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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
Incorporated pursuant to the laws of Pennsylvania
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Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). |X|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on April 30, 2004 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
March 31, 2004............................................ 3
December 31, 2003......................................... 3
Statements of Income:
Three Months Ended March 31, 2004......................... 4
Three Months Ended March 31, 2003......................... 4
Statements of Cash Flows:
Three Months Ended March 31, 2004......................... 5
Three Months Ended March 31, 2003......................... 5
Notes to Financial Statements................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......19
Item 4. Disclosure Controls and Procedures...............................19
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................20
Item 2. Changes in Securities and Use of Proceeds........................20
Item 3. Defaults Upon Senior Securities..................................20
Item 4. Submission of Matters to a Vote of Security Holders..............20
Item 5. Other Information................................................20
Item 6. Exhibits and Reports on Form 8-K.................................20
Signatures...............................................................20
Certifications...........................................................21
PART I. FINANCIAL INFORMATION, Item 1 -- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
March 31, December 31,
2004 2003
--------------- ---------------
ASSETS
Cash and due from banks $ 8,397 $ 10,062
Interest bearing balances with banks 10,493 4,693
Federal funds sold - 23,600
--------------- ---------------
Cash and Cash Equivalents 18,890 38,355
Investment securities:
Available-for-sale, at fair value 191,590 179,600
Held-to-maturity (fair value of $113,529
and $115,672, respectively) 109,965 113,525
--------------- ---------------
Total Investment Securities
301,555 293,125
Loans, net of unearned income 249,214 240,382
Less: Allowance for loan losses 3,500 3,500
--------------- ---------------
Loans, Net 245,714 236,882
Bank premises and equipment 9,762 9,935
Other real estate owned 85 121
Accrued interest receivable 3,198 3,298
Other assets 3,156 2,874
--------------- ---------------
Total Assets $ 582,360 $ 584,590
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 80,848 $ 79,726
Interest bearing 325,175 328,218
--------------- ---------------
Total Deposits 406,023 407,944
Other borrowed funds:
Repurchase agreements 20,226 19,454
Short-term borrowings 428 823
Long-term borrowings 91,327 93,523
Accrued interest payable 1,003 1,158
Other liabilities 1,324 881
--------------- ---------------
Total Liabilities 520,331 523,783
--------------- ---------------
STOCKHOLDERS' EQUITY
Common stock ($ .01 par value, 15,000,000 shares
authorized, 2,148,000 shares issued and outstanding) 21 21
Surplus 10,819 10,819
Retained earnings 48,631 48,131
Accumulated other comprehensive income 2,558 1,836
--------------- ---------------
Total Stockholders' Equity 62,029 60,807
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 582,360 $ 584,590
=============== ===============
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
-------------------- --------------------
INTEREST INCOME
Interest and fees on loans $ 3,156 $ 4,209
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 2,165 1,430
States & political subdivisions 771 636
Other securities 24 22
Interest on Federal funds sold 37 52
Interest on balances with banks 16 13
-------------------- --------------------
Total Interest Income 6,169 6,362
-------------------- --------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 170 256
Interest on other deposits 851 1,167
Interest on other borrowed funds 932 253
-------------------- --------------------
Total Interest Expense 1,953 1,676
-------------------- --------------------
Net Interest Income 4,216 4,686
Provision for loan losses 18 239
-------------------- --------------------
Net Interest Income After Provision for Loan Losses 4,198 4,447
-------------------- --------------------
OTHER INCOME
Trust department income 320 315
Service charges on deposit accounts 271 277
Merchant transaction income 1,429 1,488
Other fee income 267 284
Other operating income 127 382
Realized gains (losses) on securities, net - -
-------------------- --------------------
Total Other Income 2,414 2,746
-------------------- --------------------
OTHER EXPENSES
Salaries and employee benefits 2,299 2,202
Expense of premises and fixed assets 681 691
Merchant transaction expenses 1,121 1,264
Other operating expenses 1,214 1,112
-------------------- --------------------
Total Other Expenses 5,315 5,269
-------------------- --------------------
Income before income taxes 1,297 1,924
Applicable income taxes 152 365
-------------------- --------------------
Net Income 1,145 1,559
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains 722 (215)
-------------------- --------------------
Comprehensive Income $ 1,867 $ 1,344
==================== ====================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.53 $ 0.73
Cash Dividends Declared Per Common Share $ 0.30 $ 0.30
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
-------------------- -------------------
OPERATING ACTIVITIES
Net Income $ 1,145 $ 1,559
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 218 317
Provision for loan losses 18 239
Deferred income tax provision (benefit) 147 175
Amortization of securities, (net of accretion) 410 83
Net realized losses (gains) on securities - -
Loss (gain) on other real estate - -
(Increase) decrease in interest receivable (282) (323)
Decrease (increase) in other assets 100 (411)
Increase (decrease) in income taxes payable 4 376
(Decrease) increase in interest payable (155) (217)
(Decrease) increase in other liabilities (80) 202
-------------------- -------------------
Net cash provided by operating activities 1,525 2,000
-------------------- -------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (24,146) (5,852)
Proceeds from investment securities available-for-sale 10,483 5,000
Purchase of investment securities to be held-to-maturity - (133,749)
Proceeds from repayments of investment securities to be available-for-sale 2,523 -
