines
by non-customers to be conspicuously posted on the ATM. A number of other
provisions affecting other general regulatory requirements for banking
institutions were also adopted.
RECENT REGULATORY DEVELOPMENTS
In October 2001, the President signed into law the USA PATRIOT Act. This Act was
in direct response to the terrorist attacks on September 11, 2001, and
strengthens the anti-money laundering provisions of the Bank Secrecy Act. Most
of the new provisions added by the Act apply to accounts at or held by foreign
banks, or accounts of or transactions with foreign entities. The Bank does not
have a significant foreign business and does not expect this Act to materially
affect its operations. The Act does, however, require the banking regulators to
consider a bank's record of compliance under the Bank Secrecy Act in acting on
any application filed by a bank. As the Bank is subject to the provisions of the
Bank Secrecy Act (the reporting of cash transactions in excess of $10,000), the
Bank's record of compliance in this area will be an additional factor in any
applications filed by it in the future. To the Bank's knowledge, its record of
compliance in this area is satisfactory.
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PENNROCK FINANCIAL SERVICES CORP.
In July 2002, federal regulators proposed rules to implement Section 326 of the
USA PATRIOT Act requiring financial institutions to establish procedures for
identifying and verifying the identity of customers. Although these regulations
have not yet been finalized, the proposed rules establish minimum standards for
financial institutions to follow:
i. implement procedures to verify the identity of persons seeking to
open an account;
ii. maintain records of the information used to verify a person's
identity; and
iii. determine whether the person appears on any governmental agency list
of known or suspected terrorists or terrorist organizations.
PennRock has implemented and continues to implement procedures to comply with
these new standards.
In July 2002, the Department of Housing and Urban Development proposed rules to
reform the regulatory requirements under the Real Estate Settlement and
Procedures Act that would
i. change the way compensation to mortgage brokers is disclosed to
consumers;
ii. revise the Good Faith Estimate settlement cost disclosure; and
iii. remove regulatory barriers to permit an option for consumers with
guaranteed packages of settlement services and mortgages.
These rules have not been finalized.
THE SARBANES-OXLEY ACT
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002
in response to public concerns regarding corporate accountability in connection
with recent high visibility accounting scandals. The stated goals of the
Sarbanes-Oxley Act are to:
i. increase corporate responsibility;
ii. provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies; and
iii. protect investors by improving the accuracy and reliability of
corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. The Sarbanes-Oxley Act generally applies to all companies,
both U.S. and non-U.S., that file or are required to file periodic reports with
the Securities and Exchange Commission ("the SEC") under the Securities Exchange
Act of 1934 ("the Exchange Act").
The Sarbanes-Oxley Act includes very specific additional disclosure requirements
and new corporate governance rules, requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules and mandates further studies of certain issues by the SEC and the
Comptroller General. The Sarbanes-Oxley Act represents significant federal
involvement in matters traditionally left to state regulatory systems, such as
the regulations of the accounting profession and to state corporate law, such as
the relationship between a board of directors and management and between a board
of directors and its committees.
The Sarbanes-Oxley Act addresses among other matters:
i. audit committees;
ii. certification of financial statements by the chief executive officer
and chief financial officer;
iii. the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
iv. a prohibition on insider trading during pension black-out periods;
v. disclosure of off-balance sheet transactions;
vi. a prohibition on personal loans to directors and officers unless
subject to the provision of Regulation O;
vii. expedited filing requirements for Form 4s;
viii. disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code;
ix. "real time" filing of periodic reports;
x. the formation of a public accounting oversight board;
xi. auditor independence; and
xii. various increased criminal penalties for violations of securities
laws.
9
PENNROCK FINANCIAL SERVICES CORP.
Since PennRock's stock is listed on the Nasdaq National Market, we are subject
to regulations established by Nasdaq. In response to the Sarbanes-Oxley Act, the
Nasdaq has proposed the following rules relative to corporate governance:
i. Require shareholder approval for the adoption of all stock option
plans and for any material modification of such plans;
ii. Prohibit loans to officers and directors through the adoption of a
Nasdaq rule that mirrors the Act;
iii. Require a majority of independent directors on the board;
iv. Require a regularly convened executive session of the independent
directors;
v. Require that a company's audit committee of the board of directors
review and approve all related-party transactions;
vi. Prohibit an independent director from receiving any payments in
excess of $60,000 other than for board services, and extend such
prohibition to the receipt of payments by a non-employee family
member of the director. An audit committee member may not receive
any compensation except for board or committee service;
vii. Prohibit former partners or employees of the outside auditors who
worked on a company's audit engagement from being deemed
independent;
viii. Apply a three-year "cooling off" period to directors who are not
independent due to:
a. interlocking compensation committees;
b. the receipt by the director or a family member of the director
of any payments in excess of $60,000 other than for board
service; or
c. having worked on the company's audit engagement;
ix. Prohibit directors from serving on the audit committee in the event
they are deemed an affiliated person of the issuer or any
subsidiary;
x. Require independent director approval of director nominations;
xi. Require independent director approval of CEO compensation, either by
an independent compensation committee or by a majority of the
independent directors;
xii. Require that audit committees have the sole authority to appoint,
determine funding for, and oversee the outside auditors;
xiii. Require that audit committees approve, in advance, the provision by
the auditor of all permissible non-audit services;
xiv. Require that audit committees have the authority to engage and
determine the funding for independent counsel and other advisors;
xv. Require that the audit committee establish procedures for the
receipt, retention and treatment of complaints received by the
issuer and ensure that such complaints are treated confidentially
and anonymously;
xvi. Require that in selecting the financial expert necessary for
compliance with the Nasdaq audit committee composition requirements,
issuers consider whether a person has, through education and
experience as a public accountant or auditor or a principal
financial officer, controller or principal accounting officer of an
issuer or from a position involving the performance of similar
functions, sufficient financial expertise in the accounting and
auditing areas;
xvii. Require that all audit committee members be able to read and
understand financial statements at the time of their appointment
rather than "within a reasonable period of time" thereafter;
xviii. Require continuing education for all directors, pursuant to rules
to be developed by the Nasdaq Listing and Hearing Review Council;
xix. Require all companies to have a code of conduct addressing, at a
minimum, conflicts of interest and compliance with applicable laws,
rules and regulations, with an appropriate compliance mechanism and
disclosure of any waivers to executive officers and directors. Only
independent directors can grant waivers. The code of conduct must be
publicly available;
xx. Harmonize the Nasdaq rule on the disclosure of material information
with the SEC's Regulation FD so that issuers may use Regulation FD
compliant methods such as conference calls, press conferences and
web casts, so long as the public is provided adequate notice
(generally by press release) and granted access.
The Sarbanes-Oxley Act contains provisions that became effective upon enactment
on July 30, 2002, and provisions that will become effective from within 30 days
to one year from enactment. The SEC has been delegated the task of enacting
rules to implement various of the provisions with respect to, among other
matters, disclosure in periodic filings pursuant to the Exchange Act.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restriction on, the
business of PennRock or the Bank. It cannot be predicted whether any such
legislation will be adopted or, if adopted, how such legislation would affect
the business of PennRock or the Bank.
10
PENNROCK FINANCIAL SERVICES CORP.
As a consequence of the extensive regulation of commercial banking activities in
the United States, PennRock's business is particularly susceptible to being
affected by federal legislation and regulations that may increase the costs of
doing business.
FOREIGN OPERATIONS
PennRock does not depend on foreign sources for funds, nor does PennRock make
foreign loans.
STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES
The required Statistical Information for Item 1 can be found in Item 6,
"Selected Financial Data," Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Item 8, "Financial Statements
and Supplementary Data," of this Annual Report.
ITEM 2. PROPERTIES
PENNROCK FINANCIAL SERVICES CORP.
PennRock's headquarters are located at the main office of Blue Ball National
Bank located at 1060 Main Street, Blue Ball, Pennsylvania. PennRock owns no real
estate.
BLUE BALL NATIONAL BANK
The principal executive office and main banking office is located in Blue Ball,
Pennsylvania. An operations center, also located in Blue Ball, Pennsylvania,
accommodates the Bank's data processing, accounting, human resource, and loan
and deposit operations departments. These and 15 of the Bank's full service
community offices are owned free and clear of any indebtedness. The land on
which six of the branch offices are located is leased. The net book value of the
Bank's premises and equipment as of December 31, 2002 is $16.3 million.
THE NATIONAL ADVISORY GROUP, INC.
National's offices are located in Dresher, Pennsylvania. All real estate is
leased.
PENSION CONSULTING SERVICES, INC.
PCS's offices are located in Dresher, Pennsylvania. All real estate is leased.
ITEM 3. 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.
11
PENNROCK FINANCIAL SERVICES CORP.
ITEM 3A. EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and positions of all of the executive officers of PennRock as of
February 14, 2003, are listed below, along with the positions with PennRock and
Blue Ball National Bank held by each of them during the past five years. The
Board of Directors elects officers annually.
POSITION AND EXPERIENCE
NAME AGE DURING PAST 5 YEARS
- ---------------------------- -------- -----------------------------------------------------------------
Norman Hahn 66 PennRock Financial Services Corp.:
Chairman of the Board (January 1991 to date)
Blue Ball National Bank:
Chairman of the Board (January 1991 to date)
Glenn H. Weaver 68 PennRock Financial Services Corp.:
President (April 1989 to date)
Robert K. Weaver 54 PennRock Financial Services Corp.:
Secretary (March 1986 to date)
Blue Ball National Bank:
Secretary (1977 to date)
Melvin Pankuch 63 PennRock Financial Services Corp.:
Executive Vice President and Chief Executive Officer
(April 1989 to date)
Blue Ball National Bank:
President and Chief Executive Officer (April 1988 to date)
George B. Crisp 55 PennRock Financial Services Corp.:
Vice President and Treasurer (April 1989 to date)
Blue Ball National Bank:
Senior Vice President - Operations (July 1993 to date)
Chief Financial Officer (July 1987 to date)
Joseph C. Spada 52 Blue Ball National Bank:
Senior Vice President - Banking Sales/Service (July 1993 to date)
Michael H. Peuler 52 Blue Ball National Bank:
Senior Vice President - Financial Services (April 1995 to date)
Vice President - Financial Services (June 1993 to April 1995)
The National Advisory Group, Inc.
President and Chief Executive Officer (March 2001 to date)
Pension Consulting Services, Inc.
President and Chief Executive Officer (October 2002 to date)
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the 4th quarter of 2002.
12
PENNROCK FINANCIAL SERVICES CORP.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PennRock's common stock trades on the Nasdaq National Market under the symbol
PRFS. The price of PennRock's stock ranged from $19.96 to $32.00 in 2002 and
closed the year at $27.75. The price ranged from $11.80 to $20.91 in 2001 and
closed the year at $20.22. The book value per share was $12.59 as of December
31, 2002 and $11.30 as of December 31, 2001. All per share data have been
restated for a 5% stock dividend paid in 2001 and a 10% stock dividend paid in
2002. The prices listed below represent the high, low and quarter ending prices
for stock trades reported during each quarter.
Quarter Per Share
High Low End Dividend
----------- ----------- ------------ ------------
2002
FIRST QUARTER $25.45 $19.96 $25.45 $0.18
SECOND QUARTER 31.00 25.23 29.73 0.19
THIRD QUARTER 32.00 28.12 29.00 0.19
FOURTH QUARTER 29.66 26.34 27.75 0.20
2001
First quarter $13.85 $11.80 $13.20 $0.16
Second quarter 17.75 12.99 17.54 0.17
Third quarter 20.91 16.27 20.17 0.17
Fourth quarter 20.23 18.46 20.22 0.19
PennRock maintains a Dividend Reinvestment Plan for eligible shareholders who
elect to participate in the Plan. A copy of the Prospectus for this Plan may be
obtained by writing to:
Shannan B. Guthrie, Investor Relations Officer
PennRock Financial Services Corp.
P.O. Box 580
Blue Ball, PA 17506
Copies of PennRock's Annual Report on Form 10-K, as well as all other reports
and forms filed with the Securities and Exchange Commission by PennRock, are
available without charge on the company's web site at www.pennrock.com, or by
writing to Shannan B. Guthrie, Investor Relations Officer at the address listed
directly above.
Registrar/Transfer Agent:
American Stock Transfer and Trust (800) 937-5449
59 Maiden Lane
New York, NY 10038
Nasdaq Market Makers:
As of December 31, 2002, the following firms made a market in PennRock's
common stock:
F.J. Morrissey & Co., Inc. (800) 842-8928
Ferris, Baker, Watts, Inc. (800) 638-7411
Janney Montgomery LLC (717) 293-4100
RBC Dain Rauscher (800) 456-9234
Independent Auditors:
Simon Lever & Company
13
PENNROCK FINANCIAL SERVICES CORP.
ITEM 6. SELECTED FINANCIAL DATA
In thousands, except share and per share data
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
FOR THE YEAR:
Interest income $ 57,142 $ 62,274 $ 64,234 $ 54,783 $ 50,643
Interest expense 23,283 32,366 37,073 28,137 25,458
Net interest income 33,859 29,908 27,161 26,646 25,185
Provision for loan losses 1,750 1,548 3,076 1,026 1,225
Non-interest income 11,144 11,030 7,315 6,159 5,087
Non-interest expense 27,447 25,282 20,280 18,566 17,451
Net income 13,226 12,067 9,546 10,710 9,615
Per share:
Net income - Basic 1.90 1.74 1.38 1.55 1.37
Net income - Diluted 1.88 1.73 1.38 1.55 1.37
Cash dividends 0.76 0.69 0.60 0.54 0.52
Book value as of year-end 12.59 11.30 10.59 8.37 9.65
Market value as of year-end 27.75 20.22 12.12 15.48 19.91
Number of shares outstanding 6,909,337 6,936,580 6,856,532 6,861,797 6,937,906
AS OF YEAR-END:
Securities $ 304,814 $ 303,334 $ 323,556 $ 309,462 $ 273,722
Loans 602,840 558,369 501,140 461,179 407,930
Earning assets 915,749 860,957 841,940 766,714 683,671
Total assets 1,008,589 948,938 910,950 842,446 730,531
Total deposits 743,262 663,694 682,994 631,415 550,046
Short-term borrowings 40,363 76,754 54,175 53,207 13,780
Long-term debt 127,000 121,000 91,000 90,000 90,700
Stockholders' equity 86,978 78,404 72,598 59,233 66,911
Full-time equivalent employees 335 321 276 271 255
SELECTED RATIOS:
Return on average assets 1.34% 1.34% 1.09% 1.37% 1.39%
Return on average equity 15.86% 15.80% 14.93% 16.39% 14.86%
Efficiency ratio 58.10% 59.28% 55.90% 54.03% 53.74%
Net interest margin (tax equivalent) 3.98% 3.95% 3.71% 4.02% 4.36%
Total capital to average assets 8.64% 9.21% 8.86% 9.01% 9.96%
Total capital to risk-weighted
assets 11.57% 11.71% 12.45% 12.80% 14.77%
Price to earnings (x) 14.61 11.59 8.78 9.99 14.53
Market to book value (x) 2.20 1.79 1.15 1.85 2.06
Allowance for loan losses to loans 1.17% 1.30% 1.19% 1.20% 1.20%
Non-performing loans to loans 0.41% 0.21% 0.85% 0.43% 0.33%
Dividend payout ratio 40.49% 39.70% 43.66% 34.52% 37.70%
14
PENNROCK FINANCIAL SERVICES CORP.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following section presents management's discussion and analysis of the
financial condition and results of operations of PennRock Financial Services
Corp., a bank holding company ("PennRock"), its subsidiaries, The National
Advisory Group, Inc. ("National"), Pension Consulting Services, Inc. ("PCS") and
Blue Ball National Bank ("the Bank"), and the Bank's subsidiary, PennRock
Insurance Group, Inc. ("PIGI"). This discussion and analysis is presented to
assist the reader in understanding and evaluating the financial condition,
results of operations and future prospects of PennRock and should be read in
conjunction with the consolidated financial statements and other financial data
presented elsewhere in this Annual Report.
PennRock's results of operations are dependent primarily on its net interest
income, which is the difference between the interest earned on its assets
(primarily its loan and securities portfolios) and its cost of funds, which
consists of the interest paid on its deposits and borrowings. PennRock's results
of operations are also affected by its provision for loan losses as well as
non-interest income, non-interest expenses and income tax expense. Non-interest
expenses consist of salaries and benefits, occupancy and equipment expenses,
advertising and marketing, data processing, insurance, professional fees,
telecommunications and other operating expenses. Results of operations are also
dependent on the dollar volume and asset quality of PennRock's loans and
investments.
The results of PennRock's operations, like those of other financial
institutions, are affected by our asset and liability management policies, as
well as factors beyond our control, such as general economic conditions and the
monetary and fiscal policies of the federal government. Lending activities are
affected by the demand for commercial and mortgage financing and other types of
loans, and are thus influenced by interest rates and other economic factors.
Deposit flows and costs of funds are influenced by yields available on competing
banking and non-banking investments and by general market rates of interest.
OVERVIEW
During 2002, PennRock recorded net income of $13.2 million, an increase of $1.2
million or 10% over 2001. Basic and diluted earnings per share for the year were
$1.90 and $1.88, respectively, as compared to $1.74 and $1.73, respectively, for
2001. Net income was $9.5 million or $1.38 per share in 2000. Return on average
assets was 1.34% in both 2002 and 2001, and 1.09% in 2000. Return on average
equity was 15.86% in 2002, 15.80% in 2001 and 14.93% in 2000.
Assets grew $59.7 million to $1.008 billion, an increase of 6.3% from 2001.
Average earning assets increased $71.5 million or 8.6% during 2002, while
average interest bearing liabilities grew $62.6 million or 8.7%. The average
yield on earning assets decreased 129 percentage points from 7.86% in 2001 to
6.57% in 2002. The average yield on paying liabilities decreased 153 percentage
points from 4.52% in 2001 to 2.99% in 2002. PennRock's net interest income on a
fully taxable equivalent basis increased $3.4 million or 10.3% during 2002 and
$2.5 million or 8.5% in 2001. The net interest margin was 3.98% in 2002, 3.95%
in 2001 and 3.71% in 2000.
The provision for loan losses increased from $1.5 million in 2001 to $1.8
million in 2002. The provision for loan losses was $3.1 million in 2000.
Non-interest income from sources other than realized securities gains increased
$1.3 million or 13.5% in 2002 compared with an increase of $3.7 million or 64.6%
in 2001 and an increase of $1.1 million or 24.8% in 2000. With the exception of
realized gains on securities, all sources of non-interest income increased in
2002 over 2001 as well as in 2001 over 2000.
Non-interest expenses increased $2.2 million or 8.6% in 2002. Non-interest
expenses increased $5.0 million or 24.7% in 2001 and $1.7 million or 9.2% in
2000.
CRITICAL ACCOUNTING POLICIES
PennRock's financial position and results of operations are impacted by
management's application of accounting policies involving judgments made to
arrive at the carrying value of certain assets. Management's greatest challenge
in implementing its policies is the need to make estimates about the effect of
matters that are inherently
15
PENNROCK FINANCIAL SERVICES CORP.
less than certain. For a detailed discussion of PennRock's significant
accounting policies, see Note 1: Summary of Significant Accounting Policies in
the Notes to Consolidated Financial Statements. A material estimate that is
susceptible to significant change is the determination of the allowance for loan
losses. Estimates of the amount of the allowance for loan losses and the
placement of loans on non-accrual status both affect the carrying amount of the
loan portfolio.
The allowance for loan losses is a difficult subjective judgment that management
must make regarding the loan portfolio, and is established and maintained at
levels that management believes are adequate to cover losses resulting from the
inability of borrowers to make required payments on loans. To estimate loan
losses, we analyze:
i. historical loan losses;
ii. current trends in delinquencies and charge-offs;
iii. plans for problem loan administration and resolution;
iv. the views of regulators;
v. changes in the size and composition of the loan portfolio;
vi. peer group information;
vii. the economic climate and direction;
viii. increases or decreases in overall lending rates;
ix. political conditions;
x. legislation directly or indirectly impacting the banking industry;
and
xi. economic conditions affecting specific geographical areas in which
PennRock conducts business.
