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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 June 30, 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 July 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:
June 30, 2003............................................. 3
December 31, 2002......................................... 3
Statements of Income:
Three Months Ended June 30, 2003.......................... 4
Three Months Ended June 30, 2002.......................... 4
Six Months Ended June 30, 2003............................ 5
Six Months Ended June 30, 2002............................ 5
Statements of Cash Flows:
Six Months Ended June 30, 2003............................ 6
Six Months Ended June 30, 2002............................ 6
Notes to Financial Statements................................ 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 21
Item 4. Disclosure Controls and Procedures............................... 21
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................ 22
Item 2. Changes in Securities and Use of Proceeds........................ 22
Item 3. Defaults Upon Senior Securities.................................. 22
Item 4. Submission of Matters to a Vote of Security Holders.............. 22
Item 5. Other Information................................................ 22
Item 6. Exhibits and Reports on Form 8-K................................. 22
Signatures............................................................... 23
Certifications........................................................... 24
PART I. FINANCIAL INFORMATION, Item 1-- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
June 30, December 31,
2003 2002
--------------- ---------------
ASSETS
Cash and due from banks $ 11,053 $ 11,120
Interest bearing balances with banks 6,628 10,424
Federal funds sold 26,000 33,075
--------------- ---------------
Cash and Cash Equivalents 43,681 54,619
Investment securities:
Available-for-sale, at fair value 102,778 108,083
Held-to-maturity (fair value of $164,374
and $32,986, respectively) 160,208 31,049
--------------- ---------------
Total Investment Securities 262,986 139,132
Loans, net of unearned income 261,982 288,856
Less: Allowance for loan losses 3,500 3,347
--------------- ---------------
Loans, Net 258,482 285,509
Bank premises and equipment 10,285 9,920
Other real estate owned 419 59
Accrued interest receivable 3,676 3,399
Other assets 5,254 4,318
--------------- ---------------
Total Assets $ 584,783 $ 496,956
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 73,560 $ 78,560
Interest bearing 330,146 336,104
--------------- ---------------
Total Deposits 403,706 414,664
Other borrowed funds:
Repurchase agreements 18,794 19,419
Short-term borrowings 887 890
Long-term borrowings 97,860 -
Accrued interest payable 1,079 1,317
Other liabilities 1,845 1,691
--------------- ---------------
Total Liabilities 524,171 437,981
--------------- ---------------
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 46,915 45,060
Accumulated other comprehensive income 2,857 3,075
--------------- ---------------
Total Stockholders' Equity 60,612 58,975
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 584,783 $ 496,956
=============== ===============
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
June 30, 2003 June 30, 2002
---------------------- ----------------------
INTEREST INCOME
Interest and fees on loans $ 3,833 $ 5,326
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 2,491 1,244
States & political subdivisions 646 584
Other securities 33 19
Interest on Federal funds sold 37 18
Interest on balances with banks 27 21
---------------------- ----------------------
Total Interest Income 7,067 7,212
---------------------- ----------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 218 366
Interest on other deposits 1,144 1,669
Interest on other borrowed funds 974 77
---------------------- ----------------------
Total Interest Expense 2,336 2,112
---------------------- ----------------------
Net Interest Income 4,731 5,100
Provision for loan losses 216 240
---------------------- ----------------------
Net Interest Income After Provision for Loan Losses 4,515 4,860
---------------------- ----------------------
OTHER INCOME
Trust department income 321 352
Service charges on deposit accounts 288 284
Merchant transaction income 924 920
Other fee income 311 239
Other operating income 501 183
Realized gains (losses) on securities, net - -
---------------------- ----------------------
Total Other Income 2,345 1,978
---------------------- ----------------------
OTHER EXPENSES
Salaries and employee benefits 2,198 2,217
Expense of premises and fixed assets 631 628
Merchant transaction expenses 795 794
Other operating expenses 1,216 1,173
---------------------- ----------------------
Total Other Expenses 4,840 4,812
---------------------- ----------------------
Income before income taxes 2,020 2,026
Applicable income taxes 435 459
---------------------- ----------------------
Net Income 1,585 1,567
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (3) 1,234
---------------------- ----------------------
Comprehensive Income $ 1,582 $ 2,801
====================== ======================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.73 $ 0.73
Cash Dividends Declared Per Common Share $ 0.30 $ 0.30
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Six Months Ended Six Months Ended
June 30, 2003 June 30, 2002
---------------------- ----------------------
INTEREST INCOME
Interest and fees on loans $ 8,042 $ 10,814
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 3,921 2,547
