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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
Incorporated pursuant to the laws of Pennsylvania
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Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on April 25, 2003 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
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Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
March 31, 2003................................................3
December 31, 2002.............................................3
Statements of Income:
Three Months Ended March 31, 2003.............................4
Three Months Ended March 31, 2002.............................4
Statements of Cash Flows:
Three Months Ended March 31, 2003.............................5
Three Months Ended March 31, 2002.............................5
Notes to Financial Statements...................................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......17
Item 4. Disclosure Controls and Procedures...............................17
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................18
Item 2. Changes in Securities and Use of Proceeds........................18
Item 3. Defaults Upon Senior Securities..................................18
Item 4. Submission of Matters to a Vote of Security Holders..............18
Item 5. Other Information................................................18
Item 6. Exhibits and Reports on Form 8-K.................................18
Certifications...........................................................18
Signatures...............................................................18
PART I. FINANCIAL INFORMATION, Item 1-- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
March 31, December 31,
2003 2002
--------------- ---------------
ASSETS
Cash and due from banks $ 10,585 $ 11,120
Interest bearing balances with banks 154 10,424
Federal funds sold - 33,075
--------------- ---------------
Cash and Cash Equivalents 10,739 54,619
Investment securities:
Available-for-sale, at fair value 108,573 108,083
Held-to-maturity (fair value of $166,576
and $32,986, respectively) 164,573 31,049
--------------- ---------------
Total Investment Securities 273,146 139,132
Loans, net of unearned income 282,514 288,856
Less: Allowance for loan losses 3,300 3,347
--------------- ---------------
Loans, Net 279,214 285,509
Bank premises and equipment 9,735 9,920
Other real estate owned 105 59
Accrued interest receivable 3,722 3,399
Other assets 4,729 4,318
--------------- ---------------
Total Assets $ 581,390 $ 496,956
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 73,858 $ 78,560
Interest bearing 323,902 336,104
--------------- ---------------
Total Deposits 397,760 414,664
Other borrowed funds:
Repurchase agreements 18,312 19,419
Short-term borrowings 2,209 890
Long-term borrowings 100,000 -
Accrued interest payable 1,100 1,317
Other liabilities 2,334 1,691
--------------- ---------------
Total Liabilities 521,715 437,981
--------------- ---------------
STOCKHOLDERS' EQUITY
Common stock ($ .01 par value, 15,000,000 shares
authorized, 2,148,000 shares issued and outstanding) 21 21
Surplus 10,819 10,819
Retained earnings 45,975 45,060
Accumulated other comprehensive income 2,860 3,075
--------------- ---------------
Total Stockholders' Equity 59,675 58,975
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 581,390 $ 496,956
=============== ===============
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
INTEREST INCOME
Interest and fees on loans $ 4,209 $ 5,488
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 1,430 1,303
States & political subdivisions 636 443
Other securities 22 24
Interest on Federal funds sold 52 12
Interest on balances with banks 13 16
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Total Interest Income 6,362 7,286
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INTEREST EXPENSE
Interest on time deposits of $100,000 or more 256 397
Interest on other deposits 1,167 1,641
Interest on other borrowed funds 253 75
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Total Interest Expense 1,676 2,113
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Net Interest Income 4,686 5,173
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Provision for loan losses 239 179
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Net Interest Income After Provision for Loan Losses 4,447 4,994
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OTHER INCOME
Trust department income 315 294
Service charges on deposit accounts 277 268
Merchant transaction income 1,488 1,690
Other fee income 284 218
Other operating income 382 214
Realized gains (losses) on securities, net - -
------------------ ------------------
Total Other Income 2,746 2,684
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OTHER EXPENSES
Salaries and employee benefits 2,202 2,123
Expense of premises and fixed assets 691 667
Merchant transaction expenses 1,264 1,465
Other operating expenses 1,112 1,158
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Total Other Expenses 5,269 5,413
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Income before income taxes 1,924 2,265
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Applicable income taxes 365 576