Where there is a question as to the impairment of a specific loan, management
obtains valuations of the property or collateral securing the loan, and current
financial information of the borrower, including financial statements, when
available. Since the calculation of appropriate loan loss allowances relies on
management's estimates and judgments relating to inherently uncertain events,
actual results may differ from these estimates. The American Institute of
Certified Public Accountants is preparing further guidance for calculating the
allowance for loan losses. Implementation of that guidance could result in an
adjustment to the allowance. For a more detailed discussion on the allowance for
loan losses, see Allowance For Loan Losses under the discussion of Financial
Condition in Item 7 of this report and Allowance for Loan Losses in Note 1:
Summary of Significant Accounting Policies and Note 6: Allowance for Loan Losses
in the Notes to Consolidated Financial Statements.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the amount by which interest income on loans, investments
and other earning assets exceeds interest paid on deposits, borrowings and other
interest bearing liabilities. Net interest income is the primary source of
revenue for PennRock. The amount of net interest income earned is affected by
changes in interest rates and the balances of the various types of earning
assets and interest bearing liabilities. For comparative purposes, and
throughout this discussion unless otherwise noted, net interest income and
corresponding yields are shown on a taxable equivalent basis. This adjustment
will give effect to the interest earned on tax-exempt loans and investments by
an amount equivalent to the federal income taxes, which would have been paid if
the income received on these assets were taxable at the statutory rate of 35%
for 2002 and 34% for 2001, and 2000.
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. Table 1 presents average
balances, taxable equivalent interest income and expense and rates for
PennRock's assets and liabilities for the years ended December 31, 2002, 2001
and 2000.
16
PENNROCK FINANCIAL SERVICES CORP.
TABLE 1 - AVERAGE BALANCES, RATES AND INTEREST INCOME AND EXPENSE SUMMARY
(Taxable equivalent basis)
In thousands 2002 2001 2000
------------------------------ ---------------------------- -----------------------------
AVERAGE AVERAGE Average Average Average Average
BALANCE INTEREST RATE Balance Interest Rate Balance Interest Rate
-------- ---------- ------- -------- -------- ------- -------- -------- -------
ASSETS
Short-term investments $ 5,375 $ 100 1.86% $ 8,978 $ 374 4.17% $ 7,407 $ 479 6.47%
Mortgages held for sale 2,720 248 9.12% 2,347 212 9.03% 274 27 9.85%
Securities available for
sale:
U.S. Treasury and agency 81,916 5,842 7.13% 91,930 6,168 6.71% 132,638 9,448 7.12%
State and municipal 34,955 2,777 7.94% 71,731 5,703 7.95% 97,988 8,686 8.86%
Other 200,914 7,254 3.61% 135,367 8,610 6.36% 90,421 6,372 7.05%
-------- ---------- -------- -------- -------- --------
Total securities available
for sale 317,785 15,873 4.99% 299,028 20,481 6.85% 321,047 24,506 7.63%
Loans: (1)
Mortgage 332,256 25,687 7.73% 292,324 24,780 8.48% 271,585 22,567 8.31%
Commercial 158,603 10,858 6.85% 141,685 11,873 8.38% 127,203 12,169 9.57%
Consumer (2) 81,930 6,321 7.72% 82,816 7,281 8.79% 83,135 7,417 8.92%
-------- ---------- -------- -------- -------- --------
Total loans 572,789 42,866 7.48% 516,825 43,934 8.50% 481,923 42,153 8.75%
-------- ---------- -------- -------- -------- --------
Total earning assets 898,669 59,087 6.57% 827,178 65,001 7.86% 810,651 67,165 8.29%
---------- -------- --------
Other assets 85,931 70,514 65,350
-------- -------- --------
Total assets $984,600 6.00% $897,692 7.24% $876,001 7.67%
======== ====== ======== ===== ======== =======
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest bearing deposits:
Demand $211,869 3,661 1.73% $149,441 4,582 3.07% $139,570 5,207 3.73%
Savings 72,542 991 1.37% 57,548 1,064 1.85% 55,457 1,095 1.97%
Time 317,432 10,505 3.31% 357,190 18,366 5.14% 368,803 21,379 5.80%
-------- ---------- -------- -------- -------- --------
Total interest bearing
deposits 601,843 15,157 2.52% 564,179 24,012 4.26% 563,830 27,681 4.91%
Short-term borrowings 53,710 796 1.48% 38,094 1,304 3.42% 63,975 3,891 6.08%
Long-term debt 123,663 7,330 5.93% 114,342 7,050 6.17% 86,292 5,501 6.37%
-------- ---------- -------- -------- -------- --------
Total interest bearing
liabilities 779,216 23,283 2.99% 716,615 32,366 4.52% 714,097 37,073 5.19%
---------- -------- --------
Non-interest bearing
demand deposits 110,808 94,990 87,786
Other liabilities 11,210 9,692 10,162
Stockholders' equity 83,366 76,395 63,956
-------- -------- --------
Total liabilities and
stockholders' equity $984,600 2.36% $897,692 3.61% $876,001 4.23%
======== ====== ======== ===== ======== =======
Net interest income $ 35,804 $ 32,635 $30,092
========== ======== ========
Interest rate spread 3.58% 3.34% 3.10%
Effect of non-interest
bearing funds 0.40% 0.61% 0.61%
------ ----- -------
Net interest margin 3.98% 3.95% 3.71%
====== ===== =======
(1) Interest income on loans includes fees of $1,619,000 in 2002,
$1,598,000 in 2001 and $775,000 in 2000. Average loan balances
exclude non-accrual loans.
(2) Consumer loans outstanding net of unearned income.
2002 over 2001:
The average balance of interest-earning assets grew $71.5 million in 2002 over
2001 while the average balance of interest-bearing liabilities grew $62.6
million. The increase in average interest-earning assets generated $5.9 million
of additional interest income while the increase in average interest-bearing
liabilities generated only $1.2 million of additional interest expense,
resulting in an increase of $4.7 million of net interest income due to changes
in volumes.
17
PENNROCK FINANCIAL SERVICES CORP.
Another factor that contributed to the change in our net interest income was the
change in interest rates. The average rate earned on earning assets declined 129
percentage points which caused interest income to decline $11.8 million in 2002.
The average rate paid on interest bearing liabilities declined 153 percentage
points which caused interest expense to decline $10.3 million. Since interest
income declined by more than interest expense, net interest income declined by
$1.5 million due to changes in interest rates.
2001 over 2000
The average balance of interest earning assets increased by $16.5 million in
2001 over 2000 while the average balance of interest bearing liabilities
increased $2.5 million. The increase in average interest-earning assets
generated $1.7 million of additional interest income while the interest expense
on interest-bearing liabilities actually declined by $50,000 due to changes in
the mix of the interest-bearing liabilities. Net interest income increased $1.7
million due to changes in volumes.
The average rate earned on earning assets declined 43 percentage points which
caused interest income to decline $3.8 million in 2001. The average rate paid on
interest bearing liabilities declined 67 percentage points which caused interest
expense to decline $4.7 million. Since interest expense declined by more than
interest income, net interest income increased by $815,000 due to changes in
interest rates.
Table 2 presents the adjustment required to convert net interest income to net
interest income on a fully taxable equivalent basis for the years ended December
31, 2002, 2001 and 2000.
TABLE 2 - NET INTEREST INCOME
In thousands 2002 2001 2000
------- ------- -------
Total interest income $57,142 $62,274 $64,234
Total interest expense 23,283 32,366 37,073
------- ------- -------
Net interest income 33,859 29,908 27,161
Tax equivalent adjustment 1,945 2,727 2,931
------- ------- -------
Net interest income (fully taxable equivalent) $35,804 $32,635 $30,092
======= ======= =======
The amount of non-taxable interest earned determines the size of tax equivalent
adjustment necessary to convert net interest income into fully taxable
equivalent net interest income. The primary source of non-taxable interest
income for PennRock has traditionally been from interest earned on municipal
bonds that the Bank held in its available for sale portfolio. Since the
municipal bonds that the Bank normally purchases have maturity dates of 20 years
and longer, these bonds tend to lengthen the average life of the portfolio. As
market interest rates fell in 2001 and 2002, we restructured the portfolio over
the two-year period to shorten the average life of the portfolio. As a result,
we replaced longer-term municipal bonds with primarily shorter-term taxable
securities. The average balance of municipal bonds owned by the Bank fell from
$98.0 million in 2000 to $71.7 million in 2001 and to $35.0 million in 2002.
With a smaller investment in municipal bonds, the interest earned (on a taxable
equivalent basis) from municipal bonds declined each year as well, falling from
$8.7 million in 2000 to $5.7 million in 2001 and to $2.8 million in 2002. To
help offset the decline in the tax-free interest earned from the municipal bond
portfolio, we purchased adjustable rate and short-term callable Fannie Mae and
Federal Home Loan Mortgage Corporation ("FHLMC") preferred stock. The dividends
earned on Fannie Mae and FHLMC preferred stock are 70% tax-free, which helped
replace some, but not all, of the tax-free income lost from the municipal bond
portfolio. The Bank's investment in preferred stock increased from $6.2 million
in 2000 to $39.1 million in 2001 and to $50.8 million in 2002. The dividends
earned (on a taxable equivalent basis) from the preferred stock portfolio
increased from $451,000 in 2000 to $3.1 million in 2001 and to $4.1 million in
2002. As a result of this restructuring and the resulting decline in tax-free
income earned over the three-year period, the tax equivalent adjustment as shown
in Table 2 declined from $2.9 million in 2000 to $2.7 million in 2001 and to
$1.9 million in 2002.
Changes in interest rates as well as changes in average balances (or volumes) of
earning assets and paying liabilities have an impact on the amount of net
interest income earned and the net interest margins realized by PennRock from
year-to-year. By isolating the effect that changes in rates have on net interest
income from the effect of changes in volume, we can analyze the degree that each
influences the change in net interest income and net interest margins. Table 3
analyzes the changes in the volume and rate components of net interest income.
18
PENNROCK FINANCIAL SERVICES CORP.
TABLE 3 - VOLUME AND RATE ANALYSIS OF CHANGES IN INTEREST INCOME
(Taxable equivalent basis)
In thousands Year Ended December 31,
-----------------------------------------------------------------------------
2002 OVER 2001 2001 over 2000
------------------------------------- -----------------------------------
CHANGE DUE TO Change due to
----------------------- TOTAL --------------------- Total
VOLUME RATE CHANGE Volume Rate Change
--------- --------- --------- -------- -------- --------
Interest earned on:
Short-term investments $ (150) $ (124) $ (274) $ 102 $ (207) $ (105)
Mortgages held for sale 34 2 36 204 (19) 185
Securities 1,285 (5,893) (4,608) (1,681) (2,344) (4,025)
Loans 4,757 (5,825) (1,068) 3,053 (1,272) 1,781
--------- --------- --------- -------- -------- --------
Total interest income 5,926 (11,840) (5,914) 1,678 (3,842) (2,164)
--------- --------- --------- -------- -------- --------
Interest paid on:
Interest bearing demand deposits 1,914 (2,835) (921) 368 (993) (625)
Savings deposits 277 (350) (73) 41 (72) (31)
Time deposits (2,044) (5,817) (7,861) (673) (2,340) (3,013)
Short-term borrowings 535 (1,043) (508) (1,574) (1,013) (2,587)
Long-term debt 575 (295) 280 1,788 (239) 1,549
--------- --------- --------- -------- -------- --------
Total interest expense 1,257 (10,340) (9,083) (50) (4,657) (4,707)
--------- --------- --------- -------- -------- --------
Net interest income $ 4,669 $ (1,500) $ 3,169 $ 1,728 $ 815 $ 2,543
========= ========= ========= ======== ======== ========
Another method of analyzing the change in net interest income is to examine the
changes between interest rate spread and the net interest margin on earning
assets. The interest rate spread as shown in Table 4 is the difference between
the average rate earned on earning assets and the average rate paid on interest
bearing liabilities. The net interest margin takes into account the benefit
derived from assets funded by interest free sources such as non-interest bearing
demand deposits and capital.
TABLE 4 - INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS
(Taxable equivalent basis)
In thousands
2002 2001 2000
-------------------- --------------------- ---------------------
AVERAGE Average Average
BALANCES RATE Balances Rate Balances Rate
-------- ---- -------- ---- -------- ----
Earning assets $898,669 6.57% $827,178 7.86% $810,651 8.29%
======== ======== ========
Interest bearing liabilities $779,216 2.99% $716,615 4.52% $714,097 5.19%
---- ---- ----
Interest rate spread 3.58% 3.34% 3.10%
Interest free sources used
to fund earning assets 119,453 0.40% 110,563 0.61% 96,554 0.61%
-------- ---- -------- ---- -------- ----
Total sources of funds $898,669 $827,178 $810,651
======== ======== ========
Net interest margin 3.98% 3.95% 3.71%
==== ==== ====
The interest rate spread increased 24 percentage points while the net interest
margin increased 3 percentage points in 2002. The yield on earning assets
declined 129 percentage points. The yield on securities available for sale
declined 186 basis points while loan yields declined 102 percentage points.
Although the prime rate was only cut once in 2002, by 50 percentage points, the
yields on earning assets declined by more than prime due to maturities,
repayments and refinancing of higher yielding securities and loans being
reinvested at substantially lower rates. The rate paid on interest bearing
deposits declined 174 basis points not only due to lower deposit rates but also
because of a shift of balances from higher cost time deposits to lower cost
interest bearing demand and savings deposits. The average balance of time
deposits dropped $39.8 million and the average balance of interest bearing
demand and savings balances increased $77.4 million. The average cost of
borrowed funds declined 90 percentage points in 2002. The average rate paid on
total interest bearing liabilities declined 153 percentage points.
19
PENNROCK FINANCIAL SERVICES CORP.
Both the interest rate spread and the net interest margin grew by 24 percentage
points in 2001. The yield on earning assets declined by 43 percentage points but
this was more than offset by a 67 percentage point decrease in the cost of
funds. The prime rate was cut in half during 2001, from 9.5% to 4.75% by the end
of the year as the Federal Reserve lowered rates on 11 different occasions. The
decline in market rates had a greater impact on the yield of securities
available for sale which declined 78 percentage points, while loan yields
dropped only 25 percentage points, benefiting from an increase in loan fees of
$823,000 over loan fees earned in 2000. Interest bearing deposit costs decreased
65 percentage points as both interest bearing demand deposit and time deposit
rates dropped by 66 percentage points during the year. Short-term borrowings
costs decreased 266 percentage points and the rates paid on long-term debt
dropped 20 percentage points in 2001.
PROVISION FOR LOAN LOSSES
The amount of provision for loan losses that was charged against earnings was
$1.8 million in 2002 compared with $1.5 million in 2001 and $3.1 million in
2000. The amount of the provision is based, among other factors, on the amount
of realized net credit losses. Net credit losses totaled $1.9 million in 2002,
$259,000 in 2001 and $2.6 million in 2000. We review the adequacy of the
allowance in light of past loan loss experience, current economic conditions,
size and characteristics of the loan portfolio, volume of non-performing and
delinquent loans and other relevant information.
The ratio of net charge-offs to average loans decreased from 0.54% in 2000 to
0.05% in 2001 and increased to 0.34% in 2002. Net charge-offs in 2002 totaled
27.38% of the allowance for loan losses compared with 3.57% in 2001 and 43.81%
in 2000. Non-performing loans (loans on which we have stopped accruing interest
and loans 90 days or more past due which we continue to accrue interest)
increased from $1.2 million at the end of 2001 to $2.5 million at the end of
2002. Non-performing loans represented 0.41% of total loans as of December 31,
2002 and 0.21% at the end of 2001.
NON-INTEREST INCOME
PennRock generates non-interest income in connection with fees charged on
deposits and other products, investment and trust services, retirement plan
administration fees, sales of securities through the implementation of
management's asset/liability policy, increases in the cash surrender value of
bank-owned life insurance, sale and servicing of mortgage loans, and merchant,
ATM and debit card fees.
TABLE 5 - NON-INTEREST INCOME
Table 5 indicates changes in the major categories of non-interest income for the
three years ended December 31, 2002, 2001 and 2000.
In thousands 2002/2001 2001/2000
-------------------------------------- ---------------------------------------
INCREASE Increase
(DECREASE) (Decrease)
----------------- ----------------
2002 AMOUNT % 2001 Amount % 2000
------- ------- ----- ------- ------ ----- ------
Service charges on deposit
accounts $ 2,851 $ 307 12.1% $ 2,544 $ 806 46.4% $1,738
Other service charges and fees 308 22 7.7% 286 4 1.4% 282
Fiduciary activities 1,522 30 2.0% 1,492 90 6.4% 1,402
Investment management and
benefit plan administration 2,572 582 29.2% 1,990 1,990
Net realized gains on sales of
available for sale securities 369 (1,168) (76.0%) 1,537 (10) (0.6%) 1,547
Mortgage banking 513 13 2.6% 500 191 61.8% 309
Increase in cash surrender value
of bank owned life insurance 1,243 228 22.5% 1,015 233 29.8% 821
Other 1,766 100 6.0% 1,666 411 32.7% 1,216
------- ------- ------- ------ ------
Total $11,144 $ 114 1.0% $11,030 $3,715 50.8% $7,315
======= ======= === ======= ====== ==== ======
20
PENNROCK FINANCIAL SERVICES CORP.
Total non-interest income increased $114,000 or 1.0% in 2002 and by $3.7 million
or 50.8% in 2001. Excluding net security gains, non-interest income increased
$1.3 million or 13.5% in 2002 compared with a $3.7 million or 64.6% increase in
2001.
Service charges on deposit accounts increased $307,000 in 2002 compared with an
increase of $806,000 in 2001. The increase in fees reflects not only the growth
of the number of deposit accounts but also the introduction of several new
deposit products and services during both 2001 and 2002.
Net security gains of $369,000 million in 2002 consist of a $1.6 million gain on
debt securities and a $1.3 million loss on equity securities. Net security gains
in 2001 and 2000 totaled $1.5 in both years. In 2001, the gain consisted of a
$1.3 million gain from debt securities and a $223,000 gain from equity
securities. In 2000 the gain consisted of a $695,000 gain from debt securities
and an $852,000 gain from equity securities. Securities gains and losses in all
three years were attributable to sales of PennRock's equity portfolio and to the
sale of other securities for the purpose of adding liquidity, to control
interest rate risk and reflect the Bank's active management of the available for
sale security portfolio. We continuously monitor PennRock's interest rate
sensitivity position and periodically restructure the security portfolio as
conditions warrant such as expected changes in liquidity or projected movements
in future interest rates. PennRock and the Bank both maintain and actively
manage a portfolio of equity securities.
Fiduciary fees increased $30,000 or 2.0% in 2002 and by $90,000 or 6.4% in 2001.
The market value of assets under trust management were $293 million at the end
of 2002, an increase of $14 million or 5.0 % over assets of $279 million at the
end of 2001.
Investment management and benefit plan administration income earned in 2002 and
2001 represents fees earned by National since its acquisition by PennRock on
March 19, 2001 and by PCS since its acquisition by PennRock on October 31, 2002.
National had $111 million in assets under management at the end of 2002.
In May 1999, the Bank purchased $15 million of Bank Owned Life Insurance
("BOLI"). In August 2001, the Bank purchased an additional $8 million of BOLI.
The Bank's total investment in BOLI as of December 31, 2002 was $26.5 million
and $25.2 million as of December 31, 2001. The income from BOLI represents the
increase in the cash surrender value of BOLI and is intended to partially offset
the costs of the Bank's employee benefit plans including group life, disability
and health insurance. Income from BOLI totaled $1.2 million in 2002, $1.0
million in 2001 and $821,000 in 2000.
