Customer Services
-----------------
A detailed listing of the services offered by the Company is as follows:
DEPOSIT ACCOUNTS
All Purpose Clubs
Certificates of Deposit
Christmas Clubs
Demand Accounts
Individual Retirement Accounts
Money Market Accounts
NOW Accounts
Savings Accounts
Time Open Accounts
Vacation Clubs
LENDING
Appliance Loans
Automobile Loans
Business Loans
Collateral Loans
Commercial Equipment Leasing
Construction Loans
Cosmic Card (Debit Card, Check Card)
Credit Lines
Educational Loans
Home Equity Loans
Home Repair and Remodeling Loans
Installment Loans
MasterCard and VISA (Credit Card)
Mortgage Loans (Residential and Commercial)
Personal Loans
OTHER SERVICES
ATM Services
Bank Money Orders
Cash Management
Cashier's Checks
College Campus Card Interface
Data Processing Services
Direct Deposit of Recurring Payments
EDI-ACH Service
Foreign Remittance
Home Banking Services
Internet Banking
Investor Services
(a) Brokerage
(b) Insurance
Lockbox Services
Night Depository
Point-of-Sale Banking
Repurchase Agreements
Safe Deposit Boxes
Travelers Checks
Trust Department Services
(a) Administrator (b) Agent
(c) Custodian and Trustee for Pension Plans
(d) Executor (e) Guardian
(f) Securities Depository Service (g) Trustee (h) Trustee for Public Bond
Issues
U.S. Savings Bonds
BRANCH LOCATIONS (with ATMs)
Abington
1100 Northern Boulevard
Clarks Summit, PA
Carl M. Baruffaldi, Manager
(570) 587-4898
East Scranton
Prescott Avenue & Ash Street
Scranton, PA
Beth S. Wolff, Manager
(570) 342-9101
East Stroudsburg
Route 209 & Route 447
East Stroudsburg, PA
Denise M. Cebular, Manager
(570) 420-0432
Gouldsboro
Main & Second Streets
Gouldsboro, PA
Lori A. Dzwieleski, Manager
(570) 842-6473
Green Ridge
1901 Sanderson Avenue
Scranton, PA
Jeffrey Solimine, Manager
(570) 346-4695
Central City
150 North Washington Avenue
Scranton, PA
Andrew A. Kettel, Jr., Manager
(570) 346-7741
Mount Pocono
Route 611 & Route 940
Mount Pocono, PA
Karyn Gaus Vashlishan, Manager
(570) 839-8732
North Pocono
Main & Academy Streets
Moscow, PA
Deborah A. Wright, Manager
(570) 842-7626
South Scranton
526 Cedar Avenue
Scranton, PA
J. Patrick Dietz, Manager
(570) 343-1151
OTHER ATM LOCATIONS
Acorn Market
Route 611
Swiftwater, PA
Convenient Food Mart
Wyoming & Mulberry Streets
Scranton, PA
Dino & Francesco's Restaurant
Birney Plaza
Moosic, PA
Drive-Up ATM
Meadow Avenue & Hemlock Street
Scranton, PA
Hilton Hotel & Conference Center
Adams Avenue
Scranton, PA
Metropolitan Life Insurance Company
Morgan Highway
Clarks Summit, PA
One Stop Quick Mart, Inc.
Milford Road
East Stroudsburg, PA
Red Barn Village
Newton Ransom Boulevard
Newton, PA
Skytop Lodge
One Skytop
Skytop, PA
www.pennsecurity.com
Financial Highlights
--------------------
In thousands, except per share data
2003 2002 2001
- --------------------------------------------------------------
Earnings per share $ 2.78 $ 3.14 $ 2.62
Dividends per share $ 1.35 $ 1.35 $ 1.25
Total Capital $ 60,807 $ 58,975 $ 54,648
Total Deposits $ 407,944 $ 414,664 $ 406,531
Total Assets $ 584,590 $ 496,956 $ 482,551
Contents
--------
Customer Services.............................................Inside Front Cover
President's Letter.............................................................2
Board of Directors.............................................................3
Promotions and Appointments....................................................4
Community Events...............................................................5
Form 10-K
Part I, Item 1 Business.....................................................8
Item 2 Properties...................................................9
Item 3 Legal Proceedings............................................9
Item 4 Submission of Matters to a Vote of Security Holders..........9
Part II, Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters.......................................10
Item 6 Selected Financial Data.....................................11
Item 7 Management Discussion and Analysis of Financial
Condition and Results of Operations.......................12
Item 7A Quantitative and Qualitative Disclosures About Market Risk..21
Item 8 Financial Statements and Supplementary Data.................23
Consolidated Balance Sheets.................................23
Consolidated Statements of Income...........................24
Consolidated Statements of Stockholders' Equity.............25
Consolidated Statements of Cash Flows.......................26
General Notes to Financial Statements.......................27
Independent Auditor's Report................................37
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................38
Item 9A Controls and Procedures.....................................38
Part III, Item 10 Directors and Executive Officers of the Registrant..........38
Item 11 Executive Compensation......................................38
Item 12 Security Ownership of Certain Beneficial Owners
and Management............................................39
Item 13 Certain Relationships and Related Transactions..............39
Item 14 Principal Accounting Fees and Services......................39
Part IV, Item 15 Exhibits, Financial Statement Schedules and
Reports on Form 8-K.......................................39
Signatures....................................................................40
Certifications................................................................41
Index to Exhibits.............................................................43
Company Officers..............................................................44
Company Board Members..........................................Inside Back Cover
Penseco Financial Services Corporation / 2003 Annual Report 1
President's Letter
------------------
Dear Shareholder
For only the 5th time since I became President 28 years ago, I must report
that earnings for the year declined from the previous year. Earnings per share
decreased from $3.14 per share in 2002 to $2.78 per share in 2003. Dividends per
share remained at $1.35 per share in 2003 as in 2002. Total Assets increased to
$585 million, as of the end of 2003 from $497 million at the end of 2002. Total
Deposits decreased from $415 million in 2002 to $408 million in 2003. Capital
increased to $60.8 million at the end of 2003 from $59.0 million at the end of
2002. The primary reason for the decline in earnings was the continuing low
levels of the interest rate structure for an extended period of time, reaching
45 year lows. This has led to an avalanche of refinancing of loans and home
mortgages, largely at much lower fixed, long-term rates, which the Bank was
reluctant to keep in its portfolio. We therefore sold many of these into the
secondary market generating gains on the sale, but also reducing our net
interest income. With refinancing slowing down, rates have now come up over 100
basis points from their 45 year lows and fee income from the gains on sales of
mortgages has decreased. Net interest income is increasing and we are again
portfolioing some longer term obligations, however net interest income has not
increased fast enough to fill the gap. We expect the economy and our loan
portfolio to continue to grow rapidly over the next several years, thus
improving significantly our net interest income. To that end, in August of the
year we introduced a privately insured (TERI) student loan which can provide up
to 100% of the cost of college and graduate or professional school, thus filling
a gap left by government guaranteed student loans.
The Sarbanes-Oxley Act, enacted in July of 2002, continues to impact our
organization. We are now subject to the accelerated filing deadlines which
reduce the number of days after the end of the fiscal year, in which we have to
issue our Annual Report, from 90 to 75, days commencing with this annual report
and from 75 to 60 days next year. Similarly, the quarterly reports this current
year will have to be filed within 40 days of the end of the quarter from 45 days
before. Next year, we will lose another 5 days and quarterly reports will need
to be filed within 35 days of the end of the quarter.
Section 404 of the Act requires that, commencing with the annual report for
year 2004 which must be filed with the Securities Exchange Commission by March
1, 2005 and for each year thereafter, the report must include an internal
control report that contains management's assertions regarding the effectiveness
of the Company's internal control structure and procedures over financial
reporting. The Company's audit report must also provide an attestation to and
report on management's assessment of the Company's internal control over
financial reporting. This provision will require management to document each
type of transaction that occurs in the Bank, the risks involved in the
transaction, the internal controls established to mitigate such risks,
information and communication of the results and finally a monitoring of the
controls. Affecting all of this is the control environment within the Bank. All
of this must be accomplished by December 31, 2004 and will take an enormous
amount of management's time this year. All SEC reporting corporations will go
through the same pain this year or next and ongoing into the future, because of
the transgressions of a few knowledgeable, smart but dishonest CEO's and CFO's
of major corporations.
During the year, the following appointments and promotions were made. Mark
M. Bennett was named Assistant Vice-President, Chad J. Hazelton was named
Financial Analyst, Kristen R. Noll was named Trust Administrator, Thomas J.
Malinchak was named Retail Banking Officer, David R. Weiland was named Cost
Accounting Officer, Ellen M. Evans was named Audit Officer and Robert E. Diehl
was named Collections Officer. We are fortunate to have such a fine group of
people assuming greater responsibilities in the Company.
We think that our strong capital position, good earnings, advanced
technology and solid customer base, both in our traditional geographic market
and niche national markets, provide an excellent foundation for our continued
success. In this endeavor you can help us by recommending us to your family,
friends, and business organizations. This is your institution - let it serve
you.
Sincerely yours,
Otto P. Robinson, Jr.
President
2 Penseco Financial Services Corporation / 2003 Annual Report
Board of Directors
------------------
This page of the 2003 Annual Report to Shareholders contains one picture. A
description of the picture follows:
Seated left to right:
Emily S. Perry, Richard E. Grimm, Executive Vice-President and Treasurer;
Attorney Otto P. Robinson, Jr., President; Edwin J. Butler, and Sandra C.
Phillips
Standing left to right:
James B. Nicholas, Steven L. Weinberger, P. Frank Kozik, Secretary; Russell C.
Hazelton, D. William Hume, Robert W. Naismith, Ph.D., and James G. Keisling
Penseco Financial Services Corporation / 2003 Annual Report 3
Promotions & Appointments
-------------------------
This page of the 2003 Annual Report to Shareholders contains seven pictures. A
description of each picture follows, starting at the top, from left to right:
Mark M. Bennett
Assistant Vice-President
Chad J. Hazelton
Financial Analyst
Kristen R. Noll
Trust Administrator
Thomas J. Malinchak
Retail Banking Officer
David R. Weiland
Cost Accounting Officer
Ellen M. Evans
Audit Officer
Robert E. Diehl
Collections Officer
4 Penseco Financial Services Corporation / 2003 Annual Report
Community Events
----------------
This page of the 2003 Annual Report to Shareholders contains three pictures.
Penn Security Bank & Trust Company welcomes prospective customers to our Open
House Seminar held at the South Side Branch.
Andrew A. Kettel, Jr. speaking with prospective customers at Penn Security Bank
& Trust Company's Open House Seminar, held at the South Side Branch.
J. Patrick Dietz advising customers about community mortgage financing at the
Penn Security Bank & Trust Company's Open House Seminar.
Penseco Financial Services Corporation / 2003 Annual Report 5
Community Events
----------------
This page of the 2003 Annual Report to Shareholders contains three pictures.
Art displayed in the lobby of the Central City Branch, created by students at
Scranton High School.
Penn Security Bank & Trust Company's display at the 2003 Lackawanna Home Builder
Showcase.
A woman stopping to look at Penn Security's display at the 4th Annual Senior
Citizen's Fair.
6 Penseco Financial Services Corporation / 2003 Annual Report
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2003
Commission File Number 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
Scranton, Pennsylvania
Commonwealth of Pennsylvania
I.R.S. Employer Identification Number 23-2939222
150 North Washington Avenue
Scranton, Pennsylvania 18503-1848
Telephone number 570-346-7741
Securities Registered Under
Section 12(g) of the Act
Common Stock, Par Value $ .01 per share
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 check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes (X) No ( )
THE AGGREGATE MARKET VALUE OF THE COMPANY'S VOTING STOCK HELD BY NON-AFFILIATES
OF THE REGISTRANT ON JUNE 30, 2003, BASED ON THE CLOSING PRICE OF SUCH STOCK ON
THAT DATE, EQUALS APPROXIMATELY $85,920,000. THE NUMBER OF SHARES OF COMMON
STOCK OUTSTANDING AS OF JUNE 30, 2003 EQUALS 2,148,000.
Documents Incorporated by Reference
Portions of the Corporation's definitive proxy statement relating to the 2004
Annual Meeting of Stockholders are incorporated by reference in Part III.
Penseco Financial Services Corporation / 2003 Annual Report 7
PENSECO FINANCIAL SERVICES CORPORATION
PART I
ITEM 1 Business
GENERAL
PENSECO FINANCIAL SERVICES CORPORATION, (the "Company"), which is headquartered
in Scranton, Pennsylvania, was formed under the general corporation laws of the
State of Pennsylvania in 1997 and is registered as a financial holding company.
The Company became a holding company upon the acquisition of all of the
outstanding shares of Penn Security Bank and Trust Company (the "Bank"), a state
chartered bank, on December 31, 1997. The Company is subject to supervision by
the Federal Reserve Board. The Bank, as a state chartered financial institution,
is subject to supervision by the Federal Deposit Insurance Corporation and the
Pennsylvania Department of Banking.
The Company's principal banking office is located at 150 North Washington
Avenue, Scranton, Pennsylvania, containing trust, investor services, marketing,
audit, credit card, human resources, executive, data processing and central
bookkeeping offices. There are eight additional offices.
Through it's banking subsidiary, the Company generates interest income from
it's outstanding loans receivable and it's investment portfolio. Other income is
generated primarily from merchant transaction fees, trust fees and service
charges on deposit accounts. The Company's primary costs are interest paid on
deposits and borrowings and general operating expenses. The Bank provides a
variety of commercial and retail banking services to business and professional
customers, as well as retail customers, on a personalized basis. The Bank's
primary lending products are real estate, commercial and consumer loans. The
Bank also offers ATM access, credit cards, active investment accounts, trust
department services and other various lending, depository and related financial
services. The Bank's primary deposit products are savings and demand deposit
accounts and certificates of deposit.
The Bank has a third party marketing agreement with Fiserv Investor
Services, Inc. that allows the bank to offer a full range of securities,
brokerage and annuity sales to it's customers. The investor services division is
located in the headquarters building and the services are offered throughout the
entire branch system.
The Company is not dependent upon a single customer, or a few customers,
the loss of one or more of which would have a material adverse effect on it's
operations. The operations and earnings of the Corporation are not materially
affected by seasonal changes or by Federal, state or local environmental laws or
regulations.
COMPETITION
The Bank operates in a competitive environment in which it must share its market
with many local independent banks as well as several banks which are affiliates
or branches of very large regional holding companies. The Bank encounters
competition from diversified financial institutions, ranging in size from small
banks to the nationwide banks operating in it's region, and include commercial
banks, savings and loan associations, credit unions and other lending
institutions.
The principal competitive factors among the Bank's competitors can be
grouped into two categories: pricing and services. In the Bank's primary service
area, interest rates on deposits, especially time deposits, and interest rates
and fees charged to customers on loans are very competitive. From a service
perspective, the Bank competes in areas such as convenience of location, types
of services, service costs and banking hours.
EMPLOYEES
As of February 13, 2004, the Company employed 197 full-time equivalent
employees. The employees of the Company are not represented by any collective
bargaining group. Management of the Company considers relations with its
employees to be good.