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Net Income 1,559 1,689
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Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (215) (931)
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Comprehensive Income $ 1,344 $ 758
================== ==================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.73 $ 0.79
Cash Dividends Declared Per Common Share $ 0.30 $ 0.30
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
March 30, 2003 March 30, 2002
------------------ ------------------
OPERATING ACTIVITIES
Net Income $ 1,559 $ 1,689
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 317 310
Provision for loan losses 239 179
Deferred income tax provision (benefit) 175 84
Amortization of securities, (net of accretion) 83 35
Net realized (gains) losses on securities - -
Loss (gain) on other real estate - -
(Increase) decrease in interest receivable (323) (213)
(Increase) decrease in other assets (411) (619)
Increase (decrease) in income taxes payable 376 355
(Decrease) increase in interest payable (217) 51
Increase (decrease) in other liabilities 202 (116)
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Net cash provided by operating activities 2,000 1,755
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INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (5,852) (16,455)
Proceeds from investment securities available-for-sale 5,000 5,000
Purchase of investment securities to be held-to-maturity (133,749) -
Proceeds from repayments of investment securities to be held-to-maturity 179 318
Net loans repaid (originated) 6,010 (954)
Proceeds from other real estate - 38
Investment in premises and equipment (132) (123)
------------------ ------------------
Net cash (used) provided by investing activities (128,544) (12,176)
------------------ ------------------
FINANCING ACTIVITIES
Net (decrease) increase in demand and savings deposits (14,013) (4,325)
Net (payments) proceeds on time deposits (2,891) 5,435
Increase (decrease) in federal funds purchased - -
(Decrease) increase in repurchase agreements (1,107) (2,225)
Net increase (decrease) in short-term borrowings 1,319 2,303
Proceeds from long-term borrowings 100,000 -
Cash dividends paid (644) (644)
------------------ ------------------
Net cash provided (used) by financing activities 82,664 544
------------------ ------------------
Net (decrease) increase in cash and cash equivalents (43,880) (9,877)
Cash and cash equivalents at January 1 54,619 17,296
------------------ ------------------
Cash and cash equivalents at March 31 $ 10,739 $ 7,419
================== ==================
The Company paid interest and income taxes of $1,893 and $0 and $2,062 and $433,
for the three month periods ended March 31, 2003 and 2002, respectively.
Notes to CONSOLIDATED Financial Statements
For the Quarter Ended March 31, 2003
(unaudited)
These Notes to Financial Statements reflect events subsequent to December 31,
2002, the date of the most recent Report of Independent Auditors, through the
date of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2003.
These Notes to Financial Statements should be read in conjunction with Financial
Information and Other Information required to be furnished as part of this
Report, in particular, (1) Management's Discussion and Analysis of Financial
Condition and Results of Operations for the three months ended March 31, 2003
and March 31, 2002, with respect to the Company's capital requirements and
liquidity, (2) Part II, Item 6, Reports on Form 8-K and (3) the Company's Annual
Report - Form 10-K for the year ended December 31, 2002, incorporated herein by
reference.
NOTE 1 -- Principles of Consolidation
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated under the laws of Pennsylvania. It is the parent company of Penn
Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.
Intercompany transactions have been eliminated in preparing the consolidated
financial statements.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
NOTE 2 -- Basis of Presentation
The unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
In the opinion of management, all adjustments that are of a normal recurring
nature and are considered necessary for a fair presentation have been included.
They are not, however, necessarily indicative of the results of consolidated
operations for a full year.
For further information, refer to the consolidated financial statements and
accompanying notes included in the Company's Annual Report - Form 10-K for the
year ended December 31, 2002.
NOTE 3 -- Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowance for
losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
NOTE 4 -- Investment Securities
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity. Bonds, notes and debentures for which the Company
has the positive intent and ability to hold to maturity are reported at cost,
adjusted for amortization of premiums and accretion of discounts computed on the
straight-line basis, which approximates the interest method, over the remaining
period to maturity. Mortgage-backed securities are reported at cost, adjusted
for amortization of premium and accretion of discounts based on the estimated
percentage of principal remaining utilizing prepayment speeds estimated on the
purchase date, or actually experienced whichever is greater.
