UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

PENNROCK FINANCIAL SERVICES CORP.

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2), has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is accelerated filer (as defined in Rule 12b-2 of the Exchange Act.

As of October 27, 2004, there were 7,640,515 shares of Common Stock, Par Value $2.50 Per Share, outstanding.

PennRock Financial Services Corp. and Subsidiaries

TABLE OF CONTENTS

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PennRock Financial Services Corp. and Subsidiaries

PART I. FINANCIAL INFORMATION
For the Quarter Ended September 30, 2004

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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PennRock Financial Services Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

See accompanying notes to consolidated financial statements.

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PennRock Financial Services Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

See accompanying notes to consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See accompanying notes to consolidated financial statements.

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PennRock Financial Services Corp. and Subsidiaries

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2004

NOTE 1: BASIS OF PRESENTATION

		The accompanying consolidated financial statements include the accounts of PennRock Financial Services Corp. and its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
		The information contained in the financial statements is unaudited. In the opinion of management, all material adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results of interim periods have been made. These unaudited interim statements are presented in accordance with the requirements of Form 10-Q, accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. These condensed notes should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in PennRock’s Annual Report on Form 10-K for the year ended December 31, 2003.
		Earnings per share (“EPS”):
		Basic EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted EPS is calculated by dividing net income by the weighted-average number of shares outstanding during the period plus additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued consist of outstanding stock options and are determined by using the treasury stock method. Adjustments to net income and the weighted average number of shares of common stock are made only when such adjustments dilute earnings per share. For the three and nine months ending September 30, 2004, options to purchase 15,000 shares of PennRock’s common stock were excluded from the EPS calculation because such options were antidilutive.

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		Stock based employee compensation:
		In December 2002, the Financial Accounting Standards Board (“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 used on reported results.
		SFAS No. 148 has also amended APB Opinion 28, “Interim Financial Reporting” to require that public companies provide a tabular presentation similar to that called for in annual statements in condensed quarterly statements if, for any period presented, the intrinsic value method is used. PennRock adopted the provisions of SFAS No. 148 in December 2002 but will continue to account for stock-based employee compensation under the intrinsic value method in accordance with APB 25.
		Pro forma information regarding net income and earnings per share has been determined as if we had accounted for all stock-based compensation under the fair value method of SFAS 123.

We estimate the fair value of each option on the grant date using the Black-Scholes option-pricing model with the follow weighted average assumptions used options granted for 2004 and 2003:

On June 14, 2004, under the Stock Incentive Plan of 2002 (“the Plan”), the Board of Directors granted stock options totaling 45,000 shares at an exercise price of $28.12 per share which was the fair market value of PennRock’s common stock on the date of the grant as determined in accordance with provisions of the Plan.

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NOTE 2. 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”), Pension Consulting Services, Inc. (“PCS”) and 1906 Founders, Inc. 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. (“PIGI”) and PennRock Financial Advisors, NA. (“PFA”) are wholly owned subsidiaries of the Bank. On April 1, 2004, the net assets of National and each of its subsidiaries and the net assets of PCS as well as all operations of these companies were transferred to PFA. At the same time, the operations of the Bank’s Financial Services Division, including trust operations, were transferred to PFA. All employees of National and PCS became employees of the Bank and are contracted to PFA. The purpose of the reorganization is to promote operating efficiencies and the cross-selling of services among the various corporations. PFA is a limited purpose bank. PIGI began operations in the first quarter of 1999 to offer and sell annuity and other insurance products. 1906 Founders, Inc. owns and manages certain investment securities.

NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES

The financial statements do not reflect various commitments and contingent liabilities, such as commitments to extend credit, letters of credit and liability for assets held in a fiduciary capacity, which arise in the normal course of business. Commitments under outstanding letters of credit amounted to $52.5 million and commitments to extend credit totaled $153.9 million at September 30, 2004. Management does not anticipate any significant loss as a result of these transactions.