All other non-interest income increased $135,000 or 5.5% in 2002 and by $645,000
or 35.7% in 2001.
NON-INTEREST EXPENSE
Table 6 provides a comparison for each category of non-interest expenses for the
years ending December 31, 2002, 2001 and 2000.
TABLE 6 - NON-INTEREST EXPENSE
In thousands 2002/2001 2001/2000
-------------------------------------- ---------------------------------------
INCREASE Increase
DECREASE) (Decrease)
--------------- ----------------
2002 AMOUNT % 2001 Amount % 2000
------- ------ ---- ------- ------ ----- -------
Salaries and employee benefits $16,147 $ 929 6.1% $15,218 $3,138 26.0% $12,080
Occupancy, net 1,804 234 14.9% 1,570 181 13.0% 1,389
Equipment, depreciation and
service 1,389 30 2.2% 1,359 107 8.5% 1,252
Advertising and marketing 998 43 4.5% 955 261 37.6% 694
Computer program amortization
and maintenance 1,064 (12) (1.1%) 1,076 272 33.8% 804
Other 6,045 941 18.4% 5,104 1,043 25.7% 4,061
------- ------ ------- ------ -------
Total $27,447 $2,165 8.6% $25,282 $5,002 24.7% $20,280
======= ====== === ======= ====== ==== =======
Total non-interest expense for 2002 increased $2.2 million or 8.6%. Salaries and
employee benefits increased $929,000 or 6.1% in 2002. The number of full-time
equivalent employees increased by 14, from 321 in 2001 to 335
21
PENNROCK FINANCIAL SERVICES CORP.
by year-end 2002. Of this increase, 12 full-time equivalent employees came with
the acquisition of PCS on October 31, 2002. Other non-interest expenses
increased $941,000 or 18.4% in 2002. Included in this category are legal,
consulting and other professional fees, supplies, liability insurance, fees for
outsourced services and shares tax expense.
Total non-interest expense for 2001 increased $5.0 million or 24.7%. Most of the
increase is attributable to increases in salaries and employee benefits which
grew $3.1 million or 26.0%. Total full-time equivalent employees increased from
276 at year-end 2000 to 321 at the end of 2001. The Bank opened two new
community offices in 2001 and the acquisition of National added another 24
full-time equivalent employees. Expenses related to occupancy, real estate
depreciation and building maintenance increased $181,000 or 13.0% in 2001.
Expenses relating to equipment, depreciation and service increased by $107,000.
Other non-interest expenses increased $1.0 million or 25.7% in 2001.
The ratio of average assets (in millions) per employee was $3.17 in 2000, $2.80
in 2001 and $2.94 in 2002. The average salary and benefit expense per employee
was $44,000 in 2000, $47,000 in 2001 and $48,000 in 2002. The efficiency ratio
was 55.90% in 2000, 59.28% in 2001 and 58.10% in 2002.
PROVISION FOR INCOME TAXES
Income tax expense totaled $2.6 million in 2002, $2.0 million in 2001 and $1.6
million in 2000. The statutory federal tax rate was 35% in 2002 and 34% in 2001
and 2000. PennRock's effective tax rate was 16.3% in 2002 compared to 14.5% in
2001 and 14.2% in 2000. The primary reason for the change in the effective tax
rate is due to the change in tax-exempt income and to the amount of tax credits
available from low-income housing and rehabilitation projects in which the Bank
becomes involved. For a more comprehensive analysis of income tax expense, refer
to Note 11: Income Taxes in the Notes to Consolidated Financial Statements.
PennRock accounts for income taxes under the liability method as specified by
Statement of Financial Accounting Standards No. 109 ("SFAS No. 109"),
"Accounting for Income Taxes." Under the liability method, a deferred tax asset
or liability is determined based on the enacted tax rates which will be in
effect when the differences between the financial statement carrying amounts and
tax basis of existing assets and liabilities are expected to be reported in
PennRock's income tax returns. The deferred tax provision for the year is equal
to the net change in the deferred tax asset and liability accounts from the
beginning to the end of the year. The effect on deferred taxes of a change in
tax rates is recognized in income in the period that includes the enactment
date. The principal types of accounts that result in differences between assets
and liabilities for financial statement and tax return purposes are the
allowance for loan losses, accumulated depreciation of fixed assets and the
value of securities available for sale.
22
PENNROCK FINANCIAL SERVICES CORP.
FINANCIAL CONDITION
SOURCES AND USES OF FUNDS
Table 7 examines PennRock's financial condition in terms of its sources and uses
of funds. Average funding uses increased $71.4 million or 8.6% in 2002 compared
with an increase of $16.5 million or 2.0% in 2001.
TABLE 7 - SOURCES AND USES OF FUNDS
In thousands 2002 2001 2000
---------------------------------- --------------------------------- -------
INCREASE (DECREASE) Increase (Decrease)
AVERAGE ------------------- Average ------------------- Average
BALANCE AMOUNT % Balance Amount % Balance
-------- ------- --- -------- -------- --- --------
Funding uses:
Short-term
investments $ 5,375 $(3,603) (40.1%) $ 8,978 $ 1,571 21.2% $ 7,407
Mortgages held for
sale 2,720 373 15.9% 2,347 2,073 756.6% 274
Securities available
for sale 317,785 18,757 6.3% 299,028 (22,019) (6.9%) 321,047
Loans 572,789 55,964 10.8% 516,825 34,902 7.2% 481,923
-------- ------- -------- ------- --------
Total uses $898,669 $71,491 8.6% $827,178 $16,527 2.0% $810,651
======== ======= === ======== ======= === ========
Funding sources:
Interest-bearing
demand deposits $211,869 $62,428 41.8% $149,441 $ 9,871 7.1% $139,570
Savings deposits 72,542 14,994 26.1% 57,548 2,091 3.8% 55,457
Time deposits 317,432 (39,758) (11.1%) 357,190 (11,613) (3.1%) 368,803
Short-term
borrowings 53,710 15,616 41.0% 38,094 (25,881) (40.5%) 63,975
Long-term debt 123,663 9,321 8.2% 114,342 28,050 32.5% 86,292
Non-interest bearing
funds, net 119,453 8,890 8.0% 110,563 14,009 14.5% 96,554
-------- ------- -------- ------- --------
Total sources $898,669 $71,491 8.6% $827,178 $16,527 2.0% $810,651
======== ======= === ======== ======= === ========
SECURITIES AVAILABLE FOR SALE
Table 8 indicates the composition and maturity of the securities available for
sale ("AFS") portfolio as of December 31, 2002. Included in the portfolio are
callable agencies, state and municipal securities, mortgage-backed securities
(including adjustable rate mortgage-backed securities) and CMOs that may be
called, prepaid or reprice before final maturity. For mortgage-backed
securities, maturity is based on average lives rather than contractual maturity.
The weighted average duration of the portfolio declined from 3.6 years at the
end of 2001 to 2.1 years at the end of 2002. Duration is the weighted-average
present value of future cash flows from a financial instrument. Investment
managers use it as an indication of the potential price volatility of a
financial instrument for a change in market interest rates. The higher the
duration, the more the market value of a portfolio would be expected to
fluctuate as interest rates change.
23
PENNROCK FINANCIAL SERVICES CORP.
TABLE 8 - ANALYSIS OF SECURITIES AVAILABLE FOR SALE
In thousands Taxable
Within 1-5 6-10 Over 10 Equivalent
One Year Years Years Years Equities Total Yield
-------- ----- ----- ----- -------- -------- ----------
U.S. Treasury and agency $ $ 3,993 $ $ 3,025 $ $ 7,018 5.15%
States and political subdivisions 658 16,155 16,813 7.35%
Mortgage backed securities 7,435 73,696 81,131 5.55%
Collateralized mortgage
obligations 52,824 6,046 58,870 5.73%
Corporate obligations 75,341 75,341 3.05%
Equity securities 70,458 70,758 4.20%
------- ------- ---- ------- ------- --------
Total (amortized cost) $60,259 $83,735 $658 $94,521 $70,758 $309,931 4.76%
======= ======= ==== ======= ======= ========
Total fair value $60,626 $85,046 $661 $87,237 $71,244 $304,814
Taxable equivalent yield 5.88% 5.37% 5.78% 3.58% 4.20% 4.76%
Percent of portfolio 19.44% 27.02% 0.21% 30.49% 22.83%
Average maturity 3.54 YEARS
Measured on an amortized cost basis, securities decreased $1.2 million or 0.4%
in 2002 and decreased $16.3 million or 5.2% during 2001. As of December 31,
2002, securities available for sale at fair value totaled $304.8 million
compared with $303.3 million at the end of 2001. During 2002, PennRock sold
$119.8 million and purchased $231.1 million in available for sale securities.
During 2001, PennRock sold $200.3 million in securities and purchased $269.0
million. In addition, $112.0 million in 2002 and $87.6 million in 2001 was
received from securities that matured or were called and from principal
repayments of mortgage-backed securities.
As of December 31, 2002, the AFS portfolio had a net unrealized loss of $5.1
million consisting of gross unrealized gains of $4.4 million and gross
unrealized losses of $9.5 million. Substantially all of the gross losses were
attributable to floating-rate corporate notes held in the Bank's AFS portfolio
and in equities held in PennRock's AFS portfolio. The valuation of the corporate
notes and the equities have been depressed by the decline in the financial
markets over the past two years. As of December 31, 2001, the AFS portfolio had
a net unrealized loss of $7.8 million consisting of gross unrealized gains of
$2.1 million and gross unrealized losses of $9.9 million. All declines in market
value in the two AFS portfolios have been determined to be temporary in nature.
As of December 31, 2002, PennRock had $141.7 million invested in mortgage-backed
pass-through securities and CMOs compared with $124.9 million as of December 31,
2001. A mortgage-backed pass-through security depends on an underlying pool of
mortgage loans to provide a cash flow pass-through of principal and interest.
PennRock had $82.6 million in mortgage-backed pass-through securities as of
December 31, 2002 of which $93,000 was adjustable rate and $82.5 million were
fixed rate securities. A CMO is a mortgage-backed security that is comprised of
classes of bonds created by prioritizing the cash flows from the underlying
mortgage pool in order to meet different objectives of investors. PennRock had
$59.1 million in CMO securities at the end of 2002 all of which were fixed rate.
None of the CMOs in the portfolio was considered "high risk" as defined by
banking regulations. We increased the investment in mortgage-backed securities
to provide a dependable source of principal and interest cash flow from the
monthly amortization of these securities that could be reinvested at higher
rates should market rates increase.
The decline in the duration of the portfolio indicates our continuing efforts to
structure the portfolio for a higher interest rate environment. The shorter
duration should make the market value of the portfolio less volatile and thereby
limit the expected market value depreciation in a higher rate environment.
During 2002 and 2001, there were no investments in securities of any single,
non-federal issues in excess of 10% of stockholders' equity.
24
PENNROCK FINANCIAL SERVICES CORP.
LOANS
Table 9 presents loans outstanding, by type of loan, for the five years ended
December 31, 2002.
TABLE 9 - LOANS OUTSTANDING, NET OF UNEARNED INCOME
In thousands December 31,
------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Commercial, financial and agricultural:
Commercial, secured by real estate $327,592 $276,667 $223,722 $200,633 $168,074
Agricultural 6,838 6,368 6,589 7,408 8,999
Other 83,801 77,849 80,497 62,964 58,553
Real estate - construction 32,140 46,558 22,745 26,669 17,474
Real estate - mortgage 141,983 137,929 151,709 146,500 136,969
Consumer loans 10,486 12,998 15,878 17,005 17,861
-------- -------- -------- -------- --------
Total loans $602,840 $558,369 $501,140 $461,179 $407,930
======== ======== ======== ======== ========
Loans increased in 2002 by $44.5 million or 8.0%, compared with a $57.2 million
or 11.4% increase during 2001. The fastest growing category in loan portfolio
for the past several years has been commercial real estate loans which have
nearly doubled in the past five years. In 2002, commercial real estate loans
grew $50.9 million or 18.4% and in 2001 they grew $52.9 million or 23.6%.
Consumer loans, on the other hand, have declined in each of the past five years.
PennRock originated $71.0 million and sold $66.4 million in conforming
residential mortgage loans in 2002 and originated $60.0 million and sold $57.8
million in 2001. We retained the servicing on all loans sold. The Bank's
mortgage servicing portfolio grew from $182.7 million at the end of 2001 to
$201.7 million at the end of 2002.
As of December 31, 2002, PennRock did not have any loan concentrations exceeding
10% of total loans to any particular economic group or industry. The loan
portfolio is well diversified as to industry and companies within each industry
which helps minimize risk. Loan quality is maintained through diversification of
risk, strict credit control practices and continued monitoring of the loan
portfolio. As of December 31, 2002, PennRock did not have any loans outstanding
to any foreign entity or government.
TABLE 10 - LOAN MATURITIES AND INTEREST SENSITIVITY (1)
In thousands DECEMBER 31, 2002
--------------------------------------------------
ONE YEAR ONE THROUGH OVER
OR LESS FIVE YEARS FIVE YEARS TOTAL
-------- ---------- ---------- --------
Commercial, financial and agricultural $ 18,918 $ 72,461 $326,852 $418,231
Real estate - construction 32,140 32,140
-------- -------- -------- --------
Total $ 51,058 $ 72,461 $326,852 $450,371
======== ======== ======== ========
Loans with predetermined interest rate $ 14,128 $ 43,460 $ 29,901 $ 87,489
Loans with variable interest rate 36,930 29,001 296,951 362,882
-------- -------- -------- --------
Total $ 51,058 $ 72,461 $326,852 $450,371
======== ======== ======== ========
(1) Excludes residential mortgages and consumer loans.
25
PENNROCK FINANCIAL SERVICES CORP.
NON-PERFORMING ASSETS
Table 11 shows PennRock's non-performing loans for the five years ended December
31, 2002.
TABLE 11 - NON-PERFORMING ASSETS
In thousands December 31,
----------------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Non-accrual loans $1,203 $ 692 $3,675 $1,114 $ 143
Loans accruing but 90 days past due as to
principal or interest 1,276 476 569 853 1,196
------ ------ ------ ------ ------
Total non-performing loans 2,479 1,168 4,244 1,967 1,339
Other real estate owned 188 208 188 162
------ ------ ------ ------ ------
Total non-performing assets $2,667 $1,376 $4,432 $2,129 $1,339
====== ====== ====== ====== ======
Ratios:
Non-performing loans to total loans 0.41% 0.21% 0.85% 0.43% 0.33%
Non-performing assets to total loans and
other real estate owned 0.44% 0.25% 0.88% 0.46% 0.33%
Allowance for loan losses to
non-performing loans 285.40% 621.75% 140.74% 280.33% 365.72%
A loan is generally classified as non-accrual when principal or interest has
consistently been in default for a period of 90 days or more or when full
payment of principal and interest is not expected because of deterioration in
the financial condition of the borrower. When a loan is placed on non-accrual
status, any unpaid interest is charged against income. If a loan is past due 90
days or more but still accruing, the loan is generally well secured and in the
process of being collected or is expected to be restored to current status in
the near future.
Non-performing loans decreased by $3.1 million or 72.5% from 2000 to 2001 but
increased by $1.3 million or 112.2% in 2002. Although non-performing loans
increased in 2002, the ratio of non-performing loans to total loans at 0.41% is
consistent with the Bank's historical experience and approximately half the
average ratio of non-performing loans to total loans experienced by the Bank's
peer group (consisting of 361 U.S. banks with a similar asset size) as shown in
the most recently available FDIC Uniform Bank Performance Report ("UBPR").
As of December 31, 2002, real estate acquired in foreclosure known as "other
real estate owned" ("OREO") totaled $188,000 and was included in other assets on
the Consolidated Balance Sheets. As of December 31, 2001, OREO totaled $208,000.
During 2002, sales of OREO property totaled $479,000 and $367,000 in 2001.
Valuation reserves are established for OREO properties whenever estimated
current realizable values fall below the original fair value recorded.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses (Table 12) is established and maintained at a
level that we believe is adequate to absorb estimated losses in the Bank's loan
portfolio based upon a periodic evaluation of current information of the risks
inherent in the portfolio and is monitored with continuous internal as well as
semiannual independent loan reviews. There are many elements that we evaluate to
determine the adequacy of the allowance for loan losses.
The Bank has an internal rating system that assigns grades for all loans except
residential mortgage loans, consumer loans and commercial and commercial real
estate loans under $100,000. Loans are initially assigned to one of seven risk
grades. The loan officer assigns the loan rating at the time the loan is made.
These ratings may be changed over time to reflect changes in the financial
condition of the borrowing entity. If warranted, the risk rating may be lowered
to "eight" (substandard), "nine" (doubtful) or "ten" (loss). Loans rated "ten"
are charged-off. All loans rated seven through nine, which are considered "watch
loans," are assigned either a specific allowance allocation or a general
allowance allocation percentage. The specific allowance allocation is based on
an analysis of each loan for which a specific allowance allocation is assigned.
General allowance allocation percentages assigned to watch loans are based upon
a three-year average historical loss experience for that particular risk rating.
General allowance allocation percentages are also assigned to commercial and
commercial mortgage loans not on the watch loan list, for consumer loans,
residential mortgage loans, letters of credit and loan commitments. The general
allowance
26
PENNROCK FINANCIAL SERVICES CORP.
allocation percentage assigned to categories of non-watch loans are based on the
three-year average historical loss experience for each category of loan, letter
of credit or commitment. The sum of all allowance amounts determined by this
methodology is utilized as the primary indicator of the appropriate level of the
allowance for loan losses.
We may increase the allowance for loan losses to an amount higher than that
computed above in response to factors and conditions that may not be fully
reflected in the determination of the allowance allocation percentages. These
factors and conditions may not be adequately captured in the historical loss
component and is an assessment of information delay and its impact on the
timeliness of the risk rating process. These factors and conditions include:
i. general economic and business conditions affecting our key lending
areas;
ii. credit quality trends (including trends in non-performing loans
expected to result from existing economic conditions);
iii. trends that could affect collateral values;
iv. loan volumes and concentrations;
v. seasoning of the loan portfolio;
vi. specific industry conditions affecting portfolio segments;
vii. duration of the current business cycle;
viii. bank regulatory examination results; and
ix. the results of our internal loan review process.
In addition to the internal grading system analysis, we compare the Bank's
allowance for loan losses (as a percentage of total loans) to the peer group
average percentage as shown in the most recently available UBPR.
When we assign loan ratings to individual loans, we consider the risk elements
attributable to particular loan types or categories. These risk elements may
include:
i. for non-farm and non-residential loans, multifamily residential
loans and agricultural real estate loans, the debt service coverage
ratio (income from the property in excess of operating expenses
compared to loan payment requirements);
ii. for construction and land development loans, the perceived
feasibility of the project including the ability to sell developed
lots or improvements constructed for resale or ability to lease
property constructed for lease, experience and ability of the
developer and loan-to-value ratios;
iii. for commercial and commercial real estate loans, the operating
results of the commercial, industrial or professional enterprise,
the specific risks and volatility of income and operating results
typical for similar businesses and the value, nature and
marketability of collateral;
iv. for non-real estate agricultural loans, the operating results,
experience and ability of the borrower, historical and expected
market conditions and the value, nature and marketability of the
collateral.
In addition, for each category, we consider secondary sources of income and the
financial strength of the borrower and any guarantors.