Securities Available-for-Sale. Bonds, notes, debentures, and certain equity
securities not classified as securities to be held-to-maturity are carried at
fair value with unrealized holding gains and losses, net of tax, reported as a
net amount in a separate component of stockholders' equity until realized.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific identification method and are reported as a
separate component of other income in the Statements of Income. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
The amortized cost and fair value of investment securities at March 31, 2003 and
December 31, 2002 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 30,074 $ 1,153 $ - $ 31,227
U.S. Agency securities 47,665 2,616 - 50,281
States & political subdivisions 20,153 467 37 20,583
- --------------------------------------------------------------------------------
Total Debt Securities 97,892 4,236 37 102,091
Equity securities 6,346 136 - 6,482
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 104,238 $ 4,372 $ 37 $ 108,573
- --------------------------------------------------------------------------------
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2002 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 35,098 $ 1,358 $ - $ 36,456
U.S. Agency securities 47,679 2,927 - 50,606
States & political subdivisions 19,431 361 127 19,665
- --------------------------------------------------------------------------------
Total Debt Securities 102,208 4,646 127 106,727
Equity securities 1,215 141 - 1,356
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 103,423 $ 4,787 $ 127 $ 108,083
- --------------------------------------------------------------------------------
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Agency Obligations:
Mortgage-backed securities $ 134,943 $ 1 $ 212 $ 134,732
States & political subdivisions 29,630 2,214 - 31,844
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 164,573 $ 2,215 $ 212 $ 166,576
- --------------------------------------------------------------------------------
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2002 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Agency Obligations:
Mortgage-backed securities $ 1,420 $ 8 $ 20 $ 1,408
States & political subdivisions 29,629 1,949 - 31,578
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 31,049 $ 1,957 $ 20 $ 32,986
- --------------------------------------------------------------------------------
The amortized cost and fair value of debt securities at March 30, 2003 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
March 31, 2003 Available-for-Sale Held-to-Maturity
- ------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- ------------------------------------------------------------------------------------
Due in one year or less:
U.S. Treasury securities $ 20,078 $ 20,366 $ - $ -
U.S. Agency securities 14,900 15,309 - -
After one year through five years:
U.S. Treasury securities 9,996 10,861 - -
U.S. Agency securities 32,765 34,972 - -
After ten years:
States & political subdivisions 20,153 20,583 29,630 31,844
- ------------------------------------------------------------------------------------
Subtotal 97,892 102,091 29,630 31,844
Mortgage-backed securities - - 134,943 134,732
- ------------------------------------------------------------------------------------
Total Debt Securities $ 97,892 $ 102,091 $ 164,573 $ 166,576
- ------------------------------------------------------------------------------------
NOTE 5 -- Long-Term Debt
During the quarter ended March 31, 2003, the Bank borrowed $100,000 from the
Federal Home Loan Bank, in four loans with various maturity dates, to finance
the purchase of a mortgaged-backed security.
The loans are secured by a general collateral pledge of the Company.
A summary of the long-term debt at March 31, 2003 is as follows:
Note payable, due in monthly installments of $161,
including principal and interest at a fixed rate
of 2.73%, maturing March, 2008. $ 9,000
Note payable, due in monthly installments of $253,
including principal and interest at a fixed rate
of 3.22%, maturing March, 2010. 19,000
Note payable, due in monthly installments of $430,
including principal and interest at a fixed rate
of 3.74%, maturing March, 2013. 43,000
Note payable, due in monthly installments of $186,
including principal and interest at a fixed rate
of 4.69%, maturing March, 2023. 29,000
---------
Total long-term debt $ 100,000
=========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at March 31, 2003 are as follows:
March 31, Principal
---------- -----------
2004 $ 8,673
2005 8,981
2006 9,301
2007 9,631
2008 9,974
Thereafter 53,440
-----------
$ 100,000
===========
NOTE 6 -- Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgements by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table on the following page) of Tier I and Total
Capital to risk-weighted assets and of Tier I Capital to average assets
(Leverage ratio). The table also presents the Company's actual capital amounts
and ratios. The Bank's actual capital amounts and ratios are substantially
identical to the Company's. Management believes, as of March 31, 2003, that the
Company and the Bank meet all capital adequacy requirements to which they are
subject.
As of March 31, 2003, the most recent notification from the Federal Deposit
Insurance Corporation (FDIC) categorized the Company as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"well capitalized", the Company must maintain minimum Tier I Capital, Total
Capital and Leverage ratios as set forth in the Capital Adequacy table. There
are no conditions or events since that notification that management believes
have changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels, which could
limit the payment of dividends, although the Company and Bank currently have
capital levels, which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the Retained Earnings of the Bank. Accordingly, at March 31, 2003,
the balances in the Capital Stock and Surplus accounts totalling $10,840 are
unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
Actual Regulatory Requirements
- ---------------------------------------------- -------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of March 31, 2003 Amount Ratio Amount Ratio Amount Ratio
- ---------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 59,756 20.22% > $ 23,646 > 8.0% > $ 29,558 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 56,456 19.10% > $ 11,823 > 4.0% > $ 17,735 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 56,456 11.25% > $ * > * > $ 25,091 > 5.0%
- - - -
*3.0% ($15,055), 4.0% ($20,073) or 5.0% ($25,091) depending on the bank's CAMELS
Rating and other regulatory risk factors.