Proceeds from repayments of investment securities to be held-to-maturity 3,394 179
Net loans (originated) repaid (8,850) 6,010
Proceeds from other real estate 36 -
Investment in premises and equipment (45) (132)
-------------------- -------------------
Net cash (used) provided by investing activities (16,605) (128,544)
-------------------- -------------------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 1,378 (14,013)
Net (payments) proceeds on time deposits (3,299) (2,891)
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 772 (1,107)
Net (decrease) increase in short-term borrowings (395) 1,319
Proceeds from long-term borrowings - 100,000
Repayments of long-term borrowings (2,196) -
Cash dividends paid (645) (644)
-------------------- -------------------
Net cash (used) provided by financing activities (4,385) 82,664
-------------------- -------------------
Net (decrease) increase in cash and cash equivalents (19,465) (43,880)
Cash and cash equivalents at January 1 38,355 54,619
-------------------- -------------------
Cash and cash equivalents at September 30 $ 18,890 $ 10,739
==================== ===================
The Company paid interest and income taxes of $2,108 and $211 and $1,893 and $0,
for the three month periods ended March 31, 2004 and 2003, respectively.
Notes to CONSOLIDATED Financial Statements
For the Quarter Ended March 31, 2004
(unaudited)
These Notes to Financial Statements reflect events subsequent to December 31,
2003, the date of the most recent Report of Independent Auditors, through the
date of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2004.
These Notes to Financial Statements should be read in conjunction with Financial
Information and Other Information required to be furnished as part of this
Report, in particular, (1) Management's Discussion and Analysis of Financial
Condition and Results of Operations for the three months ended March 31, 2004
and March 31, 2003, with respect to the Company's capital requirements and
liquidity, (2) Part II, Item 6, Reports on Form 8-K and (3) the Company's Annual
Report - Form 10-K for the year ended December 31, 2003, incorporated herein by
reference.
NOTE 1 -- Principles of Consolidation
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated under the laws of Pennsylvania. It is the parent company of Penn
Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.
Intercompany transactions have been eliminated in preparing the consolidated
financial statements.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
NOTE 2 -- Basis of Presentation
The unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
In the opinion of management, all adjustments that are of a normal recurring
nature and are considered necessary for a fair presentation have been included.
They are not, however, necessarily indicative of the results of consolidated
operations for a full year.
For further information, refer to the consolidated financial statements and
accompanying notes included in the Company's Annual Report - Form 10-K for the
year ended December 31, 2003.
NOTE 3 -- Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
NOTE 4 -- Investment Securities
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, 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.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific identification method and are reported as a
separate component of other income in the Statements of Income. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
The amortized cost and fair value of investment securities at March 31, 2004 and
December 31, 2003 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 4,998 $ 310 $ - $ 5,308
U.S. Agency securities 63,414 1,256 - 64,670
Mortgage-backed securities 69,369 1,118 - 70,487
States & political subdivisions 44,306 966 60 45,212
- --------------------------------------------------------------------------------
Total Debt Securities 182,087 3,650 60 185,677
Equity securities 5,625 288 - 5,913
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 187,712 $ 3,938 $ 60 $ 191,590
================================================================================
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 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
================================================================================
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 80,578 $ 439 $ - $ 81,017
States & political subdivisions 29,387 3,125 - 32,512
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 109,965 $ 3,564 $ - $ 113,529
================================================================================
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 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
================================================================================
The amortized cost and fair value of debt securities at March 31, 2004 by
contractual maturity are shown on the next page. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
March 31, 2004 Available-for-Sale Held-to-Maturity
- -----------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -----------------------------------------------------------------------------------------
Due in one year or less:
U.S. Treasury securities $ 4,998 $ 5,308 $ - $ -
U.S. Agency securities 17,533 17,801 - -
After one year through five years:
U.S. Treasury securities - - - -
U.S. Agency securities 45,881 46,869 - -
After ten years:
States & political subdivisions 44,306 45,212 29,387 32,512
- -----------------------------------------------------------------------------------------
Subtotal 112,718 115,190 29,387 32,512
Mortgage-backed securities 69,369 70,487 80,578 81,017
- -----------------------------------------------------------------------------------------
Total Debt Securities $ 182,087 $ 185,677 $ 109,965 $ 113,529
- -----------------------------------------------------------------------------------------
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 March 31, 2004 are as
follows:
Less than twelve months Twelve months or more Totals
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
-------------------------- -------------------------- --------------------------
States & political
subdivisions $ 10,391 $ 60 $ - $ - $ 10,391 $ 60
The above table includes twenty-five (25) securities that have unrealized losses
for less than twelve months. The unrealized losses in each case are related
solely to interest rate fluctuations.