8 Penseco Financial Services Corporation / 2003 Annual Report
SUPERVISION AND REGULATION
The Company is registered as a bank holding company under the Bank Holding
Company Act of 1956, as amended, and, as such, is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board" or "FRB"). The Company is required to file quarterly reports of
its operations with the FRB.
As a financial holding company, the Company is permitted to engage in
banking-related activities as authorized by the Federal Reserve Board, directly
or through subsidiaries or by acquiring companies already established in such
activities subject to the FRB regulations relating to those activities.
The Bank, as a Pennsylvania state-chartered financial institution, is
subject to supervision, regulation and examination by the Commonwealth of
Pennsylvania Department of Banking and by the Federal Deposit Insurance
Corporation (the "FDIC"), which insures the Bank's deposits to the maximum
extent permitted by law.
FORWARD LOOKING INFORMATION
This Form 10-K contains forward-looking informational statements, in addition to
the historical financial information required by the Securities and Exchange
Commission. There are certain risks and uncertainties associated with these
forward-looking statements which could cause actual results to differ materially
from those stated herein. Such differences are discussed in the section entitled
"Management Discussion and Analysis of Financial Condition and Results of
Operations". These forward-looking statements reflect management's analysis as
of this point in time. Readers should review the other documents the Company
periodically files with the Securities and Exchange Commission in order to keep
apprised of any material changes.
ITEM 2 Properties
There are nine offices positioned throughout the greater Northeastern
Pennsylvania region. They are located in the South Scranton, East Scranton,
Green Ridge, and Central City sections of Scranton, the Borough of Moscow, the
Town of Gouldsboro, South Abington Township, the Borough of Mount Pocono and the
Borough of East Stroudsburg at Eagle Valley Corners. Through these offices, the
Company provides a full range of banking and trust services primarily to
Lackawanna, Wayne, Monroe and the surrounding counties. All offices are owned by
the Bank or through a wholly owned subsidiary of the Bank, Penseco Realty, Inc.,
with the exception of the Mount Pocono Office, which is owned by the Bank but is
located on land occupied under a long-term lease. During 2003, the Company
purchased property in the Borough of Dalton, Lackawanna County, to use for
future expansion.
The principal office, located at the corner of North Washington Avenue and
Spruce Street in the "Central City" of Scranton's business district, houses the
operations, trust, investor services, marketing, credit card and audit
departments as well as the Company's executive offices. Several remote ATM
locations are leased by the Bank, which are located throughout Northeastern
Pennsylvania. All branches and ATM locations are equipped with closed circuit
television monitoring.
ITEM 3 Legal Proceedings
There are no material pending legal proceedings, other than ordinary routine
litigation incidental to the business of the Company, as to which the Company or
subsidiary is a party or of which any of their property is subject.
ITEM 4 Submission of Matters to a Vote of Security Holders
No matter was submitted by the Company to its shareholders through the
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year covered by this report.
Penseco Financial Services Corporation / 2003 Annual Report 9
PART II
ITEM 5 Market for Registrant's Common Equity and Related Stockholder Matters
This Annual Report is the Company's annual disclosure statement as required
under Section 13 or 15(d) of the Securities Exchange Act of 1934. Questions may
be directed to any branch location of the Company or by contacting the
Controller's office at:
Patrick Scanlon, Controller
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, Pennsylvania 18503-1848
1-800-327-0394
Management of the Company is aware of the following securities dealers who make
a market in the Company stock:
Ferris, Baker, Watts, Inc.
F.J. Morrissey & Company Boenning & Scattergood, Inc.
Hill Thompson Magid, LP
Monroe Securities, Inc.
E.E. Powell & Company
Ryan, Beck & Company, Inc.
Schwab Capital Markets, LP
The Company's capital stock is traded on the "Over-the-Counter" BULLETIN BOARD
under the symbol "PFNS". The following table sets forth the price range together
with dividends paid for each of the past two years. These quotations do not
necessarily reflect the value of actual transactions.
Dividends Paid
2003 High Low Per Share
- ---------------------------------------------
First Quarter $ 40 $ 34 $ .30
Second Quarter 41 38 .30
Third Quarter 41 39 .30
Fourth Quarter 42 41 .45
------
$ 1.35
======
Dividends Paid
2002 High Low Per Share
- ---------------------------------------------
First Quarter $ 30 $ 27 $ .30
Second Quarter 34 29 .30
Third Quarter 33 31 .30
Fourth Quarter 35 31 .45
------
$ 1.35
======
DIVIDENDS PAID (in millions) YEAR
- -------------------------------------------
$ 2,900 2003
2,899 2002
2,685 2001
2,470 2000
2,363 1999
As of February 13, 2004 there were approximately 959 stockholders of the Company
based on the number of holders of record.
Reference should be made to the information about the Company's dividend policy
and regulatory guidelines on pages 20 and 35.
TRANSFER AGENT
Penn Security Bank and Trust Company, Trust Department, 150 North Washington
Avenue, Scranton, Pennsylvania 18503-1848. Stockholders' questions should be
directed to the Bank's Trust Department at 570-346-7741.
QUARTERLY FINANCIAL DATA (unaudited)
(in thousands, except per share amounts)
First Second Third Fourth
2003 Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------
Net Interest Income $ 4,686 $ 4,731 $ 4,246 $ 4,123
Provision for Loan Losses 239 216 1 20
Other Income 2,746 2,345 3,234 2,418
Other Expenses 5,269 4,840 5,422 4,923
Net Income 1,559 1,585 1,603 1,224
Earnings Per Share $ .73 $ .73 $ .75 $ .57
First Second Third Fourth
2002 Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------
Net Interest Income $ 5,173 $ 5,100 $ 4,927 $ 4,688
Provision for Loan Losses 179 240 152 242
Other Income 2,684 1,978 3,292 3,078
Other Expenses 5,413 4,812 5,596 5,277
Net Income 1,689 1,567 1,839 1,658
Earnings Per Share $ .79 $ .73 $ .85 $ .77
10 Penseco Financial Services Corporation / 2003 Annual Report
ITEM 6 Selected Financial Data
(in thousands, except per share data)
RESULTS OF OPERATIONS:
2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------
Interest Income $ 26,014 $ 27,899 $ 31,860 $ 31,043 $ 28,320
Interest Expense 8,228 8,011 12,524 13,698 11,213
- -----------------------------------------------------------------------------------------------
Net Interest Income 17,786 19,888 19,336 17,345 17,107
Provision for Loan Losses 476 813 954 233 89
- -----------------------------------------------------------------------------------------------
Net Interest Income
after Provision for
Loan Losses 17,310 19,075 18,382 17,112 17,018
Other Income 10,743 11,032 9,186 8,233 7,746
Other Expenses 20,454 21,098 20,077 19,306 18,312
Income Taxes 1,628 2,256 1,869 1,296 1,781
- -----------------------------------------------------------------------------------------------
Net Income $ 5,971 $ 6,753 $ 5,622 $ 4,743 $ 4,671
===============================================================================================
BALANCE SHEET DATA:
Assets $ 584,590 $ 496,956 $ 482,551 $ 467,230 $ 428,614
Investment Securities $ 293,125 $ 139,132 $ 128,623 $ 125,808 $ 106,511
Net Loans $ 236,882 $ 285,509 $ 320,208 $ 304,641 $ 278,577
Deposits $ 407,944 $ 414,664 $ 406,531 $ 387,439 $ 367,332
Stockholders' Equity $ 60,807 $ 58,975 $ 54,648 $ 50,067 $ 45,743
PER SHARE DATA:
Earnings per Share $ 2.78 $ 3.14 $ 2.62 $ 2.21 $ 2.17
Dividends per Share $ 1.35 $ 1.35 $ 1.25 $ 1.15 $ 1.10
Book Value per Share $ 28.31 $ 27.46 $ 25.44 $ 23.31 $ 21.30
Common Shares Outstanding 2,148,000 2,148,000 2,148,000 2,148,000 2,148,000
FINANCIAL RATIOS:
Net Interest Margin 3.24% 4.21% 4.30% 4.08% 4.22%
Return on Average Assets 1.05% 1.37% 1.18% 1.06% 1.08%
Return on Average Equity 9.87% 11.79% 10.57% 9.96% 10.12%
Average Equity to Average Assets 10.59% 11.58% 11.19% 10.60% 10.70%
Dividend Payout Ratio 48.56% 42.99% 47.71% 52.04% 50.69%
Penseco Financial Services Corporation / 2003 Annual Report 11
ITEM 7 Management Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion is intended to provide information to facilitate the
understanding and assessment of significant changes and trends related to the
financial condition of the Company and the results of its operations. This
discussion and analysis should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto. All information is
presented in thousands of dollars, except as indicated.
SUMMARY
Net earnings for 2003 totalled $5,971, a decrease of 11.6% from the $6,753
earned in 2002, which was an increase of 20.1% from the $5,622 earned in 2001.
Net earnings per share were $2.78 in 2003, compared with $3.14 in 2002 and $2.62
in 2001. Net earnings for 2003 decreased from 2002 mainly due to the refinancing
of the Company's high-yield residential mortgage loan portfolio into lower
fixed-rate obligations, which then were sold in the secondary market. Net
earnings for 2002 increased from 2001 results due to an increase in the net
interest income, fee income, mainly from the sale of non-portfolio mortgages and
the sale of U.S. Agency securities, offset by an increase in operating costs,
primarily salaries and employee benefits and applicable income tax expense.
NET INCOME (in millions) YEAR
- -------------------------------------------
$ 5,971 2003
6,753 2002
5,622 2001
4,743 2000
4,671 1999
The Company's return on average assets was 1.05% in 2003 compared to 1.37% in
2002 and 1.18% in 2001. Return on average equity was 9.87%, 11.79% and 10.57% in
2003, 2002 and 2001, respectively.
RETURN ON AVERAGE ASSETS YEAR
- -------------------------------------------
1.05% 2003
1.37% 2002
1.18% 2001
1.06% 2000
1.08% 1999
RETURN ON AVERAGE EQUITY YEAR
- -------------------------------------------
9.87% 2003
11.79% 2002
10.57% 2001
9.96% 2000
10.12% 1999
12 Penseco Financial Services Corporation / 2003 Annual Report
RESULTS OF OPERATIONS
NET INTEREST INCOME
The principal component of the Company's earnings is net interest income, which
is the difference between interest and fees earned on interest-earning assets
and interest paid on deposits and other borrowings.
Net interest income was $17.8 million in 2003, compared with $19.9 million
in 2002, a decrease of 10.6%. The decrease in net interest income in 2003
resulted from the refinancing of the Company's high-yield residential mortgage
loans into lower fixed-rate obligations, which were then sold in the secondary
market. Also net interest income was negatively impacted by accelerated purchase
premium write-downs from unprecedented pre-payments of the Company's
mortgage-backed securities portfolio due to interest rates hovering at
forty-five year lows.
In 2003, the Company purchased a FHLMC (Freddie Mac) pool of new twenty
year residential mortgages, with a 5 1/2% coupon and a face value of $100
million. The Company financed the purchase by borrowing $100 million from the
Federal Home Loan Bank with maturities ranging from 5 to 20 years. The interest
spread will vary depending on various interest rate scenarios which affect
prepayment speeds.
The Company also anticipates purchasing long-term municipal securities at
higher tax equivalent yields than the Company is presently earning, to improve
net interest income.
Net interest income was $19.9 million in 2002, compared with $19.3 million
in 2001, an increase of 3.1%. The increase in net interest income in 2002
resulted from an increase in interest-earning assets. Also, the Company had
increases in its deposit transaction accounts, which have the lowest carrying
costs.
Net interest income, when expressed as a percentage of average
interest-earning assets, is referred to as net interest margin. The Company's
net interest margin for the year ended December 31, 2003 was 3.2% compared with
4.2% for the year ended December 31, 2002, and 4.3% for the year ended December
31, 2001.
Interest income in 2003 totalled $26.0 million, compared to $27.9 million
in 2002, a decrease of 6.8%. The yield on average interest-earning assets was
4.8% in 2003, compared to 5.9% in 2002. Average interest-earning assets
increased in 2003 to $548.2 million from $472.8 million in 2002. Average loans,
which are typically the Company's highest yielding earning assets, decreased
$54.2 million in 2003, while investment securities increased on average by
$103.4 million. Average loans represented 47.9% of 2003 average interest-earning
assets, compared to 67.0% in 2002.
Interest expense also increased in 2003 to $8.2 million from $8.0 million
in 2002, an increase of $.2 million or 2.5%. The increase resulted from the
Company entering into a leveraged transaction during the first quarter of 2003,
which increased long-term interest expense. Despite this increase, the average
rate paid on interest-bearing liabilities during 2003 was 1.9%, compared to
2.2%, a decrease of 13.6% from 2002.
Interest income in 2002 totalled $27.9 million, compared to $31.9 million
in 2001, a decrease of 12.5%. The yield on average interest-earning assets was
5.9% in 2002, compared to 7.1% in 2001. Average interest-earning assets
increased in 2002 to $472.8 million from $450.0 million in 2001. Average loans,
which are typically the Company's highest yielding earning assets, decreased
$9.3 million in 2002, while investment securities increased on average by $13.7
million. Average loans represented 67.0% of 2002 average interest-earning
assets, compared to 72.4% in 2001.
Interest expense also decreased in 2002 to $8.0 million from $12.5 million
in 2001, a decrease of $4.5 million or 36.0%. This decrease resulted from the
Federal Reserve cutting short term interest rates in late 2001 due to the
economy showing anemic growth. The average rate paid on interest-bearing
liabilities during 2002 was 2.2%, compared to 3.5%, a decrease of 37.1% from
2001.
The most significant impact on net interest income between periods is
derived from the interaction of changes in the volume of and rates earned or
paid on interest-earning assets and interest-bearing liabilities. The volume of
earning dollars in loans and investments, compared to the volume of
interest-bearing liabilities represented by deposits and borrowings, combined
with the spread, produces the changes in net interest income between periods.
NET INTEREST INCOME (in millions) YEAR
- ---------------------------------------------
$ 17,786 2003
19,888 2002
19,336 2001
17,345 2000
17,107 1999
Penseco Financial Services Corporation / 2003 Annual Report 13
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY/INTEREST RATES AND
INTEREST DIFFERENTIAL
The table below presents average weekly 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 years 2003,
2002 and 2001.