As of December 31, 2002
- ---------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 59,020 17.99% > $ 26,250 > 8.0% > $ 32,813 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 55,673 16.97% > $ 13,125 > 4.0% > $ 19,688 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 55,673 11.26% > $ * > * > $ 24,717 > 5.0%
- - - -
*3.0% ($14,830), 4.0% ($19,774) or 5.0% ($24,717) depending on the bank's CAMELS
Rating and other regulatory risk factors.
PART 1. FINANCIAL INFORMATION, Item 2--
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following commentary provides an overview of the financial condition and
significant changes in the results of operations of Penseco Financial Services
Corporation and it's subsidiary, Penn Security Bank and Trust Company, for the
three months ended March 31, 2003 and March 31, 2002. Throughout this review,
the subsidiary of Penseco Financial Services Corporation, Penn Security Bank and
Trust Company, is referred to as the "Company". All intercompany accounts and
transactions have been eliminated in preparing the consolidated financial
statements. All information is presented in thousands of dollars, except as
indicated.
Overview of Financial Condition
Penseco Financial Services Corporation reported net income of $1,559 for three
months ended March 31, 2003, a decrease of $130 or 7.7% from the $1,689 reported
for the extraordinary first quarter of 2002, which had been 55.2% ahead of the
2001 first quarter. The decrease in earnings in the first quarter of 2003 is
attributed to lower net interest income, due principally to consumers
refinancing higher fixed-rate residential mortgage loans, which were then sold
in the secondary market, partially offset by an increase in other income and a
decrease in applicable income taxes.
Net Interest Income and Net Interest Margin
Net interest income, the largest contributor to the Company's earnings, is
defined as the difference between interest income on assets and the cost of
funds supporting those assets. Earning assets are composed primarily of loans
and investments while deposits, short-term and long-term borrowings represent
interest-bearing liabilities. Variations in the volume and mix of these assets
and liabilities, as well as changes in the yields earned and rates paid, are
determinants of changes in net interest income.
Net interest income after provision for loan losses decreased $547 or 11.0%,
from $4,994 for the first quarter of 2002 to $4,447 in 2003, the net result of a
lower net interest margin. This is largely due to the refinancing of fixed-rate
loans (subsequently sold into the secondary market) as customers take advantage
of interest rates at 40 year lows, somewhat offset by higher securities
portfolio income along with decreased interest costs on deposits.
The net interest margin represents the Company's net yield on its earning assets
and is calculated as net interest income divided by average earning assets. In
the first three months of 2003, the net interest margin was 3.91%, decreasing 55
basis points from 4.46% in the same period of 2002; the result of the confluence
of interest rates hovering at 40 year lows, mainly due to the sluggish economy
and uncertain geopolitical conditions.
Total average earning assets and average interest bearing funds increased in the
first quarter of 2003 as compared to 2002. Average earning assets increased
$16.1 million or 3.5%, from $463.8 million in 2002 to $479.9 million in 2003 and
average interest bearing funds increased $4.3 million, or 1.2%, from $360.4
million to $364.7 million for the same periods. As a percentage of average
assets, earning assets increased from 95.4% in the first quarter of 2002 to
95.6% in 2003. Average interest bearing funding sources decreased from 74.2% in
2002 to 72.7% of total funding sources in the first quarter of 2003.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the first quarter of both 2003 and 2002; however, the changes
in the mix of earning assets were more significant than the change in the
composition of funding sources. Average loans as a percentage of average earning
assets decreased from 70.4% in 2002 to 60.1% in 2003. Average investment
securities increased $38.7 million from 27.4% in 2002 to 34.5% in 2003.
Transaction accounts increased $3.3 million from 50.9% in 2002 to 51.2% in 2003
of interest bearing liabilities. Time deposits decreased $16.4 million from
44.0% in 2002 to 38.9% in 2003. Short-term and long-term borrowings, as well as
repurchase agreements, increased as a percentage of funding sources from 5.2% in
2002 to 9.8% in 2003.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. The investment
securities tax equivalent yield increased 16 basis points from 5.66% in the
first quarter of 2002 to 5.82% for 2003. Also, average loan yields decreased 90
basis points, from 6.74% in the first three months of 2002 to 5.84% in 2003. The
average time deposit costs decreased from 3.88% in 2002 to 2.92% in 2003, and
transaction accounts decreased 34 basis points from 1.17% in 2002 to .83% in
2003. This is the primary cause for the decrease in the total cost of funds from
2.34% in 2002 to 1.84% in 2003.