NOTE 5 -- 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.
NOTE 6 -- Long-Term Debt
During the quarter ended March 31, 2003, the Bank borrowed $100,000 from the
Federal Home Loan Bank, in four loans with various maturity dates, to finance
the purchase of a mortgaged-backed security.
The loans are secured by a general collateral pledge of the Company.
A summary of the long-term debt at March 31, 2004 is as follows:
Note payable, due in monthly installments of $161, including
principal and interest at a fixed rate of 2.73%, maturing March, 2008. $ 7,297
Note payable, due in monthly installments of $253, including
principal and interest at a fixed rate of 3.22%, maturing March, 2010. 16,540
Note payable, due in monthly installments of $430, including
principal and interest at a fixed rate of 3.74%, maturing March, 2013. 39,386
Note payable, due in monthly installments of $186, including
principal and interest at a fixed rate of 4.69%, maturing March, 2023. 28,104
--------
Total long-term debt $ 91,327
========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at March 31, 2004 are as follows:
March 31, Principal
--------- ---------
2005 $ 8,981
2006 9,300
2007 9,631
2008 9,974
2009 8,378
Thereafter 45,063
---------
$ 91,327
=========
NOTE 7 -- Employee Benefit Plans
The components of the net periodic benefit costs are as follows:
Pension Benefits Other Benefits
------------------ -----------------
Three months ended March 31, 2004 2003 2004 2003
- -----------------------------------------------------------------------------
Service cost $ 94 $ 96 $ 1 $ 1
Interest cost 167 159 4 4
Expected return on plan assets (175) (156) - -
Amortization of prior service cost - - 2 2
Amortization of net (gain) loss 34 44 - -
- -----------------------------------------------------------------------------
Net periodic pension cost $ 120 $ 143 $ 7 $ 7
- -----------------------------------------------------------------------------
Contributions
The Company previously disclosed in its financial statements for the year ended
December 31, 2003, that it expected to contribute $318 to its pension plan and
$12 to its postretirement plan in 2004, As of March 31, 2004, there has been no
contribution made to either plan. The Company presently anticipates contributing
$381 to fund its pension plan in 2004. The postretirement plan estimate has not
changed since December 31, 2003.
NOTE 8 -- Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgements by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table below) of Tier I and Total Capital to
risk-weighted assets and of Tier I Capital to average assets (Leverage ratio).
The table also presents the Company's actual capital amounts and ratios. The
Bank's actual capital amounts and ratios are substantially identical to the
Company's. Management believes, as of March 31, 2004, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of March 31, 2004, the most recent notification from the Federal Deposit
Insurance Corporation (FDIC) categorized the Company as "well capitalized" under
the regulatory framework for prompt corrective action. To be
categorized as "well capitalized", the Company must maintain minimum Tier I
Capital, Total Capital and Leverage ratios as set forth in the Capital Adequacy
table. There are no conditions or events since that notification that management
believes have changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels, which could
limit the payment of dividends, although the Company and Bank currently have
capital levels, which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the Retained Earnings of the Bank. Accordingly, at March 31, 2004,
the balances in the Capital Stock and Surplus accounts totalling $10,840 are
unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
March 31, 2004 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 62,393 20.99% > $ 23,782 > 8.0% > $ 29,728 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 58,893 19.81% > $ 11,891 > 4.0% > $ 17,837 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 58,893 10.06% > $ * > * > $ 29,283 > 5.0%
- - - -
*3.0% ($17,570), 4.0% ($23,426) or 5.0% ($29,283) 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, 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.