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investment securities:
Available-for-sale:
U.S. Treasury securities $ 30,127 $ 1,250 4.15% $ 36,550 $ 1,575 4.31% $ 40,596 $ 2,262 5.57%
U.S. Agency obligations 79,520 3,660 4.60 57,544 3,267 5.68 47,802 3,130 6.55
States & political subdivisions 20,433 947 7.02 8,962 439 7.42 6,725 245 5.52
Federal Home Loan Bank stock 4,911 97 1.98 1,960 69 3.52 1,881 122 6.49
Other 435 11 2.53 391 10 2.56 211 6 2.84
Held-to-maturity:
U.S. Agency obligations 75,194 3,365 4.48 1,862 58 3.11 3,192 185 5.80
States & political subdivisions 29,730 1,621 8.26 29,715 1,641 8.37 22,852 1,189 7.88
Loans, net of unearned income:
Real estate mortgages 194,135 11,246 5.79 245,016 16,412 6.70 250,000 19,148 7.66
Commercial 31,288 1,497 4.78 32,168 1,751 5.44 27,885 2,117 7.59
Consumer and other 36,997 1,890 5.11 39,405 2,390 6.07 47,961 3,418 7.13
Federal funds sold 35,620 340 .95 12,995 189 1.45 181 6 3.31
Interest on balances with banks 9,781 90 .92 6,277 98 1.56 651 32 4.92
- ------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets/
Total Interest Income 548,171 $ 26,014 4.75% 472,845 $ 27,899 5.90% 449,937 $ 31,860 7.08%
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks 8,760 8,234 8,310
Bank premises and equipment 9,984 10,411 11,218
Accrued interest receivable 3,144 3,432 3,831
Other assets 4,482 3,083 5,063
Less: Allowance for loan losses 3,411 3,662 3,185
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 571,130 $ 494,343 $ 475,174
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 28,738 $ 144 .50% $ 26,204 $ 159 .61% $ 25,033 $ 240 .96%
Savings 76,983 472 .61 71,470 700 .98 64,513 965 1.50
Money markets 87,973 737 .84 91,561 1,329 1.45 86,154 2,616 3.04
Time - Over $100 32,525 844 2.59 37,741 1,398 3.70 32,998 1,779 5.39
Time - Other 105,858 2,873 2.71 116,659 4,139 3.55 114,943 5,784 5.03
Federal funds purchased - - - - - - 3 - -
Repurchase agreements 22,266 183 .82 20,278 276 1.36 17,366 570 3.28
Short-term borrowings 699 11 1.57 562 10 1.78 15,520 570 3.67
Long-term borrowings 76,401 2,964 3.88 - - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 431,443 $ 8,228 1.91% 364,475 $ 8,011 2.20% 356,530 $ 12,524 3.51%
- ------------------------------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 76,421 69,482 61,823
All other liabilities 2,763 3,124 3,656
Stockholders' equity 60,503 57,262 53,165
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 571,130 $ 494,343 $ 475,174
====================================================================================================================================
Interest Spread 2.84% 3.70% 3.57%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 17,786 $ 19,888 $ 19,336
====================================================================================================================================
FINANCIAL RATIOS
Net interest margin 3.24% 4.21% 4.30%
Return on average assets 1.05% 1.37% 1.18%
Return on average equity 9.87% 11.79% 10.57%
Average equity to average assets 10.59% 11.58% 11.19%
Dividend payout ratio 48.56% 42.99% 47.71%
14 Penseco Financial Services Corporation / 2003 Annual Report
DOLLAR AMOUNT OF CHANGE IN INTEREST INCOME AND INTEREST EXPENSE
Dollar Change
Amount Change in Change in in Rate-
2003 compared to 2002 of Change Volume Rate Volume
----------------------------------------------------------------------------------
EARNING Investment securities:
ASSETS Available-for-sale:
U.S. Treasury securities $ (325) $ (277) $ (58) $ 10
U.S. Agency obligations 393 1,248 (621) (234)
States & political subdivisions 508 562 (24) (30)
Equity securities 29 105 (30) (46)
Held-to-maturity:
U.S. Agency obligations 3,307 2,281 26 1,000
States & political subdivisions (20) 1 (21) -
Loans, net of unearned income:
Real estate mortgages (5,166) (3,415) (2,230) 479
Commercial (254) (48) (212) 6
Consumer and other (500) (146) (378) 24
Federal funds sold 151 328 (65) (112)
Interest bearing balances with banks (8) 55 (41) (22)
----------------------------------------------------------------------------------
Total Interest Income (1,885) 694 (3,654) 1,075
----------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand - Interest bearing (15) 15 (28) (2)
LIABILITIES Savings (228) 54 (264) (18)
Money markets (592) (52) (559) 19
Time - Over $100 (554) (193) (419) 58
Time - Other (1,266) (378) (980) 92
Federal funds purchased - - - -
Repurchase agreements (93) 27 (110) (10)
Short-term borrowings 1 2 (1) -
Long-term borrowings 2,964 - - 2,964
----------------------------------------------------------------------------------
Total Interest Expense 217 (525) (2,361) 3,103
----------------------------------------------------------------------------------
Net Interest Income $ (2,102) $ 1,219 $ (1,293) $(2,028)
==================================================================================
Dollar Change
Amount Change in Change in in Rate-
2002 compared to 2001 of Change Volume Rate Volume
----------------------------------------------------------------------------------
EARNING Investment securities:
ASSETS Available-for-sale:
U.S. Treasury securities $ (687) $ (225) $ (512) $ 50
U.S. Agency obligations 137 638 (416) (85)
States & political subdivisions 194 81 85 28
Equity securities (49) 10 (57) (2)
Held-to-maturity:
U.S. Agency obligations (127) (77) (86) 36
States & political subdivisions 452 357 69 26
Loans, net of unearned income:
Real estate mortgages (2,736) (382) (2,400) 46
Commercial (366) 325 (599) (92)
Consumer and other (1,028) (610) (508) 90
Federal funds sold 183 424 (3) (238)
Interest bearing balances with banks 66 277 (22) (189)
----------------------------------------------------------------------------------
Total Interest Income (3,961) 818 (4,449) (330)
----------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand - Interest bearing (81) 11 (88) (4)
LIABILITIES Savings (265) 104 (335) (34)
Money markets (1,287) 163 (1,353) (97)
Time - Over $100 (381) 256 (558) (79)
Time - Other (1,645) 86 (1,701) (30)
Federal funds purchased - - - -
Repurchase agreements (294) 96 (332) (58)
Short-term borrowings (560) (549) (293) 282
----------------------------------------------------------------------------------
Total Interest Expense (4,513) 167 (4,660) (20)
----------------------------------------------------------------------------------
Net Interest Income $ 552 $ 651 $ 211 $ (310)
==================================================================================
Penseco Financial Services Corporation / 2003 Annual Report 15
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. Accordingly, there can be no assurance that existing levels of the
allowance will ultimately prove adequate to cover actual loan losses.
OTHER INCOME
The following table sets forth information by category of other income for the
Company for the past three years:
Years Ended December 31, 2003 2002 2001
- --------------------------------------------------------------
Trust department income $ 1,311 $ 1,266 $ 1,233
Service charges on
deposit accounts 1,133 1,123 1,126
Merchant transaction income 5,005 5,519 5,331
Other fee income 1,630 1,562 1,291
Other operating income 1,323 553 231
Realized gains (losses) on
securities, net 341 1,009 (26)
- --------------------------------------------------------------
Total Other Income $ 10,743 $ 11,032 $ 9,186
==============================================================
Total other income decreased $289 or 2.6% during 2003 to $10,743 from $11,032
for 2002. Merchant transaction income decreased $514 or 9.3% due to a loss of
service to a major merchant. Other fee income increased $68 or 4.4% partly from
increased fees from mortgage loans serviced for others and offset by a decrease
in brokerage income due to the softness in the economy. Other operating income
increased $770, mainly due to a $624 increase in gains on sale of low-yield,
fixed-rate, non-portfolio mortgage loans. The Company also realized a security
gain of $341 due to the sale of a $5 million, short-term U.S. Treasury and $10
million of short-term U.S. Agency securities, which were re-deployed into longer
term U.S. Agency securities.
Total other income increased $1,846 or 20.1% during 2002 to $11,032 from
$9,186 for 2001. Components of this increase include $1,009 from the gain on the
sale of U.S. Agency securities, merchant transaction income of $188 along with
an increase in fee income of $158 due to our brokerage division and a gain on
the sale of low-yield, fixed-rate non-portfolio mortgage loans of $444.
OTHER EXPENSES
The following table sets forth information by category of other expenses for the
Company for the past three years:
Years Ended December 31, 2003 2002 2001
- --------------------------------------------------------------
Salaries and employee
benefits $ 9,010 $ 9,048 $ 8,180
Occupancy expenses, net 1,388 1,384 1,416
Furniture and equipment
expenses 1,175 1,208 1,245
Merchant transaction
expenses 4,158 4,731 4,636
Other operating expenses 4,723 4,727 4,600
- --------------------------------------------------------------
Total Other Expenses $ 20,454 $ 21,098 $ 20,077
==============================================================
Other expenses decreased $644 or 3.1% for 2003 to $20,454 from $21,098 for 2002.
Salaries and employee benefits decreased $38 to $9,010 for 2003 from $9,048 for
2002 despite increased pension costs of $361. Merchant transaction expenses
decreased $573 or 12.1%, the result of a loss of service to a major merchant.
Other expenses increased $1,021 or 5.1% for 2002 to $21,098 from $20,077
for 2001. Salaries and employee benefits increased $868 or 10.6% to $9,048 for
2002 from $8,180 for 2001 partly due to staff additions, replacements, merit
increases and pension costs. Merchant transaction expenses increased $95, the
result of additional volume. Also, other operating expenses increased $127 or
2.8%, mainly due to increased expenses in advertising and other centennial year
expenses.
INCOME TAXES
Federal income tax expense decreased $628 or 27.8% to $1,628 in 2003 compared to
$2,256 in 2002, due to increased tax free income and decreased operating income.
Federal income tax expense increased $387 or 20.7% to $2,256 in 2002
compared to $1,869 in 2001, due to increased operating income.
The Company's effective income tax rate for 2003, 2002 and 2001 was 21.4%,
25.0% and 25.0%, respectively.
For further discussion pertaining to Federal income taxes, see Note 14 to
the Consolidated Financial Statements.
FINANCIAL CONDITION
Total assets increased $87.6 million or 17.6% during 2003 to $584.6 million at
December 31, 2003 compared to $497.0 million at December 31, 2002 For the year
ended December 31, 2002 total assets increased $14.4 million to $497.0 million
or a 3.0% increase over $482.6 million at December 31, 2001.
ASSETS (in millions) YEAR
- -------------------------------------
$ 584,590 2003
496,956 2002
482,551 2001
467,230 2000
428,614 1999
INVESTMENT PORTFOLIO
The Company maintains a portfolio of investment securities to provide income and
serve as a source of liquidity for its ongoing operations.
The following table presents the carrying value, by security type, for the
Company's investment portfolio.
December 31, 2003 2002 2001
- --------------------------------------------------------------------
U.S.Treasury securities $ 15,387 $ 36,456 $ 36,069
U.S. Agency obligations 221,156 52,026 60,520
States & political subdivisions 50,228 49,294 29,741
Equity securities 6,354 1,356 2,293
- -------------------------------------------------------------------
Total Investment Securities $ 293,125 $ 139,132 $ 128,623
===================================================================
16 Penseco Financial Services Corporation / 2003 Annual Report
LOAN PORTFOLIO
Details regarding the Company's loan portfolio for the past five years are as
follows:
December 31, 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------------------
Real estate - construction
and land development $ 3,078 $ 5,031 $ 9,124 $ 9,321 $ 3,241
Real estate mortgages 172,964 217,883 246,486 234,212 216,574
Commercial 30,056 30,077 30,001 21,566 18,995
Credit card and related plans 2,403 2,320 2,377 2,267 2,203
Installment 25,855 27,306 30,142 30,290 28,693
Obligations of states &
political subdivisions 6,026 6,239 5,678 10,085 11,821
- -------------------------------------------------------------------------------------------
Loans, net of unearned income 240,382 288,856 323,808 307,741 281,527
Less: Allowance for loan losses 3,500 3,347 3,600 3,100 2,950
- -------------------------------------------------------------------------------------------
Loans, net $ 236,882 $ 285,509 $ 320,208 $ 304,641 $ 278,577
===========================================================================================
LOANS
Total net loans decreased $48.6 million to $236.9 million at December 31, 2003
from $285.5 million at December 31, 2002, a decrease of 17.0%. The decrease is
due to the refinancing of higher yielding residential portfolio mortgage loans
with low fixed-rate obligations, which then were sold in the secondary market.
Total net loans decreased $34.7 million to $285.5 million at December 31,
2002 from $320.2 million at December 31, 2001, a decrease of 10.8%. The decrease
is due to management's reluctance to carry low-yield, fixed-rate mortgages,
while concentrating on increasing variable rate loans.
NET LOANS (in millions) YEAR
- -------------------------------------------
$ 236,882 2003
285,509 2002
320,208 2001
304,641 2000
278,577 1999
LOAN QUALITY
The lending activities of the Company are guided by the comprehensive lending
policy established by the Board of Directors. 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.
Penseco Financial Services Corporation / 2003 Annual Report 17
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:
December 31, 2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------
Non-accrual loans $ 1,533 $ 2,245 $ 1,917 $ 1,210 $ 836
Loans past due 90 days or more and accruing:
Guaranteed student loans 169 394 304 313 476
Credit card and home equity loans 3 - 22 23 -
- ---------------------------------------------------------------------------------------------
Total non-performing loans 1,705 2,639 2,243 1,546 1,312
Other real estate owned 121 59 143 201 33
- ---------------------------------------------------------------------------------------------
Total non-performing assets $ 1,826 $ 2,698 $ 2,386 $ 1,747 $ 1,345
=============================================================================================
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 $1,533, $2,245 and $1,917 at December 31, 2003, 2002 and 2001,
respectively. If interest on those loans had been accrued, such income would
have been $198, $171 and $152 for 2003, 2002 and 2001, respectively. Interest
income on those loans, which is recorded only when received, amounted to $29,
$77 and $86 for 2003, 2002 and 2001, respectively. There are no commitments to
lend additional funds to borrowers whose loans are on 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 portfolio quality,
and current economic conditions that may affect the borrower's ability to pay.
As of December 31, 2003, there are no significant loans as to which management
has serious doubt about their collectibility.
At December 31, 2003, 2002 and 2001, 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:
Years Ended December 31, 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------
Balance at beginning of year $ 3,347 $ 3,600 $ 3,100 $ 2,950 $ 2,830
- -----------------------------------------------------------------------------------------
Charge-offs:
Real estate mortgages 11 91 38 37 82
Commercial and all others 289 944 389 51 13
Credit card and related plans 51 44 37 27 65
Installment loans 4 22 19 24 26
- -----------------------------------------------------------------------------------------
Total charge-offs 355 1,101 483 139 186
- -----------------------------------------------------------------------------------------
Recoveries:
Real estate mortgages 24 31 20 30 -
Commercial and all others 6 - - - 195
Credit card and related plans 2 1 1 9 10
Installment loans - 3 8 17 12
- -----------------------------------------------------------------------------------------
Total recoveries 32 35 29 56 217
- -----------------------------------------------------------------------------------------
Net charge-offs (recoveries) 323 1,066 454 83 (31)
- -----------------------------------------------------------------------------------------
Provision charged to operations 476 813 954 233 89
- -----------------------------------------------------------------------------------------
Balance at End of Year $ 3,500 $ 3,347 $ 3,600 $ 3,100 $ 2,950
=========================================================================================
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.12% 0.34% 0.14% 0.03% (0.01)%
=========================================================================================
18 Penseco Financial Services Corporation / 2003 Annual Report
The allowance for loan losses is allocated as follows:
December 31, 2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------
Amount %1 Amount %1 Amount %1 Amount %1 Amount %1
- ---------------------------------------------------------------------------------------------------------------
Real estate mortgages $ 1,100 73% $ 1,600 77% $ 1,700 79% $ 1,500 79% $ 1,500 78%
Commercial
and all others 1,970 15 1,222 13 1,375 11 1,100 10 950 10
Credit card and
related plans 180 1 175 1 175 1 150 1 150 1
Personal installment loans 250 11 350 9 350 9 350 10 350 11
- ---------------------------------------------------------------------------------------------------------------
Total $ 3,500 100% $ 3,347 100% $ 3,600 100% $ 3,100 100% $ 2,950 100%
===============================================================================================================
Note: 1 - Percent of loans in each category to total loans
DEPOSITS
The primary source of funds to support the Company's operations is its deposit
base. Company deposits decreased $6.8 million to $407.9 million at December 31,
2003 from $414.7 million at December 31, 2002, a decrease of 1.6% due to a
decrease in time deposits. Company deposits increased $8.2 million to $414.7
million at December 31, 2002 from $406.5 million at December 31, 2001, an
increase of 2.0% due to increases in DDA and savings deposits.