Most significant in the change in net interest income has been from the
reduction in our loan portfolio due to the refinancing of higher rate,
long-term, fixed-rate real estate loans, which were then sold into the secondary
market. A gain in the sale of mortgage loans partially offset the decline in net
interest income
In order to supplement net interest income, $100,000 in funds were borrowed on
March 13,2003 in four separate borrowings amortizing over 5, 7, 10 and 20 year
periods. These funds were used to purchase $100,000 worth of a pool of 20 year
mortgages guaranteed by Federal Home Loan Mortgage Corporation (Freddie Mac). It
is anticipated that this transaction will result in an additional $750,000 in
net interest income for the balance of the current year with a net margin of 1%
for this year, declining to .8% in the tenth year and for every year thereafter.
The borrowing was structured so as to fully fund the remaining balance of the
mortgage pool even if rates were to increase several hundred basis points.
Distribution of Assets, Liabilities and Stockholders' Equity / Interest Rates
and Interest Differential
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the three months ended
March 31, 2003 and March 31, 2002.
- --------------------------------------------------------------------------------------------------------------
March 31, 2003 March 31, 2002
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- --------------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 36,447 $ 365 4.01% $ 36,603 $ 451 4.93%
U.S. Agency obligations 50,375 694 5.51% 55,363 832 6.01%
States & political subdivisions 20,313 226 6.74% 3,972 49 7.48%
Federal Home Loan Bank stock 1,982 18 3.63% 1,911 21 4.40%
Other 399 4 4.01% 269 3 1.12%
Held-to-maturity:
U.S. Agency obligations - GNMA 10,790 117 4.34% 2,239 20 3.57%
U.S. Agency obligations - FHLMC 15,849 254 6.41% - - -
States & political subdivisions 29,629 410 8.39% 29,741 394 8.03%
Loans, net of unearned income:
Real estate mortgages 217,084 3,320 6.12% 252,752 4,348 6.88%
Commercial 31,414 377 4.80% 32,342 472 5.84%
Consumer and other 39,712 511 5.15% 41,413 668 6.45%
Federal funds sold 20,514 52 1.01% 2,963 12 1.62%
Interest on balances with banks 5,406 14 1.04% 4,267 16 1.50%
- --------------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income 479,914 $ 6,362 5.30% 463,835 $ 7,286 6.28%
- --------------------------------------------------------------------------------------------------------------
Cash and due from banks 7,972 7,894
Bank premises and equipment 9,866 10,758
Accrued interest receivable 3,093 3,454
Other assets 4,323 3,649
Less: Allowance for loan losses 3,346 3,597
- --------------------------------------------------------------------------------------------------------------
Total Assets $ 501,822 $ 485,993
- --------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 26,142 $ 43 0.66% $ 26,083 $ 42 0.64%
Savings 74,322 136 0.73% 68,777 183 1.06%
Money markets 86,347 209 0.97% 88,619 313 1.41%
Time - Over $100 33,961 256 3.02% 40,325 397 3.94%
Time - Other 108,006 779 2.89% 118,032 1,103 3.74%
Federal funds purchased - - - - - -
Repurchase agreements 18,712 43 0.92% 17,674 71 1.61%
Short-term borrowings 1,793 8 1.78% 926 4 1.73%
Long-term borrowings 15,385 202 5.25% - - -
- --------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 364,668 $ 1,676 1.84% 360,436 $ 2,113 2.34%
- --------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 74,807 66,728
All other liabilities 2,853 3,242
Stockholders' equity 59,494 55,587
- --------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 501,822 $ 485,993
- --------------------------------------------------------------------------------------------------------------
Interest Spread 3.46% 3.94%
- --------------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,686 $ 5,173
- --------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.91% 4.46%
Return on average assets 1.24% 1.39%
Return on average equity 10.48% 12.15%
Average equity to average assets 11.86% 11.44%
Dividend payout ratio 41.10% 37.97%
- --------------------------------------------------------------------------------------------------------------
Provision for Loan Losses
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio. The process of determining the adequacy of the
allowance is necessarily judgmental and subject to changes in external
conditions. The allowance for loan losses reflects management's judgment as to
the level considered appropriate to absorb such losses based upon a review of
many factors, including historical loss experience, adverse situations that may
affect the borrower's ability to repay (including the timing of future
payments), economic conditions and trends, loan portfolio volume and mix, loan
performance trends, the value and adequacy of collateral, and the Company's
internal credit review process. Accordingly, there can be no assurance that
existing levels of the allowance will ultimately prove adequate to cover actual
loan losses. The quarterly provision for loan losses charged to operating
expense is that amount which is sufficient to bring the balance of the allowance
for possible loan losses to an adequate level to absorb anticipated losses.