States & political subdivisions 1,282 1,027
Other securities 55 43
Interest on Federal funds sold 89 30
Interest on balances with banks 40 37
---------------------- ----------------------
Total Interest Income 13,429 14,498
---------------------- ----------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 474 763
Interest on other deposits 2,311 3,310
Interest on other borrowed funds 1,227 152
---------------------- ----------------------
Total Interest Expense 4,012 4,225
---------------------- ----------------------
Net Interest Income 9,417 10,273
Provision for loan losses 455 419
---------------------- ----------------------
Net Interest Income After Provision for Loan Losses 8,962 9,854
---------------------- ----------------------
OTHER INCOME
Trust department income 636 646
Service charges on deposit accounts 565 552
Merchant transaction income 2,412 2,610
Other fee income 595 457
Other operating income 883 397
Realized gains (losses) on securities, net - -
---------------------- -------------------
Total Other Income 5,091 4,662
---------------------- -------------------
OTHER EXPENSES
Salaries and employee benefits 4,400 4,340
Expense of premises and fixed assets 1,322 1,295
Merchant transaction expenses 2,059 2,259
Other operating expenses 2,328 2,331
---------------------- -------------------
Total Other Expenses 10,109 10,225
---------------------- -------------------
Income before income taxes 3,944 4,291
Applicable income taxes 800 1,035
---------------------- -------------------
Net Income 3,144 3,256
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (218) 303
---------------------- -------------------
Comprehensive Income $ 2,926 $ 3,559
====================== ===================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 1.46 $ 1.52
Cash Dividends Declared Per Common Share $ 0.60 $ 0.60
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
Six Months Ended Six Months Ended
June 30, 2003 June 30, 2002
-------------------- --------------------
OPERATING ACTIVITIES
Net Income $ 3,144 $ 3,256
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 608 619
Provision for loan losses 455 419
Deferred income tax (benefit) provision (35) (72)
Amortization of securities, (net of accretion) 317 86
Net realized (gains) losses on securities - -
Loss (gain) on other real estate 6 -
(Increase) decrease in interest receivable (277) (202)
(Increase) decrease in other assets (936) (591)
Increase (decrease) in income taxes payable 56 90
(Decrease) increase in interest payable (238) 19
Increase (decrease) in other liabilities 245 (403)
-------------------- --------------------
Net cash provided by operating activities 3,345 3,221
-------------------- --------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (5,852) (20,192)
Proceeds from investment securities available-for-sale 10,756 10,000
Purchase of investment securities to be held-to-maturity (133,749) -
Proceeds from repayments of investment securities to be held-to-maturity 4,344 588
Net loans repaid (originated) 26,206 1,233
Proceeds from other real estate - 143
Investment in premises and equipment (973) (186)
-------------------- --------------------
Net cash (used) provided by investing activities (99,268) (8,414)
-------------------- --------------------
FINANCING ACTIVITIES
Net (decrease) increase in demand and savings deposits (6,787) 9,440
Net (payments) proceeds on time deposits (4,171) 1,486
Increase (decrease) in federal funds purchased - -
(Decrease) increase in repurchase agreements (625) 1,215
Net (decrease) increase in short-term borrowings (3) 856
Proceeds from long-term borrowings 100,000 -
Repayments of long-term borrowings (2,140) -
Cash dividends paid (1,289) (1,289)
-------------------- --------------------
Net cash provided (used) by financing activities 84,985 11,708
-------------------- --------------------
Net (decrease) increase in cash and cash equivalents (10,938) 6,515
Cash and cash equivalents at January 1 54,619 17,296
-------------------- --------------------
Cash and cash equivalents at June 30 $ 43,681 $ 23,811
==================== ====================
The Company paid interest and income taxes of $4,250 and $755 and $4,206 and
$1,150, for the six month periods ended June 30, 2003 and 2002, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended June 30, 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 June 30, 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 June 30, 2003 and
June 30, 2002 and for the six months ended June 30, 2003 and June 30, 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 June 30, 2003 and
December 31, 2002 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 30,051 $ 991 $ - $ 31,042
U.S. Agency securities 42,652 2,306 - 44,958
States & political subdivisions 20,155 839 - 20,994
- --------------------------------------------------------------------------------
Total Debt Securities 92,858 4,136 - 96,994
Equity securities 5,590 194 - 5,784
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 98,448 $ 4,330 $ - $ 102,778
- --------------------------------------------------------------------------------
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
June 30, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Agency Obligations:
Mortgage-backed securities $ 130,668 $ 1,051 $ 16 $ 131,703
States & political subdivisions 29,540 3,131 - 32,671
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 160,208 $ 4,182 $ 16 $ 164,374
- --------------------------------------------------------------------------------
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 June 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.