The maturities of time deposits of $100,000 or more are as follows:
Three months or less $ 9,143
Over three months through six months 2,676
Over six months through twelve months 7,824
Over twelve months 10,678
--------
Total $ 30,321
========
DEPOSITS (in millions) YEAR
- --------------------------------------
$ 407,944 2003
414,664 2002
406,531 2001
387,439 2000
367,332 1999
ASSET/LIABILITY MANAGEMENT
The Company's policy is to match its level of rate-sensitive assets and
rate-sensitive liabilities within a limited range, thereby reducing its exposure
to interest rate fluctuations. While no single measure can completely identify
the impact of changes in interest rates on net interest income, one gauge of
interest rate-sensitivity is to measure, over a variety of time periods, the
differences in the amounts of the Company's rate-sensitive assets and
rate-sensitive liabilities. These differences, or "gaps", provide an indication
of the extent to which net interest income may be affected by future changes in
interest rates. A positive gap exists when rate-sensitive assets exceed
rate-sensitive liabilities and indicates that a greater volume of assets than
liabilities will reprice during a given period. This mismatch may enhance
earnings in a rising interest rate environment and may inhibit earnings when
interest rates decline. Conversely, when rate-sensitive liabilities exceed
rate-sensitive assets, referred to as a negative gap, it indicates that a
greater volume of liabilities than assets may reprice during the period. In this
case, a rising interest rate environment may inhibit earnings and declining
interest rates may enhance earnings. However, because interest rates for
different asset and liability products offered by financial institutions respond
differently, the gap is only a general indicator of interest rate sensitivity.
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.
Penseco Financial Services Corporation / 2003 Annual Report 19
LIQUIDITY (continued)
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.
The Company offers collateralized repurchase agreements, that have a one
day maturity, as an alternative deposit option for its customers. The Company
also has long-term debt outstanding to the FHLB, which was used to purchase a
Freddie Mac pool of residential mortgages, as described earlier in this report.
The Company continues to have $95,701 of available borrowing capacity with the
FHLB.
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.
Financial instruments whose contract amounts represent credit risk at
December 31, 2003 and 2002 are as follows:
2003 2002
- ----------------------------------------------------
Commitments to extend credit:
Fixed rate $ 19,147 $ 12,273
Variable rate $ 52,188 $ 66,257
Standby letters of credit $ 15,363 $ 10,586
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 21.99% at December 31,
2003. The Company's risk-based capital ratio is more than the 10.00% ratio that
Federal regulators use as the "well capitalized" threshold. This is the current
criteria which the FDIC uses in determining the lowest insurance rate for
deposit insurance. The Company's risk-based capital ratio is more than double
the 8.00% limit which determines whether a company is "adequately capitalized".
Under these rules, the Company could significantly increase its assets and still
comply with these capital requirements without the necessity of increasing its
equity capital.
DIVIDEND POLICY
Payment of future dividends will be subject to the discretion of the Board of
Directors and will depend upon the earnings of the Company, its financial
condition, its capital requirements, its need for funds and other matters as the
Board deems appropriate.
Dividends on the Company common stock, if approved by the Board of
Directors, are customarily paid on or about March 15, June 15, September 15 and
December 15.
STOCKHOLDERS' EQUITY (in millions) YEAR
- ----------------------------------------------
$ 60,807 2003
58,975 2002
54,648 2001
50,067 2000
45,743 1999
20 Penseco Financial Services Corporation / 2003 Annual Report
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk
The Company currently does not enter into derivative financial instruments,
which include futures, forwards, interest rate swaps, option contracts and other
financial instruments with similar characteristics. However, the Company is
party to financial instruments with off-balance sheet risk in the normal course
of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit, financial guarantees and
letters of credit. These instruments involve to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
Consolidated Balance Sheets. 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 fixed expiration dates or other
termination clauses and may require payment of a fee. Standby letters of credit
are conditional commitments issued to guarantee the performance of a customer to
a third party up to a stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded
as an asset or liability by the Company until the instrument is exercised.
The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximizing income. Management realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and an interest rate shock simulation report. The Company
has no market risk sensitive instruments held for trading purposes. It appears
the Company's market risk is reasonable at this time.
The following table provides information about the Company's market rate
sensitive instruments used for purposes other than trading that are sensitive to
changes in interest rates. For loans, securities, and liabilities with
contractual maturities, the table presents principal cash flows and related
weighted-average interest rates by contractual maturities as well as the
Company's historical experience of the impact of interest rate fluctuations on
the prepayment of residential and home equity loans and mortgage-backed
securities. For core deposits (e.g., DDA, interest checking, savings and money
market deposits) that have no contractual maturity, the table presents principal
cash flows and, as applicable, related weighted-average interest rates based on
the Company's historical experience, management's judgment, and statistical
analysis, as applicable, concerning their most likely withdrawal behaviors.
Penseco Financial Services Corporation / 2003 Annual Report 21
MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2003
The table below presents States and political subdivisions securities on a fully
taxable equivalent basis.
Non-Rate
2004 2005 2006 2007 2008 Thereafter Sensitive Total Fair Value
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed interest rate securities:
U.S. Treasury securities $ 10,030 $ 5,357 $ - $ - $ - $ - $ - $ 15,387 $ 15,387
Yield 3.00% 6.79% - - - - - 4.32%
U.S. Agency obligations 15,490 34,444 23,727 3,153 3,297 68,239 - 148,350 147,770
Yield 4.27% 4.47% 2.69% 4.48% 4.48% 4.48% - 4.17%
States & political subdivisions - - - - - 50,228 - 50,228 52,947
Yield - - - - - 7.55% - 7.55%
Variable interest rate securities:
U.S. Agency obligations 20,559 21,034 21,195 4,972 5,046 - - 72,806 72,814
Yield 3.50% 3.49% 3.46% 4.48% 4.48% - - 3.62%
Federal Home Loan Bank stock - - - - - 5,840 - 5,840 5,840
Yield - - - - - 1.40% - 1.40%
Other - - - - - 514 - 514 514
Yield - - - - - 4.63% - 4.63%
Fixed interest rate loans:
Real estate mortgages 4,194 3,597 3,875 3,592 3,518 31,087 - 49,863 50,225
Yield 6.91% 7.18% 6.79% 7.20% 7.20% 6.78% - 6.88%
Consumer and other 1,579 1,423 1,279 1,014 850 1,051 - 7,196 7,337
Yield 6.76% 6.57% 6.24% 5.73% 5.35% 7.98% - 6.50%
Variable interest rate loans:
Real estate mortgages 24,844 12,356 11,700 11,287 11,331 54,661 - 126,179 127,294
Yield 4.22% 4.33% 4.36% 4.35% 4.35% 4.59% - 4.43%
Commercial 30,056 - - - - - - 30,056 30,056
Yield 4.78% - - - - - - 4.78%
Consumer and other 11,247 3,925 3,509 3,051 3,141 2,215 - 27,088 27,187
Yield 4.77% 5.53% 4.71% 3.51% 3.51% 3.54% - 4.48%
Less: Allowance for loan losses 697 354 339 315 314 1,481 - 3,500
Interest bearing deposits with banks 4,693 - - - - - - 4,693 4,693
Yield .80% - - - - - - .80%
Federal funds sold 23,600 - - - - - - 23,600 23,600
Yield .89% - - - - - - .89%
Cash and due from banks - - - - - - 10,062 10,062 10,062
Other assets - - - - - - 16,228 16,228
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 145,595 $ 81,782 $ 64,946 $ 26,754 $ 26,869 $ 212,354 $ 26,290 $ 584,590 $ 575,726
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
Demand - Interest bearing $ - $ 30,515 $ - $ - $ - $ - $ - $ 30,515 $ 30,515
Yield - .25% - - - - - .25%
Savings - 80,689 - - - - - 80,689 80,689
Yield - .49% - - - - - .49%
Money markets 89,103 - - - - - - 89,103 89,103
Yield .70% - - - - - - .70%
Time - Other 10,063 - - - - - - 10,063 10,063
Yield 2.92% - - - - - - 2.92%
Fixed interest rate deposits:
Time - Over $100,000 19,643 2,781 2,644 3,061 2,092 100 - 30,321 30,860
Yield 1.72% 2.40% 3.64% 4.77% 3.87% 5.00% - 2.42%
Time - Other 48,015 8,068 7,206 14,443 6,970 2,825 - 87,527 88,384
Yield 1.66% 2.70% 3.19% 4.66% 3.60% 4.54% - 2.62%
Demand - Non-interest bearing - - - - - - 79,726 79,726 79,726
Repurchase agreements 19,454 - - - - - - 19,454 19,454
Yield .75% - - - - - - .75%
Short-term borrowings 823 - - - - - - 823 823
Yield .76% - - - - - - .76%
Long-term borrowings 6,648 9,139 9,464 9,801 9,181 49,290 - 93,523 93,549
Yield 3.52% 3.52% 3.53% 3.53% 3.53% 4.12% - 3.84%
Other liabilities - - - - - - 2,039 2,039
Stockholders' equity - - - - - - 60,807 60,807
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 193,749 $ 131,192 $ 19,314 $ 27,305 $ 18,243 $ 52,215 $ 142,572 $ 584,590 $ 523,166
====================================================================================================================================
Excess of (liabilities) assets
subject to interest rate change $ (48,154) $ (49,410) $ 45,632 $ (551) $ 8,626 $ 160,139 $(116,282) $ -
====================================================================================================================================
22 Penseco Financial Services Corporation / 2003 Annual Report
ITEM 8 Financial Statements and Supplementary Data
Consolidated Balance Sheets
(in thousands, except per share data)
December 31, 2003 2002
---------------------------------------------------------------
ASSETS Cash and due from banks $ 10,062 $ 11,120
Interest bearing balances with banks 4,693 10,424
Federal funds sold 23,600 33,075
---------------------------------------------------------------
Cash and Cash Equivalents 38,355 54,619
Investment securities:
Available-for-sale, at fair value 179,600 108,083
Held-to-maturity (fair value of $115,672
and $32,986, respectively) 113,525 31,049
---------------------------------------------------------------
Total Investment Securities 293,125 139,132
Loans, net of unearned income 240,382 288,856
Less: Allowance for loan losses 3,500 3,347
---------------------------------------------------------------
Loans, Net 236,882 285,509
Bank premises and equipment 9,935 9,920
Other real estate owned 121 59
Accrued interest receivable 3,298 3,399
Other assets 2,874 4,318
---------------------------------------------------------------
Total Assets $ 584,590 $ 496,956
===============================================================
LIABILITIES Deposits:
Non-interest bearing $ 79,726 $ 78,560
Interest bearing 328,218 336,104
Total Deposits 407,944 414,664
Other borrowed funds:
Repurchase agreements 19,454 19,419
Short-term borrowings 823 890
Long-term borrowings 93,523 -
Accrued interest payable 1,158 1,317
Other liabilities 881 1,691
---------------------------------------------------------------
Total Liabilities 523,783 437,981
---------------------------------------------------------------
STOCKHOLDERS' Common stock, $.01 par value, 15,000,000
EQUITY shares authorized, 2,148,000
shares issued and outstanding 21 21
Surplus 10,819 10,819
Retained earnings 48,131 45,060
Accumulated other comprehensive income 1,836 3,075
---------------------------------------------------------------
Total Stockholders' Equity 60,807 58,975
---------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 584,590 $ 496,956
===============================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
Penseco Financial Services Corporation / 2003 Annual Report 23
Consolidated Statements of Income
(in thousands, except per share data)
Years Ended December 31, 2003 2002 2001
-------------------------------------------------------------------------
INTEREST Interest and fees on loans $ 14,632 $ 20,553 $ 24,683
Interest and dividends on investments:
U.S. Treasury securities and U.S.