Based on this ongoing evaluation, management determines the provision necessary
to maintain an appropriate allowance.
In the three months ended March 31, 2003, the provision for loan losses was
$239, an increase from $179 in the three months ended March 31, 2002. Loans
charged-off totaled $287 and recoveries were $1 for the three months ended March
31, 2003. In the same period of 2002, loans charged off were $29.
Other Income
The following table sets forth information by category of other income for the
Company for three months ended March 31, 2003 and March 31, 2002, respectively:
March 31, March 31,
Three Months Ended: 2003 2002
- ----------------------------------------------------------------------
Trust department income $ 315 $ 294
Service charges on deposit accounts 277 268
Merchant transaction income 1,488 1,690
Other fee income 284 218
Other operating income 382 214
Realized losses on securities, net - -
- ----------------------------------------------------------------------
Total Other Income $ 2,746 $ 2,684
- ----------------------------------------------------------------------
For the first quarter of 2003, total other income increased $62 or 2.3% to
$2,746 from $2,684. Trust department income increased $21 or 7.1% due to
increased business. Merchant transaction income decreased $202 or 12.0% from the
first quarter of 2002 to $1,488 from $1,690, the result of a large university
discontinuing acceptance of tuition payments via credit cards, along with
customers postponing purchases due to the sluggish economy. Other fee income
increased $66 or 30.3%, mostly due to increases in cardholder discounts and fee
income on mortgage loans serviced for others. Other operating income grew $168
or 78.5%, which included gains on the sale of new and refinanced fixed-rate
residential real estate loans of $265, which was partially offset by a decrease
in brokerage income of $85, largely due to the general stock market malaise.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended March 31, 2003 and March 31, 2002,
respectively:
March 31, March 31,
Three Months Ended: 2003 2002
- ----------------------------------------------------------------------
Salaries and employee benefits $ 2,202 $ 2,123
Expense of premises and fixed assets 691 667
Merchant transaction expenses 1,264 1,465
Other operating expenses 1,112 1,158
- ----------------------------------------------------------------------
Total Other Expenses $ 5,269 $ 5,413
- ----------------------------------------------------------------------
Other expenses decreased $144 or 2.7% to $5,269, in the first three months of
2003 as compared to $5,413 in the same period of 2002. Salaries and benefits
increased $79 or 3.7% due primarily to increased pension expense. Merchant
transaction expenses decreased $201 or 13.7% due to a large university
discontinuing acceptance of tuition payments via credit cards, along with
consumers postponing purchases due to the sluggish economy. Other operating
expenses decreased $46 or 4.0% to $1,112 from $1,158.
Loan Portfolio
Details regarding the Company's loan portfolio:
March 31, December 31,
As Of: 2003 2002
- -----------------------------------------------------------------------------
Real estate - construction and land development $ 3,436 $ 5,031
Real estate mortgages 206,986 217,883
Commercial 32,649 30,077
Credit card and related plans 2,248 2,320
Installment 26,625 27,306
Obligations of states & political subdivisions 10,570 6,239
- -----------------------------------------------------------------------------
Loans, net of unearned income 282,514 288,856
Less: Allowance for loan losses 3,300 3,347
- -----------------------------------------------------------------------------
Loans, net $ 279,214 $ 285,509
- -----------------------------------------------------------------------------
Loan Quality
The comprehensive lending policy established by the Board of Directors guides
the lending activities of the Company. Loans must meet criteria, which include
consideration of the character, capacity and capital of the borrower, collateral
provided for the loan, and prevailing economic conditions.
Regardless of credit standards, there is risk of loss inherent in every loan
portfolio. The allowance for loan losses is an amount that management believes
will be adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of the loans. The
evaluations take into consideration such factors as change in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, industry experience, collateral value and current economic
conditions that may affect the borrower's ability to pay. Management believes
that the allowance for loan losses is adequate. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
The allowance for loan losses is increased by periodic charges against earnings
as a provision for loan losses, and decreased periodically by charge-offs of
loans (or parts of loans) management has determined to be uncollectible, net of
actual recoveries on loans previously charged-off.