The Board of Directors reviews the allowance on a quarterly basis to determine
whether the amount of monthly provision is adequate or whether additional
provisions should be made to the allowance. The internally classified watch
list, along with the list of non-accrual and non-performing loans, helps the
Board and management assess the overall quality of the loan portfolio and the
adequacy of the allowance. Loans classified as an "eight" (substandard) are
loans with clear and defined weaknesses such as highly leveraged positions,
unfavorable financial ratios, uncertain repayment sources or poor financial
condition which may jeopardize recoverability of the loan. Loans classified as a
"nine" (doubtful) are those loans that have characteristics similar to
substandard loans, but also have an increased risk that a loss may occur or at
least a portion of the loan may require a charge-off if liquidated. Both "eight"
and "nine" rated loans categories may include loans that are past due at least
90 days, are on non-accrual status or have been restructured. As of December 31,
2002, there were no loans rated "nine" or "ten." The total allowance amount is
available to absorb losses across the Bank's entire portfolio.
27
PENNROCK FINANCIAL SERVICES CORP.
The following table shows the changes in the allowance for loan losses for the
five years ended December 31, 2002.
TABLE 12 - ALLOWANCE FOR LOAN LOSSES
In thousands Year Ended December 31,
--------------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Balance, beginning of year $ 7,262 $ 5,973 $ 5,514 $ 4,897 $ 4,247
Provision charged to expense 1,750 1,548 3,076 1,026 1,225
Loans charged off:
Commercial, financial and agricultural 2,104 393 1,258 216 396
Consumer 93 195 1,582 277 283
-------- -------- -------- -------- --------
Total loans charged off 2,197 588 2,840 493 679
-------- -------- -------- -------- --------
Recoveries:
Commercial, financial and agricultural 215 290 106 21 51
Consumer 45 39 117 63 53
-------- -------- -------- -------- --------
Total recoveries 260 329 223 84 104
-------- -------- -------- -------- --------
Net charge-offs 1,937 259 2,617 409 575
-------- -------- -------- -------- --------
Balance, end of year $ 7,075 $ 7,262 $ 5,973 $ 5,514 $ 4,897
======== ======== ======== ======== ========
Total loans
Average $576,305 $518,202 $485,999 $430,015 $395,460
Year-end 602,840 558,369 501,140 461,179 407,930
Ratios:
Net charge-offs to:
Average loans 0.34% 0.05% 0.54% 0.10% 0.15%
Total loans 0.32% 0.05% 0.52% 0.09% 0.14%
Allowance for loan losses 27.38% 3.57% 43.81% 7.42% 11.74%
Provision for loan losses 110.69% 16.73% 85.08% 39.86% 46.94%
Allowance for loan losses to:
Average loans 1.23% 1.40% 1.23% 1.28% 1.24%
Loans as of year-end 1.17% 1.30% 1.19% 1.20% 1.20%
The allowance for loan losses totaled $7.1 million as of December 31, 2002, a
decrease of 2.6% from 2001. The allowance for loan losses as a percentage of
year-end loans was 1.17% as of December 31, 2002 and 1.30% as of December 31,
2001. Net charge-offs exceeded the provision by $187,000 in 2002. However, the
provision exceeds the net charge-off average of $1.2 million over the past five
years. The provision for loan losses exceeded net charge-offs by $1.3 million in
2001 and by $459,000 in 2000. The allowance for loan losses as a percentage of
non-performing loans was 285.4% at year-end 2002, 621.8% at year-end 2001 and
140.7% at year-end 2000.
Total loans charged-off increased from $588,000 in 2001 to $2.2 million in 2002.
Loans charged-off in 2000 totaled $2.8 million. Recoveries of loans previously
charged-off increased from $223,000 in 2000 to $329,000 in 2001 and decreased to
$260,000 in 2002. The ratio of net charge-offs to average loans was 0.34% in
2002, 0.05% in 2001 and 0.54% in 2000.
Based on our analysis of the loan portfolio as well as other factors and
conditions, we believe the current allowance is adequate. However, changing
economic and other conditions may require future adjustments to the allowance
for loan losses.
28
PENNROCK FINANCIAL SERVICES CORP.
Table 13 presents the allocation of the allowance for loan losses by major loan
category for the five years ended December 31, 2002. The specific allocations in
any particular category may prove to be excessive or inadequate to absorb actual
future charge-offs so balances may be reallocated in the future to reflect
changing conditions. Accordingly, the entire allowance is considered available
to absorb losses in any category.
TABLE 13 - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
In thousands December 31,
--------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------- ------------- -------------- -------------- -------------
% OF % of % of % of % of
AMOUNT LOANS Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Commercial, financial
and agricultural $ 5,693 69.4% $6,216 64.6% $4,232 61.7% $4,181 58.7% $3,523 57.7%
Real estate -
construction 578 5.3% 8.4% 4.6% 5.8% 4.3%
Real estate - mortgage 111 23.6% 71 24.7% 185 30.5% 225 31.8% 235 33.6%
Consumer 693 1.7% 975 2.3% 484 3.2% 440 3.7% 407 4.4%
Unallocated 1,072 668 732
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total $7,075 100.0% $7,262 100.0% $5,973 100.0% $5,514 100.0% $4,897 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
The identification of impaired loans is conducted in conjunction with the review
of the adequacy of the allowance for loan losses. Loss allowances are
established for specifically identified impaired loans based on the fair value
of the underlying collateral in accordance with SFAS No. 114.
Impairment losses are included in the allowance for loan losses through a change
to the provision for loan losses. Adjustments to impairment losses resulting
from changes in the fair value of an impaired loan's collateral are included in
the provision for loan losses. Upon disposition of an impaired loan, any related
valuation allowance is removed from the allowance for loan losses.
The following table presents the status of impaired loans.
In thousands
2002 2001
------ ------
Impaired loans with a reserve $1,100 $ 308
Impaired loans with no reserve 112 397
------ ------
Total impaired loans $1,212 $ 705
====== ======
Reserve for impaired loans(1) $ 343 $ 80
Average balance of impaired loans during the year $ 959 $2,300
(1) The reserve for impaired loans is part of the overall allowance for loan
losses.
LIQUIDITY
The purpose of liquidity management is to ensure that there are sufficient cash
flows available to meet a variety of needs while minimizing the cost of funds
and maximizing yields on liquid assets. These needs 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 measured by PennRock's ability to convert assets to cash at a
reasonable cost or a minimum loss. We achieve these objectives through the
implementation of our asset/liability policy. Maturities and sales of investment
securities (Table 8), loan payments and maturities (Table 10), and liquidating
money market investments such as federal funds sold all provide liquidity. In
addition, PennRock is a member of the Federal Home Loan Bank of Pittsburgh (the
"FHLB") which provides a reliable source of long and short-term funds. As of
December 31, 2002, PennRock had unused lines of credit with the FHLB of $208
million, unused federal funds line of credit of $12 million and unpledged
securities available for sale of $247 million. However, PennRock's primary
source of
29
PENNROCK FINANCIAL SERVICES CORP.
liquidity lies in our ability to renew, replace and expand its base of core
deposits (consisting of demand, NOW, money market and cash management accounts,
savings accounts and time deposits less than $100,000.)
Total deposits increased $79.6 million or 12.0% in 2002 compared with a decrease
of $19.3 million or 2.8% in 2001. Core deposits increased $73.4 million in 2002
compared with an increase of $1.9 million in 2001. Deposits grew in every
category in 2002. Total time deposits grew the most in 2002 increasing $30.7
million or 10.6%. On a percentage basis, the fastest growing category was
non-interest bearing deposits which grew $13.1 million or 12.0%. Non-maturity
deposits (all deposits other than time deposits) grew $48.9 million or 13.1% in
2002. The average rate paid on interest bearing deposits in 2002 declined 174
percentage points from 4.26% in 2001 to 2.52%. The average rate paid in 2001
declined 65 percentage points from 2000. Table 14 reflects the changes in the
major classifications of deposits by comparing the year-end balances for the
five years ended December 31, 2002. Table 15 reflects the maturity of time
deposits of $100,000 or more for the three years ended December 31, 2002.
TABLE 14 - DEPOSITS BY MAJOR CLASSIFICATION
In thousands December 31,
----------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Non-interest bearing deposits $121,598 $108,529 $ 94,001 $ 87,524 $ 88,061
NOW accounts 44,429 40,936 37,390 38,418 39,931
Money market deposit accounts 176,967 160,590 98,130 117,603 80,048
Savings accounts 79,884 63,966 55,526 57,545 56,534
Time deposits under $100,000 278,323 253,757 340,868 283,309 248,252
-------- -------- -------- -------- --------
Total core accounts 701,201 627,778 625,915 584,399 512,826
Time deposits of $100,000 or more 42,061 35,916 57,079 47,016 37,220
-------- -------- -------- -------- --------
Total deposits $743,262 $663,694 $682,994 $631,415 $550,046
======== ======== ======== ======== ========
TABLE 15 - MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
In thousands December 31,
-----------------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Three months or less $ 8,996 $10,182 $28,208 $19,228 $12,848
Over three months through six
months 11,780 5,660 11,416 9,786 14,151
Over six months through twelve
months 11,884 14,677 13,809 9,374 8,020
Over twelve months 9,401 5,397 3,646 8,628 2,201
------- ------- ------- ------- -------
Total $42,061 $35,916 $57,079 $47,016 $37,220
======= ======= ======= ======= =======
Deposit levels may be affected by a number of factors, including rates paid by
competitors, general interest rate levels, returns available to customers on
alternative investments and general economic conditions. Loan repayments are a
relatively stable source of funds, but such loans generally are not readily
convertible to cash and are subject to risks associated with borrower's ability
to pay that may be impacted by national and local economic conditions.
Accordingly, PennRock may be required from time to time to rely on secondary
sources of liquidity to meet loan and withdrawal demands or otherwise fund
operations. Such sources include FHLB advances, federal funds lines of credit
from correspondent banks and Federal Reserve Bank borrowings.
30
PENNROCK FINANCIAL SERVICES CORP.
The Bank may borrow funds from the FHLB of Pittsburgh and from other sources.
The FHLB system acts as an additional source of funding for financial
institutions. In addition, the Bank uses federal funds lines and securities sold
under agreements to repurchase as funding sources. In order to utilize the
services of the FHLB, the Bank is required to own stock in the FHLB. The amount
of stock held by the Bank varies with the total amount of advances the Bank has
outstanding at any point in time. As of December 31, 2002, the Bank held $8.6
million in stock of the FHLB. The FHLB uses various factors to determine the
amount of credit to extend to a financial institution. These factors include:
i. total regulatory capital;
ii. net income;
iii. the quality and composition of assets;
iv. lending policies and practices;
v. the level of current borrowings from all sources; and
vi. the amount of qualifying collateral.
Securities sold under agreements to repurchase ("repurchase agreements") are
another source of borrowed funds. Under this type of borrowing, securities are
pledged against borrowed funds and are released when the funds are repaid. The
Bank uses this type of short-term borrowing alternative on an overnight basis.
The repurchase agreements with customers are part of a cash management account
arrangement the Bank maintains with certain of its larger corporate customers.
Short-term borrowings decreased from $76.8 million as of December 31, 2001 to
$40.4 million as of December 31, 2002. Of the repurchase agreements outstanding
at year-end 2002, $23.4 million were with bank customers while $12.0 million
were outstanding at the FHLB. The level of short-term borrowings depends on loan
growth, deposit growth, current market rates and other factors. The average cost
of short-term borrowings decreased from 6.08% in 2000 to 3.42% in 2001 and to
1.48% in 2002. The average balance of short-term borrowings outstanding during
the year was $64.0 million in 2000, $38.1 million in 2001 and $53.7 million on
2002. Table 16 shows PennRock's short-term borrowings for the five years ended
December 31, 2002.
TABLE 16 - SHORT-TERM BORROWINGS
In thousands December 31,
-----------------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Securities sold under agreements to
repurchase:
FHLB $12,000 $45,000 $30,000 $40,000 $
Customers 23,363 26,752 21,567 8,107 7,192
Federal funds purchased 4,330 3,600 6,550
Advances from FHLB
U.S. Treasury tax and loan note 5,000 672 2,608 1,500 38
------- ------- ------- ------- -------
Total short-term borrowings $40,363 $76,754 $54,175 $53,207 $13,780
======= ======= ======= ======= =======
LONG-TERM DEBT
In addition to short-term borrowings from the FHLB, the Bank has long-term fixed
rate advances from the FHLB. All of the long-term advances are convertible
advances that permit the FHLB to convert the advance from a fixed-rate to a
variable-rate at its discretion on a specified call date following an initial
"lock-out" period ranging from one year to five years. Some of the long-term
advances further restrict the FHLB's ability to call the advance unless 3-month
LIBOR is at or above a specified rate. If the FHLB exercises its option to
convert an advance, the Bank has the option to repay the advance in full. During
2002 and 2001, the FHLB did not exercise its option to convert any advances.
These long-term advances are part of the same line of credit with the FHLB
utilized by the Bank's short-term advances.
As of December 31, 2002, the Bank had $127.0 million of long-term fixed rate
advances with maturities ranging from 2003 to 2012. The average rate paid on
these advances during 2002 was 5.93%. The average rate on these advances at
year-end 2002 was 5.61%. As of December 31, 2001, the Bank had $121.0 million of
long-term fixed rate advances with maturities ranging from 2002 to 2011. The
average rate paid on these advances during 2002 was 6.17%. The average rate on
these advances at year-end 2001 was 5.97%.
31
PENNROCK FINANCIAL SERVICES CORP.
CAPITAL RESOURCES
On June 25, 2002, the Board of Directors of PennRock authorized the repurchase
of up to 400,000 shares of common stock. Any repurchased shares will be held as
treasury shares available for issuance in connection with future stock dividends
and stock splits, employee benefit plans, executive compensation plans, the
Dividend Reinvestment Plan and other appropriate corporate purposes. PennRock
began open market repurchases of its outstanding common stock in 1995. In 2002,
PennRock purchased 117,891 shares for $3.1 million and reissued 90,648 shares.
In 2001, PennRock purchased 34,676 shares for $588,000 and reissued 114,725
shares. PennRock purchased 109,560 shares for $1.6 million and reissued 105,280
shares in 2000. There were 108,379 shares with a cost of $2.9 million as of
December 31, 2002 and 81,136 shares with a cost of $1.6 million as of December
31, 2001 held as treasury stock.
Total stockholders' equity increased $8.6 million or 10.9% in 2002 compared with
an increase of $5.8 million or 8.0% in 2001. In 2002, stockholders' equity
increased by net income of $13.2 million less dividends of $5.4 million. The
change in net unrealized gains and losses on AFS securities increased equity by
$1.8 million. In 2001, stockholders' equity increased by net income of $12.1
million less dividends of $4.8 million. The change in net unrealized gains and
losses on AFS securities decreased equity by $2.6 million. The ratio of average
equity to average assets was 8.47% in 2002, compared with 8.51% for 2001 and
7.30% in 2000. Internal capital generation is calculated by multiplying return
on average equity by the percentage of earnings retained. Internal capital
generation amounted to 9.44% in 2002, 9.53% in 2001 and 8.41% in 2000.
Regulatory risk based capital is segregated into two components, tier 1 capital
and tier 2 capital. Tier 1 capital includes stockholders' equity reduced by
certain intangibles and excludes net unrealized holding gains and losses on AFS
securities except for net unrealized losses on marketable equity securities are
deducted from Tier 1 capital. Tier 2 capital includes the allowance for loan
losses (subject to limitations) and qualifying debt obligations. Banking
organizations must adjust their assets and off-balance sheet exposures by
assigning risk-weighted percentages, ranging for 0% to 100%, depending on
regulatory defined credit risks. Off-balance-sheet assets must be converted to
credit equivalents before being risk weighted. These risk-weighted on and
off-balance sheet balances are then added to determine total risk weighted
assets.
As of December 31, 2002, the most recent notification from the Federal Reserve
Bank categorized PennRock as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, PennRock must
maintain a minimum total risk-based capital ratio of 10%, a Tier 1 risk-based
capital ratio of 6% and a Tier 1 leverage ratio of 5%. As of December 31, 2002,
PennRock's total risk-based capital ratio was 11.57%, its Tier 1 risk-based
capital ratio was 10.61% and its Tier 1 leverage ratio was 7.92%. There are no
conditions or events since that notification that management believes have
changed this category. The Bank also exceeded all minimum ratios at the end of
2002. Table 17 shows PennRock's and the Bank's capital resources for the past
three years.
32
PENNROCK FINANCIAL SERVICES CORP.
TABLE 17 - CAPITAL RESOURCES
December 31,
-----------------------------------
2002 2001 2000
------- ------- -------
PennRock Financial Services Corp:
Leverage ratios:
Total capital to total average assets 8.64% 9.21% 8.86%
Tier 1 capital to total average assets 7.92% 8.40% 8.20%
Risk-based ratios:
Common stockholders' equity to risk
weighted assets 11.45% 11.10% 11.38%
Tier 1 capital to risk-weighted assets 10.61% 10.68% 11.52%
Total capital to risk-weighted assets 11.57% 11.71% 12.45%
Blue Ball National Bank:
Leverage ratios:
Total capital to total average assets 8.56% 8.85% 8.33%
Tier 1 capital to total average assets 7.79% 7.99% 7.66%
Risk-based ratios:
Common stockholders' equity to risk
weighted assets 10.11% 9.59% 10.62%
Tier 1 capital to risk-weighted assets 10.51% 10.13% 10.76%
Total capital to risk-weighted assets 11.55% 11.22% 11.70%
INTEREST RATE RISK
Information regarding interest rate risk may be found in Item 7A of this Annual
Report under the caption "Quantitative and Qualitative Disclosures about Market
Risk."
RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS No. 142:
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
142, "Goodwill and Other Intangible Assets." SFAS No. 142 addresses the
recognition and measurement of goodwill and other intangible assets subsequent
to acquisition. Under this standard, goodwill is no longer amortized. Instead,
it is tested for impairment at least annually. PennRock adopted the provisions
of SFAS No. 142 on January 1, 2002. The adoption of SFAS No. 142 eliminates
annual goodwill amortization of approximately $587,000 per year. We tested
goodwill for impairment as of June 30, 2002. Based on this test, we concluded
that there was no impairment. Goodwill totaled $9.8 million as of December 31,
2002 which includes reclassified goodwill of $308,000 that had previously been
classified as an unidentified intangible and excluded from the provisions of
SFAS No. 142. With the adoption of SFAS No. 147 (see the discussion on the
adoption of SFAS No. 147 under this section), this unidentified intangible was
reclassified and will be accounted for and reported prospectively as goodwill
under SFAS No. 142. Goodwill totaled $7.8 million as of December 2001.
33
PENNROCK FINANCIAL SERVICES CORP.
The following table provides pro-forma information on net income and earnings
per share had amortization of goodwill not been expensed in the two years ended
December 31, 2002 and 2001:
For the Years Ended
In thousands December 31,
---------------------
2002 2001
-------- -------
Reported net income $ 13,226 $12,067
Add back goodwill amortization 358
-------- -------
Pro-forma net income $ 13,226 $12,425
======== =======
Basic earnings per share:
Net income as reported $ 1.90 $ 1.74
Goodwill amortization 0.06
-------- -------
Pro-forma basic earning per share $ 1.90 $ 1.80
======== =======
Diluted earnings per share:
Net income as reported $ 1.88 $ 1.73
Goodwill amortization 0.05
-------- -------
Pro-forma basic earning per share $ 1.88 $ 1.78
======== =======
There was no goodwill amortized in 2000.
SFAS No. 144:
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets" which supercedes SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the
accounting and reporting provisions of APB No. 30, "Reporting the Results of
Operation - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business. While SFAS No. 144 retains many of the
fundamental provisions of SFAS No. 121, it establishes a single accounting model
for long-lived assets to be disposed of by sale, and resolves certain
implementation issues not previously addressed by SFAS No. 121. Statement 144 is
effective for fiscal years beginning after December 15, 2001. This Statement is
not expected to have a material impact on the PennRock's consolidated financial
statements.
SFAS No. 145:
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of
April 2002." Under SFAS No. 4, all gains and losses from extinguishment of debt
were required to be aggregated and, if material, classified as an extraordinary
item, net of related income tax effect. This was an exception to Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions," ("APB No. 30")
which defines extraordinary items as events and transactions that are
distinguished by their unusual nature and by the infrequency of their
occurrence.