Agency obligations 8,275 4,900 5,577
States & political subdivisions 2,569 2,080 1,434
Other securities 108 79 128
Interest on Federal funds sold 340 189 6
Interest on balances with banks 90 98 32
-------------------------------------------------------------------------
Total Interest Income 26,014 27,899 31,860
-------------------------------------------------------------------------
INTEREST Interest on time deposits
EXPENSE of $100,000 or more 844 1,398 1,779
Interest on other deposits 4,226 6,327 9,605
Interest on other borrowed funds 3,158 286 1,140
Total Interest Expense 8,228 8,011 12,524
-------------------------------------------------------------------------
Net Interest Income 17,786 19,888 19,336
Provision for loan losses 476 813 954
-------------------------------------------------------------------------
Net Interest Income After Provision
for Loan Losses 17,310 19,075 18,382
-------------------------------------------------------------------------
OTHER Trust department income 1,311 1,266 1,233
INCOME Service charges on deposit accounts 1,133 1,123 1,126
Merchant transaction income 5,005 5,519 5,331
Other fee income 1,630 1,562 1,291
Other operating income 1,323 553 231
Realized gains (losses) on securities, net 341 1,009 (26)
-------------------------------------------------------------------------
Total Other Income 10,743 11,032 9,186
-------------------------------------------------------------------------
OTHER Salaries and employee benefits 9,010 9,048 8,180
EXPENSES Occupancy expenses, net 1,388 1,384 1,416
Furniture and equipment expenses 1,175 1,208 1,245
Merchant transaction expenses 4,158 4,731 4,636
Other operating expenses 4,723 4,727 4,600
-------------------------------------------------------------------------
Total Other Expenses 20,454 21,098 20,077
-------------------------------------------------------------------------
Income before income taxes 7,599 9,009 7,491
Applicable income taxes 1,628 2,256 1,869
-------------------------------------------------------------------------
Net Income $ 5,971 $ 6,753 $ 5,622
=========================================================================
Earnings Per Share $ 2.78 $ 3.14 $ 2.62
=========================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
24 Penseco Financial Services Corporation / 2003 Annual Report
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2003, 2002 and 2001
- --------------------------------------------
Accumulated
Other Total
Common Retained Comprehensive Stockholders'
(in thousands except per share data) Stock Surplus Earnings Income Equity
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 $ 21 $ 10,819 $ 38,269 $ 958 $ 50,067
Comprehensive income:
Net income, 2001 - - 5,622 - 5,622
Unrealized gains on securities,
net of reclassification adjustment
and taxes - - - 1,644 1,644
-------
Comprehensive income 7,266
Cash dividends declared ($1.25 per share) - - (2,685) - (2,685)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 21 10,819 41,206 2,602 54,648
Comprehensive income:
Net income, 2002 - - 6,753 - 6,753
Unrealized gains on securities,
net of reclassification adjustment
and taxes - - - 473 473
-------
Comprehensive income 7,226
Cash dividends declared ($1.35 per share) - - (2,899) - (2,899)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 21 10,819 45,060 3,075 58,975
Comprehensive income:
Net income, 2003 - - 5,971 - 5,971
Unrealized losses on securities,
net of reclassification adjustment
and taxes - - - (1,239) (1,239)
-------
Comprehensive income 4,732
Cash dividends declared ($1.35 per share) - - (2,900) - (2,900)
- ----------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 $ 21 $ 10,819 $ 48,131 $ 1,836 $ 60,807
==========================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
Penseco Financial Services Corporation / 2003 Annual Report 25
Consolidated Statements of Cash Flows
(in thousands) Years Ended December 31, 2003 2002 2001
------------------------------------------------------------------------------------------
OPERATING Net Income $ 5,971 $ 6,753 $ 5,622
ACTIVITIES Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 1,119 1,240 1,288
Provision for loan losses 476 813 954
Deferred income tax (benefit) provision (182) 95 (213)
Amortization of securities
(net of accretion) 1,050 201 38
Net realized (gains) losses on securities (341) (1,009) 26
Loss (gain) on other real estate 15 2 (14)
Loss on disposition of fixed assets - 7 -
Decrease in interest receivable 101 200 391
Decrease (increase) in other assets 1,441 (2,419) (299)
Increase (decrease) in income taxes payable 252 (252) 208
Decrease in interest payable (159) (260) (691)
(Decrease) increase in other liabilities (239) (34) 78
------------------------------------------------------------------------------------------
Net cash provided by
operating activities 9,504 5,337 7,388
------------------------------------------------------------------------------------------
INVESTING Purchase of investment securities
ACTIVITIES available-for-sale (122,157) (34,798) (41,035)
Proceeds from sales and maturities of investment
securities available-for-sale 48,715 24,797 52,568
Purchase of investment securities to be
held-to-maturity (103,031) - (13,407)
Proceeds from repayments of investment
securities to be held-to-maturity 19,894 1,017 1,487
Net loans repaid (originated) 47,677 33,629 (16,786)
Proceeds from other real estate 397 339 337
Proceeds from sale of fixed assets - 5 -
Investment in premises and equipment (1,134) (389) (364)
------------------------------------------------------------------------------------------
Net cash (used) provided by
investing activities (109,639) 24,600 (17,200)
------------------------------------------------------------------------------------------
FINANCING Net increase in demand and savings deposits 6,862 18,906 14,784
ACTIVITIES Net (payments) proceeds on time deposits (13,582) (10,773) 4,308
Increase in repurchase agreements 35 1,279 3,054
Net (decrease) increase in short-term borrowings (67) 873 (11,486)
Proceeds from long-term borrowings 100,000 - -
Payments on long-term borrowings (6,477) - -
Cash dividends paid (2,900) (2,899) (2,685)
------------------------------------------------------------------------------------------
Net cash provided by
financing activities 83,871 7,386 7,975
------------------------------------------------------------------------------------------
Net (decrease) increase in cash
and cash equivalents (16,264) 37,323 (1,837)
Cash and cash equivalents at January 1 54,619 17,296 19,133
------------------------------------------------------------------------------------------
Cash and cash equivalents at December 31 $ 38,355 $ 54,619 $ 17,296
==========================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
26 Penseco Financial Services Corporation / 2003 Annual Report
General Notes To Financial Statements
1 NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated in 1997 under the laws of Pennsylvania. It is the parent company of
Penn Security Bank and Trust Company (Bank), a state chartered bank.
The Company operates from nine banking offices under a state bank charter
and provides full banking services, including trust services, to individual and
corporate customers primarily in Northeastern Pennsylvania. The Company's
primary deposit products are savings and demand deposit accounts and
certificates of deposit. Its primary lending products are real estate,
commercial and consumer loans.
The Company's revenues are attributable to a single reportable segment,
therefore segment information is not presented.
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.
BASIS OF PRESENTATION
The Financial Statements of the Company have been consolidated with those of its
wholly-owned subsidiary, Penn Security Bank and Trust Company, eliminating all
intercompany items and transactions.
The Statements are presented on the accrual basis of accounting.
All information is presented in thousands of dollars, except per share
data.
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 allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
EMERGING ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51". The Interpretation provides new guidance for the
consolidation of variable interest entities (VIEs) and requires such entities to
be consolidated by their primary beneficiaries if the entities do not
effectively disperse risk among parties involved. The consolidation requirements
apply immediately to VIEs created after January 31, 2003 and are effective for
the first fiscal year or interim period beginning after December 15, 2003 for
VIEs acquired before February 1, 2003.
The Company presently does not have any variable interest entities which
will be affected by the application of Interpretation No. 46.
In December 2003, the FASB issued Statement No. 132 (revised 2003),
"Employers' Disclosure about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88 and 106". The Statement retains all
required disclosures contained in the original Statement No. 132 and requires
additional disclosures about assets, obligations, cash flows and net periodic
benefit costs of defined benefit pension plans and other defined benefit
postretirement benefit plans. The disclosure requirements are generally
effective for years ended after December 15, 2003 with the following exceptions:
Disclosure of estimated future benefit payments (as of the date of the
latest balance sheet) expected to be paid in each of the next five fiscal years,
and in the aggregate for the five fiscal years thereafter, is effective for
fiscal years ending after June 15, 2004.
Companies with foreign plans may defer certain disclosures (the accumulated
benefit obligation, estimated contributions, the measurement date and certain
information about plan assets) associated with those plans until fiscal years
ending after June 15, 2004.
Employers are required to report various elements of pension and other
benefit costs in interim financial statements for quarters beginning after
December 15, 2003.
Management does not anticipate that the adoption of the additional
disclosures required by the Statement will have a significant effect on the
Company's earnings or financial position.
INVESTMENT SECURITIES
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, debentures and mortgage-backed
securities 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.
Securities Available-for-Sale Bonds, notes, debentures, mortgage-backed
securities 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.
The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities, adjusted, when necessary,
for advanced prepayments in excess of those estimates.
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.
LOANS AND PROVISION (ALLOWANCE) FOR POSSIBLE LOAN LOSSES
Loans are stated at the principal amount outstanding, net of any unearned
income, deferred loan fees and the allowance for loan losses. Interest is
accrued daily on the outstanding balances.
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.
Penseco Financial Services Corporation / 2003 Annual Report 27
1 NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
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.
The provision for loan losses is based on past loan loss experience,
management's evaluation of the potential loss in the current loan portfolio
under current economic conditions and such other factors as, in management's
best judgement, deserve current recognition in estimating loan losses. The
annual 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.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Provision for depreciation and amortization, computed principally on the
straight-line method, is charged to operating expenses over the estimated useful
lives of the assets. Maintenance and repairs are charged to current expense as
incurred.
LONG-LIVED ASSETS
The Company reviews the carrying value of long-lived assets for impairment
whenever events or changes in circumstances indicate that carrying amounts of
the assets might not be recoverable, as prescribed in Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" (SFAS 144).
LOAN SERVICING
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair
value of those rights. Fair values are estimated using discounted cash flows
based on current market rates of interest and current expected future prepayment
rates. For purposes of measuring impairment, the rights must be stratified by
one or more predominant risk characteristics of the underlying loans. The
Company stratifies its capitalized mortgage servicing rights based on the
product type, interest rate and term of the underlying loans. The amount of
impairment recognized is the amount, if any, by which the amortized cost of the
rights for each stratum exceed the fair value.
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expenses for the years
ended December 31, 2003, 2002 and 2001, amounted to $473, $650 and $497,
respectively.
INCOME TAXES
Provisions for income taxes are based on taxes payable or refundable for the
current year (after exclusion of non-taxable income such as interest on state
and municipal securities) as well as deferred taxes on temporary differences,
between the amount of taxable income and pre-tax financial income and between
the tax bases of assets and liabilities and their reported amounts in the
Financial Statements. Deferred tax assets and liabilities are included in the
Financial Statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled as prescribed in Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" (SFAS 109). As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
PENSION EXPENSE
Pension expense has been determined in accordance with Statement of Financial
Accounting Standards No. 87, "Employers Accounting for Pensions" (SFAS 87).
POSTRETIREMENT BENEFITS EXPENSE
Postretirement benefits expense has been determined in accordance with Statement
of Financial Accounting Standards No. 106, "Employers Accounting for
Postretirement Benefits Other Than Pensions" (SFAS 106).
CASH FLOWS
For purposes of the Statements of Cash Flows, cash and cash equivalents include
cash on hand, due from banks, interest bearing balances with banks and Federal
funds sold for a one-day period.
The Company paid interest and income taxes during the years ended December 31,
2003, 2002 and 2001 as follows:
2003 2002 2001
- -----------------------------------------------------
Income taxes paid $ 1,698 $ 2,636 $ 1,909
Interest paid $ 8,387 $ 8,271 $ 13,215
Non-cash transactions during the years ended December 31, 2003, 2002 and 2001,
comprised entirely of the net acquisition of real estate in the settlement of
loans, amounted to $474, $257 and $265, respectively.
TRUST ASSETS AND INCOME
Assets held by the Company in a fiduciary or agency capacity for its customers
are not included in the Financial Statements since such items are not assets of
the Company. Trust income is reported on the accrual basis of accounting.
EARNINGS PER SHARE
Basic earnings per share is computed on the weighted average number of common
shares outstanding during each year (2,148,000) as prescribed in Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). A
calculation of diluted earnings per share is not applicable to the Company.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 2003
presentation.
- --------------------------------------------------------------------------------
2 CASH AND DUE FROM BANKS
Cash and due from banks are summarized as follows:
December 31, 2003 2002
- -----------------------------------------------------------
Cash items in process of collection $ 5,452 $ 127
Non-interest bearing balances 1,371 8,708
Cash on hand 3,239 2,285
- -----------------------------------------------------------
Total $ 10,062 $ 11,120
===========================================================
The Company may, from time to time, maintain bank balances with other
financial institutions in excess of $100,000 each. Management is not aware of
any evidence that would indicate that such deposits are at risk.
28 Penseco Financial Services Corporation / 2003 Annual Report
3 INVESTMENT SECURITIES
The amortized cost and fair value of investment securities at December 31, 2003
and 2002 are as follows:
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
2003 Cost Gains Losses Value
- --------------------------------------------------------------------------
U.S. Treasury securities $ 15,008 $ 379 $ - $ 15,387
U.S. Agency securities 63,568 1,435 - 65,003
Mortgage-backed
securities 71,975 147 107 72,015
States & political
subdivisions 20,158 683 - 20,841
- --------------------------------------------------------------------------
Total Debt Securities 170,709 2,644 107 173,246
Equity securities 6,109 245 - 6,354
- --------------------------------------------------------------------------
Total Available -
for-Sale $ 176,818 $ 2,889 $ 107 $179,600
==========================================================================
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
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
==========================================================================
Equity securities at December 31, 2003 and 2002, consisted primarily of Federal
Home Loan Bank stock, which is a required investment in order to participate in
an available line of credit program. The stock is stated at par value as there
is no readily determinable fair value.
A summary of transactions involving available-for-sale debt securities in 2003,
2002 and 2001 are as follows:
December 31, 2003 2002 2001
- ------------------------------------------------------------
Proceeds from sales $ 15,640 $ 13,832 $ 28,594
Gross realized gains 341 1,009 53
Gross realized losses - - 79
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
2003 Cost Gains Losses Value
- --------------------------------------------------------------------------
Mortgage-backed
securities $ 84,138 $ 8 $ 580 $ 83,566
States & political
subdivisions 29,387 2,719 - 32,106
- --------------------------------------------------------------------------
Total Held-to-
Maturity $ 113,525 $ 2,727 $ 580 $ 115,672
==========================================================================
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
2002 Cost Gains Losses Value
- --------------------------------------------------------------------------
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
==========================================================================
Investment securities with amortized costs and fair values of $81,461 and
$85,653 at December 31, 2003 and $88,034 and $92,907 at December 31, 2002, were
pledged to secure trust funds, public deposits and for other purposes as
required by law.
The amortized cost and fair value of debt securities at December 31, 2003
by contractual maturity, are shown in the following table. 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.
Available-for-Sale Held-to-Maturity
- --------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- --------------------------------------------------------------------------------
Due in one year or less:
U.S. Treasury securities $ 10,010 $ 10,030 $ - $ -
U.S. Agency
securities 12,570 12,731 - -
After one year through
five years:
U.S. Treasury
securities 4,998 5,357 - -
U.S. Agency
securities 50,998 52,272 - -
After ten years:
States & political
subdivisions 20,158 20,841 29,387 32,106
- --------------------------------------------------------------------------------
Subtotal 98,734 101,231 29,387 32,106
Mortgage-backed securities 71,975 72,015 84,138 83,566
- --------------------------------------------------------------------------------
Total Debt Securities $ 170,709 $ 173,246 $ 113,525 $ 115,672
================================================================================
The gross fair value and unrealized losses of the Company's investments,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2003 are as
follows:
Fair Unrealized
Mortgaged-backed securities Value Losses
- -------------------------------------------------------
Less than twelve months $ 130,285 $ 687
Twelve months or more - -
- -------------------------------------------------------
Totals $ 130,285 $ 687
=======================================================
The above table includes three (3) securities that have unrealized losses for
less than twelve months. The unrealized losses in each case are related solely
to interest rate fluctuations.
Penseco Financial Services Corporation / 2003 Annual Report 29
4 LOANS
Major classifications of loans are as follows:
December 31, 2003 2002
- ------------------------------------------------------------------
Loans secured by real estate:
Construction and land development $ 3,078 $ 5,031
Secured by farmland - -
Secured by 1-4 family residential
properties:
Revolving, open-end loans 18,945 15,818
Secured by first liens 93,380 135,602
Secured by junior liens 15,588 20,921
Secured by multi-family properties 165 635
Secured by non-farm, non-residential
properties 44,886 44,907
Commercial and industrial loans
to U.S. addressees 30,056 30,077
Loans to individuals for household, family
and other personal expenditures:
Credit card and related plans 2,403 2,320
Other (installment and
student loans, etc.) 25,192 26,942
Obligations of states &
political subdivisions 6,026 6,239
All other loans 663 364
- ------------------------------------------------------------------
Gross Loans 240,382 288,856
Less: Unearned income on loans - -
- ------------------------------------------------------------------
Loans, Net of Unearned Income $ 240,382 $288,856
==================================================================
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,533, $2,245 and $1,917 at December 31, 2003, 2002 and 2001, respectively.
If interest on those loans had been accrued, such income would have been $198,
$171 and $152 for 2003, 2002 and 2001, respectively. Interest income on those
loans, which is recorded only when received, amounted to $29, $77 and $86 for
2003, 2002 and 2001, respectively. Also, at December 31, 2003 and 2002, the Bank
had loans totalling $172 and $394, respectively, which were past due 90 days or
more and still accruing interest (credit card, home equity and guaranteed
student loans).