Non-Performing Assets
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned. The following
table sets forth information regarding non-performing assets as of the dates
indicated:
March 31, December 31, March 31,
As Of: 2003 2002 2002
- --------------------------------------------------------------------------------------
Non-accrual loans $ 1,935 $ 2,245 $ 2,116
Loans past due 90 days or more and accruing:
Guaranteed student loans 381 394 335
Credit card and home equity loans 22 - 5
- --------------------------------------------------------------------------------------
Total non-performing loans 2,338 2,639 2,456
Other real estate owned 105 59 195
- --------------------------------------------------------------------------------------
Total non-performing assets $ 2,443 $ 2,698 $ 2,651
- --------------------------------------------------------------------------------------
Loans are generally placed on a non-accrual status when principal or interest is
past due 90 days or when payment in full is not anticipated. When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is charged against current income. Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,935 and $2,116 at March 31, 2003 and March 31, 2002, respectively. If
interest on those loans had been accrued, such income would have been $194 and
$166 for the three months ended March 31, 2003 and March 31, 2002, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $5 and $9 for March 31, 2003 and March 31, 2002, respectively. There are no
commitments to lend additional funds to individuals whose loans are in
non-accrual status.
The management process for evaluating the adequacy of the allowance for loan
losses includes reviewing each month's loan committee reports, which list all
loans that do not meet certain internally developed criteria as to collateral
adequacy, payment performance, economic conditions and overall credit risk.
These reports also address the current status and actions in process on each
listed loan. From this information, adjustments are made to the allowance for
loan losses. Such adjustments include both specific loss allocation amounts and
general provisions by loan category based on present and past collection
experience, nature and volume of the loan portfolio, overall quality, and
current economic conditions that may affect the borrower's ability to pay. As of
March 31, 2003 there are no significant loans as to which management has serious
doubt about their collectibility other than what is included above.
At March 31, 2003 and December 31, 2002, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
Loan Loss Experience
The following tables present the Company's loan loss experience during the
periods indicated:
March 31, March 31,
Three Months Ended: 2003 2002
- ------------------------------------------------------------------------------
Balance at beginning of period $ 3,347 $ 3,600
Charge-offs:
Real estate mortgages - 25
Commercial and all others 277 -
Credit card and related plans 7 4
Installment loans 3 -
- ------------------------------------------------------------------------------
Total charge-offs 287 29
- ------------------------------------------------------------------------------
Recoveries:
Real estate mortgages - -
Commercial and all others - -
Credit card and related plans 1 -
Installment loans - -
- ------------------------------------------------------------------------------
Total recoveries 1 -
- ------------------------------------------------------------------------------
Net charge-offs (recoveries) 286 29
- ------------------------------------------------------------------------------
Provision charged to operations 239 179
- ------------------------------------------------------------------------------
Balance at End of Period $ 3,300 $ 3,750
- ------------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.099% 0.009
- ------------------------------------------------------------------------------
Due to the continuing economic uncertainties, management believes the allowance
for loan losses is considered adequate based on its methodology. The allowance
for loan losses, as a percentage of total loans, stands at 1.2% at March 31,
2003 and March 31, 2002, respectively.
The allowance for loan losses is allocated as follows:
As Of: March 31, 2003 December 31, 2002 March 31, 2002
- --------------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- --------------------------------------------------------------------------------------
Real estate mortgages $ 1,500 74% $ 1,600 77% $ 1,700 77%
Commercial and all others 1,275 15% 1,222 13% 1,525 13%
Credit card and related plans 175 1% 175 1% 175 1%
Personal installment loans 350 10% 350 9% 350 9%
- --------------------------------------------------------------------------------------
Total $ 3,300 100% $ 3,347 100% $ 3,750 100%
- --------------------------------------------------------------------------------------
* Percent of loans in each category to total loans
Liquidity
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Treasury and U.S. Agency
bond portfolios, additional deposits, earnings, overnight loans to and from
other companies (Federal Funds) and lines of credit at the Federal Reserve Bank
and the Federal Home Loan Bank. The Company is not a party to any commitments,
guarantees or obligations that could materially affect its liquidity.
Commitments And Contingent Liabilities
In the normal course of business, there are outstanding commitments and
contingent liabilities, created under prevailing terms and collateral
requirements such as commitments to extend credit, financial guarantees and
letters of credit, which are not reflected in the accompanying Financial
Statements. The Company does not anticipate any losses as a result of these
transactions. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
Related Parties
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. The Bank has issued a standby letter of
credit for the account of a related party in the amount of $6,353.