June 30, 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 $ 20,055 $ 20,258 $ - $ -
U.S. Agency securities 17,453 17,981 - -
After one year through five years:
U.S. Treasury securities 9,996 10,784 - -
U.S. Agency securities 25,199 26,977 - -
After ten years:
States & political subdivisions 20,155 20,994 29,540 32,671
- ----------------------------------------------------------------------------------------------------
Subtotal 92,858 96,994 29,540 32,671
Mortgage-backed securities - - 130,668 131,703
- ----------------------------------------------------------------------------------------------------
Total Debt Securities $ 92,858 $ 96,994 $ 160,208 $ 164,374
- ----------------------------------------------------------------------------------------------------
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 June 30, 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. $ 8,579
Note payable, due in monthly installments of $253,
including principal and interest at a fixed rate
of 3.22%, maturing March, 2010. 18,392
Note payable, due in monthly installments of $430,
including principal and interest at a fixed rate
of 3.74%, maturing March, 2013. 42,109
Note payable, due in monthly installments of $186,
including principal and interest at a fixed rate
of 4.69%, maturing March, 2023. 28,780
--------
Total long-term debt $ 97,860
========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at June 30, 2003 are as follows:
June 30, Principal
----------- ---------
2004 $ 8,749
2005 9,060
2006 9,382
2007 9,716
2008 9,579
Thereafter 51,374
---------
$ 97,860
=========
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 below) 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 June 30, 2003, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of June 30, 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 June 30, 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 June 30, 2003 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 60,717 19.42% > $ 25,017 > 8.0% > $ 31,272 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 57,217 18.30% > $ 12,509 > 4.0% > $ 18,763 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 57,217 10.51% > $ * > * > $ 27,208 > 5.0%
- - - -
*3.0% ($16,325), 4.0% ($21,766) or 5.0% ($27,208) 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 June 30, 2003 and June 30, 2002 and for the six months ended
June 30, 2003 and June 30, 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 $1,585 or $.73 per
share for the three months ended June 30, 2003 compared with $1,567 or $.73 per
share reported for the three months ended June 30, 2002. This is a result of the
Company experiencing declining net interest income due to the sale of all new
and refinancing fixed rate mortgages in the secondary market, which was mostly
offset by a gain on the sale of these new and refinanced mortgages to the
secondary market, along with increases in other fee based income. The second
quarter net interest income was aided by the leverage transaction noted below.
The Company reported a decrease in net income of $112 or 3.4% to $3,144 or $1.46
per share for the six months ended June 30, 2003 compared with $3,256 or $1.52
per share reported for the first half of 2002, largely due to the sale of all
new and refinanced fixed rate mortgages in the secondary market. The second
quarter net interest income was aided by the leverage transaction noted below.
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 $345 or 7.1% from
$4,860 for the three months ended June 30, 2002 to $4,515 in 2003. In addition,
earning assets repriced downward 114 basis points due to the refinancing of
long-term fixed-rate real estate loans with historical interest rates at 45 year
lows, somewhat offset by higher securities portfolio income. Liabilities
repriced downward 22 basis points, as shown on the following schedule.
In the three months ended June 30, 2003, the net interest margin was 3.36%,
decreasing 99 basis points from 4.35% in the same period of 2002.