- --------------------------------------------------------------------------------
5 ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
Years Ended December 31, 2003 2002 2001
- ---------------------------------------------------------------------
Balance at beginning of year $ 3,347 $ 3,600 $ 3,100
Provision charged to operations 476 813 954
Recoveries credited to allowance 32 35 29
- ---------------------------------------------------------------------
3,855 4,448 4,083
Losses charged to allowance (355) (1,101) (483)
- ---------------------------------------------------------------------
Balance at End of Year $ 3,500 $ 3,347 $ 3,600
=====================================================================
A comparison of the provision for loan losses for Financial Statement purposes
with the allowable bad debt deduction for tax purposes is as follows:
Years Ended December 31, Book Provision Tax Deduction
- ------------------------ -------------- -------------
2003 $ 476 $ 323
2002 $ 813 $ 1,066
2001 $ 954 $ 454
The balance of the Reserve for Bad Debts as reported for Federal income tax
purposes was $948, $948 and $948 at December 31, 2003, 2002 and 2001,
respectively.
- --------------------------------------------------------------------------------
6 LOAN SERVICING
The Company services $73,663 in mortgage loans for Freddie Mac which are not
included in the accompanying Consolidated Balance Sheets.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in deposits, were approximately $709 and $299, at
December 31, 2003 and 2002, respectively. The balance of the servicing rights
was $647 and $227 at December 31, 2003 and 2002, respectively, net of
amortization.
The Company recorded $569 and $236 in new mortgage servicing rights in 2003
and 2002, respectively. Amortization expense of $149 and $9 was recorded for the
years ended December 31, 2003 and 2002, respectively.
There was no allowance for impairment recorded at December 31, 2003 or
2002.
- --------------------------------------------------------------------------------
7 BANK PREMISES AND EQUIPMENT
December 31, 2003 2002
- --------------------------------------------------------
Land $ 3,122 $ 2,919
Buildings and improvements 14,531 14,519
Furniture and equipment 12,458 11,539
- --------------------------------------------------------
30,111 28,977
Less: Accumulated depreciation 20,176 19,057
- --------------------------------------------------------
Net Bank Premises
and Equipment $ 9,935 $ 9,920
========================================================
Buildings and improvements are being depreciated over 10 to 50 year periods and
equipment over 3 to 10 year periods. Depreciation expense amounted to $1,119 in
2003, $1,240 in 2002 and $1,288 in 2001.
Occupancy expenses were reduced by rental income received in the amount of
$64, $63 and $61 in the years ended December 31, 2003, 2002 and 2001,
respectively.
- --------------------------------------------------------------------------------
8 OTHER REAL ESTATE OWNED
Real estate acquired through foreclosure is recorded at the lower of cost or
market at the time of acquisition. Any subsequent write-downs are charged
against operating expenses. The other real estate owned as of December 31, 2003
and 2002 was $121 and $59, respectively, supported by appraisals of the real
estate involved.
- --------------------------------------------------------------------------------
9 INVESTMENT IN AND LOAN TO, INCOME FROM DIVIDENDS AND EQUITY IN EARNINGS OR
LOSSES OF SUBSIDIARY
Penseco Realty, Inc. is a wholly-owned subsidiary of the Bank which owns certain
banking premises. Selected financial information is presented below:
Equity in
underlying Bank's
Percent Total net assets Amount proportionate
of voting investment at balance of part of loss
Year stock owned and loan sheet date dividends for the period
- --------------------------------------------------------------------------
2003 100% $ 3,450 $ 3,435 None $ -
2002 100% $ 3,550 $ 3,535 None $ -
2001 100% $ 3,650 $ 3,635 None $ -
30 Penseco Financial Services Corporation / 2003 Annual Report
10 DEPOSITS
December 31, 2003 2002
- ---------------------------------------------------------
Demand - Non-interest
bearing $ 79,726 $ 78,560
Demand - Interest bearing 30,515 31,363
Savings 80,689 73,786
Money markets 89,103 89,462
Time - Over $100,000 30,321 33,686
Time - Other 97,590 107,807
- ---------------------------------------------------------
Total $ 407,944 $ 414,664
=========================================================
Scheduled maturities of time deposits are as follows:
2004 $ 77,721
2005 10,849
2006 9,850
2007 17,504
2008 9,062
2009 and thereafter 2,925
- --------------------------------------
Total $ 127,911
=======================================
- --------------------------------------------------------------------------------
11 OTHER BORROWED FUNDS
At December 31, 2003 and 2002, other borrowed funds consisted of demand notes to
the U.S. Treasury and Repurchase agreements.
Short-term borrowings generally have original maturity dates of thirty days
or less.
Investment securities with amortized costs and fair values of $28,025 and
$29,289 at December 31, 2003 and $27,133 and $29,008 at December 31, 2002, were
pledged to secure repurchase agreements.
Years Ended December 31, 2003 2002
- ------------------------------------------------------------
Amount outstanding at year end $ 20,277 $ 20,309
Average interest rate at year end .75% 1.57%
Maximum amount outstanding at
any month end $ 19,948 $ 24,649
Average amount outstanding $ 22,176 $ 20,792
Weighted average interest rate
during the year:
Federal funds purchased 2.12% .53%
Repurchase agreements .88% 1.00%
Demand notes to U.S. Treasury .90% 1.00%
The Company has an available credit facility with the Federal Reserve Bank in
the amount of $10,000, secured by pledged securities with amortized costs and
fair values of $10,298 and $10,226 at December 31, 2003 and $10,010 and $10,150
at December 31, 2002 and with interest rates of 2.00% and .75% at December 31,
2003 and December 31, 2002, respectively. There is no stated expiration date for
the credit facility as long as the Company maintains the pledged securities at
the Federal Reserve Bank. There was no outstanding balance as of December 31,
2003 and 2002, respectively.
The Company has the availability of a $5,000 overnight Federal funds line
of credit with Wachovia Bank, N.A. There was no balance outstanding as of
December 31, 2003 and 2002, respectively.
The Company maintains a collateralized maximum borrowing capacity of
$95,701 with the Federal Home Loan Bank of Pittsburgh (FHLB).
- --------------------------------------------------------------------------------
12 LONG-TERM DEBT
The loans from the Federal Home Loan Bank, which were borrowed to purchase a
mortgage-backed security, are secured by a general collateral pledge of the
Company's assets.
A summary of long-term debt, including amortizing principal and interest
payments, at December 31, 2003 is as follows:
Monthly Fixed Maturity
Installment Rate Date Balance
- ------------------------------------------------
$ 161 2.73% 03/13/08 $ 7,727
253 3.22% 03/13/10 17,163
430 3.74% 03/13/13 40,302
186 4.69% 03/13/23 28,331
- ------------------------------------------------
Total $ 93,523
================================================
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at December 31, 2003 are as follows: 2004
$6,648, 2005 $9,139, 2006 $9,464, 2007 $9,801, 2008 $9,181 and thereafter
$49,290 for a total of $93,523.
- --------------------------------------------------------------------------------
13 EMPLOYEE BENEFIT PLANS
The Company provides an Employee Stock Ownership Plan (ESOP), a Retirement
Profit Sharing Plan, an Employees' Pension Plan, as well as an unfunded
supplemental executive pension plan and a Postretirement Life Insurance Plan,
all non-contributory, covering all eligible employees.
Under the Employee Stock Ownership Plan (ESOP), amounts voted by the Board
of Directors are paid into the ESOP and each employee is credited with a share
in proportion to their annual compensation. All contributions to the ESOP are
invested in or will be invested primarily in Company stock. Distribution of a
participant's ESOP account occurs upon retirement, death or termination in
accordance with the plan provisions.
At December 31, 2003 and 2002, the ESOP held 89,204 and 88,962 shares,
respectively of the Company's stock, all of which were acquired as described
above and allocated to specific participant accounts. These shares are treated
the same for dividend purposes and earnings per share calculations as are any
other outstanding shares of the Company's stock. The Company contributed $0,
$140 and $140 to the plan during the years ended December 31, 2003, 2002 and
2001, respectively.
Under the Retirement Profit Sharing Plan, amounts voted by the Board of
Directors are paid into a fund and each employee is credited with a share in
proportion to their annual compensation. Upon retirement, death or termination,
each employee is paid the total amount of their credits in the fund in one of a
number of optional ways in accordance with the plan provisions. The Company
contributed $70, $0 and $0 to the plan during the years ended December 31, 2003,
2002 and 2001, respectively.
Under the Pension Plan, amounts computed on an actuarial basis are paid by
the Company into a trust fund. Provision is made for fixed benefits payable for
life upon retirement at the age of 65, based on length of service and
compensation levels as defined in the plan. Plan assets of the trust fund are
invested and administered by the Trust Department of Penn Security Bank and
Trust Company.
The unfunded supplemental executive pension plan provides certain officers
with additional retirement benefits to replace benefits lost due to limits
imposed on qualified plans by Federal tax law.
The postretirement life insurance plan is an unfunded, non-vesting defined
benefit plan. The plan is non-contributory and provides for a reducing level of
term life insurance coverage following retirement.
For the unfunded plans above, amounts calculated on an actuarial basis are
recorded as a liability.
Penseco Financial Services Corporation / 2003 Annual Report 31
13 EMPLOYEE BENEFIT PLANS (continued)
A reconciliation of the funded status of the plans with amounts reported on the
Consolidated Balance Sheets is as follows:
Pension Benefits Other Benefits
------------------ ----------------
December 31, 2003 2002 2003 2002
- ---------------------------------------------------------------------------
Change in benefit
obligation:
Benefit obligation,
beginning $ 9,855 $ 9,059 $ 250 $ 186
Service cost 385 370 6 5
Interest cost 635 588 15 15
Change in assumptions 237 - 7 -
Amendments - 111 - -
Actuarial gain (loss) 88 26 - 51
Benefits paid (316) (299) (9) (7)
- ---------------------------------------------------------------------------
Benefit obligation,
ending 10,884 9,855 269 250
- ---------------------------------------------------------------------------
Change in plan assets:
Fair value of plan
assets, beginning 7,804 8,100 - -
Actual return on plan
assets 897 (219) - -
Employer contribution 328 222 - -
Benefits paid (316) (299) - -
- ---------------------------------------------------------------------------
Fair value of plan
assets, ending 8,713 7,804 - -
- ---------------------------------------------------------------------------
Funded status (2,171) (2,051) (269) (250)
Unrecognized net transition
asset - - - -
Unrecognized net actuarial
loss (gain) 2,723 2,845 (27) (34)
Unrecognized prior service
cost 55 56 57 64
- ---------------------------------------------------------------------------
Prepaid (accrued) benefit
cost $ 607 $ 850 $ (239) $ (220)
===========================================================================
A reconciliation of net periodic pension and other benefit costs is as follows:
Pension Benefits
------------------
Years Ended December 31, 2003 2002 2001
- ---------------------------------------------------------------------
Components of net periodic
pension cost:
Service cost $ 385 $ 370 $ 310
Interest cost 635 588 540
Expected return on plan assets (624) (726) (732)
Amortization of transition asset - - (66)
Amortization of prior service cost - (104) -
Amortization of unrecognized
net loss 175 82 -
- ---------------------------------------------------------------------
Net periodic pension cost $ 571 $ 210 $ 52
=====================================================================
Other Benefits
------------------
Years Ended December 31, 2003 2002 2001
- ---------------------------------------------------------------------
Components of net periodic
other benefit cost:
Service cost $ 6 $ 5 $ 5
Interest cost 15 15 11
Amortization of prior service cost 8 7 8
Amortization of unrecognized
net gain (1) (1) (7)
- ---------------------------------------------------------------------
Net periodic other benefit cost $ 28 $ 26 $ 17
=====================================================================
The projected benefit obligation, accumulated benefit obligation and fair value
of plan assets for the pension plan with accumulated benefit obligations in
excess of plan assets were $153, $153 and $0, respectively at December 31, 2003
and $98, $98 and $0, respectively at December 31, 2002.
Weighted-average assumptions used to determine benefit obligations were as
follows:
Pension Benefits Other Benefits
---------------- --------------
December 31, 2003 2002 2003 2002
- -----------------------------------------------------------------------
Discount rate 6.25% 6.25% - 6.50% 6.25% 6.25%
Rate of compensation
increase 4.25% 4.50% 4.50% 4.50%
Pension Benefits Other Benefits
---------------- --------------
Years Ended December 31, 2003 2002 2003 2002
- -----------------------------------------------------------------------
Discount rate 6.25% 6.25% - 6.50% 6.25% 6.25%
Expected return on
plan assets 8.00% 9.00% - -
Rate of compensation
increase 4.25% 4.50% 4.50% 4.50%
The expected long-term return on plan assets was determined using average
historical returns of the Company's plan assets. The rate was reduced during
2003 due to the reduction in returns for the prior year.
The Company's pension plan weighted-average asset allocations at December
31, 2003 and 2002, by asset category are as follows:
Plan Assets at December 31,
---------------------------
2003 2002
- ---------------------------------------------------------
Asset Category
- --------------
Equity securities 52.4% 42.1%
Corporate bonds 33.3% 36.8%
U.S. Government securities 13.1% 16.4%
Foreign equity securities - 2.7%
Cash and cash equivalents 1.2% 2.0%
- ---------------------------------------------------------
100.0% 100.0%
- ---------------------------------------------------------
The Company investment policies and strategies include:
1.) The Trust and Investment Division's equity philosophy is Large-Cap Core with
a value bias. We invest in individual high-grade common stocks that are selected
from our approved list.
2.) Diversification is maintained by having no more than 20% in any industry
sector and no individual equity representing more than 10% of the portfolio.
3.) The fixed income style is conservative but also responsive to the various
needs of our individual clients. For our "Fixed Income" securities, we buy U.S.
Government bonds and Agencies or high-grade Corporate rated "A" or better. The
Company targets the following allocation percentages: cash equivalents 10%,
fixed income 40% and equities 50%.
There is no Company stock included in equity securities at December 31,
2003 or 2002.
Contributions
- -------------
The Company expects to contribute $318,519 to its pension plan and $11,576 to
its other postretirement plan in 2004.
32 Penseco Financial Services Corporation / 2003 Annual Report
14 INCOME TAXES
The total income taxes in the Statements of Income are as follows:
Years Ended December 31, 2003 2002 2001
- ------------------------------------------------------------------
Currently payable $ 1,810 $ 2,161 $ 2,082
Deferred (benefit) provision (182) 95 (213)
- ------------------------------------------------------------------
Total $ 1,628 $ 2,256 $ 1,869
==================================================================
A reconciliation of income taxes at statutory rates to applicable income taxes
reported in the Statements of Income is as follows:
Years Ended December 31, 2003 2002 2001
- ------------------------------------------------------------------
Tax at statutory rate $ 2,584 $ 3,063 $ 2,547
Reduction for non-taxable
interest (978) (828) (746)
Other additions 22 21 68
- ------------------------------------------------------------------
Applicable Income Taxes $ 1,628 $ 2,256 $ 1,869
==================================================================
The components of the deferred income tax (benefit) provision, which result from
temporary differences, are as follows:
Years Ended December 31, 2003 2002 2001
- ------------------------------------------------------------------
Accretion of discount on bonds $ (121) $ 53 $ 53
Accelerated depreciation 67 (36) (96)
Supplemental benefit plan (16) 4 (9)
Allowance for loan losses (53) 86 (180)
Prepaid pension cost (59) (12) 19
- ------------------------------------------------------------------
Total $ (182) $ 95 $ (213)
==================================================================
The significant components of deferred tax assets and liabilities are as
follows:
December 31, 2003 2002
- ------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 868 $ 815
Accumulated depreciation 339 406
Accrued supplemental benefit plan 47 31
- ------------------------------------------------------------
Total Deferred Tax Assets 1,254 1,252
============================================================
Deferred tax liabilities:
Unrealized securities gains 946 1,584
Prepaid pension costs 284 343
Accumulated accretion 27 148
- ------------------------------------------------------------
Total Deferred Tax Liabilities 1,257 2,075
- ------------------------------------------------------------
Net Deferred Tax Liabilities $ (3) $ (823)
============================================================
In management's opinion, the deferred tax assets are realizable in as much as
there is a history of strong earnings and a carryback potential greater than the
deferred tax assets. Management is not aware of any evidence that would preclude
the realization of the benefit in the future and, accordingly, has not
established a valuation allowance against the deferred tax assets.