NOTE 4. SECURITIES AVAILABLE FOR SALE

The amortized cost and estimated fair value of securities available for sale are as follows:

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The amortized cost and estimated fair value of debt securities as of September 30, 2004 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.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section presents management’s discussion and analysis of the financial condition and results of operations of PennRock Financial Services Corp. and its subsidiaries. This discussion should be read in conjunction with the financial statements which appear elsewhere in this report.

FORWARD LOOKING STATEMENTS

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

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. In implementing its policies, management must make estimates and assumptions about the effect of matters that are inherently less than certain. Actual results could differ significantly from these estimates which could materially affect the amounts of our assets, liabilities, income and expenses. A variety of estimates impact the carrying value of the loan portfolio, including the amount of the allowance for loan losses, the placement of loans on non-accrual status, and the valuation of mortgages held for sale and mortgage servicing rights. For a more detailed discussion on critical accounting policies, see “Critical Accounting Policies” in PennRock’s Annual Report on Form 10-K for the year ended December 31, 2003.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total assets of PennRock increased $38.1 million or 3.4% from year-end 2003. Loans grew $33.5 million, securities available for sale decreased $7.8 million, deposits increased $47.3 million while borrowed funds decreased $13.4 million.

Net income for the third quarter of 2004 was $3.6 million or $.47 per share compared with $3.3 million or $.43 per share for the third quarter of 2003, an increase of $326,000 or 9.9%. Dividends paid in the third quarter of 2004 totaled $1.5 million or $.20 per share and $1.4 million or $.18 per share for the third quarter of 2003.

For the first nine months of 2004, net income totaled $10.8 million or $1.42 per share compared with $10.5 million or $1.38 per share for the first nine months of 2003, an increase of $302,000 or 2.9%. Net interest income increased $708,000, non-interest income excluding security gains and losses increased $130,000 and non-interest expenses increased $840,000. Dividends of $4.6 million or $.60 per share were paid in the first nine months of 2004 compared with $4.2 million or $.55 per share in 2003. The dividend payout ratio was 42% in 2004 and 40% in 2003.

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PennRock Financial Services Corp. and Subsidiaries

NET INTEREST INCOME

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

Table 1 presents net interest income on a fully taxable equivalent basis for the third quarter and first nine months of 2004 and 2003. For the third quarter of 2004, net interest income on a fully taxable equivalent basis totaled $9.4 million, an increase of $117,000 or 1.3% from $9.3 million earned for the same period of 2003. For the first nine months of 2004 and 2003, net interest income on a fully taxable equivalent basis totaled $28.5 million and $27.8 million, respectively.

TABLE 1. — NET INTEREST INCOME

		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 sources of non-taxable interest income for PennRock are from interest earned on municipal bonds, dividends from Fannie Mae and Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock and, to a smaller degree, from loans which qualify for tax-exempt status. The dividends earned on Fannie Mae and FHLMC preferred stock are 70% tax-free.
		Table 2 presents the average balances, taxable equivalent interest income and expense and rates for PennRock’s assets and liabilities for the three and nine months ended June 30, 2004 and 2003.
		Net interest income earned in the third quarter of 2004 increased from the third quarter of last year even though the yield on earning assets declined and funding costs increased. For the third quarter and first nine months of 2004, both net interest spread and net interest margin declined.

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TABLE 2 — AVERAGE BALANCES, RATES, AND INTEREST INCOME AND EXPENSE
(Taxable equivalent basis)

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PennRock Financial Services Corp. and Subsidiaries

Comparing the third quarter of 2004 with the second quarter of 2004:

Although the Federal Reserve raised interest rate 50 percentage points in the third quarter of 2004, the yield on earning assets declined from 5.39% in the second quarter of 2004 to 5.35% in the third quarter. Yields earned on securities available for sale increased from 3.92% to 4.10% in the third quarter while yields on loans decreased from 6.05% to 5.92%. Although the yield on new loans increased from 5.29% for new loans recorded during the second quarter of 2004 to 6.06% for new loans recorded in the third quarter, the fees realized from these new loans declined from $628,000 in the second quarter to $289,000 in the third quarter due to the decrease in new loan volume. New loans totaled $110 million in the second quarter and $68 million in the third quarter. The amount of fees earned is included in the calculation of loan yields.