Net interest income after provision for loan losses decreased $345 or 7.1% to
$4,515 for the three months ended June 30, 2003 compared to $4,860 for the three
months ended June 30, 2002. Earnings assets repriced downward 1.14 basis points,
largely due to the reduction in out loan portfolio due to the refinancing of
residential portfolio mortgage loans with low fixed rates which were then sold
in the secondary market with rates at 45 year lows. Offsetting this decrease was
increased securities portfolio income and 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 three months ended June 30, 2003, net interest margin was 3.36% decreasing
99 basis points from 4.35% in the same period of 2002.
Total average earning assets and average interest bearing funds increased in the
three months ended June 30, 2003 as compared to 2002. Average earning assets
increased $94.6 million or 20.2%, from $468.5 million in 2002 to $563.1 million
in 2003 and average interest bearing funds increased $81.9 million, or 22.2%,
from $369.3 million to $451.2 million for the same periods. As a percentage of
average assets, earning assets increased to 96.0% for the three months ended
June 30, 2003 from 94.9% for the year ago period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the three months of 2003 and 2002. Average loans as a
percentage of average earning assets decreased from 68.3% in 2002 to 48.3% in
2003; average investments increased $130.9 million from 29.4% to 47.7%. Average
short-term investments, federal funds sold and interest bearing balances with
banks increased $11.7 million to $22.3 from $10.6 and also increased as a
percentage of average earning assets from 2.3% in 2002 to 4.0% in 2003. Average
time deposits decreased $17.4 million or 10.9% from 43.1% in 2002 to 31.4% in
2003. However, average short-term borrowings, long-term borrowings and
repurchase agreements increased $100.3 from 5.3% in 2002 to 26.6% in 2003, as a
percentage of funding sources.
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 decreased 102 basis points from 6.24% in the
three months ended June 30, 2002 to 5.22% for 2003. Also, average loan yields
decreased 102 basis points, from 6.65% in the three months ended June 30, 2002
to 5.63% in 2003. The average time deposit costs decreased 84 basis points from
3.62% in 2002 to 2.78% in 2003, along with money market accounts decreasing 72
basis points from 1.66% in 2002 to .94% in 2003. These are the primary causes of
the decrease in the total cost of funds rate from 2.29% in 2002 to 2.07% in
2003.
The most significant change in net interest income has been the reduction in our
loan portfolio due to the refinancing of higher rate, long-term, fixed-rate real
estate loans, which were sold in 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).
The Bank recorded $260 net interest income for the three months ended June 30,
2003. It is anticipated that this transaction will result in an additional $439
in net interest income for the balance of the current year with an estimated 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 June
30, 2003 and June 30, 2002.
- ------------------------------------------------------------------------------------------------------------
June 30, 2003 June 30, 2002
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 31,218 $ 322 4.13% $ 33,723 $ 373 4.42%
U.S. Agency obligations 47,767 668 5.59% 55,335 855 6.18%
States & political subdivisions 19,766 213 6.53% 14,994 188 7.60%
Federal Home Loan Bank stock 5,554 31 2.23% 2,087 16 3.07%
Other 395 2 2.03% 269 3 1.11%
Held-to-maturity:
U.S. Agency obligations - GNMA 31,549 316 4.01% 1,655 16 3.87%
U.S. Agency obligations - FHLMC 101,956 1,185 4.65% - - -
States & political subdivisions 30,352 432 8.63% 29,655 397 8.11%
Loans, net of unearned income:
Real estate mortgages 201,111 2,957 5.88% 246,176 4,247 6.90%
Commercial 32,028 380 4.75% 34,764 439 5.05%
Consumer and other 39,093 497 5.09% 39,239 639 6.51%
Federal funds sold 12,308 38 1.23% 5,085 18 1.42%
Interest on balances with banks 10,008 26 1.04% 5,553 21 1.51%
- ------------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income 563,105 $ 7,067 5.02% 468,535 $ 7,212 6.16%
- ------------------------------------------------------------------------------------------------------------
Cash and due from banks 8,397 8,188
Bank premises and equipment 9,814 10,288
Accrued interest receivable 3,424 3,486
Other assets 5,059 7,235
Less: Allowance for loan losses 3,298 3,917