- --------------------------------------------------------------------------------
15 ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income of $1,836, $3,075 and $2,602 at December
31, 2003, 2002 and 2001, respectively consisted entirely of unrealized gains or
losses on available-for-sale securities, net of tax.
A reconciliation of other comprehensive income for the years ended December
31, 2003 and 2002 is as follows:
Tax
Before-Tax (Expense) Net-of-Tax
2002 Amount Benefit Amount
- ------------------------------------------------------------------------------
Unrealized losses on
available-for-sale securities:
Unrealized losses arising during
the year $(1,536) $ 522 $(1,014)
Less: Reclassification adjustment
for gains realized in income 341 (116) 225
- ------------------------------------------------------------------------------
Net unrealized losses $(1,877) $ 638 $(1,239)
==============================================================================
Tax
Before-Tax (Expense) Net-of-Tax
2002 Amount Benefit Amount
- ------------------------------------------------------------------------------
Unrealized gains on
available-for-sale securities:
Unrealized gains arising during
the year $ 1,726 $ (587) $ 1,139
Less: Reclassification adjustment
for gains realized in income 1,009 (343) 666
- ------------------------------------------------------------------------------
Net unrealized gains $ 717 $ (244) $ 473
==============================================================================
- --------------------------------------------------------------------------------
16 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.
Financial instruments whose contract amounts represent credit risk at
December 31, 2003 and 2002 are as follows:
2003 2002
- --------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 19,147 $ 12,273
Variable rate $ 52,188 $ 66,257
Standby letters of credit $ 15,363 $ 10,586
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.
Various actions and proceedings are presently pending to which the Company
is a party. Management is of the opinion that the aggregate liabilities, if any,
arising from such actions would not have a material adverse effect on the
financial position of the Company.
Penseco Financial Services Corporation / 2003 Annual Report 33
17 FAIR VALUE DISCLOSURE
GENERAL
Statement of Financial Accounting Standards No.107, "Disclosures about Fair
Value of Financial Instruments" (SFAS 107), requires the disclosure of the
estimated fair value of on and off-balance sheet financial instruments.
VALUATION METHODS AND ASSUMPTIONS
Estimated fair values have been determined using the best available data, an
estimation methodology suitable for each category of financial instruments. For
those loans and deposits with floating interest rates it is presumed that
estimated fair values generally approximate the carrying amount balances.
Financial instruments actively traded in a secondary market have been
valued using quoted available market prices. Those with stated maturities have
been valued using a present value discounted cash flow with a discount rate
approximating current market for similar assets and liabilities. Those
liabilities with no stated maturities have an estimated fair value equal to both
the amount payable on demand and the carrying amount balance. The net loan
portfolio has been valued using a present value discounted cash flow. The
discount rate used in these calculations is the current loan rate adjusted for
non-interest operating costs, credit loss and assumed prepayment risk. Off
balance sheet carrying amounts and fair value of letters of credit represent the
deferred income fees arising from those unrecognized financial instruments.
Changes in assumptions or estimation methodologies may have a material
effect on these estimated fair values.
All assets and liabilities which are not considered financial instruments
have not been valued differently than has been customary with historical cost
accounting.
December 31, 2003 December 31, 2002
- --------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- --------------------------------------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 10,062 $ 10,062 $ 11,120 $ 11,120
Interest bearing balances with banks 4,693 4,693 10,424 10,424
Federal funds sold 23,600 23,600 33,075 33,075
- --------------------------------------------------------------------------------------------
Cash and cash equivalents 38,355 38,355 54,619 54,619
Investment Securities:
Available-for-sale:
U.S. Treasury securities 15,387 15,387 36,456 36,456
U.S. Agency obligations 137,018 137,018 50,606 50,606
States & political subdivisions 20,841 20,841 19,665 19,665
Federal Home Loan Bank stock 5,840 5,840 946 946
Other securities 514 514 410 410
Held-to-maturity:
U.S. Agency obligations 84,138 83,566 1,420 1,408
States & political subdivisions 29,387 32,106 29,629 31,578
- --------------------------------------------------------------------------------------------
Total investment securities 293,125 295,272 139,132 141,069
Loans, net of unearned income:
Real estate mortgages 176,042 177,519 222,914 225,138
Commercial 30,056 30,056 30,077 30,077
Consumer and other 34,284 34,524 35,865 36,107
Less: Allowance for loan losses 3,500 3,347
- --------------------------------------------------------------------------------------------
Loans, net 236,882 242,099 285,509 291,322
- --------------------------------------------------------------------------------------------
Total Financial Assets 568,362 $ 575,726 479,260 $ 487,010
Other assets 16,228 17,696
- --------------------------------------------------------------------------------------------
Total Assets $ 584,590 $ 496,956
============================================================================================
Financial Liabilities:
Demand - Non-interest bearing $ 79,726 $ 79,726 $ 78,560 $ 78,560
Demand - Interest bearing 30,515 30,515 31,363 31,363
Savings 80,689 80,689 73,786 73,786
Money markets 89,103 89,103 89,462 89,462
Time 127,911 129,307 141,493 144,981
- --------------------------------------------------------------------------------------------
Total Deposits 407,944 409,340 414,664 418,152
Repurchase agreements 19,454 19,454 19,419 19,419
Short-term borrowings 823 823 890 890
Long-term borrowings 93,523 93,549 - -
- --------------------------------------------------------------------------------------------
Total Financial Liabilities 521,744 $ 523,166 434,973 $ 438,461
Other Liabilities 2,039 3,008
Stockholders' Equity 60,807 58,975
- --------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 584,590 $ 496,956
============================================================================================
Standby Letters of Credit $ (153) $ (153) $ (106) $ (106)
34 Penseco Financial Services Corporation / 2003 Annual Report
18 OPERATING LEASES
The Company leases the land upon which the Mount Pocono Office was built and the
land upon which a drive-up ATM was built on Meadow Avenue, Scranton. The Company
also leases space at several locations which are being used as remote banking
facilities. Rental expense was $86 in 2003, $80 in 2002 and $81 in 2001. All
leases contain renewal options. The Mount Pocono and the Meadow Avenue leases
contain the right of first refusal for the purchase of the properties and
provisions for annual rent adjustments based upon the Consumer Price Index.
Future minimum rental commitments under these leases at December 31, 2003
are as follows:
Mount Meadow ATM
Pocono Avenue Sites Total
- -----------------------------------------------------------
2004 $ 48 $ 19 $ 17 $ 84
2005 48 20 12 80
2006 48 13 - 61
2007 48 - - 48
2008 48 - - 48
2009 to 2012 119 - - 119
- -----------------------------------------------------------
Total minimum
payments required $ 359 $ 52 $ 29 $ 440
===========================================================
- --------------------------------------------------------------------------------
19 LOANS TO DIRECTORS, PRINCIPAL OFFICERS AND RELATED PARTIES
The Company has had, and may be expected to have in the future, banking
transactions in the ordinary course of business with directors, principal
officers, their immediate families and affiliated companies in which they are
principal stockholders (commonly referred to as related parties), on the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with others. A summary of loans to directors,
principal officers and related parties is as follows:
Years Ended December 31, 2003 2002
- -------------------------------------------------
Beginning Balance $ 4,483 $ 6,664
Additions 2,065 748
Collections (1,283) (2,929)
- -------------------------------------------------
Ending Balance $ 5,265 $ 4,483
=================================================
In addition to the loan amounts shown above, the Bank has issued a standby
letter of credit for the account of a related party in the amount of $6,353.
- --------------------------------------------------------------------------------
20 REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgements by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table on the following page) of Tier I and Total
Capital to risk-weighted assets and of Tier I Capital to average assets
(Leverage ratio). The table also presents the Company's actual capital amounts
and ratios. The Bank's actual capital amounts and ratios are substantially
identical to the Company's. Management believes, as of December 31, 2003, that
the Company and the Bank meet all capital adequacy requirements to which they
are subject.
As of December 31, 2003, the most recent notification from the Federal
Deposit Insurance Corporation (FDIC) categorized the Company as "well
capitalized" under the regulatory framework for prompt corrective action. To be
categorized as "well capitalized", the Company must maintain minimum Tier I
Capital, Total Capital and Leverage ratios as set forth in the Capital Adequacy
table. There are no conditions or events since that notification that management
believes have changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels which could
limit the payment of dividends, although the Company and Bank currently have
capital levels which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment
of dividends to the Retained Earnings of the Bank. Accordingly, at December 31,
2003, the balances in the Capital Stock and Surplus accounts totalling $10,840
are unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
Penseco Financial Services Corporation / 2003 Annual Report 35
20 REGULATORY MATTERS (continued)
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
December 31, 2003 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 61,824 21.99% > $ 22,490 > 8.0% > $ 28,112 > 10.0%
- - - -
Tier I Capital
(to Risk Weighted Assets) $ 58,324 20.75% > $ 11,245 > 4.0% > $ 16,867 > 6.0%
- - - -
Tier I Capital
(to Average Assets) $ 58,324 10.21% > * > * > $ 28,556 > 5.0%
- - - -
* 3.0% ($17,134), 4.0% ($22,845) or 5.0% ($28,556) depending on the bank's
CAMELS Rating and other regulatory risk factors.
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 59,020 17.99% > $ 26,250 > 8.0% > $ 32,813 > 10.0%
- - - -
Tier I Capital
(to Risk Weighted Assets) $ 55,673 16.97% > $ 13,125 > 4.0% > $ 19,688 > 6.0%
- - - -
Tier I 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.
- --------------------------------------------------------------------------------
21 PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)
The condensed Company-only information follows:
BALANCE SHEETS
December 31, 2003 2002
- ----------------------------------------------------------------------
Cash $ 7 $ 7
Investment in bank subsidiary 60,389 58,626
Equity Investments 494 390
- ----------------------------------------------------------------------
Total Assets $ 60,890 $ 59,023
======================================================================
Total Liabilities $ 83 $ 48
Total Stockholders' Equity 60,807 58,975
======================================================================
Total Liabilities and Stockholders' Equity $ 60,890 $ 59,023
======================================================================
STATEMENTS OF INCOME
Years Ended December 31, 2003 2002 2001
- -------------------------------------------------------------------
Dividends from bank subsidiary $ 2,900 $ 2,899 $ 2,892
Dividends on investment securities 10 9 5
- -------------------------------------------------------------------
Total Income 2,910 2,908 2,897
Other non-interest expense 10 8 7
- -------------------------------------------------------------------
Net income before undistributed
earnings of bank subsidiary 2,900 2,900 2,890
Undistributed earnings of bank
subsidiary 3,071 3,853 2,732
- -------------------------------------------------------------------
Net Income $ 5,971 $ 6,753 $ 5,622
===================================================================
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003 2002 2001
- --------------------------------------------------------------------------
Operating Activities:
Net Income $ 5,971 $ 6,753 $ 5,622
Adjustments to reconcile net income
to net cash provided by
operating activities:
Equity in undistributed net
income of bank subsidiary (3,071) (3,853) (2,732)
- --------------------------------------------------------------------------
Net cash provided by
operating activities 2,900 2,900 2,890
- --------------------------------------------------------------------------
Investing Activities:
Purchase of equity investment - - (199)
- --------------------------------------------------------------------------
Net cash used by
investing activities - - (199)
- --------------------------------------------------------------------------
Financing Activities:
Cash dividends paid (2,900) (2,899) (2,685)
- --------------------------------------------------------------------------
Net cash used by
financing activities (2,900) (2,899) (2,685)
- --------------------------------------------------------------------------
Net increase in cash and
cash equivalents - 1 6
Cash and cash equivalents at January 1 7 6 -
- --------------------------------------------------------------------------
Cash and cash equivalents at December 31 $ 7 $ 7 $ 6
==========================================================================
36 Penseco Financial Services Corporation / 2003 Annual Report
McGrail Merkel Quinn & Associates
Certified Public Accountants & Consultants
January 30, 2004
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
Scranton, Pennsylvania
Report of Independent Registeres Public Accounting Firm
-------------------------------------------------------
We have audited the accompanying consolidated balance sheets of Penseco
Financial Services Corporation and its wholly-owned subsidiary, Penn Security
Bank and Trust Company as of December 31, 2003 and 2002, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Penseco
Financial Services Corporation and subsidiary as of December 31, 2003 and 2002,
and the consolidated results of their operations and their cash flows for each
of the years in the three year period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.
/s/ McGrail, Merkel, Quinn & Associates
37 Penseco Financial Services Corporation / 2002 Annual Report
ITEM 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There were no changes in or disagreements with accountants on matters of
accounting principles or practices or financial statement disclosures in 2003.
ITEM 9A Controls and Procedures
Based on the Company's principal executive officer, Otto P. Robinson, Jr.,
President and the Company's principal financial officer, Patrick Scanlon,
Controller, evaluations of the Company's Disclosure Controls and Procedures as
of February 19, 2004 (evaluation date), they have concluded that the Company's
disclosure controls are effective, reasonably ensure that material information
relating to the Company and its consolidated subsidiaries is made known to them
by others within those entities, particularly during the period in which this
report is being prepared, and identify significant deficiencies or material
weaknesses in internal controls which could adversely affect the Company's
ability to record, process, summarize and report financial data.
Based on information available to them, they are not aware of significant
deficiencies or material weaknesses in the Company's internal control system.
Based on information available to them, they are not aware of any
significant changes made in internal controls or in other factors that could
significantly affect those controls subsequent to February 19, 2004 (evaluation
date) and prior to the date of their certifications.
Based on information available to them, they are not aware of any fraud
that involves management or other employees of the Company.
PART III
--------
ITEM 10 Directors and Executive Officers of the Registrant
CODE OF ETHICS
--------------
The Company has had for many years a Code of Ethics applicable to all employees
including the Company's principal Executive Officer and principal Financial
Officer (Controller). The purpose of the Code is to promote honest and ethical
conduct, full and fair disclosures of financial information, compliance with
laws and regulations and accountability for actions.
A copy of the Code of Ethics may be obtained, without charge, by
contacting:
Patrick Scanlon, Controller
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, PA 18503-1848
1-800-327-0394
AUDIT COMMITTEE FINANCIAL EXPERT
--------------------------------
The Sarbanes-Oxley Act of 2002 requires the Company to disclose whether or
not its Audit Committee has, as one of its members, an "Audit Committee
Financial Expert", as that term is defined by the U. S. Securities and Exchange
Commission (SEC).