PART 1. FINANCIAL INFORMATION, Item 2 --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following commentary provides an overview of the financial condition and
significant changes in the results of operations of Penseco Financial Services
Corporation and it's subsidiary, Penn Security Bank and Trust Company, for the
three months ended March 31, 2004 and March 31, 2003. Throughout this review,
the subsidiary of Penseco Financial Services Corporation, Penn Security Bank and
Trust Company, is referred to as the "Company". All intercompany accounts and
transactions have been eliminated in preparing the consolidated financial
statements. All information is presented in thousands of dollars, except as
indicated.
Critical Accounting Policies
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.
Provision (allowance) for possible loan losses - 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.
Actuarial assumptions associated with pension, post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan assets.
Provision for income taxes - Management believes that the assumptions and
judgements used to record tax related assets or liabilities have been
appropriate.
Fair value of certain investment securities - Fair value of investment
securities are based on quoted market prices.
Loan servicing rights - 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.
Premium amortization - 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.
Executive Summary
Penseco Financial Services Corporation reported a decrease in net income of $414
or 26.6% to $1,145 or $.53 per share for the three months ended March 31, 2004
compared with $1,559 or $.73 per share reported for the year earlier period. Net
interest income fell $470 or 10.0% to $4,216 for the first quarter of 2004
compared to $4,686 for the same quarter of 2003. The margin compression was the
result of the Company experiencing an historically high volume of mortgage loan
refinancing during 2003, directly related to the low interest rate environment,
which has remained low for the past two and one half years. Currently, the
Company is experiencing increased loan growth in its loan portfolio, mainly
commercial and real estate loans. Due to the Company's asset quality, the
provision for loan losses was $18 for the three months ended March 31, 2004
versus $239 for the same period of 2003. However, the Company also experienced a
decrease in other operating income of $255, primarily due to a reduction in
gains from the sale of loans in the secondary market versus the same period of
2003. Applicable income taxes decreased $213 due to increased tax free income
along with lower net income.
Net Interest Income and Net Interest Margin
Net interest income, the largest contributor to the Company's earnings, is
defined as the difference between interest income on assets and the cost of
funds supporting those assets. Earning assets are composed primarily of loans
and investments while deposits, short-term and long-term borrowings represent
interest-bearing liabilities. Variations in the volume and mix of these assets
and liabilities, as well as changes in the yields earned and rates paid, are
determinants of changes in net interest income.
Net interest income after provision for loan losses decreased $249 or 5.6% to
$4,198 for the three months ended March 31, 2004 compared to $4,447 for the
three months ended March 31, 2003. Earning assets repriced downward 93 basis
points, largely due to the reduction in our loan portfolio, due to the
refinancing of residential portfolio mortgage loans with lower fixed-rate
obligations, during 2003. Offsetting this decrease was increased securities
portfolio income and a reduction in the provision for loan losses from $239 in
2003 to $18 in 2004.
The net interest margin represents the Company's net yield on its earning assets
and is calculated as net interest income divided by average earning assets. In
the three months ended March 31, 2004, net interest margin was 2.99% decreasing
92 basis points from 3.91% in the same period of 2003.
Total average earning assets and average interest bearing funds increased in the
three months ended March 31, 2004 as compared to 2003. Average earning assets
increased $85.1 million or 17.7%, from $479.9 million in 2003 to $565.0 million
in 2004 and average interest bearing funds increased $76.4 million, or 20.9%,
from $364.7 million to $441.1 million for the same period, mainly due to a
leverage transaction entered into during March of 2003. As a percentage of
average assets, earning assets increased to 96.5% for the three months ended
March 31, 2004 from 95.6% for the year ago period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the three months of 2004 and 2003. Average loans as a
percentage of average earning assets decreased from 60.0% in 2003 to 43.4% in
2004, due in part to the sale of all new and refinanced fixed rate mortgages in
the secondary market and also due to the increase in total assets caused by the
leverage transaction noted below; average investments increased $130.2 million
from 34.5% to 52.4%. Average short-term investments, federal funds sold and
interest bearing balances with banks decreased $2.1 million to $23.8 from $25.9
and also decreased as a percentage of average earning assets from 5.4% in 2003
to 4.2% in 2004. Average time deposits decreased $15.2 million or 10.7% from
38.9% of interest bearing liabilities in 2003 to 28.7% in 2004. However, average
short-term borrowings, long-term borrowings and repurchase agreements increased
$78.9 from 9.8% in 2003 to 26.0% in 2004, as a percentage of funding sources.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. The investment
securities tax equivalent yield decreased 80 basis points from 5.34% in the
three months ended March 31, 2003 to 4.54% for 2004. Also, average loan yields
decreased 69 basis points, from 5.84% in the three months ended March 31, 2003
to 5.15% in 2004.