Capital Resources
A strong capital position is important to the continued profitability of the
Company and promotes depositor and investor confidence. The Company's capital
provides a basis for future growth and expansion and also provides additional
protection against unexpected losses.
Additional sources of capital would come from retained earnings from the
operations of the Company and from the sale of additional common stock.
Management has no plans to offer additional common stock at this time.
The Company's total risk-based capital ratio was 20.22% at March 31, 2003. The
Company's risk-based capital ratio is more than the 10.00% ratio that Federal
regulators use as the "well capitalized" threshold. This is the current criteria
which the FDIC uses in determining the lowest insurance rate for deposit
insurance. The Company's risk-based capital ratio is more than double the 8.00%
limit which determines whether a company is "adequately capitalized". Under
these rules, the Company could significantly increase its assets and still
comply with these capital requirements without the necessity of increasing its
equity capital.
PART 1. FINANCIAL INFORMATION, Item 3--
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises principally from interest rate risk inherent in
its lending, deposit and borrowing activities. Management actively monitors and
manages its interest rate risk exposure. Although the Company manages other
risks, such as credit quality and liquidity risk in the normal course of
business, management considers interest rate risk to be its most significant
market risk and the risk that could potentially have the largest material effect
on the Company's financial condition and results of operations. Other types of
market risks such as foreign currency exchange risk and commodity price risk do
not arise in the normal course of community banking activities.
Achieving consistent growth in net interest income is the primary goal of the
Company's asset/liability function. The Company attempts to control the mix and
maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates. The Company seeks to
accomplish this goal while maintaining adequate liquidity and capital. A
continuation of historically low interest rates will most likely affect
negatively the Company's net interest income. The Company continues to evaluate
its mix of assets and liabilities in response to the changing economy.
PART 1. FINANCIAL INFORMATION, Item 4--
DISCLOSURE CONTROLS AND PROCEDURES
Based on the Company's principal executive officer, Otto P. Robinson, Jr.,
President and the Company's principal financial officer, Patrick Scanlon,
Controller, evaluations of the Company's Disclosure Controls and Procedures as
of May 13, 2003 (evaluation date), they have concluded that the Company's
disclosure controls are effective, reasonably ensure that material information
relating to the Company and its consolidated subsidiaries is made known to them
by others within those entities, particularly during the period in which this
report is being prepared, and identify significant deficiencies or material
weaknesses in internal controls which could adversely affect the Company's
ability to record, process, summarize and report financial data.
Based on information available to them, they are not aware of significant
deficiencies or material weaknesses in the Company's internal control system.
Based on information available to them, they are not aware of any significant
changes made in internal controls or in other factors that could significantly
affect those controls subsequent to May 13, 2003 (evaluation date) and prior to
the date of their certifications.
Based on information available to them, they are not aware of any fraud that
involves management or other employees of the Company.
Despite these and other controls and procedures, the Company's two hundred or so
employees process over 10 million financial transactions every year. The
Company's computer systems consist of some 17 million lines of code used in the
processing of this financial information. Financial accounting rules encompass
thousands of pages of instructions and contain many confusing and "gray" areas.
From time to time honest errors in the entry, processing, or reporting of this
information are discovered or a dishonest or disloyal employee surfaces.
Fortunately, in the past any such errors or discoveries have not been material
and therefore we have never had to restate the Company's financial results. The
probability is that we won't in the future, but the possibility does exist and
the certifications marked as exhibits 99.1, 99.2, 99.3 and 99.4 are made subject
to these contingencies.
PART II. OTHER INFORMATION
Item 1 -- Legal Proceedings
None.
Item 2 -- Changes in Securities and Use of Proceeds
None.
Item 3 -- Defaults Upon Senior Securities
None.
Item 4 -- Submission of Matters to a Vote of Security Holders
None.
Item 5 -- Other Information
None.
Item 6 -- Exhibits and Reports on Form 8-K
a. Exhibits
99.1 Certification by the President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
99.2 Certification by the Controller pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
99.3 Certification by the President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.4 Certification by the Controller pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended March 31, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENSECO FINANCIAL SERVICES CORPORATION
By /s/ RICHARD E. GRIMM
------------------------------
Richard E. Grimm
Executive Vice-President
Dated: May 15, 2003
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: May 15, 2003