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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 September 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 | |
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). | |
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on October 24, 2003 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
----
Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
September 30, 2003..........................................3
December 31, 2002...........................................3
Statements of Income:
Three Months Ended September 30, 2003.......................4
Three Months Ended September 30, 2002.......................4
Nine Months Ended September 30, 2003........................5
Nine Months Ended September 30, 2002........................5
Statements of Cash Flows:
Nine Months Ended September 30, 2003........................6
Nine Months Ended September 30, 2002........................6
Notes to Financial Statements..................................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.....................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......22
Item 4. Disclosure Controls and Procedures...............................23
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................23
Item 2. Changes in Securities and Use of Proceeds........................23
Item 3. Defaults Upon Senior Securities..................................23
Item 4. Submission of Matters to a Vote of Security Holders..............23
Item 5. Other Information................................................23
Item 6. Exhibits and Reports on Form 8-K.................................23
Signatures...............................................................24
Certifications...........................................................25
PART I. FINANCIAL INFORMATION, Item 1 -- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
September 30, December 31,
2003 2002
--------------- ---------------
ASSETS
Cash and due from banks $ 8,501 $ 11,120
Interest bearing balances with banks 18,877 10,424
Federal funds sold 75,000 33,075
--------------- ---------------
Cash and Cash Equivalents 102,378 54,619
Investment securities:
Available-for-sale, at fair value 121,867 108,083
Held-to-maturity (fair value of $119,874
and $32,986, respectively) 117,520 31,049
--------------- ---------------
Total Investment Securities 239,387 139,132
Loans, net of unearned income 241,313 288,856
Less: Allowance for loan losses 3,500 3,347
--------------- ---------------
Loans, Net 237,813 285,509
Bank premises and equipment 10,093 9,920
Other real estate owned 278 59
Accrued interest receivable 3,074 3,399
Other assets 4,021 4,318
--------------- ---------------
Total Assets $ 597,044 $ 496,956
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 83,240 $ 78,560
Interest bearing 329,227 336,104
--------------- ---------------
Total Deposits 412,467 414,664
Other borrowed funds:
Repurchase agreements 25,194 19,419
Short-term borrowings 228 890
Long-term borrowings 95,701 -
Accrued interest payable 993 1,317
Other liabilities 1,500 1,691
--------------- ---------------
Total Liabilities 536,083 437,981
--------------- ---------------
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 47,874 45,060
Accumulated other comprehensive income 2,247 3,075
--------------- ---------------
Total Stockholders' Equity 60,961 58,975
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 597,044 $ 496,956
=============== ===============
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
September 30, 2003 September 30, 2002
-------------------- --------------------
INTEREST INCOME
Interest and fees on loans $ 3,401 $ 5,107
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 2,141 1,256
States & political subdivisions 645 503
Other securities 33 18
Interest on Federal funds sold 147 64
Interest on balances with banks 28 33
-------------------- --------------------
Total Interest Income 6,395 6,981
-------------------- --------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 202 346
Interest on other deposits 975 1,634
Interest on other borrowed funds 972 74
-------------------- --------------------
Total Interest Expense 2,149 2,054
-------------------- --------------------
Net Interest Income 4,246 4,927
Provision for loan losses 1 152
-------------------- --------------------
Net Interest Income After Provision for Loan Losses 4,245 4,775
-------------------- --------------------
OTHER INCOME
Trust department income 345 333
Service charges on deposit accounts 283 287
Merchant transaction income 1,729 1,820
Other fee income 328 262
Other operating income 549 231
Realized gains (losses) on securities, net - 359
-------------------- --------------------
Total Other Income 3,234 3,292
-------------------- --------------------
OTHER EXPENSES
Salaries and employee benefits 2,219 2,271
Expense of premises and fixed assets 607 650