SFAS No. 145 eliminates Statement No. 4 and by doing so eliminates the exception
to applying APB No. 30 to all gains and losses related to extinguishments of
debt (other than extinguishment of debt to satisfy sinking-fund requirements).
As a result, gains and losses from extinguishment of debt should be classified
as extraordinary items only if they meet the criteria in APB No. 30. Applying
APB No. 30 will distinguish transactions that are part of an entity's recurring
operations from those that are unusual or infrequent in nature or that meet the
criteria for classification as an extraordinary item. The provisions of SFAS No.
145 related to the rescission of Statement No. 4 are to be applied in fiscal
years beginning after May 15, 2002. On January 1, 2003, PennRock adopted the
provisions of SFAS No. 145 which will result in a reclassification of any
extraordinary item related to early extinguishment of debt, to non-interest
income in the consolidated statement of operations.
34
PENNROCK FINANCIAL SERVICES CORP.
FASB Interpretation No. 45:
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", an interpretation of FASB Statements No.
5, 57, and 107 and rescission of FASB Interpretation No. 34. This interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. It also clarifies that a guarantor is required to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. This interpretation does not prescribe a
specific approach for subsequently measuring the guarantor's recognized
liability over the term of the related guarantee. This interpretation also
incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others," which is being
superseded.
The initial recognition and initial measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. Due to the prospective application of this
interpretation, the impact on PennRock's financial statements has not been
determined.
SFAS No. 147:
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." SFAS No. 147 clarifies that a branch acquisition that
meets the definition of a "business" is to be accounted for as a business
combination. If the acquisition is a business combination then the purchase
accounting provisions of SFAS No. 141 "Business Combinations" apply. Prior to
SFAS No. 147, the intangibles arising from a branch acquisition were accounted
for in accordance with SFAS No. 72, "Accounting for Certain Acquisitions of Bank
and Thrift Institutions." Certain of these intangibles may have been identified
as core deposit intangibles ("CDIs"). CDIs are amortized over the estimated
average life of the deposit base acquired. CDIs will continue to be subject to
the provisions of SFAS No.72 and will continue to be amortized. Other
intangibles may not have been identified or may be in excess of the established
CDI. These intangibles were designated unidentified intangibles. If the branch
acquisition was considered a business combination, the unamortized balance of
these unidentified intangibles are to be reclassified as goodwill and accounted
for and reported prospectively under the provisions of SFAS No. 142. Under SFAS
No. 142, this "reclassified goodwill" will be evaluated for impairment but will
no longer be amortized. PennRock adopted the provisions of SFAS No. 147 during
the fourth quarter of 2002.
Subsequent to the adoption of SFAS No. 147, $308,000 of an unidentified
intangible from a prior branch acquisition was reclassified as goodwill in
accordance with SFAS No. 147. In addition, $75,000 of amortization of the
reclassified intangible previously expensed for the first three quarters of 2002
was reversed and taken back into income.
SFAS No. 148:
In December 2002, the FASB issued 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.
35
PENNROCK FINANCIAL SERVICES CORP.
Under SFAS No. 148, an entity electing to convert from the intrinsic value
method of APB Opinion 25, "Accounting for Stock Issued to Employees" can choose
among three approaches:
i. Full prospective approach - SFAS No. 123 is applied to employee
awards granted, modified or settled after the beginning of the year
in which SFAS No. 123 is first adopted. The prospective method was
the only method originally permitted by SFAS No. 123.
ii. The modified prospective approach - Stock based employee
compensation cost is recognized from the beginning of the fiscal
year in which SFAS No. 123 is first applied as if the fair value
method had been employed to account for awards granted, modified or
settled in fiscal years beginning after December 15, 1994.
iii. The retroactive restatement method - All periods presented are
restated to reflect the fair value method for employee awards
granted, modified or settled in fiscal years beginning after
December 15, 1994. Restatement of periods before those that are
presented is allowed but not required.
SFAS No. 148 requires the following disclosures to be presented in the "Summary
of Significant Accounting Policies" in the Notes to Consolidated Financial
Statements:
i. The method used to account for stock-based employee compensation
(the intrinsic value method or the fair value method);
ii. When an entity switches from the fair value method, a description of
the approach for reporting the change;
iii. If unvested awards were outstanding and accounted for under the
intrinsic value method for any period in which an income statement
is presented, the following information must be disclosed in tabular
form:
a. Net income, basic and diluted earnings per share as reported;
b. The amount of stock-based employee compensation cost, net of
tax effect, as reported;
c. The amount of stock-based employee compensation cost, net of
tax effect, that would have been included in the determination
of net income if the fair value method had been applied to all
awards granted, modified or settled in fiscal years beginning
after December 15, 1994;
d. Pro-forma net income and basic and diluted earnings per share
as if the fair value method had been applied to all awards
granted, modified or settled in fiscal years beginning after
December 15, 1994.
iv. For entities electing the retroactive restatement approach, both the
amounts of the transition adjustment and of the effects of
restatement should be disclosed in the year in which SFAS No. 123 is
first adopted.
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. For further discussion on stock options and stock-based employee
compensation, see Note 1: Summary of Significant Accounting Policies and Note
13: Stock Option Plan in the Notes to Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PennRock's financial performance is impacted by, among other factors, interest
rate risk and credit risk. We manage credit risk by relying on strict credit
standards, loan review and adequate loan loss reserves. Interest rate risk
refers to PennRock's degree of exposure to loss of earnings resulting from
changes in market interest rates. As a financial intermediary, PennRock invests
in various types of interest-earning assets (primarily loans and securities)
that are funded largely by interest-bearing liabilities (primarily deposits and
FHLB advances). Such financial instruments have varying levels of sensitivity to
changes in market interest rates. The disparity of sensitivity between financial
assets and liabilities creates interest rate risk for PennRock. The magnitude of
this exposure depends on the severity and timing of the market rate changes and
on our ability to adjust the composition of the balance sheet in reaction to
those changes. PennRock's Asset Liability Management Committee ("the ALCO")
addresses this risk. The Bank's senior management team comprises the ALCO. The
ALCO monitors interest rate risk by modeling the estimated net interest income
and net income under various interest rate scenarios. The ALCO attempts to
manage the various components of PennRock's balance sheet to minimize the impact
of sudden and sustained changes in interest rates on net interest income and net
income. However, the ALCO may sometimes structure the balance sheet to take
advantage of expected interest rate movements.
36
PENNROCK FINANCIAL SERVICES CORP.
PennRock's exposure to interest rate risk is reviewed on a monthly basis by the
Board of Directors and the ALCO. Interest rate risk exposure is measured using
interest rate sensitivity analysis to determine PennRock's change in net
interest income and net income in the event of hypothetical changes in interest
rates. If the potential changes to net interest income and net income resulting
from hypothetical interest rate swings are not within the exposure limits
established by the Board, the Board may direct management to adjust its asset
and liability mix to bring interest rate risk within Board-approved limits.
PennRock's net interest income, the most significant component of its net
income, is impacted by changes in market interest rates and yield curves,
particularly if there are differences, or gaps, in the repricing frequencies of
its interest-earning assets and the interest-bearing liabilities which fund
them. The ALCO monitors such interest rate gaps and seeks to manage interest
rate risk by adjusting the repricing frequencies of its interest-earning assets
and interest-bearing liabilities. If more assets than liabilities mature or
reprice within a given time frame, PennRock is asset sensitive. If more
liabilities mature or reprice during the time frame, PennRock is liability
sensitive. An asset sensitive gap will generally benefit PennRock in a period of
rising rates while a liability sensitive gap will generally benefit PennRock
during declining rates. Gap analysis has certain limitations. For example,
although certain assets and liabilities may have similar maturities or periods
to repricing, they may react in different degrees to changes in market interest
rates. Some types of financial instruments are very sensitive to changes in
market rates while others may lag behind such changes. Certain assets such as
adjustable-rate loans have limits on the amount of change in interest rates
allowed in the short-term (periodic caps) and over the life of the loan
(lifetime caps). Further, changes in interest rates may change the
characteristics of certain financial instruments and cause them to react
differently than expected due to imbedded options. For example, a decrease in
market rates could trigger the option that allows mortgage customers to
refinance their mortgages while an increase in market rates may induce customers
to exercise their option to redeem their certificates of deposit prior to
maturity. These and other changes would likely cause actual results to deviate
significantly from the assumptions used in calculating changes in net interest
income or net income. While ALCO continuously monitors and adjusts the gap
position to maximize profitability, the primary objective is to maintain net
interest income and net income within self-imposed parameters for a wide range
of possible changes in interest rates. The following table presents an interest
sensitivity analysis of PennRock's assets and liabilities as of December 31,
2002. All interest rates are on a tax equivalent basis.
37
PENNROCK FINANCIAL SERVICES CORP.
TABLE 18 - INTEREST SENSITIVITY ANALYSIS
In thousands DECEMBER 31, 2002
-----------------------------------------------------------------------------
INTEREST SENSITIVITY PERIOD
-----------------------------------------------------------------------------
MORE
THAN 3 MORE THAN MORE THAN
LESS THAN MONTHS TO 6 MONTHS 1 YEAR TO MORE THAN
3 MONTHS 6 MONTHS TO 1 YEAR 5 YEARS 5 YEARS TOTAL
-------- --------- -------- --------- ---------- ----------
Earning assets:
Short-term investments $ 9,226 $ $ $ $ $ 9,226
Weighted average interest rate 1.02% 1.02%
Mortgages held for sale 7,147 7,147
Weighted average interest rate 5.70% 5.70%
Securities available for sale 154,807 38,091 47,608 33,512 35,913 309,931
Weighted average interest rate 4.35% 6.22% 6.05% 6.26% 4.33% 5.04%
Loans 241,156 35,739 69,549 232,682 23,714 602,840
Weighted average interest rate 5.58% 7.03% 7.28% 7.54% 6.52% 6.65%
-------- ------- -------- -------- ------- --------
Total interest earning assets $412,336 $73,830 $117,157 $266,194 $59,627 $929,144
======== ======= ======== ======== ======= ========
Interest bearing liabilities:
Interest bearing demand
deposits (1) $177,522 $ 555 $ 1,111 $ 8,886 $33,322 $221,396
Weighted average interest rate 1.56% 0.25% 0.25% 0.25% 0.25% 1.30%
Savings deposits (2) 999 999 1,997 15,977 59,913 79,884
Weighted average interest rate 1.00% 1.00% 1.00% 1.00% 1.00% 1.00%
Time deposits 69,929 87,774 81,487 81,006 188 320,384
Weighted average interest rate 2.47% 2.60% 2.81% 3.06% 3.75% 2.74%
Short-term borrowings 40,363 40,363
Weighted average interest rate 1.08% 1.08%
Long-term debt 25,000 102,000 127,000
Weighted average interest rate 7.11% 5.24% 5.61%
-------- ------- -------- -------- ------- --------
Total interest bearing
liabilities $288,813 $114,328 $84,595 $207,869 $93,423 $789,027
======== ======== ======= ======== ======= ========
Interest sensitivity gap:
Period $123,523 ($40,498) $ 32,562 $ 58,325 ($33,796)
Cumulative 123,523 83,025 115,587 173,913 140,117
Interest sensitive assets to
interest
sensitive liabilities ratio:
Period 142.77% 64.58% 138.49% 128.06% 63.83%
Cumulative 142.77% 120.59% 123.70% 125.00% 117.76%
(1) Assumes NOW account balances are withdrawn at 5% per year.
(2) Assumes savings balances are withdrawn at 5% per year.
This analysis indicates that PennRock is asset sensitive over all time frames.
This means that PennRock's balance sheet should be well positioned for rising
interest rates. If, however, ALCO is concerned that rates may fall within the
next year and that a drop in market rates would reduce net interest income and
net income, it can take action to reduce the asset sensitivity of the balance
sheet such as by purchasing fixed rate securities and funding such purchases
with short-term borrowings.
38
PENNROCK FINANCIAL SERVICES CORP.
While the preceding table helps provide some information about PennRock's
interest sensitivity within one year, it is not reliable in predicting the
trends of future earnings in the longer term. For this reason, we use financial
modeling to forecast earnings under different interest rate projections.
PennRock's Board of Directors has adopted an interest rate risk policy which
establishes a maximum decrease in the net interest income and net income in the
event of a sudden and sustained increase or decrease in market interest rates of
200 percentage points. The following tables present the Bank's projected change
in net interest income and net income for 100 and 200 percentage point rate
shocks as of December 31, 2002 and the Board's established limit. The impact on
net interest income and net income relate to the Bank only. The assets and
liabilities of the parent company only or for National and PCS are not
considered in this analysis and their corresponding earnings at risk do not have
a significant effect on this analysis.
TABLE 19 - CHANGES IN NET INTEREST INCOME
In thousands
Net Interest Percent Board
Change in Interest Rates Income Computed Change Change Limit
- ----------------------------- ------------ --------------- ------- --------
200 PERCENTAGE POINT RISE $37,926 $4,080 12.05% (15.00%)
100 PERCENTAGE POINT RISE 36,609 2,762 8.16%
BASE RATE SCENARIO 33,846
100 PERCENTAGE POINT DECLINE 32,082 (1,764) (5.21%)
200 PERCENTAGE POINT DECLINE 30,963 (2,884) (8.52%) (15.00%)
TABLE 20 - CHANGES IN NET INCOME
In thousands
Net Interest Percent Board
Change in Interest Rates Income Computed Change Change Limit
- ----------------------------- ------------ --------------- ------- --------
200 PERCENTAGE POINT RISE $15,256 $2,846 22.93% (20.00%)
100 PERCENTAGE POINT RISE 14,312 1,902 15.33%
BASE RATE SCENARIO 12,410
100 PERCENTAGE POINT DECLINE 11,163 (1,247) (10.05%)
200 PERCENTAGE POINT DECLINE 10,382 (2,028) (16.34%) (20.00%)
The preceding tables indicate that as of December 31, 2002, in the event of a
sudden and sustained decrease in prevailing market interest rates, both
PennRock's net interest income and net income would be expected to decrease $2.9
million and $2.0 million respectively. However, if market rates increased by 200
percentage points, net interest income and net income would be expected to
increase. This simulation analysis agrees with Table 18 gap analysis that
indicates that PennRock is asset sensitive. PennRock's interest income and net
income increase if rates rise and decline if rates fall. At December 31, 2002,
PennRock's estimated changes in net interest income and net income are within
policy limits.
Computation of forecasted effects of hypothetical interest rate changes are
based on numerous assumptions. These include loan and mortgage-backed security
prepayment rates, calls of callable securities, conversions of fixed-rate FHLB
advances to adjustable advances, and rates of deposit decay, and should not be
relied upon as indicative of actual future results. Even minor changes in these
assumptions may significantly alter the results of the model. Further, the
computations do not contemplate any actions the ALCO could take to mitigate any
negative effects of changes in interest rates as discussed above.
39
PENNROCK FINANCIAL SERVICES CORP.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements are set forth in this
Annual Report of Form 10-K on the following pages:
PennRock Financial Services Corp. and Subsidiaries
Independent Auditors' Report............................... 40
Consolidated Balance Sheets................................ 41
Consolidated Statements of Income.......................... 42
Consolidated Statements of Stockholders' Equity............ 43
Consolidated Statements of Cash Flows...................... 44
Notes to Consolidated Financial Statements................. 45
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders of PennRock Financial Services Corp.
We have audited the accompanying consolidated balance sheets of PennRock
Financial Services Corp. and Subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of income, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2002.
These consolidated financial statements are the responsibility of PennRock's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
PennRock Financial Services Corp. and Subsidiaries as of December 31, 2002 and
2001, and the consolidated results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 2002 in conformity
with accounting principles generally accepted in the United States of America.
/s/ SIMON LEVER & COMPANY
January 29, 2003
Lancaster, Pennsylvania
40
PENNROCK FINANCIAL SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
In thousands, except share and per share data
December 31,
-----------------------------
ASSETS 2002 2001
----------- -----------
Cash and due from banks $ 23,092 $ 23,242
Short-term investments 9,226 4,787
Mortgages held for sale 7,147 2,420
Securities available for sale (at fair value) 304,814 303,334
Loans 602,840 558,369
Allowance for loan losses (7,075) (7,262)
----------- -----------
Net loans 595,765 551,107
Premises and equipment 16,256 14,428
Accrued interest receivable 3,282 3,890
Bank owned life insurance 26,491 25,248
Other assets 22,516 20,482
----------- -----------
Total assets $ 1,008,589 $ 948,938
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest bearing $ 121,598 $ 108,529
Interest bearing 621,664 555,165
----------- -----------
Total deposits 743,262 663,694
Short-term borrowings 40,363 76,754
Long-term debt 127,000 121,000
Accrued interest payable 2,465 2,960
Other liabilities 8,521 6,126
----------- -----------
Total liabilities 921,611 870,534
Stockholders' Equity:
Common stock, par value $2.50 per share; authorized -
20,000,000 shares; issued - 7,017,716 shares 17,544 15,952
Surplus 33,745 16,446
Accumulated other comprehensive loss, net of tax (3,377) (5,165)
Retained earnings 41,926 52,780
Treasury stock at cost (108,379 and 81,136 shares) (2,860) (1,609)
----------- -----------
Total stockholders' equity 86,978 78,404
----------- -----------
Total liabilities and stockholders' equity $ 1,008,589 $ 948,938
=========== ===========
See notes to consolidated financial statements.
41
PENNROCK FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME
In thousands, except share and per share data
Year Ended December 31,
------------------------------------------
2002 2001 2000
---------- ---------- ----------
Interest income:
Interest and fees on loans $ 42,733 $ 43,787 $ 41,959
Securities available for sale:
Taxable 12,159 13,995 15,820
Tax-exempt 1,902 3,906 5,949
Mortgages held for sale 248 212 27
Other 100 374 479
---------- ---------- ----------
Total interest income 57,142 62,274 64,234
---------- ---------- ----------
Interest expense:
Deposits 15,157 24,012 27,681
Short-term borrowings 796 1,304 3,891
Long-term debt 7,330 7,050 5,501
---------- ---------- ----------
Total interest expense 23,283 32,366 37,073
---------- ---------- ----------
Net interest income 33,859 29,908 27,161
Provision for loan losses 1,750 1,548 3,076
---------- ---------- ----------
Net interest income after provision for loan losses 32,109 28,360 24,085
---------- ---------- ----------
Non-interest income:
Service charges on deposit accounts 2,851 2,544 1,738
Other service charges and fees 308 286 282
Fiduciary activities 1,522 1,492 1,402
Investment management and benefit plan administration 2,572 1,990
Net realized gains on sales of available for sale securities 369 1,537 1,547
Mortgage banking 513 500 309
Increase in cash surrender value of bank owned life
insurance 1,243 1,015 821
Other 1,766 1,666 1,216
---------- ---------- ----------
Total non-interest income 11,144 11,030 7,315
---------- ---------- ----------
Non-interest expenses:
Salaries and benefits 16,147 15,218 12,080
Occupancy, net 1,804 1,570 1,389
Equipment depreciation and service 1,389 1,359 1,252
Advertising and marketing 998 955 694
Computer program amortization and maintenance 1,064 1,076 804
Other 6,045 5,104 4,061
---------- ---------- ----------
Total non-interest expense 27,447 25,282 20,280
---------- ---------- ----------
Income before income taxes 15,806 14,108 11,120
Income taxes 2,580 2,041 1,574
---------- ---------- ----------
Net income $ 13,226 $ 12,067 $ 9,546
========== ========== ==========
Per share information:
Basic earnings $ 1.90 $ 1.74 $ 1.38
Diluted earnings 1.88 1.73 1.38
Cash dividends 0.76 0.69 0.60
Weighted average number of shares outstanding:
Basic 6,946,836 6,915,403 6,893,306
Diluted 7,025,462 6,966,241 6,913,515
See notes to consolidated financial statements.