The average time deposit costs decreased 61 basis points from 2.92% in 2003 to
2.31% in 2004, along with money market accounts decreasing 26 basis points from
..97% in 2003 to .71% in 2004. These reductions are offset by the interest on new
fixed-rate, long-term borrowings, which results in a net average interest cost
reduction of 7 basis points versus the same period last year.
The most significant change in net interest income has been the reduction in our
loan portfolio due to the refinancing of higher rate, long-term, fixed-rate real
estate loans, which were sold in the secondary market. A gain on the sale of
mortgage loans partially offset the decline in net interest income, during 2003.
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 has purchased long-term municipal securities at higher tax
equivalent yields than the Company was previously earning.
Distribution of Assets, Liabilities and Stockholders' Equity / Interest Rates
and Interest Differential
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the three months ended
March 31, 2004 and March 31, 2003.
- ----------------------------------------------------------------------------------------------------------
March 31, 2004 March 31, 2003
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 9,225 $ 115 4.99% $ 36,447 $ 365 4.01%
U.S. Agency obligations 135,763 1,123 3.31% 50,375 694 5.51%
States & political subdivisions 33,477 362 6.55% 20,313 226 6.74%
Federal Home Loan Bank stock 5,417 18 1.33% 1,982 18 3.63%
Other 517 5 3.87% 399 4 4.01%
Held-to-maturity:
U.S. Agency obligations 82,414 927 4.50% 26,639 371 5.57%
States & political subdivisions 29,387 410 8.46% 29,629 410 8.39%
Loans, net of unearned income:
Real estate mortgages 177,092 2,329 5.26% 217,084 3,320 6.12%
Commercial 33,047 389 4.71% 31,414 377 4.80%
Consumer and other 34,818 438 5.03% 39,712 511 5.15%
Federal funds sold 15,631 37 0.95% 20,514 52 1.01%
Interest on balances with banks 8,217 16 0.78% 5,406 14 1.04%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest
Income 565,005 $ 6,169 4.37% 479,914 $ 6,362 5.30%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 8,249 7,972
Bank premises and equipment 9,867 9,866
Accrued interest receivable 2,916 3,093
Other assets 3,116 4,323
Less: Allowance for loan losses 3,496 3,346
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 585,657 $ 501,822
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 30,191 $ 25 0.33% $ 26,142 $ 43 0.66%
Savings 80,471 99 0.49% 74,322 136 0.73%
Money markets 88,945 157 0.71% 86,347 209 0.97%
Time - Over $100 29,505 170 2.30% 33,961 256 3.02%
Time - Other 97,260 570 2.34% 108,006 779 2.89%
Federal funds purchased - - - - - -
Repurchase agreements 22,118 41 0.74% 18,712 43 0.92%
Short-term borrowings 349 1 1.15% 1,793 8 1.78%
Long-term borrowings 92,286 890 3.86% 15,385 202 5.25%
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 441,125 $ 1,953 1.77% 364,668 $ 1,676 1.84%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 81,394 74,807
All other liabilities 2,052 2,853
Stockholders' equity 61,086 59,494
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 585,657 $ 501,822
- ----------------------------------------------------------------------------------------------------------
Interest Spread 2.60% 3.46%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,216 $ 4,686
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 2.99% 3.91%
Return on average assets 0.78% 1.24%
Return on average equity 7.50% 10.48%
Average equity to average assets 10.43% 11.86%
Dividend payout ratio 56.60% 41.10%
- ----------------------------------------------------------------------------------------------------------
Investments
The Company's investment portfolio consists primarily of two functions: One to
provide liquidity and two to contribute to earnings. To provide liquidity the
Company may invest in short-term securities such as Federal funds sold, interest
bearing deposits with banks, U.S. Treasury securities and U.S. Agency Securities
all with maturities of one year or less. These funds are invested short-term to
ensure the availability of funds to meet customer demand for credit needs. The
Company enhances interest income by securing long-term investments within its
investment portfolio, by means of U.S. Treasury Securities, U.S. Agency
securities, municipal securities and mortgage-backed securities generally with
maturities greater than one year.
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 determined 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.
During 2003, the Company experienced accelerated pre-payments of its fixed-rate
mortgage-backed securities portfolio, due to the historically low-rate interest
environment. Additionally, amortization of the bond premium was also accelerated
relative to the increased pre-payments of principal on the mortgage-backed
securities, which impacted earnings on a negative basis. The proceeds of the
pre-payments have been reinvested in long-term municipal securities.