Merchant transaction expenses 1,378 1,526
Other operating expenses 1,218 1,149
-------------------- --------------------
Total Other Expenses 5,422 5,596
-------------------- --------------------
Income before income taxes 2,057 2,471
Applicable income taxes 454 632
-------------------- --------------------
Net Income 1,603 1,839
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (610) 1,080
-------------------- --------------------
Comprehensive Income $ 993 $ 2,919
==================== ====================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.75 $ 0.85
Cash Dividends Declared Per Common Share $ 0.30 $ 0.30
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
-------------------- --------------------
INTEREST INCOME
Interest and fees on loans $ 11,443 $ 15,921
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 6,062 3,803
States & political subdivisions 1,927 1,530
Other securities 88 61
Interest on Federal funds sold 236 94
Interest on balances with banks 68 70
-------------------- --------------------
Total Interest Income 19,824 21,479
-------------------- --------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 676 1,109
Interest on other deposits 3,286 4,944
Interest on other borrowed funds 2,199 226
-------------------- --------------------
Total Interest Expense 6,161 6,279
-------------------- --------------------
Net Interest Income 13,663 15,200
Provision for loan losses 456 571
-------------------- --------------------
Net Interest Income After Provision for Loan Losses 13,207 14,629
-------------------- --------------------
OTHER INCOME
Trust department income 981 979
Service charges on deposit accounts 848 839
Merchant transaction income 4,141 4,430
Other fee income 923 719
Other operating income 1,432 628
Realized gains (losses) on securities, net - 359
-------------------- --------------------
Total Other Income 8,325 7,954
-------------------- --------------------
OTHER EXPENSES
Salaries and employee benefits 6,619 6,611
Expense of premises and fixed assets 1,929 1,945
Merchant transaction expenses 3,437 3,785
Other operating expenses 3,546 3,480
-------------------- --------------------
Total Other Expenses 15,531 15,821
-------------------- --------------------
Income before income taxes 6,001 6,762
Applicable income taxes 1,254 1,667
-------------------- --------------------
Net Income 4,747 5,095
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (828) 1,383
-------------------- --------------------
Comprehensive Income $ 3,919 $ 6,478
==================== ====================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 2.21 $ 2.37
Cash Dividends Declared Per Common Share $ 0.90 $ 0.90
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
------------------ ------------------
OPERATING ACTIVITIES
Net Income $ 4,747 $ 5,095
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 891 928
Provision for loan losses 456 571
Deferred income tax provision (benefit) 20 (57)
Amortization of securities, (net of accretion) 694 149
Net realized losses (gains) on securities - (359)
Loss (gain) on other real estate 13 -
Decrease (increase) in interest receivable 325 168
Decrease (increase) in other assets 297 (1,434)
Increase (decrease) in income taxes payable 55 (107)
(Decrease) increase in interest payable (324) (252)
Increase (decrease) in other liabilities 160 575
------------------ ------------------
Net cash provided by operating activities 7,334 5,277
------------------ ------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (37,383) (25,396)
Proceeds from investment securities available-for-sale 22,142 15,570
Purchase of investment securities to be held-to-maturity (103,031) -
Proceeds from repayments of investment securities to be held-to-maturity 16,069 767
Net loans repaid (originated) 46,865 12,880
Proceeds from other real estate 143 283
Investment in premises and equipment (1,064) (292)
------------------ ------------------
Net cash (used) provided by investing activities (56,259) 3,812
------------------ ------------------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 8,729 17,243
Net (payments) proceeds on time deposits (10,926) (5,926)
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 5,775 5,469
Net (decrease) increase in short-term borrowings (662) 872
Proceeds from long-term borrowings 100,000 -
Repayments of long-term borrowings (4,299) -
Cash dividends paid (1,933) (1,933)
------------------ ------------------
Net cash provided (used) by financing activities 96,684 15,725
------------------ ------------------
Net increase (decrease) in cash and cash equivalents 47,759 24,814
Cash and cash equivalents at January 1 54,619 17,296
------------------ ------------------
Cash and cash equivalents at September 30 $ 102,378 $ 42,110
================== ==================
The Company paid interest and income taxes of $6,485 and $1,518 and $6,531 and
$1,532, for the nine month periods ended September 30, 2003 and 2002,
respectively.