42
PENNROCK FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
In thousands, except per share data Accumulated
Other
Comprehensive
Common Retained Treasury Income (Loss)
Stock Surplus Earnings Stock Net of Tax Total
------- ------- -------- -------- -------------- -------
Balance as of January 1, 2000 $15,194 $11,114 $46,609 $(3,068) $(10,616) $59,233
Comprehensive income:
Net income 9,546 9,546
Change in net unrealized gains and
losses on securities available for
sale, net of reclassification
adjustment and tax effects 8,039 8,039
-------
Total comprehensive income 17,585
Purchase of treasury stock (1,584) (1,584)
Sale of treasury stock under
dividend reinvestment plan (318) 1,825 1,507
Treasury stock issued as compensation (7) 32 25
Cash dividend ($0.60 per share) (4,168) (4,168)
------- ------- ------- ------- ------- -------
Balance as of December 31, 2000 15,194 11,114 51,662 (2,795) (2,577) 72,598
Comprehensive income:
Net income 12,067 12,067
Change in net unrealized gains and
losses on securities available for
sale, net of reclassification
adjustment and tax effects (2,588) (2,588)
-------
Total comprehensive income 9,479
Purchase of treasury stock (588) (588)
Sale of treasury stock under
dividend reinvestment plan 28 (78) 1,751 1,701
Treasury stock issued as compensation 1 (3) 23 21
5% stock dividend and cash paid in
lieu of fractional shares 758 5,303 (6,077) (16)
Cash dividend ($0.69 per share) (4,791) (4,791)
------- ------- ------- ------- ------- -------
Balance as of December 31, 2001 15,952 16,446 52,780 (1,609) (5,165) 78,404
Comprehensive income:
Net income 13,226 13,226
Change in net unrealized gains and
losses on securities available for
sale, net of reclassification
adjustment and tax effects 1,788 1,788
-------
Total comprehensive income 15,014
Purchase of treasury stock (3,139) (3,139)
Sale of treasury stock under
dividend reinvestment plan (28) 342 1,527 1,841
Treasury stock issued as compensation (1) 5 53 57
Stock options exercised (122) 308 186
10% stock dividend and cash paid in
lieu of fractional shares 1,592 17,328 (18,950) (30)
Cash dividend ($0.76 per share) (5,355) (5,355)
------- ------- ------- ------- ------- -------
Balance as of December 31, 2002 $17,544 $33,745 $41,926 $(2,860) ($3,377) $86,978
======= ======= ======= ======= ======= =======
See notes to consolidated financial statements.
43
PENNROCK FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
Year Ended December 31,
-----------------------------------------
2002 2001 2000
--------- --------- ---------
OPERATING ACTIVITIES:
Net income $ 13,226 $ 12,067 $ 9,546
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 1,750 1,548 3,076
Depreciation and amortization 1,331 1,462 1,310
Amortization of goodwill 258
Accretion and amortization of securities 1,708 (958) (998)
Deferred income taxes (290) (323) (125)
Net realized gains on sale of available for sale securities (369) (1,537) (1,547)
Proceeds from sales of mortgage loans 66,382 57,794 23,443
Originations of mortgages held for sale (71,019) (59,994) (23,448)
(Gain) loss on sale of mortgage loans, net (90) 15 65
(Increase) decrease in interest receivable 608 2,415 (427)
Increase (decrease) in interest payable (495) (1,807) 1,169
Increase in cash surrender value of bank owned life insurance (1,243) (1,015) (821)
Other changes, net (1,741) (2,544) 678
--------- --------- ---------
Net cash provided by operations 9,758 7,381 11,921
--------- --------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale 119,799 200,277 90,373
Purchases of securities available for sale (231,116) (269,044) (100,886)
Maturities of securities available for sale 111,994 87,563 11,144
Proceeds from sale of other real estate 479 367 266
Purchase of bank owned life insurance (8,000)
Net increase in loans (44,471) (57,229) (42,578)
Net cash paid for business acquisition (1,665) (7,677)
Purchases of premises and equipment (3,226) (2,274) (1,369)
--------- --------- ---------
Net cash used in investing activities (48,206) (56,017) (43,050)
--------- --------- ---------
FINANCING ACTIVITIES:
Net increase in non-interest bearing deposits 13,068 14,528 6,477
Net increase (decrease) in interest bearing deposits 66,499 (33,828) 45,102
Net increase (decrease) in short-term borrowings (36,391) 22,579 968
Net increase in long-term debt 6,000 30,000 1,000
Issuance of treasury stock 2,085 1,722 1,532
Purchase of treasury stock (3,139) (588) (1,584)
Cash dividends (5,355) (4,791) (4,168)
Cash paid with stock dividend (30) (16)
--------- --------- ---------
Net cash provided by financing activities 42,737 29,606 49,327
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 4,289 (19,030) 18,198
Cash and cash equivalents at beginning of year 28,029 47,059 28,861
--------- --------- ---------
Cash and cash equivalents at end of year $ 32,318 $ 28,029 $ 47,059
========= ========= =========
Supplemental schedule of interest and income taxes paid:
Total interest paid $ 23,778 $ 30,558 $ 33,367
Total income taxes paid 3,189 1,750 2,654
See notes to consolidated financial statements.
44
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of PennRock Financial Services Corp.
("PennRock") and subsidiaries conform to accounting principles generally
accepted in the United States of America and to general practices within the
banking industry. The following is a description of PennRock's more significant
accounting policies.
BUSINESS:
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, began operations in the first quarter of
1999 to offer and sell annuity and other insurance products. National,
established in 1984, is the parent company of 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) that consists of two portfolios: The Dresher Comprehensive
Growth Fund and The Dresher Classic Retirement Fund.
BASIS OF PRESENTATION:
The consolidated financial statements of PennRock include the accounts of
PennRock and its subsidiaries. All significant intercompany balances and
transactions have been eliminated. Certain prior year amounts have been
reclassified to conform to current year presentation. All share and per-share
data have been restated to reflect the impact of a 10% stock dividend paid on
August 13, 2002 and a 5% stock dividend paid on August 10, 2001.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the consolidated balance sheets and operations for the reporting periods. One
material estimate that is particularly susceptible to significant change in the
near-term relates to the determination of the allowance for loan losses. Actual
results could differ significantly from those estimates.
CASH AND CASH EQUIVALENTS:
For purposes of the Consolidated Statements of Cash Flows, PennRock defines cash
and cash equivalents to include cash, amounts due from banks, federal funds sold
and other short-term investments. Generally, federal funds are purchased and
sold for one-day periods.
MORTGAGES HELD FOR SALE:
Mortgages held for sale are carried at the lower of aggregate cost or market
value with market determined on the basis of open commitments for committed
loans. For uncommitted loans, market is determined on the basis of current
delivery prices in the secondary mortgage market. Any resulting unrealized
losses are included in other income.
SECURITIES AVAILABLE FOR SALE:
Debt securities are classified as available for sale if management intends to
hold these securities for an indefinite period of time but not necessarily to
maturity. All equity securities must be classified as available for sale. All
securities purchased by PennRock or the Bank are classified as available for
sale ("AFS"). Any decision to sell a security classified as available for sale
would be based on various factors, including significant movements in interest
rates, changes in the maturity mix of PennRock's assets and liabilities,
liquidity needs, regulatory capital considerations, and other similar factors.
AFS securities are carried at fair value.
Unrealized gains or losses, net of the related deferred tax effect, are reported
as other comprehensive income (loss) in stockholders' equity.
A decline in the market value of any debt or equity security below cost that is
deemed to be other than temporary is charged to income resulting in the
establishment of a new cost basis for the security.
45
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Purchase premiums and discounts on securities are amortized and accreted to
interest income using a method which approximates a level yield over the period
to maturity of the related securities. Purchase premiums and discounts on
mortgage-backed securities are amortized and accreted to interest income using a
method which approximates a level yield over the remaining lives of the
securities, taking into consideration assumed prepayment patterns. Interest and
dividend income are recognized when earned. Realized gains and losses for
securities are included in other income and are derived using the specific
identification method for determining the costs of securities sold.
LOANS:
Loans are carried at the principal amount outstanding, net of unearned income,
if any, and are reduced by any charge-offs or specific valuation accounts.
Interest income is accounted for on an accrual basis. Loan fees, net of certain
origination costs are deferred and amortized over the lives of the underlying
loans using a method, which approximates a level yield. Interest income is
generally not accrued when, in the opinion of management, its full
collectibility is doubtful or when the loan becomes past due 90 days as to
principal or interest. When a loan is designated as non-accrual, any accrued
interest receivable is charged against current earnings. Loans may be returned
to accrual status when they become current as to principal and interest or
demonstrate a period of performance under the contractual terms, and, in
management's opinion, are fully collectible.
A loan is considered to be impaired when it is probable that all amounts,
including principal and interest, will not be collected in accordance with the
contractual terms of the loan agreement. In such cases, the amount of impairment
and any subsequent changes are recorded as an adjustment to the allowance for
loan losses. This analysis applies to all loans, both collateralized and
uncollateralized, except for large groups of smaller balance homogeneous loans
that are collectively evaluated for impairment, loans held for sale and debt
securities. PennRock evaluates a loan for impairment when the loan is internally
classified as an "8" (substandard) or "9" (doubtful). All non-accrual loans not
meeting the definition of smaller balance homogeneous loans are considered
impaired. PennRock generally measures impairment based upon the present value of
the loan's expected future cash flows, except where foreclosure or liquidation
is probable or when the primary source of repayment is provided by real estate
collateral. In these circumstances, impairment is based upon the fair value of
the collateral. Impairment with regard to substantially all of PennRock's
impaired loans has been measured by the fair value of the underlying collateral.
ALLOWANCE FOR LOAN LOSSES:
PennRock's allowance for loan losses is established and maintained based upon
management's evaluation of the risks inherent in PennRock's loan portfolio
including the economic trends and other conditions in specific geographic areas
as they relate to the nature of PennRock's portfolio. PennRock's one-to four
family residential loans and consumer loans are homogeneous in nature and no
single loan is individually significant in terms of its size or potential risk
of loss. Therefore, management evaluates these loans as a group of loans.
Management utilizes historical loan losses, current trends in delinquencies and
charge-offs, plans for problem loan administration and resolution, the views of
its regulators, and other relevant factors, such as assumptions and projections
of current economic and market conditions in order to determine the adequacy of
the allowance for loan losses on these loans. For individually impaired
commercial real estate loans, an estimated value of the property or collateral
securing the loan is determined through an appraisal, where possible. If the
unpaid balance of the loan is greater than the estimated fair value of the
property, a reserve is established for the difference between the carrying value
and the estimated fair value or liquidation value. Other impaired loans such as
non-mortgage commercial loans are evaluated individually as well. For these
loans, a determination is made of the value of the collateral, if any, through
examination of current financial information. If the unpaid balance of the loan
is greater than estimated fair value of the property, a reserve is established
for the difference between the carrying value and the estimated fair value or
liquidation value.
Allowances are also established on some classes of the performing portfolio and
represent loss allowances that have been established to recognize the probable
losses inherent in that class of the loan portfolio. In determining the adequacy
of the loss allowance, management considers changes in the size and composition
of the loan portfolio, historical loan loss experience, current economic and
market conditions and PennRock's credit administration procedures.
46
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Management believes that the allowance for loan losses is adequate. While
management uses historical and currently available information to evaluate the
adequacy of the allowance, this evaluation is inherently subjective as it
requires material estimates, including the amounts and timing of expected future
cash flows on impaired loans, which may be susceptible to significant change.
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 allowance for loan losses.
Such agencies may require changes to the allowance based on their judgments
about information available to them at the time of their examination.
Loan losses are charged directly against the allowance for loan losses, and
recoveries on previously charged off loans are added to the allowance.
Provisions for loan losses charged against income increase the allowance.
OTHER REAL ESTATE OWNED:
Other real estate owned represents properties acquired through customers' loan
defaults. When properties are acquired through foreclosure or deed in lieu of
foreclosure, any excess of the loan balance at the time of foreclosure over the
fair value of the real estate held as collateral is recognized as a loss and
charged to the allowance for loan losses. After foreclosure, other real estate
is reported at the lower of fair value at acquisition date or current fair value
less estimated disposal costs. Fair value is determined on the basis of current
appraisals obtained from independent sources. Subsequent write-downs are charged
to an allowance for other real estate established through provisions for other
real estate expenses. Costs of significant property improvements which enhance
the salability of the property are capitalized while costs associated with
holding or maintaining other real estate are charged to operations as incurred.
Other real estate owned is recorded as other assets in the Consolidated Balance
Sheets.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed on straight line and accelerated methods based on the
estimated service lives of the assets. When assets are retired or otherwise
disposed of, the cost and related accumulated depreciation are removed from the
accounts and any resulting gain or loss is reflected in income for the period.
Maintenance, repairs, and minor improvements are expensed as incurred.
Significant renewals and improvements are capitalized.
GOODWILL:
Goodwill represents the excess of cost over the assigned value of net assets
acquired in a business combination. In July 2001, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 142
("SFAS No. 142"), "Goodwill and Other Intangible Assets." On January 1, 2002,
PennRock adopted the provisions of SFAS No. 142. This statement eliminates the
regularly scheduled amortization of goodwill and other intangibles with
indefinite lives and replaces this method with a two-step process for testing
the impairment of goodwill on at least an annual basis. This includes goodwill
and intangibles recorded from past business combinations and acquisitions. In
October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial
Institutions." SFAS No. 147 clarifies that a branch acquisition that meets the
definition of a "business" is to be accounted for as a business combination. If
the acquisition is a business combination then the purchase accounting
provisions of SFAS No. 141 "Business Combinations" apply. Prior to SFAS No. 147,
the intangibles arising from a branch acquisition were accounted for in
accordance with SFAS No. 72, "Accounting for Certain Acquisitions of Bank and
Thrift Institutions" and were therefore not considered goodwill for purposes of
SFAS No. 142. If the branch acquisition is considered a business combination,
SFAS No. 147 requires that the unamortized balance of these intangibles are to
be reclassified as goodwill and accounted for and reported prospectively under
the provisions of SFAS No. 142. Under SFAS No. 142, this "reclassified goodwill"
will be evaluated for impairment but will no longer be amortized. PennRock
adopted the provisions of SFAS No. 147 during the fourth quarter of 2002, and
subsequently reclassified $308,000 of intangibles from prior branch acquisitions
to goodwill. In addition, $75,000 of amortization of the reclassified intangible
previously expensed for the first three quarters of 2002 was reversed and taken
back into income. The adoption of SFAS No. 142 and SFAS No. 147 eliminates
annual goodwill amortization of approximately $587,000 per year. As of December
31, 2002, PennRock has goodwill of $9.8 million which includes the reclassified
goodwill. Goodwill totaled $7.8 million as of December 2001.
47
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
ORIGINATED MORTGAGE SERVICING RIGHTS:
Originated mortgage loan servicing rights ("OMSRs") are capitalized when
realized through the origination of mortgage loans that are subsequently sold
with servicing rights retained. PennRock recognizes OMSRs as an allocation of
the carrying amount of the loans sold between the loans sold and the servicing
rights retained. PennRock receives fees for servicing mortgage loans it has
sold. Servicing fees, expressed as a percentage of the unpaid principal balance,
are collected from the borrower's payments. Late charges and other ancillary
fees are also included in servicing income. Servicing fee revenue is recognized
as earned, unless collection is doubtful.
OMSRs are periodically evaluated for impairment based on the fair value of these
rights. The fair value of OMSRs is determined by discounting the estimated
future cash flows using a discount rate commensurate with the risks involved.
This method of valuation incorporates assumptions that market participants would
use in estimating future servicing income and expense, including assumptions
about prepayment, default, and interest rates. For purposes of measuring
impairment, the loans underlying the OMSRs are stratified by type (conventional
fixed-rate, conventional adjustable-rate, etc.). Impairment is measured by the
amount the book value of the OMSRs exceeds the fair value of the OMSRs.
Impairment, if any, is recognized through a valuation allowance and a charge to
current operations. The recovery of any previously established impairment
reserve is recognized as income in current operations. OMSRs, net of valuation
allowances, are amortized in proportion to, and over the period of, the
estimated net servicing revenue of the underlying mortgages, which are secured
by single-family properties. The amortization expense is deducted from the
related servicing fee revenue in the Consolidated Statements of Income. The
amortization of OMSRs is periodically evaluated and adjusted, if necessary, to
reflect changes in prepayment rates or other related factors.
FIDUCIARY ASSETS AND ASSETS UNDER MANAGEMENT:
Assets held by the Bank or National in a fiduciary or agency capacity are not
included in the consolidated financial statements since such assets are not
assets of the Bank or National. In accordance with banking industry practice,
income from fiduciary activities is generally recognized on a cash basis which
is not significantly different from amounts that would have been recognized on
the accrual basis.
FEDERAL INCOME TAXES:
PennRock and its subsidiaries file consolidated income tax returns. Deferred
income taxes have been provided for elements of income and expense that are
recognized for financial reporting purposes in periods different than when such
items are recognized for income tax purposes. PennRock accounts for income taxes
under the liability method which applies the enacted statutory tax rates in
effect as of the balance sheet date to differences between the book and tax
bases of assets and liabilities. The resulting deferred tax assets or
liabilities are adjusted to reflect changes in tax rates or laws. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period the change is enacted. For further discussion on federal
income taxes and deferred tax assets and liabilities, see Note 11: Income Taxes
in Notes to Consolidated Financial Statements.
TREASURY STOCK:
The purchase of PennRock's treasury stock is recorded at cost. At the date of
subsequent reissue, the treasury stock account is reduced by the cost of such
stock on a first-in, first-out method.
PROFIT SHARING PLAN:
Profit sharing contributions are calculated by a formula approved by the Board
of Directors and are based on the Bank's return on equity. Costs are funded as
accrued.
ADVERTISING, MARKETING AND PUBLIC RELATIONS:
PennRock expenses advertising, marketing and public relations costs as incurred.
These expenses for 2002, 2001 and 2000 totaled $998,000, $955,000 and $694,000,
respectively.
48
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
STOCK-BASED COMPENSATION:
PennRock accounts for its stock options and stock-based compensation plans using
the intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock Based Compensation." Under this
method, no compensation expense is recognized for stock options when the
exercise price of the option equals fair value, or market price, of the
underlying stock at the date of grant. Under the provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123," the fair value of a stock option is
recognized as compensation expense over the service period (generally the
vesting period). Since we have chosen to continue to account for stock options
and stock-based compensation plans in accordance with APB 25, we have adopted
the disclosure-only provisions of SFAS No. 123. This requires us to provide pro
forma net income and earnings per share information to show the impact on
earnings from the compensation expense as if the fair value approach of SFAS No.
123 had been adopted. This disclosure is provided in Note 13: Stock Option Plan
in the Notes to Consolidated Financial Statements.
NET INCOME PER SHARE:
Basic earnings per share ("EPS") is computed by dividing net income available to
common stockholders by the weighted-average number of common shares outstanding
during the period. Diluted EPS is computed by dividing net income available to
common stockholders by the weighted-average number of common shares outstanding
during the period plus the maximum number of potentially dilutive common shares
related to PennRock's outstanding stock options. Potentially dilutive common
shares are computed using the treasury stock method.
SEGMENT DISCLOSURE:
Management measures the performance and allocates the resources of PennRock as a
single segment, community banking. Therefore, we do not have any operating
segments that require additional information.
NOTE 2: RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain average balances of reserves on deposit with
the Federal Reserve Bank based on deposits outstanding. The amount of those
required reserves as of December 31, 2002 was approximately $8.0 million.
Balances maintained at the Federal Reserve Bank are included in cash and due
from banks.