Deposits
The Company is largely dependent on its core deposit base to fund operations.
Management has competitively priced its deposit products in checking, savings,
money market and time deposits to provide a stable source of funding.
As the economy shows strength and improves, migration of some deposits may
return to the equity markets as consumers become more prone to increased yields.
Historically, such changes in the Company's deposit base have been minimal.
Provision for Loan Losses
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio. The process of determining the adequacy of the
allowance is necessarily judgmental and subject to changes in external
conditions. The allowance for loan losses reflects management's judgment as to
the level considered appropriate to absorb such losses based upon a review of
many factors, including historical loss experience, adverse situations that may
affect the borrower's ability to repay (including the timing of future
payments), economic conditions and trends, loan portfolio volume and mix, loan
performance trends, the value and adequacy of collateral, and the Company's
internal credit review process. Accordingly, there can be no assurance that
existing levels of the allowance will ultimately prove adequate to cover actual
loan losses. The quarterly provision for loan losses charged to operating
expense is that amount which is sufficient to bring the balance of the allowance
for possible loan losses to an adequate level to absorb anticipated losses.
Based on this ongoing evaluation, management determines the provision necessary
to maintain an appropriate allowance.
For the three months ended March 31, 2004, the provision for loan losses
decreased to $18 from $239 in the three months ended March 31, 2003. Loans
charged off totaled $21 and recoveries were $3 for the three months ended March
31, 2004. In the same period of 2003, loans charged off were $287 and recoveries
were $1. At March 31, 2004, the allowance for loan losses was set at $3,500 or
1.40% of loans based upon the Bank's analysis methodology and as an act of
prudence by management.
Other Income
The following table sets forth information by category of other income for the
Company for three months ended March 31, 2004 and March 31, 2003, respectively:
March 31 March 31
Three Months Ended: 2004 2003
- -----------------------------------------------------------------------
Trust department income $ 320 $ 315
Service charges on deposit accounts 271 277
Merchant transaction income 1,429 1,488
Other fee income 267 284
Other operating income 127 382
Realized gains (losses) on securities, net - -
- -----------------------------------------------------------------------
Total Other Income $ 2,414 $ 2,746
- -----------------------------------------------------------------------
Other income decreased $332 or 12.1% to $2,414 for the first quarter of 2004
compared with $2,746 for the same period of 2003. Other operating income
decreased $255, primarily due to a reduction in gains on the sale of loans in
the secondary market of lower, fixed, long-term obligations, which peaked during
2003. Also, merchant transaction income decreased $59 or 4.0% due to lower
business volumes from the softness in the economy.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended March 31, 2004 and March 31, 2003,
respectively:
March 31 March 31
Three Months Ended: 2004 2003
- -----------------------------------------------------------------------
Salaries and employee benefits $ 2,299 $ 2,202
Expense of premises and fixed assets 681 691
Merchant transaction expenses 1,121 1,264
Other operating expenses 1,214 1,112
- -----------------------------------------------------------------------
Total Other Expenses $ 5,315 $ 5,269
- -----------------------------------------------------------------------
Total other expenses increased $46 or 1.0% to $5,315 for the first quarter of
2004 compared with $5,269 for the same period of 2003. Salaries and employment
benefits expense increased $97 or 4.4%, mainly from increases in salaries of
$35, pension expense of $42 and employee education costs of $20. Other operating
expenses increased $102 or 9.2%, mostly from increases of $56 in amortization of
loan servicing rights, and general operating expenses.
Applicable income taxes decreased $213 due to increased tax free income along
with lower net income.
Loan Portfolio
Details regarding the Company's loan portfolio:
March 31, December 31,
As Of: 2004 2003
- ---------------------------------------------------------------------------
Real estate - construction
and land development $ 2,660 $ 3,078
Real estate mortgages 179,701 172,964
Commercial 32,738 30,056
Credit card and related plans 2,351 2,403
Installment 25,513 25,855
Obligations of states & political subdivisions 6,251 6,026
- ---------------------------------------------------------------------------
Loans, net of unearned income 249,214 240,382
Less: Allowance for loan losses 3,500 3,500
- ---------------------------------------------------------------------------
Loans, net $ 245,714 $ 236,882
- ---------------------------------------------------------------------------
Loan Quality
The comprehensive lending policy established by the Board of Directors guides
the lending activities of the Company. Loans must meet criteria, which include
consideration of the character, capacity and capital of the borrower, collateral
provided for the loan, and prevailing economic conditions.