Notes to CONSOLIDATED Financial Statements
For the Quarter Ended September 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 September 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
September 30, 2003 and September 30, 2002 and for the nine months ended
September 30, 2003 and September 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 September 30, 2003
and December 31, 2002 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 25,028 $ 744 $ - $ 25,772
U.S. Agency securities 40,639 1,770 - 42,409
U.S. Agency Obligations:
Mortgage-backed securities 26,236 154 - 26,390
States & political subdivisions 20,156 507 18 20,645
- --------------------------------------------------------------------------------
Total Debt Securities 112,059 3,175 18 115,216
Equity securities 6,403 248 - 6,651
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 118,462 $ 3,423 $ 18 $ 121,867
- --------------------------------------------------------------------------------
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
September 30, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Agency Obligations:
Mortgage-backed securities $ 87,979 $ 19 $ 121 $ 87,877
States & political subdivisions 29,541 2,456 - 31,997
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 117,520 $ 2,475 $ 121 $ 119,874
- --------------------------------------------------------------------------------
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 Company purchased, on February 27, 2003, a 30 year, $30 million FNMA,
adjustable rate mortgage-backed security. At September 30, 2003, the Company
transferred, to the "Available-for-Sale" category, the net carrying value of
$26,236. At the date of transfer the unrealized gain on the security was $154.
The security had been classified in prior interim reports as "Held-to-Maturity",
although it was intended, at purchase, to be classified as "Available-for-Sale".
The unrealized (loss)/gain not previously reported on this security was $(70) at
March 31, 2003 and $427 at June 30, 2003, which amounts were immaterial to those
interim presentations.
The amortized cost and fair value of debt securities at September 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.
September 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 $ 20,031 $ 20,333 $ - $ -
U.S. Agency securities 25,613 26,129 - -
After one year through five years:
U.S. Treasury securities 4,997 5,439 - -
U.S. Agency securities 15,026 16,280 - -
After ten years:
States & political subdivisions 20,156 20,645 29,541 31,997
- -----------------------------------------------------------------------------------------
Subtotal 85,823 88,826 29,541 31,997
Mortgage-backed securities 26,236 26,390 87,979 87,877
- -----------------------------------------------------------------------------------------
Total Debt Securities $ 112,059 $ 115,216 $ 117,520 $ 119,874
- -----------------------------------------------------------------------------------------
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 September 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. $ 8,154
Note payable, due in monthly installments of $253, including principal
and interest at a fixed rate of 3.22%, maturing March, 2010. 17,780
Note payable, due in monthly installments of $430, including principal
and interest at a fixed rate of 3.74%, maturing March, 2013. 41,210
Note payable, due in monthly installments of $186, including principal
and interest at a fixed rate of 4.69%, maturing March, 2023. 28,557
--------
Total long-term debt $ 95,701
========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at September 30, 2003 are as follows:
September 30, Principal
------------- ---------
2004 $ 8,826
2005 9,139
2006 9,464
2007 9,801
2008 9,181
Thereafter 49,290
---------
$ 95,701
=========
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 September 30, 2003, that the Company and
the Bank meet all capital adequacy requirements to which they are subject.
As of September 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 September 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 September 30, 2003
- ---------------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 61,547 21.22% > $ 23,202 > 8.0% > $ 29,002 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 58,047 20.01% > $ 11,601 > 4.0% > $ 17,401 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 58,047 10.29% > $ * > * > $ 28,202 > 5.0%
- - - -
*3.0% ($16,921), 4.0% ($22,561) or 5.0% ($28,202) depending on the bank's CAMELS
Rating and other regulatory risk factors.
Actual Regulatory Requirements
- ------------------------------------------------ ----------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
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 September 30, 2003 and September 30, 2002 and for the nine
months ended September 30, 2003 and September 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 a decrease in net income of $236
or 12.8% to $1,603 or $.75 per share for the three months ended September 30,
2003 compared with $1,839 or $.85 per share reported for the year earlier
period. Largely, the decrease came from a reduction in our loan portfolio due to
the refinancing of residential mortgage loans with lower fixed-rate obligations,
which were then sold in the secondary market. This was somewhat offset by a gain
on the sale of these new and refinanced mortgages to the secondary market, which
was recorded in other operating income. During the third quarter of 2002 U.S.