- ------------------------------------------------------------------------------------------------------------
Total Assets $ 586,501 $ 493,815
- ------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 29,171 $ 42 0.58% $ 27,143 $ 40 0.59%
Savings 76,154 139 0.73% 72,817 176 0.97%
Money markets 84,200 198 0.94% 90,605 377 1.66%
Time - Over $100 32,882 218 2.64% 38,101 366 3.84%
Time - Other 108,794 765 2.81% 120,996 1,076 3.56%
Federal funds purchased - - - - - -
Repurchase agreements 20,864 48 0.92% 19,176 75 1.56%
Short-term borrowings 222 1 1.80% 486 2 1.65%
Long-term borrowings 98,904 925 3.74% - - -
- ------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 451,191 $ 2,336 2.07% 369,324 $ 2,112 2.29%
- ------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 72,282 66,836
All other liabilities 2,954 1,896
Stockholders' equity 60,074 55,759
- ------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 586,501 $ 493,815
- ------------------------------------------------------------------------------------------------------------
Interest Spread 2.95% 3.87%
- ------------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,731 $ 5,100
- ------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.36% 4.35%
Return on average assets 1.08% 1.27%
Return on average equity 10.55% 11.24%
Average equity to average assets 10.24% 11.29%
Dividend payout ratio 41.10% 39.47%
- ------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses decreased $892 or 9.1% from
$9,854 for the first half of 2002 to $8,962 in 2003. Earning assets repriced
downward 107 basis points, largely due to the reduction in our loan portfolio
due to the refinancing of residential portfolio mortgage loans with low fixed
rates, which then were sold in the secondary market with rates at 45 year lows.
Offsetting this decrease was increased securities portfolio income and 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 six months of 2003, the net interest margin was 3.61%, decreasing 80
basis points from 4.41% in the same period of 2002.
Total average earning assets and average interest bearing funds increased in the
first half of 2003 as compared to 2002. Average earning assets increased $55.3
million or 11.9%, from $466.2 million in 2002 to $521.5 million in 2003 and
average interest bearing funds increased $43.0 million, or 11.8%, from $364.9
million to $407.9 million for the same periods. As a percentage of average
assets, earning assets increased to 95.8% for the first half of 2003 from 95.2%
for the year ago period. Interest bearing liabilities increased to 75.0% from
74.5%, as a percentage of total liabilities and stockholders' equity, compared
to the year ago period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the first half of 2003 and 2002. Average loans as a
percentage of average earning assets decreased from 69.3% in 2002 to 53.7% in
2003; average investments increased from 28.7% to 41.6%. Average short-term
investments, federal funds sold and interest bearing balances with banks
increased $15.2 million to $24.1 from $8.9 and also increased as a percentage of
average earning assets from 1.9% in 2002 to 4.6% in 2003. Average time deposits
decreased $16.9 million from 43.5% in 2002 to 34.8% in 2003. However, average
short-term borrowings, long-term borrowings and repurchase agreements increased
$58.8 from 5.2% in 2002 to 19.1% in 2003, as a percentage of funding sources.
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 decreased 73 basis points from 6.19% in the
first half of 2002 to 5.46% for 2003. Also, average loan yields decreased 95
basis points, from 6.69% in the first half of 2001 to 5.74% in 2003. The average
time deposit costs decreased from 3.71% in 2002 to 2.84% in 2003, along with
money market accounts decreasing 59 basis points from 1.54% in 2002 to .95% in
2003. These are the primary determinants of the decrease in the total cost of
funds rate from 2.32% in 2002 to 1.97% in 2003.
The most significant change in net interest income has been the reduction in our
loan portfolio due to the refinancing of higher rate, long-term, fixed-rate real
estate loans, which were sold in 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).
Also, it was noted for the year to date period, the Bank recorded $311 net
interest income as of June 30, 2002. It is anticipated that this transaction
will result in an additional $439 in net interest income for the balance of the
current year with an estimated 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 six months ended June
30, 2003 and June 30, 2002.