Regardless of credit standards, there is risk of loss inherent in every loan
portfolio. The allowance for loan losses is an amount that management believes
will be adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of the loans. The
evaluations take into consideration such factors as change in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, industry experience, collateral value and current economic
conditions that may affect the borrower's ability to pay. Management believes
that the allowance for loan losses is adequate. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
The allowance for loan losses is increased by periodic charges against earnings
as a provision for loan losses, and decreased periodically by charge-offs of
loans (or parts of loans) management has determined to be uncollectible, net of
actual recoveries on loans previously charged-off.
Non-Performing Assets
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned. The following
table sets forth information regarding non-performing assets as of the dates
indicated:
March 31, December 31, March 31,
As Of: 2004 2003 2003
- -----------------------------------------------------------------------------------------
Non-accrual loans $ 1,729 $ 1,533 $ 1,935
Loans past due 90 days or more and accruing:
Guaranteed student loans 165 169 381
Credit card and home equity loans 3 3 22
- -----------------------------------------------------------------------------------------
Total non-performing loans 1,897 1,705 2,338
Other real estate owned 85 121 105
- -----------------------------------------------------------------------------------------
Total non-performing assets $ 1,982 $ 1,826 $ 2,443
- -----------------------------------------------------------------------------------------
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 $1,729 and $1,935 at March 31, 2004 and March 31, 2003, respectively. If
interest on those loans had been accrued, such income would have been $223 and
$194 for the three months ended March 31, 2004 and March 31, 2003, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $2 and $5 for March 31, 2004 and March 31, 2003, respectively. There are no
commitments to lend additional funds to individuals whose loans are in
non-accrual status.
The management process for evaluating the adequacy of the allowance for loan
losses includes reviewing each month's loan committee reports, which list all
loans that do not meet certain internally developed criteria as to collateral
adequacy, payment performance, economic conditions and overall credit risk.
These reports also address the current status and actions in process on each
listed loan. From this information, adjustments are made to the allowance for
loan losses. Such adjustments include both specific loss allocation amounts and
general provisions by loan category based on present and past collection
experience, nature and volume of the loan portfolio, overall quality, and
current economic conditions that may affect the borrower's ability to pay. As of
March 31, 2004 there are no significant loans as to which management has serious
doubt about their collectibility other than what is included above.
At March 31, 2004 and December 31, 2003, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
Loan Loss Experience
The following tables present the Company's loan loss experience during the
periods indicated:
March 31, March 31,
Three Months Ended: 2004 2003
- -------------------------------------------------------------------------
Balance at beginning of period $ 3,500 $ 3,347
Charge-offs:
Real estate mortgages - -
Commercial and all others 11 277
Credit card and related plans 10 7
Installment loans - 3
- ------------------------------------------------------------- -----------
Total charge-offs 21 287
- -------------------------------------------------------------------------
Recoveries:
Real estate mortgages 3 -
Commercial and all others - -
Credit card and related plans - 1
Installment loans - -
- -------------------------------------------------------------------------
Total recoveries 3 1
- -------------------------------------------------------------------------
Net charge-offs (recoveries) 18 286
- -------------------------------------------------------------------------
Provision charged to operations 18 239
- -------------------------------------------------------------------------
Balance at End of Period $ 3,500 $ 3,300
- -------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.007% 0.099%
- -------------------------------------------------------------------------
Due to the continuing economic uncertainties, management believes the allowance
for loan losses is considered adequate based on its methodology. The allowance
for loan losses, as a percentage of total loans, stands at 1.40% at March 31,
2004 and 1.17% at March 31, 2003.
The allowance for loan losses is allocated as follows:
As Of: March 31, 2004 December 31, 2003 March 31, 2003
- ------------------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- ------------------------------------------------------------------------------------------
Real estate mortgages $ 1,100 73% $ 1,100 73% $ 1,500 74%
Commercial and all others 1,970 13% 1,970 15% 1,275 15%
Credit card and related plans 180 1% 180 1% 175 1%
Personal installment loans 250 13% 250 11% 350 10%
- ------------------------------------------------------------------------------------------
Total $ 3,500 100% $ 3,500 100% $ 3,300 100%
- ------------------------------------------------------------------------------------------
* Percent of loans in each category to total loans
Liquidity
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Treasury and U.S. Agency
bond portfolios, additional deposits, earnings, overnight loans to and from
other companies (Federal funds) and lines of credit at the Federal Reserve Bank
and the Federal Home Loan Bank. The Company is not a party to any commitments,
guarantees or obligations that could materially affect its liquidity.