Agency securities were sold for a gain of $359 or $.10 per share, due to a minor
repositioning of our securities portfolio. No gains were recognized in the
corresponding 2003 quarter.
The Company reported a decrease in net income of $348 or 6.8% to $4,747 or $2.21
per share for the nine months ended September 30, 2003 compared with $5,095 or
$2.37 per share reported for the nine months ended September 30, 2002. This is a
result of the Company experiencing declining net interest income due to the sale
of all new and refinanced fixed rate mortgages in the secondary market, which
was somewhat offset by a gain on the sale of these new and refinanced mortgages
to the secondary market, which was recorded in other operating income. Also, the
Company experienced increased pre-payments of its mortgage-backed securities
portfolio, which caused accelerated premium write-downs due to the historically
low interest rate environment. During the third quarter of 2002 U.S. Agency
securities were sold for a gain of $359 or $.10 per share, due to a minor
repositioning of our securities portfolio. No gains were recognized in the
corresponding 2003 quarter. The nine month period 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 $530 or 11.1% to
$4,245 for the three months ended September 30, 2003 compared to $4,775 for the
three months ended September 30, 2002. Earning assets repriced downward 1.36
basis points, largely due to the reduction in our loan portfolio due to the
refinancing of residential portfolio mortgage loans with lower fixed-rate
obligations, which were then sold in the secondary market. Offsetting this
decrease was increased securities portfolio income and a reduction in the
provision for loan losses.
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 September 30, 2003, net interest margin was 2.93%
decreasing 114 basis points from 4.07% in the same period of 2002.
Total average earning assets and average interest bearing funds increased in the
three months ended September 30, 2003 as compared to 2002. Average earning
assets increased $95.4 million or 19.7%, from $484.3 million in 2002 to
$579.7 million in 2003 and average interest bearing funds increased $86.9
million, or 23.3%, from $372.5 million to $459.4 million for the same periods.
As a percentage of average assets, earning assets increased to 96.0% for the
three months ended September 30, 2003 from 95.8% 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 65.8% in 2002 to 42.8% in
2003, due in part to the sale of all new and refinanced fixed rate mortgages in
the secondary market and the increase in total assets caused by the leverage
transaction noted below; average investments increased $113.5 million from 29.3%
to 44.1%. Average short-term investments, federal funds sold and interest
bearing balances with banks increased $52.5 million to $75.9 from $23.4 and also
increased as a percentage of average earning assets from 4.8% in 2002 to 13.1%
in 2003. Average time deposits decreased $15.4 million or 10.0% from 41.3% of
interest bearing liabilities in 2002 to 30.1% in 2003. However, average
short-term borrowings, long-term borrowings and repurchase agreements increased
$97.6 from 6.2% in 2002 to 26.3% 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 80 basis points from 5.73% in the
three months ended September 30, 2002 to 4.93% for 2003. Also, average loan
yields decreased 93 basis points, from 6.40% in the three months ended September
30, 2002 to 5.47% in 2003. The average time deposit costs decreased 106 basis
points from 3.62% in 2002 to 2.56% in 2003, along with money market accounts
decreasing 76 basis points from 1.50% in 2002 to .74% in 2003. These are the
primary causes of the decrease in the total cost of funds rate from 2.21% in
2002 to 1.87% 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 on 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 $26 net interest income for the three months ended September
30, 2003. Income was adjusted by $160 during the quarter due to increased
pre-payments, which resulted in accelerated premium amortization.
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
September 30, 2003 and September 30, 2002.