- ------------------------------------------------------------------------------------------------------------
June 30, 2003 June 30, 2002
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 33,832 $ 688 4.07% $ 35,163 $ 824 4.69%
U.S. Agency obligations 49,071 1,362 5.55% 55,349 1,687 6.10%
States & political subdivisions 20,039 440 6.65% 9,483 237 7.57%
Federal Home Loan Bank stock 3,768 49 2.60% 1,999 37 3.70%
Other 397 6 3.02% 269 6 2.23%
Held-to-maturity:
U.S. Agency obligations - GNMA 21,170 434 4.10% 1,947 36 3.70%
U.S. Agency obligations - FHLMC 58,902 1,438 4.88% - - -
States & political subdivisions 29,990 842 8.51% 29,698 791 8.07%
Loans, net of unearned income:
Real estate mortgages 209,097 6,277 6.00% 249,464 8,595 6.89%
Commercial 31,721 757 4.77% 33,553 911 5.43%
Consumer and other 39,403 1,007 5.11% 40,326 1,307 6.48%
Federal funds sold 16,411 89 1.08% 4,024 30 1.49%
Interest on balances with banks 7,707 40 1.04% 4,910 37 1.51%
- ------------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income 521,508 $ 13,429 5.15% 466,185 $ 14,498 6.22%
- ------------------------------------------------------------------------------------------------------------
Cash and due from banks 8,185 8,041
Bank premises and equipment 9,840 10,523
Accrued interest receivable 3,259 3,470
Other assets 4,691 5,442
Less: Allowance for loan losses 3,322 3,757
- ------------------------------------------------------------------------------------------------------------
Total Assets $ 544,161 $ 489,904
- ------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 27,656 $ 85 0.61% $ 26,613 $ 82 0.62%
Savings 75,238 275 0.73% 70,797 359 1.01%
Money markets 85,273 407 0.95% 89,612 690 1.54%
Time - Over $100 33,422 474 2.83% 39,213 763 3.89%
Time - Other 108,400 1,544 2.85% 119,514 2,179 3.65%
Federal funds purchased - - - - - -
Repurchase agreements 19,788 91 0.92% 18,425 146 1.58%
Short-term borrowings 1,008 9 1.79% 706 6 1.70%
Long-term borrowings 57,144 1,127 3.94% - - -
- ------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 407,929 $ 4,012 1.97% 364,880 $ 4,225 2.32%
- ------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 73,545 66,782
All other liabilities 2,903 2,569
Stockholders' equity 59,784 55,673
- ------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 544,161 $ 489,904
- ------------------------------------------------------------------------------------------------------------
Interest Spread 3.18% 3.90%
- ------------------------------------------------------------------------------------------------------------
Net Interest Income $ 9,417 $ 10,273
- ------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.61% 4.41%
Return on average assets 1.16% 1.33%
Return on average equity 10.52% 11.70%
Average equity to average assets 10.99% 11.36%
Dividend payout ratio 41.10% 39.47%
- ------------------------------------------------------------------------------------------------------------
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.
For the three months ended June 30, 2003, the provision for loan losses
decreased to $216 from $240 in the three months ended June 30, 2002. Loans
charged off totaled $18 and recoveries were $2 for the three months ended June
30, 2003. In the same period of 2002, loans charged off were $60 and recoveries
were $20.
In the first half of 2003, the provision for loan losses was $455, an increase
from $419 in the first six months of 2002. Loans charged-off totaled $305 and
recoveries were $3 for the six months ended June 30, 2003. In the same period of
2002, loans charged off were $89, offset by recoveries of $20. At June 30, 2003,
the allowance for loan losses was set at $3,500 or 1.34% of loans based upon the
Bank's analysis methodology and as an act of prudence by management.
Other Income
The following table sets forth information by category of other income for the
Company for three months ended June 30, 2003 and June 30, 2002, respectively:
June 30, June 30,
Three Months Ended: 2003 2002
- ------------------------------------------------------------------------
Trust department income $ 321 $ 352
Service charges on deposit accounts 288 284
Merchant transaction income 924 920
Other fee income 311 239
Other operating income 501 183
Realized losses on securities, net - -
- ------------------------------------------------------------------------
Total Other Income $ 2,345 1,978
- ------------------------------------------------------------------------
Other income increased $367 or 18.6% to $2,345 from $1,978 for the three months
ended June 30, 2002. Trust department income decreased $31 or 8.8% due to lower
market valuations. Other fee income increased $72 or 30.1%, mostly due to fee
income on mortgage loans serviced for others. Other operating income grew $318
or 173.8%, which included gains on the sale of new and refinanced fixed-rate
residential real estate loans of $388, which was partially offset by a decrease
in brokerage income of $71, largely due to the investor malaise and general
stock market decline and low interest rates.