The Board of Directors has elected not to designate any member as an "Audit
Committee Financial Expert". The audit program at our organization has always
been strong. We have our own, full-time, Internal Auditor reporting to the Audit
Committee who has a staff of four full-time assistants. Our financial statements
are audited by an independent public accounting firm, which has received
approval from the Public Company Accounting Oversight Board to audit financial
reports of SEC reporting companies. In addition to that, since we are a banking
company, our bank, Penn Security Bank & Trust Company, is examined every year on
an alternate basis by either the Pennsylvania Department of Banking or the
Federal Deposit Insurance Corporation and our parent holding company, Penseco
Financial Services Corporation, is examined yearly by the Federal Reserve. Our
four member Audit Committee includes three members with substantial education
and experience in accounting and financial management, of which, two are Chief
Executive Officers of Companies and one is a former Executive Vice-President of
our organization. The Audit Committee, as well as the entire Board of Directors,
are ethical people who will act responsibly if anything is wrong. We think that
our Committee members acting together have the expertise, information and advice
to assure that our financial statements are fairly presented.
Other information required by this Item as to Directors of the Company
contained under the headings "Election of Directors", and "Board and Committee
Meetings" within the definitive proxy statement relating to the Company's Annual
Meeting of Shareholders, to be held May 4, 2004, is incorporated herein by
reference thereto.
ITEM 11 Executive Compensation
The information contained under the headings "Executive Compensation",
"Directors Compensation", "Compensation Committee Report on Executive
Compensation" and "Compensation Committee Interlocks and Insider Participation"
in the definitive proxy statement relating to the Company's Annual Meeting of
stockholders, to be held May 4, 2004, is incorporated herein by reference
thereto.
38 Penseco Financial Services Corporation / 2003 Annual Report
ITEM 12 Security Ownership of Certain Beneficial Owners and Management
The information contained under the heading "Voting Securities & Principal
Holders Thereof" in the definitive proxy statement relating to the Company's
Annual Meeting of stockholders, to be held May 4, 2004, is incorporated herein
by reference thereto.
ITEM 13 Certain Relationships and Related Transactions
The information contained under the heading "Transactions with Directors and
Principal Officers" in the definitive proxy relating to the company's annual
meeting of stockholders, to be held May 4, 2004 is incorporated herein by
reference thereto.
ITEM 14 Principal Accounting Fees and Services
The information contained under the heading "Our Relationship with Our Auditors"
in the definitive proxy relating to the Company's Annual Meeting of
Stockholders, to be held May 4, 2004 is incorporated herein by reference
thereto.
PART IV
-------
ITEM 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - The following financial statements are
incorporated by reference in Part II, Item 8 hereof:
Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
General Notes to Financial Statements
Independent Auditor's Report
(2) Financial Statement Schedules - The Financial Statement Schedules are
incorporated by reference in Part II, Item 8 hereof.
(3) Exhibits
The following exhibits are filed herewith or incorporated by reference
as part of this Annual Report.
3(i) Registrant's Articles of Incorporation (Incorporated herein by
reference to Exhibit 3(i) of Registrant's report on Form 10-K
filed with the SEC on March 30, 1998.)
3(ii)Registrant's By-Laws (Incorporated herein by reference to
Exhibit 3(ii) of Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.)
10 Material contracts - Supplemental Benefit Plan Agreement
(Incorporated herein by reference to Exhibit 10 of Registrant's
report on Form 10-Q filed with the SEC on May 10, 1999.)
13 Annual report to security holders (Included herein by reference
on pages 1-40, including the cover.)
21 Subsidiaries of the registrant (Incorporated herein by reference
to Exhibit 21 of Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.)
(b) No current report on Form 8-K was filed for the fourth quarter of the
fiscal year ended December 31, 2003.
(c) The exhibits required to be filed by this Item are listed under Item
14. (a) 3, above.
(d) There are no financial statement schedules required to be filed under
this item.
Penseco Financial Services Corporation / 2003 Annual Report 39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on February 24, 2004.
By: /s/ Otto P. Robinson, Jr.
-------------------------
Otto P. Robinson, Jr.
President
By: /s/ Richard E. Grimm
-------------------------
Richard E. Grimm
Executive Vice-President
By: /s/ Patrick Scanlon
-------------------------
Patrick Scanlon
Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on February 24, 2004.
By: /s/ Edwin J. Butler By: /s/ Robert W. Naismith, Ph.D.
------------------------- -------------------------
Edwin J. Butler Robert W. Naismith, Ph.D.
Director Director
By: /s/ Richard E. Grimm By: /s/ James B. Nicholas
------------------------- -------------------------
Richard E. Grimm James B. Nicholas
Director Director
By: /s/ Russell C. Hazelton By: /s/ Emily S. Perry
------------------------- -------------------------
Russell C. Hazelton Emily S. Perry
Director Director
By: /s/ D. William Hume By: /s/ Sandra C. Phillips
------------------------- -------------------------
D. William Hume Sandra C. Phillips
Director Director
By: /s/ James G. Keisling By: /s/ Otto P. Robinson, Jr.
------------------------- -------------------------
James G. Keisling Otto P. Robinson, Jr.
Director Director
By: /s/ P. Frank Kozik By: /s/ Steven L. Weinberger
------------------------- -------------------------
P. Frank Kozik Steven L. Weinberger
Director Director
40 Penseco Financial Services Corporation / 2003 Annual Report
CERTIFICATIONS
I, Otto P. Robinson, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: February 19, 2004
/s/ OTTO P. ROBINSON JR.
- -------------------------
Otto P. Robinson, Jr.
President
I, Patrick Scanlon, certify that:
1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: February 19, 2004
/s/ PATRICK SCANLON
- --------------------
Patrick Scanlon
Controller
Penseco Financial Services Corporation / 2003 Annual Report 41
CERTIFICATION OF PERIODIC FINANCIAL REPORT PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to his knowledge that:
(1) The Annual Report on Form 10-K of the Company for the year ended
December 31, 2003 (the "Form 10-K") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Act");
and
(2) The information contained in the Form 10-K fairly presents, in all
material respects, the financial conditions and results of operations of
the Company as for the dates and for the periods referred to in the Form
10-K.
/s/ OTTO P. ROBINSON JR
-----------------------
Otto P. Robinson, Jr.
President
February 19, 2004
The foregoing certification is being furnished solely pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (subsection (a) and (b) of Section 1350, Chapter
63 of Title 18, United States Code).
A signed original of the foregoing certification has been provided to the
Company and will be retained by the Company in accordance with Rule 12b-11(d) of
the Act and furnished to the Securities and Exchange Commission or its staff
upon request.
This certification is qualified in its entirety by the report to which it is
attached as an exhibit.
- --------------------------------------------------------------------------------
CERTIFICATION OF PERIODIC FINANCIAL REPORT PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to his knowledge that:
(1) The Annual Report on Form 10-K of the Company for the year ended
December 31, 2003 (the "Form 10-K") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Act");
and
(2) The information contained in the Form 10-K fairly presents, in all
material respects, the financial conditions and results of operations of
the Company as for the dates and for the periods referred to in the Form
10-K.
/s/ PATRICK SCANLON
-----------------------
Patrick Scanlon
Controller
February 19, 2004
The foregoing certification is being furnished solely pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (subsection (a) and (b) of Section 1350, Chapter
63 of Title 18, United States Code).
A signed original of the foregoing certification has been provided to the
Company and will be retained by the Company in accordance with Rule 12b-11(d) of
the Act and furnished to the Securities and Exchange Commission or its staff
upon request.
This certification is qualified in its entirety by the report to which it is
attached as an exhibit.
42 Penseco Financial Services Corporation / 2003 Annual Report
INDEX TO EXHIBITS
Exhibit Number
Referred to
Item 601 of Prior Filing or Exhibit
Regulation S-K DESCRIPTION OF EXHIBIT Page Number Herein
- ----------------------------------------------------------------------------------------------------------------------------
2 Plan of acquisition, reorganization, arrangement, None
liquidation or succession
3 (i) Articles of Incorporation Incorporated herein by reference to Exhibit 3 (i) of
Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.
(ii) By-Laws Incorporated herein by reference to Exhibit 3 (ii) of
Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.
4 Instruments defining the rights of security holders, None
including indentures
9 Voting trust agreement None
10 Material contracts - Supplemental Benefit Plan Incorporated herein by reference to Exhibit 10 of
Agreement Registrant's report on Form 10-Q filed with the
SEC on May 10, 1999.
11 Statement re: Computation of per share earnings None
12 Statements re: Computation of ratios None
13 Annual report to security holders, Form 10-Q or Included herein by reference on pages 1-40,
quarterly report to security holders including the cover.
14 Code of Ethics Included herein by reference on page 38.
16 Letter re: Change in certifying accountant None
18 Letter re: Change in accounting principles None
21 Subsidiaries of the registrant Incorporated herein by reference to Exhibit 21 of
Registrant's report on Form 10-K filed with the
SEC on March 30, 1998.
22 Published report regarding matters submitted to None
vote of security holders
23 Consents of experts and counsel None
24 Power of attorney None
31 Rule 13a-14(a)/15d-14(a) Certifications Included herein by reference on page 41.
32 Section 1350 Certifications Included herein by reference on page 42.
99 Additional Exhibits None
Penseco Financial Services Corporation / 2003 Annual Report 43
Company Officers
----------------
EXECUTIVE OFFICERS
Otto P. Robinson, Jr.
President and General Counsel
Richard E. Grimm
Executive Vice-President, Treasurer and Cashier
Peter F. Moylan
Executive Vice-President Non-Deposit Services and Trust Officer
William J. Calpin, Jr.
Senior Vice-President, Trust Services
Andrew A. Kettel, Jr.
Senior Vice-President
Christe A. Casciano
Vice-President, Director of Marketing
Audrey F. Markowski
Vice-President
Michael G. Ostermayer
Vice-President, Chief Investment Officer, Trust Services
Richard P. Rossi
Vice-President, Director of Human Resources
Lynn Peters Thiel
Vice-President and Compliance Officer
James Tobin
Vice-President, Charge Card Manager
John H. Warnken
Vice-President, Operations
Robert P. Heim
Director of Internal Audit
Patrick Scanlon
Controller
P. Frank Kozik
Secretary
ASSISTANT VICE-PRESIDENTS
John R. Anderson III
Carl M. Baruffaldi
Mark M. Bennett
and Assistant Secretary
Denise M. Cebular
Carol Curtis McMullen
Assistant Trust Officer and Assistant Secretary
Paula M. DePeters
and Assistant Treasurer
J. Patrick Dietz
Karyn Gaus Vashlishan
Lisa A. Kearney
Eleanor Kruk
Caroline Mickelson
Louis J. Rizzo
Aleta Sebastianelli
and Assistant Secretary
Jeffrey Solimine
Jennifer S. Wohlgemuth
Linda Wolf
and Training Officer
Beth S. Wolff
Deborah A. Wright
Mark J. Zakoski
ASSISTANT CASHIERS
Lori A. Dzwieleski
Pamela Edwards
Frank Gardner
Barbara Garofoli
Susan T. Holweg
Susan A. Kopp
Jacqueline Lucke
Kristen A. McGoff
and Branch Operations Officer
Candace F. Quick
Nereida Santiago
Sharon Thauer
ACCOUNTING OFFICER
Luree M. Waltz
ASSISTANT BRANCH OPERATIONS OFFICERS
Carolyn E. Brown
Robin L. Jenkins
ASSISTANT CHARGE CARD MANAGER
Eileen Yanchak
ASSISTANT CONTROLLER
Susan M. Bray
and Assistant Treasurer
ASSISTANT DIRECTOR OF INTERNAL AUDIT
Paula A. Ralston Nenish
ASSISTANT STUDENT LOAN OFFICER
Jo Ann M. Bevilaqua
ASSISTANT TRUST OFFICER
Dominick P. Gianuzzi
AUDIT OFFICER
Ellen M. Evans
BRANCH OPERATIONS OFFICERS
Patricia A. Bruno
Stephen A. Hoffman
BUSINESS DEVELOPMENT OFFICER
Mary Carol Cicco
COLLECTIONS OFFICER
Robert E. Diehl
COMPUTER OPERATIONS OFFICER
Charles Penn
COST ACCOUNTING OFFICER
David R. Weiland
DIRECTOR OF CAMPUS BANKING
Douglas R. Duguay
DIRECTOR OF SYSTEMS / NETWORKING
Robert J. Saslo
FINANCIAL ANALYST
Chad J. Hazelton
LOAN ADMINISTRATION OFFICERs
Susan D. Blascak
Carol J. Ives
LOAN OFFICER
Denise Belton
MERCHANT OFFICER
Jill Ross
OPERATIONS OFFICER
Patricia Pliske
RETAIL BANKING OFFICER
Thomas J. Malinchak
TAX OFFICER
Robert W. McDonald
TRUST ADMINISTRATOR
Kristen R. Noll
TRUST OPERATIONS OFFICER
Carol Trezzi
TRUST INVESTMENT OFFICER
Katherine M. Oven
44 Penseco Financial Services Corporation / 2003 Annual Report
(INSIDE BACK COVER)
Company Board Members
---------------------
PENSECO FINANCIAL SERVICES CORPORATION AND PENN SECURITY BANK AND TRUST COMPANY
BOARD OF DIRECTORS
Edwin J. Butler
Retired Bank Officer
Richard E. Grimm
Executive Vice-President, Treasurer and Cashier
Russell C. Hazelton
Retired Captain, Trans World Airlines
D. William Hume
Retired Bank Officer
James G. Keisling
CEO Compression Polymers Corp. and Vycom Corp.,
Manufacturers of Plastic Sheet Products
P. Frank Kozik
President & CEO, Scranton Craftsmen, Inc., Manufacturer of
Ornamental Iron and Precast Concrete Products
Robert W. Naismith, Ph.D.
Chairman & CEO, Life Science Analytics, Inc.
James B. Nicholas
President, D. G. Nicholas Co., Wholesale Auto Parts Company
Emily S. Perry
Retired Insurance Account Executive & Community Volunteer
Sandra C. Phillips
Penn State Master Gardener & Community Volunteer
Otto P. Robinson, Jr.
Attorney-at-Law, President
Steven L. Weinberger
President of G. Weinberger Company, Mechanical Contractor
Specializing in Commercial & Industrial Construction
PENN SECURITY BANK AND TRUST COMPANY
ADVISORY BOARDS
ABINGTON OFFICE
Carl M. Baruffaldi
James L. Burne, DDS
Keith Eckel
Richard C. Florey
C. Lee Havey, Jr.
Attorney Patrick J. Lavelle
Sandra C. Phillips
EAST SCRANTON OFFICE
Marie W. Allen
J. Conrad Bosley
Judge Carmen Minora
Mark R. Sarno
Beth S. Wolff
EAST STROUDSBURG OFFICE
Denise M. Cebular
Robert J. Dillman, Ph.D.
Attorney Kirby Upright
Jeffrey Weichel
GREEN RIDGE OFFICE
Joseph N. Connor
Everett Jones
George Noone
Howard J. Snowdon
Jeffrey Solimine
MOUNT POCONO OFFICE
Bruce Berry
Francis Cappelloni
Robert C. Hay
David Lansdowne
Karyn Gaus Vashlishan
NORTH POCONO OFFICE
Jacqueline A. Carling
Anthony J. Descipio
George F. Edwards
James A. Forti
Attorney David Z. Smith
Deborah A. Wright
SOUTH SIDE OFFICE
Attorney Zygmunt R. Bialkowski, Jr.
Michael P. Brown
J. Patrick Dietz
Lois Ferrari
Jeffrey J. Leventhal
Ted M. Stampien, DDS
www.pennsecurity.com