- ----------------------------------------------------------------------------------------------------------
September 30, 2003 September 30, 2002
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 31,034 $ 326 4.20% $ 36,230 $ 377 4.16%
U.S. Agency obligations 72,719 871 4.79% 62,139 866 5.57%
States & political subdivisions 20,994 265 7.65% 9,902 118 7.22%
Federal Home Loan Bank stock 6,113 31 2.03% 2,006 16 3.19%
Other 448 2 1.79% 403 2 1.99%
Held-to-maturity:
U.S. Agency obligations 94,711 944 3.99% 1,731 13 3.00%
States & political subdivisions 29,540 380 7.79% 29,698 385 7.86%
Loans, net of unearned income:
Real estate mortgages 183,014 2,554 5.58% 246,308 4,086 6.64%
Commercial 30,660 394 5.14% 32,701 454 5.55%
Consumer and other 34,607 453 5.24% 39,703 567 5.71%
Federal funds sold 62,615 147 0.94% 16,010 64 1.60%
Interest on balances with banks 13,236 28 0.85% 7,428 33 1.78%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income 579,691 $ 6,395 4.41% 484,259 $ 6,981 5.77%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 9,053 8,488
Bank premises and equipment 10,214 10,293
Accrued interest receivable 3,014 3,544
Other assets 5,324 3,088
Less: Allowance for loan losses 3,504 3,954
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 603,792 $ 505,718
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 29,581 $ 24 0.32% $ 25,774 $ 38 0.59%
Savings 77,896 97 0.50% 72,576 182 1.00%
Money markets 92,805 172 0.74% 97,278 365 1.50%
Time - Over $100 32,605 202 2.48% 35,848 346 3.86%
Time - Other 105,774 682 2.58% 117,948 1,049 3.56%
Federal funds purchased - - - - - -
Repurchase agreements 23,518 43 0.73% 22,608 72 1.27%
Short-term borrowings 444 1 0.90% 463 2 1.73%
Long-term borrowings 96,754 928 3.84% - - -
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 459,377 $ 2,149 1.87% 372,495 $ 2,054 2.21%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 80,405 72,605
All other liabilities 2,739 2,837
Stockholders' equity 61,271 57,781
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 603,792 $ 505,718
- ----------------------------------------------------------------------------------------------------------
Interest Spread 2.54% 3.56%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,246 $ 4,927
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 2.93% 4.07%
Return on average assets 1.06% 1.45%
Return on average equity 10.46% 12.73%
Average equity to average assets 10.15% 11.43%
Dividend payout ratio 40.13% 35.29%
- ----------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses decreased $1,422 or 9.7%
from $14,629 for the nine months ended September 30, 2002 to $13,207 in 2003.
Earning assets repriced downward 117 basis points, largely due to the reduction
in our loan portfolio from the refinancing of residential portfolio mortgage
loans with lower fixed-rate obligations, which then were sold in the secondary
market. Offsetting this decrease somewhat was increased securities portfolio
income, decreased interest costs on deposits and a lower provision for loan
losses.
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 nine months of 2003, the net interest margin was 3.37%, decreasing 92
basis points from 4.29% in the same period of 2002.
Total average earning assets and average interest bearing funds increased for
the nine months ended September 30, 2003 as compared to 2002. Average earning
assets increased $68.1 million or 14.4%, from $472.8 million in 2002 to $540.9
million in 2003 and average interest bearing funds increased $59.2 million, or
16.2%, from $365.9 million to $425.1 million for the same periods. As a
percentage of average assets, earning assets increased to 95.9% for the nine
months ended September 30, 2003 from 95.7% for the year ago period. Interest
bearing liabilities increased to 75.4% from 74.1%, 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 for the nine months ended September 30, 2003 and 2002. Average
loans as a percentage of average earning assets decreased from 68.3% in 2002 to
49.8% in 2003; average investments increased from 28.9% to 42.5%. Average
short-term investments, federal funds sold and interest bearing balances with
banks increased $28.0 million to $41.4 from $13.4 and also increased as a
percentage of average earning assets from 2.8% in 2002 to 7.7% in 2003. Average
time deposits decreased $16.3 million from 42.9% in 2002 to 33.1% in 2003.
However, average short-term borrowings, long-term borrowings and repurchase
agreements increased $72.0 from 5.5% in 2002 to 21.7% 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 78 basis points from 6.04% for the
nine months ended September 30, 2002 to 5.26% for 2003. Also, average loan
yields decreased 92 basis points, from 6.57% for the nine months ended September
30, 2002 to 5.65% in 2003. The average time deposit costs decreased from 3.68%
in 2002 to 2.75% in 2003, along with money market accounts decreasing 65 basis
points from 1.53% in 2002 to .88% in 2003. These are the primary determinants of
the decrease in the total cost of funds rate from 2.29% in 2002 to 1.93% 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 on 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 $336 net
interest income on the transaction. During the quarter end interest income was
adjusted by $160 due to increased pre-payments, which resulted in accelerated
premium amortization. It is anticipated that this transaction will have an
estimated net margin of .5% for this year.