The following table sets forth information by category of other income for the
Company for six months ended June 30, 2003 and June 30, 2002, respectively:
June 30, June 30,
Six Months Ended: 2003 2002
- ------------------------------------------------------------------------
Trust department income $ 636 $ 646
Service charges on deposit accounts 565 552
Merchant transaction income 2,412 2,610
Other fee income 595 457
Other operating income 883 397
Realized losses on securities, net - -
- ------------------------------------------------------------------------
Total Other Income $ 5,091 $ 4,662
- ------------------------------------------------------------------------
Other income increased $429 or 9.2% to $5,091 from $4,662 during the first half
of 2003. Contributions came from an increase in other fee income of $138 or
30.2% to $595 from $457 partly from $60 in other service charge commissions and
fees, as well as $73 in fees earned on mortgage loans serviced for others. Other
operating income increased $486 or 122.4% to $883 from $397 mainly due to gains
on the sale of new low fixed-rate residential real estate loans of $642, which
was partially offset by a decrease in brokerage income of $155, largely due to
the general investor malaise. Also, merchant transaction income decreased $198
or 7.6%, mostly the result of a large university discontinuing the credit card
payment of tuition.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended June 30, 2003 and June 30, 2002,
respectively:
June 30, June 30,
Three Months Ended: 2003 2002
- ------------------------------------------------------------------------
Salaries and employee benefits $ 2,198 $ 2,217
Expense of premises and fixed assets 631 628
Merchant transaction expenses 795 794
Other operating expenses 1,216 1,173
- ------------------------------------------------------------------------
Total Other Expenses $ 4,840 $ 4,812
- ------------------------------------------------------------------------
Other expenses increased $28 or .5% to $4,840 in the first three months of 2003
as compared to $4,812 in the same period of 2002. Salaries and benefits
decreased $19 or .5% due management's diligence on controlling personnel costs
offset by an increase of $43 or 43.9% in pension costs. Other operating expenses
increased $43 or 3.7% to $1,216 from $1,173 mainly from miscellaneous increased
operating expenses.
The following table sets forth information by category of other expenses for the
Company for the six months ended June 30, 2003 and June 30, 2002, respectively:
June 30, June 30,
Six Months Ended: 2003 2002
- ------------------------------------------------------------------------
Salaries and employee benefits $ 4,400 $ 4,340
Expense of premises and fixed assets 1,322 1,295
Merchant transaction expenses 2,059 2,259
Other operating expenses 2,328 2,331
- ------------------------------------------------------------------------
Total Other Expenses $ 10,109 $ 10,225
- ------------------------------------------------------------------------
Other expenses decreased $116 or 1.1% to $10,109 from $10,225 during the first
half of 2003. Salaries and employee benefits increased only $60 or 1.4%, despite
increased pension costs of $120. Merchant expenses decreased $200 or 8.9%,
largely due to lower transaction volume mostly the result of a large university
discontinuing the credit card payment of tuition. Applicable income taxes
decreased $235 due to increased tax-free income from our securities portfolio
along with lower taxable income.
Loan Portfolio
Details regarding the Company's loan portfolio:
June 30, December 31,
As Of: 2003 2002
- --------------------------------------------------------------------------------
Real estate - construction
and land development $ 3,464 $ 5,031
Real estate mortgages 188,580 217,883
Commercial 31,121 30,077
Credit card and related plans 2,242 2,320
Installment 26,069 27,306
Obligations of states & political subdivisions 10,506 6,239
- --------------------------------------------------------------------------------
Loans, net of unearned income 261,982 288,856
Less: Allowance for loan losses 3,500 3,347
- --------------------------------------------------------------------------------
Loans, net $ 258,482 $ 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:
June 30, December 31, June 30,
As Of: 2003 2002 2002
- ---------------------------------------------------------------------------------------
Non-accrual loans $ 1,638 $ 2,245 $ 2,104
Loans past due 90 days or more and accruing:
Guaranteed student loans 247 394 301
Credit card and home equity loans 20 - 3
- ---------------------------------------------------------------------------------------
Total non-performing loans 1,905 2,639 2,408
Other real estate owned 419 59 -
- ---------------------------------------------------------------------------------------
Total non-performing assets $ 2,324 2,698 2,408
- ---------------------------------------------------------------------------------------
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 $1,638 and $2,104 at June 30, 2003 and June 30, 2002, respectively. If
interest on those loans had been accrued, such income would have been $178 and
$195 for the six months ended June 30, 2003 and June 30, 2002, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $15 and $17 for June 30, 2003 and June 30, 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
June 30, 2003 there are no significant loans as to which management has serious
doubt about their collectibility other than what is included above.