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 $181,751 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.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
Related Parties
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. The Bank has issued a standby letter of
credit for the account of a related party in the amount of $6,353.
Capital Resources
A strong capital position is important to the continued profitability of the
Company and promotes depositor and investor confidence. The Company's capital
provides a basis for future growth and expansion and also provides additional
protection against unexpected losses.
Additional sources of capital would come from retained earnings from the
operations of the Company and from the sale of additional common stock.
Management has no plans to offer additional common stock at this time.
The Company's total risk-based capital ratio was 20.99% at March 31, 2004. 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.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act, enacted in July of 2002, continues to impact the
Company. The Company is now subject to the accelerated filing deadlines which
reduced the number of days to issue the 2004 Annual Report from 75 to 60 days.
Similarly, the quarterly reports for 2004 have to be filed within 40 days of the
end of each quarter from 45 days in prior years. In 2005, the Company will lose
another 5 days and quarterly reports will need to be filed within 35 days of the
end of each 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 auditors must also provide an opinion about whether Management's
Assessment of the effectiveness of its internal control over financial reporting
is fairly stated in all material respects. 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.
PART 1. FINANCIAL INFORMATION, Item 3 --
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises principally from interest rate risk inherent in
its lending, deposit and borrowing activities. Management actively monitors and
manages its interest rate risk exposure. Although the Company manages other
risks, such as credit quality and liquidity risk in the normal course of
business, management considers interest rate risk to be its most significant
market risk and the risk that could potentially have the largest material effect
on the Company's financial condition and results of operations. Other types of
market risks such as foreign currency exchange risk and commodity price risk do
not arise in the normal course of community banking activities.
Achieving consistent growth in net interest income is the primary goal of the
Company's asset/liability function. The Company attempts to control the mix and
maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates. The Company seeks to
accomplish this goal while maintaining adequate liquidity and capital. A
continuation of historically low interest rates will most likely affect
negatively the Company's net interest income. The Company continues to evaluate
its mix of assets and liabilities in response to the changing economy.
PART 1. FINANCIAL INFORMATION, Item 4 --
CONTROLS AND PROCEDURES
Based on the evaluations by the Company's principal executive officer, Otto P.
Robinson, Jr., President and the Company's principal financial officer, Patrick
Scanlon, Controller, of the Company's Disclosure Controls and Procedures as of
March 31, 2004, they have concluded that the Company's disclosure controls are
effective, reasonably ensure that material information relating to the Company
and its consolidated subsidiaries is made known to them by others within those
entities, particularly during the period in which this report is being prepared,
and identify significant deficiencies or material weaknesses in internal
controls which could adversely affect the Company's ability to record, process,
summarize and report financial data.
Based on information available to them, they are not aware of significant
deficiencies or material weaknesses in the Company's internal control system.
Based on information available to them, they are not aware of any changes made
in internal controls or in other factors during the reporting period that could
materially affect or is reasonably likely to materially affect the Company's
internal controls over financial reporting.
Based on information available to them, they are not aware of any fraud that
involves management or other employees of the Company.
Despite these and other controls and procedures, the Company's two hundred or so
employees process over 10 million financial transactions every year. The
Company's computer systems consist of some 17 million lines of code used in the
processing of this financial information. Financial accounting rules encompass
thousands of pages of instructions and contain many confusing and "gray" areas.
From time to time honest errors in the entry, processing, or reporting of this
information are discovered or a dishonest or disloyal employee surfaces.
Fortunately, in the past any such errors or discoveries have not been material
and therefore we have never had to restate the Company's financial results. The
probability is that we won't in the future, but the possibility does exist and
the certifications marked as exhibits 31 and 32 are made subject to these
contingencies.
PART II. OTHER INFORMATION
Item 1 -- Legal Proceedings
None.
Item 2 -- Changes in Securities and Use of Proceeds
None.
Item 3 -- Defaults Upon Senior Securities
None.
Item 4 -- Submission of Matters to a Vote of Security Holders
None.
Item 5 -- Other Information
None.
Item 6 -- Exhibits and Reports on Form 8-K
a. Exhibits
31 Certifications required under Section 302 of the Sarbanes-Oxley Act
of 2002
32 Certifications required under Section 906 of the Sarbanes-Oxley Act
of 2002
b. Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended March 31, 2004.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENSECO FINANCIAL SERVICES CORPORATION
By /s/ RICHARD E. GRIMM
------------------------------
Richard E. Grimm
Executive Vice-President
Dated: April 30, 2004
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: April 30, 2004