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 nine months ended
September 30, 2003 and September 30, 2002.
- ----------------------------------------------------------------------------------------------------------
September 30, 2003 September 30, 2002
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 32,900 $ 1,013 4.11% $ 36,535 $ 1,202 4.39%
U.S. Agency obligations 70,231 2,650 5.03% 59,242 2,553 5.75%
States & political subdivisions 20,358 705 7.00% 6,707 252 7.59%
Federal Home Loan Bank stock 4,550 80 2.34% 1,972 54 3.65%
Other 414 8 2.58% 389 7 2.40%
Held-to-maturity:
U.S. Agency obligations 71,674 2,399 4.46% 1,972 48 3.24%
States & political subdivisions 29,840 1,222 8.27% 29,720 1,278 8.69%
Loans, net of unearned income:
Real estate mortgages 200,403 8,832 5.88% 249,508 12,681 6.78%
Commercial 31,367 1,150 4.89% 32,865 1,365 5.54%
Consumer and other 37,803 1,461 5.15% 40,481 1,875 6.18%
Federal funds sold 31,812 236 0.99% 7,917 94 1.58%
Interest on balances with banks 9,550 68 0.95% 5,469 70 1.71%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest Income 540,902 $ 19,824 4.89% 472,777 $ 21,479 6.06%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 8,473 8,142
Bank premises and equipment 9,965 10,525
Accrued interest receivable 3,177 3,489
Other assets 4,902 2,709
Less: Allowance for loan losses 3,383 3,770
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 564,036 $ 493,872
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 28,298 $ 109 0.51% $ 26,157 $ 120 0.61%
Savings 76,124 372 0.65% 70,833 541 1.02%
Money markets 87,784 579 0.88% 91,836 1,054 1.53%
Time - Over $100 33,150 676 2.72% 38,462 1,109 3.84%
Time - Other 107,523 2,226 2.76% 118,498 3,229 3.63%
Federal funds purchased - - - - - -
Repurchase agreements 21,031 134 0.85% 19,569 218 1.48%
Short-term borrowings 820 10 1.63% 582 8 1.83%
Long-term borrowings 70,348 2,055 3.89% - - -
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 425,078 $ 6,161 1.93% 365,937 $ 6,279 2.29%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 75,829 68,705
All other liabilities 2,849 2,883
Stockholders' equity 60,280 56,347
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 564,036 $ 493,872
- ----------------------------------------------------------------------------------------------------------
Interest Spread 2.96% 3.77%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 13,663 $ 15,200
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.37% 4.29%
Return on average assets 1.12% 1.38%
Return on average equity 10.50% 12.06%
Average equity to average assets 10.69% 11.41%
Dividend payout ratio 40.68% 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.
For the three months ended September 30, 2003, the provision for loan losses
decreased to $1 from $152 in the three months ended September 30, 2002. Loans
charged off totaled $29 and recoveries were $28 for the three months ended
September 30, 2003. In the same period of 2002, loans charged off were $769 and
recoveries were $14.
For the nine months ended September 30, 2003, the provision for loan losses was
$456, a decrease from $571 in the first nine months of 2002. Loans charged-off
totaled $334 and recoveries were $31 for the nine months ended September 30,
2003. In the same period of 2002, loans charged off were $858, offset by
recoveries of $34. At September 30, 2003, the allowance for loan losses was set
at $3,500 or 1.45% 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 September 30, 2003 and September 30, 2002,
respectively:
September 30, September 30,
Three Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Trust department income $ 345 $ 333
Service charges on deposit accounts 283 287
Merchant transaction income 1,729 1,820
Other fee income 328 262
Other operating income 549 231
Realized gains (losses) on securities, net - 359
- -----------------------------------------------------------------------------
Total Other Income $ 3,234 $ 3,292
- -----------------------------------------------------------------------------
Other income decreased $58 or 1.8% to $3,234 from $3,292 for the three months
ended September 30, 2002. Merchant transaction fee income decreased $91 or 5.0%,
mostly the result of two universities discontinuing tuition payments via credit
cards. Other fee income increased $66 or 25.2%, mostly due to fee income on
mortgage loans serviced for others. Other operating income grew $318 or 137.7%,
which included gains on the sale of new and refinanced fixed-rate residential
real estate loans of $251, as well as an increase in brokerage income of $59,
largely due to renewed interest in the overall market. Also during September
2002, U.S. Agency securities were sold for a gain of $359.