At June 30, 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:
June 30, June 30,
Three Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Balance at beginning of period $ 3,300 $ 3,750
Charge-offs:
Real estate mortgages 5 29
Commercial and all others - 23
Credit card and related plans 13 7
Installment loans - 1
- -----------------------------------------------------------------------------
Total charge-offs 18 60
- -----------------------------------------------------------------------------
Recoveries:
Real estate mortgages - 19
Commercial and all others - -
Credit card and related plans 1 -
Installment loans 1 1
- -----------------------------------------------------------------------------
Total recoveries 2 20
- -----------------------------------------------------------------------------
Net charge-offs (recoveries) 16 40
- -----------------------------------------------------------------------------
Provision charged to operations 216 240
- -----------------------------------------------------------------------------
Balance at End of Period $ 3,500 $ 3,950
- -----------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.006% 0.012%
- -----------------------------------------------------------------------------
June 30, June 30,
Six Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Balance at beginning of period $ 3,347 $ 3,600
Charge-offs:
Real estate mortgages 6 54
Commercial and all others 276 23
Credit card and related plans 20 11
Installment loans 3 1
- -----------------------------------------------------------------------------
Total charge-offs 305 89
- -----------------------------------------------------------------------------
Recoveries:
Real estate mortgages - 19
Commercial and all others - -
Credit card and related plans 2 -
Installment loans 1 1
- -----------------------------------------------------------------------------
Total recoveries 3 20
- -----------------------------------------------------------------------------
Net charge-offs (recoveries) 302 69
- -----------------------------------------------------------------------------
Provision charged to operations 455 419
- -----------------------------------------------------------------------------
Balance at End of Period $ 3,500 $ 3,950
- -----------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.108% 0.021%
- -----------------------------------------------------------------------------
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 1.34% at June 30,
2003 and 1.22% at June 30, 2002.
The allowance for loan losses is allocated as follows:
As Of: June 30, 2003 December 31, 2002 June 30, 2002
- --------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- --------------------------------------------------------------------------------
Real estate mortgages $ 1,500 73% $ 1,600 77% $ 1,800 77%
Commercial and all others 1,475 16% 1,222 13% 1,625 13%
Credit card and related plans 175 1% 175 1% 175 1%
Personal installment loans 350 10% 350 9% 350 9%
- --------------------------------------------------------------------------------
Total $ 3,500 100% $ 3,347 100% $ 3,950 100%
- --------------------------------------------------------------------------------
* 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 19.42% at June 30, 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 evaluations by the Company's principal executive officer, Otto P.
Robinson, Jr., President and the Company's principal financial officer, Patrick
Scanlon, Controller, of the Company's Disclosure Controls and Procedures as of
June 30, 2003, 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 changes made
in internal controls or in other factors during the reporting period that could
materially affect or is reasonably likely to materially affect the Company's
internal controls over financial reporting.
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 31 and 32 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
The Annual Meeting of Shareholders of Penseco Financial Services Corporation
was held on May 6, 2003.
The results of the items submitted for a vote are as follows:
The following three Directors, whose term will expire in 2007, were elected:
number of votes number of votes number of
cast for director cast against director votes not cast
----------------- --------------------- --------------
Edwin J. Butler 1,998,567 64,615 84,818
P. Frank Kozik 1,955,738 107,444 84,818
Steven L. Weinberger 2,013,575 49,607 84,818
Item 5 -- Other Information
None.
Item 6 -- Exhibits and Reports on Form 8-K
a. Exhibits
31 Certifications required under Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications required under Section 906 of the Sarbanes-Oxley
Act of 2002
b. Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended June 30, 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: August 7, 2003
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: August 7, 2003