NOTE 3: SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities available for sale are
as follows:
In thousands DECEMBER 31, 2002
---------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
U.S. Treasury securities and other
U.S. government agencies $ 7,018 $ 105 $ 0 $ 7,123
Obligations of states and political
subdivisions 16,813 295 (598) 16,510
U.S. agency mortgage-backed securities 81,131 1,538 (102) 82,567
Collateralized mortgage obligations 58,870 419 (192) 59,097
Corporate notes 75,341 26 (7,096) 68,271
-------- -------- -------- --------
Total debt securities available for sale 239,173 2,383 (7,988) 233,568
Equity securities 70,758 1,974 (1,486) 71,246
-------- -------- -------- --------
Total securities available for sale $309,931 $ 4,357 ($ 9,474) $304,814
======== ======== ======== ========
49
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In thousands December 31, 2001
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U.S. Treasury securities and other
U.S. government agencies $ 17,082 $ 205 $ (38) $ 17,249
Obligations of states and political
subdivisions 45,448 171 (1,209) 44,410
U.S. agency mortgage-backed securities 39,733 171 (61) 39,843
Collateralized mortgage obligations 85,137 456 (486) 85,107
Corporate notes 65,600 2 (5,783) 59,819
-------- -------- -------- --------
Total debt securities available for sale 253,000 1,005 (7,577) 246,428
Equity securities 58,160 1,077 (2,331) 56,906
-------- -------- -------- --------
Total securities available for sale $311,160 $ 2,082 $ (9,908) $303,334
======== ======== ======== ========
The amortized cost and fair value of debt securities as of December 31, 2002, by
contractual maturity, are shown below. Expected maturities may differ from
contractual maturities because issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.
In thousands DECEMBER 31, 2002
------------------------
AMORTIZED FAIR
COST VALUE
-------- --------
Due after one year through five years $ 2,000 $ 2,006
Due after five years through ten years 237 260
Due after ten years 96,935 89,638
-------- --------
99,172 91,904
Mortgage backed securities 81,131 82,567
Collateralized mortgage obligations 58,870 59,097
-------- --------
Total debt securities $239,173 $233,568
======== ========
Gains and losses from sales of securities available for sale are as follows:
In thousands
2002 2001 2000
--------- --------- ---------
Debt securities
Gross gains $ 1,751 $ 1,693 $ 708
Gross losses (103) (379) (13)
--------- --------- ---------
Total debt securities 1,648 1,314 695
Equity securities, net (1,279) 223 852
--------- --------- ---------
Total securities gains $ 369 $ 1,537 $ 1,547
========= ========= =========
Proceeds from sales of securities available for sale are as follows:
In thousands
2002 2001 2000
--------- --------- ---------
Debt securities $ 100,456 $ 172,499 $ 62,942
Equity securities 19,343 27,778 27,431
--------- --------- ---------
Total proceeds $ 119,799 $ 200,277 $ 90,373
========= ========= =========
Securities with a carrying value of $57.6 million and $81.5 million as of
December 31, 2002 and 2001 were pledged to secure public and trust deposits,
repurchase agreements as well as other purposes.
50
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4: LOANS
The loan portfolio, net of unearned income and deferred loan fees, as of
December 31, 2002 and 2001 is as follows:
In thousands
2002 2001
-------- --------
Commercial, financial and agricultural:
Commercial, secured by real estate $327,592 $276,667
Agricultural 6,838 6,368
Other 83,801 77,849
Real estate - construction 32,140 46,558
Real estate - mortgage 141,983 137,929
Consumer 10,486 12,998
-------- --------
Total loans $602,840 $558,369
======== ========
In the ordinary course of business, the Bank has loan, deposit, and other
transactions with its directors, their affiliated companies, executive
management and their associates (as defined), collectively referred to as
related parties. Such transactions are on substantially the same terms,
including interest rates and collateral (with regard to loans), as those
prevailing at the time for comparable transactions with others. Activity for the
related party loans for the year ended December 31, 2002, was as follows:
In thousands
Balance, January 1, 2002 $ 11,333
New loans 8,357
Repayments (4,661)
--------
Balance, December 31, 2002 $ 15,029
========
Included in the loan portfolio are loans on which the Bank has ceased the
accrual of interest. Such loans amounted to $1.2 million and $692,000 as of
December 31, 2002 and 2001. If interest income had been recorded on all
non-accrual loans outstanding during the years 2002, 2001 and 2000, interest
income would have been increased as shown in the following table:
In thousands
2002 2001 2000
---- ---- ----
Interest which would have been recorded
under original terms $ 78 $161 $527
Interest income recorded during the year 27 25 31
---- ---- ----
Net impact on interest income $ 51 $136 $496
==== ==== ====
PennRock accounts for impaired loans in accordance with SFAS No. 114. Under this
standard, once a loan has been identified as being impaired, management measures
impairment using discounted cash flows, or in the case of collateral dependent
loans, the fair value of the collateral. When the recorded investment in an
impaired loan exceeds the estimated fair value, such impairment is recognized as
a valuation reserve that is included in the overall allowance for loan losses.
51
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table presents the status of impaired loans.
In thousands
2002 2001
------ ------
Impaired loans with a reserve $1,100 $ 308
Impaired loans with no reserve 112 397
------ ------
Total impaired loans $1,212 $ 705
====== ======
Reserve for impaired loans (1) $ 343 $ 80
Average balance of impaired loans during the year $ 959 $2,300
(1) The reserve for impaired loans is part of the overall allowance for loan
losses.
NOTE 5: LOAN SERVICING
Mortgage loans serviced for Fannie Mae and Federal Home Loan Mortgage
Corporation are not included in the accompanying Consolidated Balance Sheets.
The unpaid principal balances of those loans were $201.7 million as of December
31, 2002 and $182.7 million as of December 31, 2001.
During 2002, $359,000 of originated mortgage servicing rights were capitalized
and $346,000 of amortization and impairment of mortgage servicing rights were
recorded. In 2001, $280,000 of originated mortgage servicing rights were
capitalized and $244,000 of amortization and impairment of mortgage servicing
rights were recorded. The estimated fair value of mortgage servicing rights was
$571,000 as of December 31, 2002 and $630,000 as of December 31, 2001 which are
included in Other Assets in the Consolidated Balance Sheets.
NOTE 6: ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses were as follows:
In thousands
2002 2001 2000
------- ------- -------
Balance at beginning of year $ 7,262 $ 5,973 $ 5,514
Provision charged to expense 1,750 1,548 3,076
Recoveries of loans charged-off 260 329 223
------- ------- -------
9,272 7,850 8,813
Loans charged off (2,197) (588) (2,840)
------- ------- -------
Balance at end of year $ 7,075 $ 7,262 $ 5,973
======= ======= =======
NOTE 7: PREMISES AND EQUIPMENT
Details of premises and equipment as of December 31 are as follows:
In thousands
2002 2001
-------- --------
Land $ 2,081 $ 2,097
Premises 15,128 12,932
Furniture and equipment 14,347 13,021
Construction in progress 42 347
-------- --------
Total cost 31,598 28,397
Less accumulated depreciation (15,342) (13,969)
-------- --------
Net book value $ 16,256 $ 14,428
======== ========
Depreciation expense was $1.3 million in 2002 and 2001 and $1.2 million in 2000.
52
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future minimum rental payments that are related to non-cancelable operating
leases having initial terms in excess of one year are:
2003 $270,012
2004 246,440
2005 241,190
2006 176,140
2007 149,430
Thereafter 313,850
Total lease payments were $318,000, $229,000 and $108,000 in 2002, 2001 and
2000.
NOTE 8: DEPOSITS
The following is a summary of deposit account balances as of December 31, 2002
and 2001:
In thousands
2002 2001
-------- --------
Non-interest bearing deposits $121,598 $108,529
NOW accounts 44,429 40,936
Money market deposit accounts 176,967 160,590
Savings accounts 79,884 63,966
Time deposits 320,384 289,673
-------- --------
Total deposits $743,262 $663,694
======== ========
The following shows the maturity of time deposits by year as of December 31,
2002:
In thousands
2003 $239,001
2004 67,183
2005 9,959
2006 2,422
2007 1,819
--------
Total $320,384
========
NOTE 8: SHORT-TERM BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase and the
treasury tax and loan note generally mature within one to thirty days from the
transaction date.
A summary of short-term borrowings is as follows for the years ended December
31, 2002, 2001 and 2000.
In thousands
2002 2001 2000
-------- -------- --------
Securities sold under agreements to repurchase:
Federal Home Loan Bank $ 12,000 $ 45,000 $ 30,000
Customers 23,363 26,752 21,567
Federal funds purchased 4,330
U.S. Treasury tax and loan note 5,000 672 2,608
-------- -------- --------
Total short-term borrowings outstanding at year-end $ 40,363 $ 76,754 $ 54,175
======== ======== ========
Average interest rate at year-end 1.08% 1.68% 6.04%
Maximum outstanding at any month-end $ 80,692 $ 76,754 $107,726
Average amount outstanding $ 53,710 $ 38,094 $ 63,975
Weighted average interest rate 1.48% 3.42% 6.08%
53
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Bank controls all securities that serve as collateral for the securities
sold under agreements to repurchase.
The Bank has approved federal funds lines totaling $12.0 million and a borrowing
capacity of $347.2 million at the Federal Home Loan Bank of Pittsburgh ("the
FHLB") as of December 31, 2002.
NOTE 9: LONG-TERM DEBT
Long-term debt consists of fixed rate advances from the FHLB with maturity
schedules as follows:
In thousands
DECEMBER 31, 2002 December 31, 2001
- ------------------------------------------------------ --------------------------------------------------
INTEREST Interest
AMOUNT MATURITY DATE RATE Amount Maturity Date Rate
- -------------- ----------------------- ------------ ------------ ---------------------- ---------
$ 25,000 JUNE 2, 2003 7.11% $ 15,000 September 17, 2002 5.74%
15,000 APRIL 21, 2005 6.27% 25,000 June 2, 2003 7.11%
25,000 JUNE 2, 2005 6.89% 15,000 April 21, 2005 6.27%
11,000 JUNE 4, 2007 6.76% 25,000 June 2, 2005 6.89%
30,000 MARCH 23, 2011 3.94% 11,000 June 4, 2007 6.76%
6,000 JULY 16, 2012 4.09% 30,000 March 23, 2011 3.94%
15,000 SEPTEMBER 16, 2012 3.41%
-------- --------
$127,000 $121,000
======== ========
All of the long-term advances are convertible advances that permit the FHLB to
convert the advance from a fixed-rate to a variable-rate at its discretion on a
specified call date following an initial "lock-out" period ranging from one year
to five years. Some of the long-term advances further restrict the FHLB's
ability to call the advance unless 3-month LIBOR is at or above a specified
rate. If the FHLB exercises its option to convert an advance, the Bank has the
option to repay the advance in full. During 2002 and 2001, the FHLB did not
exercise its option to convert any advances.
All advances from the FHLB are collateralized by a security agreement covering
qualified mortgage loans, and treasury, agency and mortgage-backed securities.
NOTE 10: CAPITAL TRANSACTIONS
On June 25, 2002, PennRock announced that the Board of Directors had authorized
the repurchase of up to 400,000 shares of PennRock's outstanding common stock.
Any repurchased shares will be held as treasury shares available for issuance
with future stock dividends and stock splits, employee benefit plans, executive
compensation plans, for issuance under the Dividend Reinvestment Plan or for
issuance for any other appropriate corporate purpose. PennRock began open market
repurchases of its outstanding common stock in 1995. In 2002, PennRock purchased
117,891 shares for $3.1 million and reissued 90,648 shares. In 2001, PennRock
purchased 34,676 shares for $588,000 and reissued 114,725 shares. PennRock
purchased 109,560 shares for $1.6 million and reissued 105,280 shares in 2000.
There were 108,379 shares with a cost of $2.9 million as of December 31, 2002
and 81,136 shares with a cost of $1.6 million as of December 31, 2001 held as
treasury stock.
NOTE 11: INCOME TAXES
An analysis of the provision for income taxes included in the Consolidated
Statements of Income is as follows:
In thousands
2002 2001 2000
------- ------- -------
Current expense $ 2,870 $ 2,364 $ 1,699
Deferred taxes (290) (323) (125)
------- ------- -------
Total income tax expense $ 2,580 $ 2,041 $ 1,574
======= ======= =======
54
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A reconciliation between the provision for income taxes and the amount computed
by applying the statutory federal income tax rate to income before provision for
income taxes is as follows:
2002 2001 2000
------ ------ ------
Statutory federal income tax rate 35.0% 34.0% 34.0%
Tax exempt income, net (12.0%) (15.0%) (20.2%)
Low income housing, rehabilitation
and other tax credits (5.7%) (4.9%) (0.6%)
Disqualifying disposition of options (0.4%)
Other, net (0.6%) 0.4% 1.0%
------ ------ ------
Effective income tax rate 16.3% 14.5% 14.2%
====== ====== ======
The tax effect of tax-exempt income on income tax expense is shown net of TEFRA
interest expense disallowance.
Deferred taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of PennRock's
deferred tax liabilities and assets as of December 31, 2002 and 2001 are as
follows:
In thousands
2002 2001
------ ------
Deferred tax assets:
Allowance for loan losses $2,399 $2,367
Net unrealized loss on securities available for sale 1,740 2,661
Goodwill amortization or impairment 165 163
Other 29
------ ------
Total deferred tax assets 4,333 5,191
------ ------
Deferred tax liabilities:
Depreciation 205 196
Investment security discount 253 323
Other 166
------ ------
Total deferred tax liabilities 458 685
------ ------
Net deferred tax asset $3,875 $4,506
====== ======
Included in the table above is the recognition of unrealized gains and losses on
certain investments in debt and equity securities accounted for under SFAS No.
115 for which no deferred tax expense or benefit was recognized in the
Consolidated Statements of Income.
Management believes that it is more likely than not that the net deferred tax
asset of $3.9 million will be realized since PennRock has a long history of
earnings and has a carry-back potential greater than the deferred tax asset and
is unaware of any reason that PennRock would not ultimately realize this asset.
NOTE 12: EMPLOYEE BENEFIT PLAN
The Bank has a non-contributory profit sharing plan covering substantially all
full time employees of the Bank. Contributions made to the plan by PennRock were
$1.3 million in 2002, $1.1 million in 2001 and $825,000 in 2000.
NOTE 13: STOCK INCENTIVE PLAN
PennRock has a Stock Incentive Plan ("the Plan"), the terms of which permit the
granting of incentive stock options, nonqualified stock options and bonus stock
to key employees of PennRock and its subsidiaries. All options under this Plan
are granted at an exercise price equal to the market price at the date of the
grant.
55
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of PennRock's options outstanding as of December 31 is as follows:
2002 2001 2000
----------------------- ----------------------- ------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
-------- --------- -------- -------- -------- ---------
Outstanding, beginning
of year 176,271 $15.14 85,198 $16.65 47,099 $18.86
Granted 59,947 25.44 96,444 13.41 38,099 13.91
Exercised (14,123) 13.15
Forfeited (5,371) 13.15
------- ------- ------
Outstanding, end of
year 222,095 $17.92 176,271 $15.14 85,198 $16.65
======= ====== ======= ====== ====== ======
The weighted average fair value of options granted in the past three years is as
follows:
2002 2001 2000
----------------------- ----------------------- ---------------------
PER Per Per
TOTAL SHARE Total Share Total Share
----- ----- ----- ----- ----- -----
$506,539 $8.45 $294,515 $3.56 $159,152 $4.59
======== ===== ======== ===== ======== =====
PennRock has elected to account for its stock options and stock-based
compensation plans using the intrinsic value method in accordance with APB 25,
"Accounting for Stock Based Compensation." Under this method, no compensation
expense is recognized for stock options when the exercise price equals fair
value at the date of grant. Since the Plan stipulates that the exercise price of
the options is always equal to the market price at the date of the grant, we
have recognized no compensation costs under the Plan. Had compensation costs for
the Plan been determined based on the fair value of the options at the grant
dates in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," as amended, PennRock's net income and earnings per share would
have been as follows:
In thousands, except per share data
2002 2001 2000
------- ------- -------
Net income - as reported $13,226 $12,067 $ 9,546
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (165) (186) (65)
------- ------- -------
Pro-forma net income $13,061 $11,881 $ 9,481
======= ======= =======
Earnings per share:
Basic - as reported $ 1.90 $ 1.74 $ 1.38
Basic - pro-forma 1.88 1.72 1.37
Diluted - as reported 1.88 1.73 1.38
Diluted - pro-forma 1.86 1.71 1.37
The fair value of each option is estimated on the date of the grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 2002, 2001 and 2000:
2002 2001 2000
---------- --------- -------
Dividend yield 3.33% 3.82% 2.50%
Expected volatility 36.00% 30.00% 30.00%
Risk free interest rate 5.58% 5.44% 6.67%
Expected average life 7.12 YEARS 3.41 years 5 years
56
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table sets forth information as of December 31, 2002, with respect
to stock compensation plans under which equity securities are authorized for
issuance:
Number of
Securities to be Weighted Number of
Issued Upon Average Securities
Exercise of Exercise Price Remaining
Outstanding of Outstanding Available for
Options Options Future Issues
---------------- -------------- -------------
Stock based compensation plans approved
by stockholders 221,747 $17.93 490,000
Stock based compensation plans not
approved by stockholders 348 13.15
------- ------ -------
Total 222,095 $17.92 490,000
======= ====== =======
Of the shares outstanding under stock based compensation plans approved by
stockholders, 162,147 were issued under the Omnibus Stock Plan of 1992 and
59,600 were issued under the Stock Incentive Plan of 2002.
NOTE 14: COMMITMENTS AND CONTINGENT LIABILITIES AND CONCENTRATIONS OF CREDIT
RISK
PennRock's financial statements do not reflect various commitments and
contingent liabilities that arise in the normal course of business to meet the
financing needs of its customers that involve elements of credit risk, interest
rate risk and liquidity risk. These financial instruments include commitments to
extend credit, standby letters of credit, guarantees, and liability for assets
held in trust. PennRock's exposure to credit loss in the event of nonperformance
by the other party on the financial instrument is represented by the contractual
amount and the collateral value, if any, of those instruments. PennRock uses the
same credit policies in commitments and conditional obligations as it does for
on-balance sheet instruments.
A summary of PennRock's commitments and contingent liabilities as of December
31, 2002 and 2001 are as follows:
In thousands
2002 2001
-------- --------
Commitments to extend credit $146,559 $156,707
Financial and performance standby letters of credit 42,271 40,137
Commercial letters of credit 164 189
Commitments to extend credit are agreements to lend to a customer to the extent
that 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. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not represent
future cash requirements. Management evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained if deemed necessary
by management upon extension of credit is based on a credit evaluation of the
customer.
Stand-by letters of credit are conditional commitments issued by PennRock to
guarantee the performance of a customer to a third party. The term of the
letters of credit varies from one month to 24 months and may have renewal
features. The credit risk involved in issuing letters of credit is essentially
the same as that involved in extending loans to customers. PennRock holds
collateral supporting those commitments for which collateral is deemed
necessary.
57
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Most of PennRock's business activity is with customers located within PennRock's
defined market area. Investments in state and municipal securities may also
involve government entities within PennRock's market area. The concentrations by
loan type are set forth in Note 4: Loans in the Notes to Consolidated Financial
Statements. The distribution of commitments to extend credit approximates the
distribution of loans outstanding. The Bank, as a matter of policy, does not
extend credit to any single borrower or group of related borrowers in excess of
65% of its legal lending limit. As of December 31, 2002, this limit was
$8,466,000.
NOTE 15: RESTRICTIONS ON RETAINED EARNINGS
Certain restrictions exist regarding the ability of the Bank to transfer funds
to PennRock in the form of cash dividends. The approval of the Comptroller of
the Currency is required if the total dividends declared by a national bank in
any calendar year exceeds the Bank's net profits (as defined) for that year
combined with its retained net profits for the preceding two calendar years.