The following table sets forth information by category of other income for the
Company for nine months ended September 30, 2003 and September 30, 2002,
respectively:
September 30, September 30,
Nine Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Trust department income $ 981 $ 979
Service charges on deposit accounts 848 839
Merchant transaction income 4,141 4,430
Other fee income 923 719
Other operating income 1,432 628
Realized gains (losses) on securities, net - 359
- -----------------------------------------------------------------------------
Total Other Income $ 8,325 $ 7,954
- -----------------------------------------------------------------------------
Other income increased $371 or 4.7% to $8,325 from $7,954 for the nine months
ended September 30, 2002. Contributions came from an increase in other fee
income of $204 or 28.4% to $923 from $719 partly from $45 in other service
charge commissions and fees, as well as $126 in fees earned on mortgage loans
serviced for others. Other operating income increased $804 or 128.0% to $1,432
from $628 mainly due to gains on the sale of new low fixed-rate residential real
estate loans of $892, which was partially offset by a decrease in brokerage
income of $97, largely due to the general investor malaise in the first half of
this year. However, as of this writing, the equity markets seem to be
recovering. Merchant transaction income decreased $289 or 6.5%, mostly the
result of two universities discontinuing the credit card payment of tuition.
Also during September 2002, U.S. Agency securities were sold for a gain of $359.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended September 30, 2003 and September 30, 2002,
respectively:
September 30, September 30,
Three Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Salaries and employee benefits $ 2,219 $ 2,271
Expense of premises and fixed assets 607 650
Merchant transaction expenses 1,378 1,526
Other operating expenses 1,218 1,149
- -----------------------------------------------------------------------------
Total Other Expenses $ 5,422 $ 5,596
- -----------------------------------------------------------------------------
Other expenses decreased $174 or 3.1% to $5,422 for the three months ended
September 30, 2002 as compared to $5,596 in the same period of 2002. Salaries
and benefits decreased $52 or 2.3% due management's diligence on controlling
personnel costs offset by an increase of $43 or 43.9% in pension costs. Other
operating expenses increased $69 or 6.0% to $1,218 from $1,149 mainly from
miscellaneous increased operating expenses. Merchant transaction expenses
decreased $148 or 9.7% to $1,378 from $1,526 mostly due to lower transaction
volumes.
The following table sets forth information by category of other expenses for the
Company for the nine months ended September 30, 2003 and September 30, 2002,
respectively:
September 30, September 30,
Nine Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Salaries and employee benefits $ 6,619 $ 6,611
Expense of premises and fixed assets 1,929 1,945
Merchant transaction expenses 3,437 3,785
Other operating expenses 3,546 3,480
- -----------------------------------------------------------------------------
Total Other Expenses $ 15,531 $ 15,821
- -----------------------------------------------------------------------------
Other expenses decreased $290 or 1.8% to $15,531 from $15,821 for the nine
months ended September 30, 2002. Salaries and employee benefits increased only
$8, despite increased pension costs of $175. Merchant transaction expenses
decreased $348 or 9.2%, largely due to lower transaction volume, mostly the
result of two universities discontinuing the credit card payment of tuition.
Applicable income taxes decreased $413 due to increased tax-free income from our
securities portfolio along with lower taxable income.