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		The rate paid on interest bearing deposits increased from 2.02% in the second quarter of 2004 to 2.17% in the third quarter. The rate paid on time deposits increased from 2.44% to 2.76% while the rate paid on short-term borrowings increased from 1.14% to 1.56%.
		The interest rate spread declined from 3.37% to 3.18%, while the net interest margin declined 3.72% to 3.54% during the third quarter.
		Comparing the third quarter of 2004 with the third quarter of 2003:
		The yield on earning assets declined from 5.52% during the third quarter of 2003 to 5.35% in the third quarter of 2004. Although the yield on securities available for sale increased from 3.53% to 4.10% in the third quarter of 2004, the yield on loans declined from 6.46% to 5.92%. The cost of interest bearing liabilities increased from 2.04% to 2.17%. Interest bearing deposit costs increased from 1.75% to 1.87% while the rate paid on short-term borrowings increased from 1.12% to 1.56%. The interest rate spread decreased from 3.47% to 3.18% and the net interest margin decreased from 3.79% to 3.54%.
		Comparing the first nine months of 2004 with the first nine months of 2003:
		The yield on earning assets declined from 5.84% in the first nine months of 2003 to 5.38% for the first nine months of 2004. The yield on securities available for sale increased from 3.88% to 4.06% and the yield on loans declined from 6.81% to 5.99%. The cost of interest bearing liabilities decreased from 2.25% to 2.07%. Interest bearing deposit costs decreased from 1.80% to 1.77%, the rate paid on short-term borrowings increased from 1.17% to 1.29% and the rate paid on long-term debt decreased from 5.36% to 4.81%. The interest rate spread decreased from 3.59% to 3.31% and the net interest margin decreased from 3.93% to 3.66%.
		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.

TABLE 3 — VOLUME AND RATE ANALYSIS OF CHANGES IN INTEREST INCOME
(Taxable equivalent basis)

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		The average balance of interest-earning assets in the third quarter of 2004 grew $84.0 million over the third quarter of 2003 while the average yield declined 17 percentage points. The volume increase generated $1.2 million of additional interest income which was reduced by $514,000 with the decline in yield. Total interest income for the third quarter of 2004 increased by $715,000 over the third quarter of 2003.
		The average balance of interest bearing liabilities in the third quarter of 2004 grew $61.8 million over the third quarter of 2003 while the rate paid increased 13 percentage points. The volume increase caused interest expense to increase $273,000 and the increase in the rate paid increased interest expense $325,000. Total interest expense for the third quarter of 2004 increased $598,000 over the third quarter of 2003.
		For the third quarter of 2004 over the third quarter of 2003, net interest income increased $956,000 due to volume increases and declined $839,000 due to changes in rates. Total net interest income increased $117,000.
		The average balance of interest-earning assets for the first nine months of 2004 grew $93.2 million over the first nine months of 2003 while the average yield declined 46 percentage points. The volume increase generated $4.5 million of additional interest income which was reduced by $3.8 million with the decline in yield. Total interest income for the nine months of 2004 increased by $673,000 over the first nine months of 2003.
		The average balance of interest bearing liabilities in the third quarter of 2004 grew $63.0 million over the third quarter of 2003 while the rate paid decreased 18 percentage points. The volume increase caused interest expense to increase $458,000 while the decrease in the rate paid decreased interest expense $492,000. Total interest expense for the first nine months of 2004 decreased $34,000 from the first nine months of 2003.
		For the first nine months of 2004 over the first nine months of 2003, net interest income increased $4.1 million due to volume increases and declined $3.4 million due to changes in rates. Total net interest income increased $707,000.

NON-INTEREST INCOME

Table 4 indicates changes in the major categories of non-interest income for the three and nine months ended September 30, 2004 and 2003. PennRock generates non-interest income in connection with fees charged on deposits and other products, asset management 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.

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TABLE 4 — NON-INTEREST INCOME