Under this formula, the Bank can declare dividends during 2003, without approval
of the Comptroller of the Currency, of approximately $11.3 million plus an
additional amount equal to the Bank's net profit (as defined) for 2003 up to the
date of any such dividend declaration.
NOTE 16: COMPREHENSIVE INCOME
PennRock has elected to report its comprehensive income in the Consolidated
Statements of Stockholders' Equity. The only element of "other comprehensive
income (loss)" applicable to PennRock is the net unrealized gain or loss on
available for sale securities.
The components of the change in unrealized gains (losses) on securities
available for sale are as follows:
In thousands
2002 2001 2000
-------- -------- --------
Net unrealized holding gains (losses) arising during the year $ 3,120 ($ 2,384) $ 13,726
Reclassification adjustment for gains realized in net income (369) (1,537) (1,547)
-------- -------- --------
Net unrealized holding gains (losses) before taxes 2,751 (3,921) 12,179
Tax effect (963) 1,333 (4,140)
-------- -------- --------
Net change $ 1,788 ($ 2,588) $ 8,039
======== ======== ========
NOTE 17: REGULATORY MATTERS
PennRock 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 PennRock's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, PennRock and the Bank must meet specific capital guidelines
that involve quantitative measures of PennRock's assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting practices.
PennRock's and the Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require PennRock and the Bank to maintain minimum amounts and ratios (set forth
in the table below) of total and Tier 1 capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of December 31, 2002, that
PennRock and the Bank meet all capital adequacy requirements to which they are
subject.
58
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 2002, the most recent notification from the Federal Reserve
Bank categorized PennRock as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, PennRock must
maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios
as set forth below. There are no conditions or events since that notification
that management believes have changed this category. PennRock's and the Bank's
actual capital amounts and ratios are also presented in the following table.
To Be Well
Capitalized Under
Prompt Corrective For Capital
Actual Action Provisions Adequacy Purposes
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
----------- -------- ---------- --------- ---------- ---------
PennRock Financial
Services Corp.
As of December 31, 2002:
Total capital to
risk-weighted assets $87,528 11.57% $60,523 8.0%
Tier 1 capital:
to risk-weighted assets 80,234 10.61% 30,262 4.0%
to average assets 80,234 7.92% 40,532 4.0%
As of December 31, 2001:
Total capital to
risk-weighted assets $82,647 11.71% $56,482 8.0%
Tier 1 capital:
to risk-weighted assets 75,385 10.68% 28,241 4.0%
to average assets 75,385 8.40% 35,908 4.0%
Blue Ball National Bank
As of December 31, 2002:
Total capital to
risk-weighted assets $86,831 11.55% $75,178 10.0% $60,143 8.0%
Tier 1 capital:
to risk-weighted assets 79,029 10.51% 45,107 6.0% 30,071 4.0%
to average assets 79,029 7.79% 50,735 5.0% 40,587 4.0%
As of December 31, 2001:
Total capital to
risk-weighted assets $78,686 11.22% $70,147 10.0% $56,118 8.0%
Tier 1 capital:
to risk-weighted assets 71,055 10.13% 42,088 6.0% 28,059 4.0%
to average assets 71,055 7.99% 44,477 5.0% 35,581 4.0%
NOTE 18: FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the balance sheet, for which it is practicable to estimate that
value. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions would significantly affect the estimates. SFAS
No. 107 excludes certain financial instruments and all non-financial instruments
from its disclosure requirements.
59
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Fair value estimates are based on existing on and off-balance sheet financial
instruments without attempting to estimate the value of future business. The
value of significant sources of income such as fiduciary or asset management
fees or mortgage banking operations has not been estimated. In addition, the tax
effect relative to the recognition of unrealized gains and losses can have a
significant impact on fair value estimates and have not been considered in any
of the estimates. Accordingly, the aggregate fair value amounts do not represent
the underlying value of PennRock.
We used the following methods and assumptions in estimating the fair value of
PennRock's financial instruments:
Cash and cash equivalents:
The carrying amounts reported in the Consolidated Balance Sheets for
cash and short-term investments approximate their fair values.
Mortgages held for sale:
The fair value of mortgages held for sale is estimated using current
secondary market rates.
Securities:
Fair values for securities are based on quoted prices, where
available. If quoted prices are not available, fair values are based
on quoted prices of comparable instruments.
Loans:
Loans are segregated by category, such as commercial, commercial
real estate, residential mortgage, and installment. Each loan
category is further segmented into fixed and adjustable rate
interest terms and by performing and non-performing status. The fair
value of loans is calculated by discounting scheduled cash flows
through the estimated maturity using estimated market discount rates
that reflect the credit risk inherent in the loan. The estimate of
average maturity is based on historical experience with prepayments
for each loan classification modified, as required, by an estimate
of the effect of current economic and lending conditions. The
carrying amount of accrued interest receivable approximates its fair
value.
Off-balance sheet instruments:
For PennRock's off-balance sheet instruments consisting of
commitments to extend credit and financial and performance standby
letters of credit, the estimated fair value is the same as the
instrument's contract or notional values since they are priced at
market at the time of funding.
Deposit liabilities:
The fair values of deposits with no stated maturities, such as
demand deposits, savings accounts, NOW and money market deposits are
calculated using estimated future cash flows, discounted at the FHLB
overnight advance rate less the Bank's operating costs to service
the account. We also assume that 1% of the outstanding balance of
the accounts will be withdrawn each month for 100 months. Fair
values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
Short-term borrowings:
The carrying amounts of federal funds purchased and securities sold
under agreements to repurchase, advances from the Federal Home Loan
Bank and other short-term borrowings approximate their fair values.
Long-term debt:
The fair values of long-term debt are estimated using discounted
cash flow analyses, based on PennRock's incremental borrowing rates
for similar types of borrowing arrangements.
Accrued interest payable:
The fair value of accrued interest payable is estimated to be the
current book value.
60
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 2002 and 2001, the estimated fair values of financial
instruments based on disclosed assumptions are as follows:
In thousands
2002 2001
--------------------------- --------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
--------- --------- --------- ---------
Financial assets:
Cash and due from banks $ 23,092 $ 23,092 $ 23,242 $ 23,242
Short-term investments 9,226 9,226 4,787 4,787
Mortgages held for sale 7,147 7,147 2,420 2,423
Securities available for sale 304,814 304,814 303,334 303,334
Loans:
Commercial, financial and agricultural 418,231 437,122 360,884 378,833
Real estate - construction 32,140 33,547 46,558 48,789
Real estate - mortgage 141,983 146,458 137,929 142,375
Consumer 10,486 10,654 12,998 12,953
Allowance for loan losses (7,075) (7,262)
--------- --------- --------- ---------
Net loans 595,765 627,781 551,107 582,950
Accrued interest receivable 3,282 3,282 3,890 3,890
Financial liabilities:
Deposits:
Non-interest bearing demand 121,598 120,258 108,529 99,159
Interest bearing demand 221,396 220,943 201,526 187,585
Savings 79,884 78,601 63,966 58,885
Time deposits under $100,000 278,323 281,749 253,757 257,649
Time deposits over $100,000 42,061 42,579 35,916 36,094
--------- --------- --------- ---------
Total deposits 743,262 744,130 663,694 639,372
Short-term borrowings 40,363 40,363 76,754 76,754
Long-term debt 127,000 142,373 121,000 136,402
Accrued interest payable 2,465 2,465 2,960 2,960
Off-balance sheet financial instruments:
Commitments to extend credit 146,559 146,559 156,707 156,707
Financial and performance standby letters
of credit 42,271 42,271 40,137 40,137
Commercial letters of credit 164 164 189 189
NOTE 19: ACQUISITION
On October 31, 2002, PennRock acquired Pension Consulting Services, Inc. ("PCS")
for $1.7 million. The transaction was accounted for under the purchase method of
accounting. Substantially the entire purchase price was allocated to goodwill.
PCS will retain its name and operate as a wholly owned subsidiary of PennRock.
PCS is a third party administrator of retirement plans for small to medium sized
business and professional corporations located in Pennsylvania, New Jersey,
Maryland and Delaware. Since the acquisition was accounted for under the
purchase method of accounting, the results of operations of PCS are not included
in the financial statements of PennRock for periods prior to October 31, 2002.
61
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 20: PARENT COMPANY ONLY FINANCIAL INFORMATION
The following represents parent only financial information:
PENNROCK FINANCIAL SERVICES CORP. (PARENT COMPANY ONLY) BALANCE SHEETS
In thousands
December 31,
-------------------------
2002 2001
-------- --------
ASSETS:
Cash and cash equivalents $ 103 $ 20
Securities available for sale 1,588 2,420
Investment in subsidiaries 87,409 74,797
Receivable from subsidiary 627 2,054
Other assets 973 1,364
-------- --------
Total assets $ 90,700 $ 80,655
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Dividends payable $ 1,386 $ 1,324
Payable to subsidiary 611
Note payable to subsidiary 850 909
Accrued expenses and taxes 875 18
-------- --------
Total liabilities 3,722 2,251
-------- --------
Stockholders' equity:
Common stock 17,544 15,952
Surplus 33,745 16,446
Accumulated other comprehensive loss, net of tax (3,377) (5,165)
Retained earnings 41,926 52,780
Treasury stock at cost (2,860) (1,609)
-------- --------
Total stockholders' equity 86,978 78,404
-------- --------
Total liabilities and stockholders' equity $ 90,700 $ 80,655
======== ========
PENNROCK FINANCIAL SERVICES CORP. (PARENT COMPANY ONLY) STATEMENTS OF INCOME
In thousands
December 31,
------------------------------------------
2002 2001 2000
-------- -------- --------
Income:
Dividends from bank subsidiary $ 6,400 $ 10,020 $ 4,500
Securities available for sale 14 54 215
Management fee from subsidiaries 337 456
Net realized gains (losses) on sales of available for sale
securities (1,645) (537) 586
-------- -------- --------
Total income 5,106 9,993 5,301
General and administrative expenses 636 628 802
-------- -------- --------
Income before income taxes and undistributed net income
of subsidiaries 4,470 9,365 4,499
Income tax expense (benefit) (659) (309) 8
Equity in undistributed net income of subsidiaries 8,097 2,393 5,055
-------- -------- --------
Net income $ 13,226 $ 12,067 $ 9,546
======== ======== ========
62
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PENNROCK FINANCIAL SERVICES CORP. (PARENT COMPANY ONLY) STATEMENTS OF CASH FLOWS
In thousands
Year Ended December 31,
------------------------------------------
2002 2001 2000
-------- -------- --------
OPERATING ACTIVITIES
Net income $ 13,226 $ 12,067 $ 9,546
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income from subsidiaries (8,097) (2,393) (5,055)
Net realized (gains) losses on sale of available for sale
securities 1,645 537 (586)
(Increase) decrease in receivable from subsidiary 1,737 (1,829) (432)
Other, net (401) 7 136
-------- -------- --------
Net cash provided by operating activities 8,110 8,389 3,609
-------- -------- --------
INVESTING ACTIVITIES
Net cash paid for business acquisition (1,665) (7,677)
Proceeds from sale of securities available for sale 720 1,599 10,530
Purchases of securities available for sale (584) (1,448) (8,097)
-------- -------- --------
Net cash provided by (used in) investing activities (1,529) (7,526) 2,433
-------- -------- --------
FINANCING ACTIVITIES
Net increase (decrease) in short-term borrowings (59) 909
Issuance of common and treasury stock 2,085 1,722 1,532
Purchase of treasury stock (3,139) (588) (1,584)
Cash dividends paid (5,355) (4,791) (4,168)
Cash paid with stock dividend (30) (16)
-------- -------- --------
Net cash used in financing activities (6,498) (2,764) (4,220)
-------- -------- --------
Increase (decrease) in cash and cash equivalents 83 (1,901) 1,822
Cash and cash equivalents at beginning of year 20 1,921 99
-------- -------- --------
Cash and cash equivalents at end of year $ 103 $ 20 $ 1,921
======== ======== ========
63
PENNROCK FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 21: CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands except per share data
2002
----------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
Interest income $14,686 $14,207 $13,769 $14,480
Interest expense 6,124 5,954 5,845 5,360
------- ------- ------- -------
Net interest income 8,562 8,253 7,924 9,120
Provision for loan losses 444 375 226 705
Non-interest income 2,455 2,643 2,979 3,067
Non-interest expense 6,523 6,771 6,915 7,238
------- ------- ------- -------
Income before income taxes 4,050 3,750 3,762 4,244
Income taxes 704 606 719 551
------- ------- ------- -------
Net income $ 3,346 $ 3,144 $ 3,043 $ 3,693
======= ======= ======= =======
Net income per share $ 0.48 $ 0.45 $ 0.44 $ 0.53
======= ======= ======= =======
Dividends declared per share $ 0.18 $ 0.19 $ 0.19 $ 0.20
======= ======= ======= =======
2001
----------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $16,299 $15,797 $15,310 $14,868
Interest expense 9,438 8,717 7,734 6,477
------- ------- ------- -------
Net interest income 6,861 7,080 7,576 8,391
Provision for loan losses 444 376 227 502
Non-interest income 2,628 2,538 3,032 2,831
Non-interest expense 5,396 6,004 6,685 7,196
------- ------- ------- -------
Income before income taxes 3,649 3,238 3,696 3,524
Income taxes 628 232 694 486
------- ------- ------- -------
Net income $ 3,021 $ 3,006 $ 3,002 $ 3,038
======= ======= ======= =======
Net income per share $ 0.44 $ 0.43 $ 0.43 $ 0.44
======= ======= ======= =======
Dividends declared per share $ 0.16 $ 0.17 $ 0.17 $ 0.19
======= ======= ======= =======
64
PENNROCK FINANCIAL SERVICES CORP.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and nominees for election to the Board of
Directors is incorporated herein by reference to the Registrant's Proxy
Statement for its annual meeting to be held on April 22, 2003 under the caption
"Information about Nominees, Continuing Directors and Executive Officers", and
information concerning executive officers is included under Part I, Item 3A,
"Executive Officers of the Registrant" of this report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning director compensation is incorporated herein by reference
to the Registrant's Proxy Statement for its annual meeting to be held on April
22, 2003 under the caption "Compensation of Directors" and concerning executive
compensation under the caption "Executive Compensation and Related Matters,"
except that information appearing under the caption "Board Report on Executive
Compensation" and information appearing under the caption "Stock Performance
Graph" is not incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners is
incorporated herein by reference to the Registrant's Proxy Statement for its
annual meeting to be held on April 22, 2003, under the caption "Voting of Shares
and Principal Holders Thereof" and concerning security ownership of management
under the caption "Information about Nominees and Continuing Directors."
Information concerning PennRock's stock compensation plan can be found in Note
13: Stock Incentive Plan in the Notes to Consolidated Financial Statements.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information under the caption "Transactions with Directors and Executive
Officers" is incorporated herein by reference to the Registrant's Proxy
Statement for its annual meeting to be held on April 22, 2003.
ITEM 14. 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, within 90 days
prior to the filing date of 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. 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.
65
PENNROCK FINANCIAL SERVICES CORP.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. The financial statements of PennRock required in response to this
Item are incorporated by reference to Item 8 of this Report.
The following consolidated financial statements of PennRock and
the report of the independent certified public accountants
thereon filed with this report:
Independent Auditors' Report (Simon Lever & Company)
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Income for the years ended December
31, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
(a)2. Not applicable.
(a)3. See the exhibits listed below under Item 14(c).
(b) PennRock filed the following Current Reports on Form 8-K From
October 1, 2002 to the date of this Report:
Current Report on Form 8-K dated October 31, 2002, announcing
that PennRock had acquired Pension Consulting Services, Inc.,
a third party retirement plan administrator.
Current Report on Form 8-K dated January 16, 2003, announcing
PennRock's earnings for the fourth quarter and year ended
December 31, 2002.
(c) Exhibit Index
(3)(a) Articles of Incorporation of PennRock, incorporated by
reference to Exhibit 3(a) of PennRock's Annual Report on
Form 10-K for the year ended December 31, 2000.
(3)(b) Bylaws of PennRock, incorporated by reference to Exhibit
99 of PennRock's Current Report on Form 8-K dated
November 13, 2001.
(10)(a) Omnibus Stock Plan, incorporated by reference to Exhibit
4.1 to PennRock's Registration Statement Number 33-53022
of Form S-8 dated October 8, 1992.
(10)(b) Executive Incentive Compensation Plan, incorporated by
reference to Exhibit 10(b) of PennRock's Annual Report
on Form 10-K for the year ended December 31, 2000.
(10)(c) Melvin Pankuch Deferred Compensation Agreement Plan,
incorporated by reference to Exhibit 10(c) of PennRock's
Annual Report on Form 10-K for the year ended December
31, 2000.
(10)(d) Melvin Pankuch Employment Agreement, incorporated by
reference to Exhibit 10(d) of PennRock's Annual Report
on Form 10-K for the year ended December 31, 2000.
(10)(e) Employment Agreement with Certain Executive Officers,
incorporated by reference to Exhibit 10(e) of PennRock's
Annual Report on Form 10-K for the year ended December
31, 2000.
(10)(f) Stock Incentive Plan of 2002, incorporated by reference
to Exhibit 10(f) of PennRock's Quarterly Report on Form
10-Q for the quarter ended March 31, 2002.
66
PENNROCK FINANCIAL SERVICES CORP.
(21) Subsidiaries of the Registrant
(23) Consent of Simon Lever & Company, Independent Auditors
(99) Certifications of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(d) Financial Statement Schedules - None.
67
PENNROCK FINANCIAL SERVICES CORP.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
-------------------------------------------
(Registrant)
Dated: March 11, 2003 By /s/ Glenn H. Weaver
-------------------------------------------
Glenn H. Weaver, President
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 in
the capacities indicated on the 11th of March 2003.
Signatures Title
- ------------------------------ --------------------------------------------
/s/ Norman Hahn Chairman and Director
- ------------------------------
NORMAN HAHN
/s/ Glenn H. Weaver President and Director
- ------------------------------
GLENN H. WEAVER
/s/ Robert K. Weaver Secretary and Director
- ------------------------------
ROBERT K. WEAVER
/s/ Melvin Pankuch Executive Vice President, Chief
- ------------------------------ Executive Officer and Director
MELVIN PANKUCH
/s/ George B. Crisp Vice President and Treasurer
- ------------------------------ (Principal Financial and Accounting Officer)
GEORGE B. CRISP
/s/ Dale M. Weaver Director
- ------------------------------
DALE M. WEAVER
/s/ Aaron S. Kurtz Director
- ------------------------------
AARON S. KURTZ
/s/ Robert L. Spotts Director
- ------------------------------
ROBERT L. SPOTTS
/s/ Elton Horning Director
- ------------------------------
ELTON HORNING
/s/ Lewis M. Good Director
- ------------------------------
LEWIS M. GOOD
/s/ Irving E. Bressler Director
- ------------------------------
IRVING E. BRESSLER
/s/ Sandra J. Bricker Director
- -------------------------------
SANDRA J. BRICKER
68
PENNROCK FINANCIAL SERVICES CORP.
Certification of Chief Executive Officer as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Melvin Pankuch, certify that:
1. I have reviewed this annual report on Form 10-K of PennRock Financial
Services Corp.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. designed such disclosure controls and procedures 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 annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: March 11, 2003 /s/ Melvin Pankuch
----------------------------------------
Melvin Pankuch, Executive Vice President
and Chief Executive Officer
69
PENNROCK FINANCIAL SERVICES CORP.
Certification of Chief Financial Officer as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, George B. Crisp, certify that:
1. I have reviewed this annual report on Form 10-K of PennRock Financial
Services Corp.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. designed such disclosure controls and procedures 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 annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
d. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
e. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: March 11, 2003 /s/ George B. Crisp
-----------------------------------
George B. Crisp, Vice President and
Chief Financial Officer
70