Loan Portfolio
Details regarding the Company's loan portfolio:
September 30, December 31,
As Of: 2003 2002
- -------------------------------------------------------------------------------
Real estate - construction
and land development $ 2,288 $ 5,031
Real estate mortgages 175,089 217,883
Commercial 29,940 30,077
Credit card and related plans 2,330 2,320
Installment 25,789 27,306
Obligations of states & political subdivisions 5,877 6,239
- -------------------------------------------------------------------------------
Loans, net of unearned income 241,313 288,856
Less: Allowance for loan losses 3,500 3,347
- -------------------------------------------------------------------------------
Loans, net $ 237,813 $ 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:
September 30, December 31, September 30,
As Of: 2003 2002 2002
- --------------------------------------------------------------------------------------------
Non-accrual loans $ 2,192 $ 2,245 $ 2,217
Loans past due 90 days or more and accruing:
Guaranteed student loans 227 394 300
Credit card and home equity loans 24 - 14
- --------------------------------------------------------------------------------------------
Total non-performing loans 2,443 2,639 2,531
Other real estate owned 278 59 85
- --------------------------------------------------------------------------------------------
Total non-performing assets $ 2,721 $ 2,698 $ 2,616
- --------------------------------------------------------------------------------------------
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 $2,192 and $2,217 at September 30, 2003 and September 30, 2002, respectively.
If interest on those loans had been accrued, such income would have been $195
and $204 for the nine months ended September 30, 2003 and September 30, 2002,
respectively. Interest income on those loans, which is recorded only when
received, amounted to $34 and $70 for September 30, 2003 and September 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
September 30, 2003 there are no significant loans as to which management has
serious doubt about their collectibility other than what is included above.
At September 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:
September 30, September 30,
Three Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Balance at beginning of period $ 3,500 $ 3,950
Charge-offs:
Real estate mortgages - 12
Commercial and all others 13 740
Credit card and related plans 15 5
Installment loans 1 12
- -----------------------------------------------------------------------------
Total charge-offs 29 769
- -----------------------------------------------------------------------------
Recoveries:
Real estate mortgages 24 12
Commercial and all others - -
Credit card and related plans - 1
Installment loans 4 1
- -----------------------------------------------------------------------------
Total recoveries 28 14
- -----------------------------------------------------------------------------
Net charge-offs (recoveries) 1 755
- -----------------------------------------------------------------------------
Provision charged to operations 1 152
- -----------------------------------------------------------------------------
Balance at End of Period $ 3,500 $ 3,347
- -----------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.001% 0.237%
- -----------------------------------------------------------------------------
September 30, September 30,
Nine Months Ended: 2003 2002
- -----------------------------------------------------------------------------
Balance at beginning of period $ 3,347 $ 3,600
Charge-offs:
Real estate mortgages 6 66
Commercial and all others 289 763
Credit card and related plans 35 16
Installment loans 4 13
- -----------------------------------------------------------------------------
Total charge-offs 334 858
- -----------------------------------------------------------------------------
Recoveries:
Real estate mortgages 24 31
Commercial and all others - -
Credit card and related plans 2 1
Installment loans 5 2
- -----------------------------------------------------------------------------
Total recoveries 31 34
- -----------------------------------------------------------------------------
Net charge-offs (recoveries) 303 824
- -----------------------------------------------------------------------------
Provision charged to operations 456 571
- -----------------------------------------------------------------------------
Balance at End of Period $ 3,500 $ 3,347
- -----------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.112% 0.255%
- -----------------------------------------------------------------------------
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 1.45% at September
30, 2003 and 1.08% at September 30, 2002.
The allowance for loan losses is allocated as follows:
As Of: September 30, 2003 December 31, 2002 September 30, 2002
- --------------------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- --------------------------------------------------------------------------------------------
Real estate mortgages $ 1,400 73% $ 1,600 77% $ 1,600 78%
Commercial and all others 1,575 15% 1,222 13% 1,222 12%
Credit card and related plans 175 1% 175 1% 175 1%
Personal installment loans 350 11% 350 9% 350 9%
- --------------------------------------------------------------------------------------------
Total $ 3,500 100% $ 3,347 100% $ 3,347 100%
- --------------------------------------------------------------------------------------------
* 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 21.22% at September 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
September 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
None.
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 September 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: November 4, 2003
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: November 4, 2003