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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
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SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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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
(717) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes x No --- ---
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on July 31, 1998, was 2,148,000.
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<PAGE>
PENSECO FINANCIAL SERVICES CORPORATION
Page
----
Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
June 30, 1998.............................................. 3
December 31, 1997.......................................... 3
Statements of Income:
Three Months Ended June 30, 1998........................... 4
Three Months Ended June 30, 1997........................... 4
Six Months Ended June 30, 1998............................. 5
Six Months Ended June 30, 1997............................. 5
Statements of Cash Flows:
Six Months Ended June 30, 1998............................. 6
Six Months Ended June 30, 1997............................. 6
Notes to Financial Statements................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 11
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................... 17
Item 2. Changes in Securities........................................... 18
Item 3. Defaults Upon Senior Securities................................. 18
Item 4. Submission of Matters to a Vote of Security Holders............. 18
Item 5. Other Information............................................... 18
Item 6. Exhibits and Reports on Form 8-K................................ 18
Signatures.............................................................. 18
<PAGE>
PART I. FINANCIAL INFORMATION, Item 1 -- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands of dollars)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash and due from banks $ 10,519 $ 10,928
Interest-bearing balances with banks 448 -
Federal funds sold 9,900 7,650
----------- -----------
Cash and Cash Equivalents 20,867 18,578
Investment securities:
Available-for-sale, at fair value 95,826 114,942
Held-to-maturity (fair value of $ 8,032
and $10,102, respectively) 8,100 10,106
----------- -----------
Total Investment Securities 103,926 125,048
Loans, net of unearned income 286,322 272,046
Less: Allowance for loan losses 2,800 2,600
----------- -----------
Loans, Net 283,522 269,446
Bank premises and equipment 10,426 8,646
Other real estate owned 105 339
Accrued interest receivable 3,597 3,895
Other assets 2,178 1,625
----------- -----------
Total Assets $ 424,621 $ 427,577
=========== ===========
LIABILITIES
Deposits:
Non-interest bearing $ 51,117 $ 46,127
Interest bearing 318,193 328,361
----------- -----------
Total Deposits 369,310 374,488
Other borrowed funds:
Repurchase agreements 7,532 5,922
Short-term borrowings 754 893
Accrued interest payable 2,187 2,524
Other liabilities 615 826
----------- -----------
Total Liabilities 380,398 384,653
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 33,056 31,662
Accumulated other comprehensive income 327 422
----------- -----------
Total Stockholders' Equity 44,223 42,924
----------- -----------
Total Liabilities and Stockholders' Equity $ 424,621 $ 427,577
=========== ===========
</TABLE>
<PAGE>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
June 30, 1998 June 30, 1997
-------------------- --------------------
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 5,593 $ 5,261
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 1,730 1,911
Other securities - -
Interest on Federal funds sold 128 17
Interest on balances with banks 1 -
-------- --------
Total Interest Income 7,452 7,189
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 536 364
Interest on other deposits 2,693 2,514
Interest on other borrowed funds 82 48
-------- --------
Total Interest Expense 3,311 2,926
Net Interest Income 4,141 4,263
Provision for loan losses 104 46
-------- --------
Net Interest Income After Provision for Loan Losses 4,037 4,217
OTHER INCOME
Trust department income 274 203
Service charges on deposit accounts 159 158
Other fee income 865 805
Other operating income 42 30
Realized gains on securities, net - -
-------- --------
Total Other Income 1,340 1,196
OTHER EXPENSES
Salaries and employee benefits 1,849 1,727
Expense of premises and fixed assets 529 556
Other operating expenses 1,498 1,609
-------- --------
Total Other Expenses 3,876 3,892
-------- --------
Income before income taxes 1,501 1,521
Applicable income taxes 454 442
-------- --------
Net Income 1,047 1,079
Other comprehensive income, net of taxes:
Unrealized securities losses (58) 178
-------- --------
Comprehensive Income $ 989 $ 1,257
======== ========
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.49 $ 0.50
Cash Dividends Declared Per Common Share $ 0.21 $ 0.20
</TABLE>
<PAGE>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1998 June 30, 1997
---------------- ----------------
<S> <C> <C>
Interest and fees on loans $ 11,349 $ 10,286
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 3,547 3,824
Other securities 1 1
Interest on Federal funds sold 300 95
Interest on balances with banks 1 -
--------- ---------
Total Interest Income 15,198 14,206
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 1,075 685
Interest on other deposits 5,466 4,937
Interest on other borrowed funds 160 85
--------- ---------
Total Interest Expense 6,701 5,707
Net Interest Income 8,497 8,499
Provision for loan losses 210 176
--------- ---------
Net Interest Income After Provision for Loan Losses 8,287 8,323
OTHER INCOME
Trust department income 492 416
Service charges on deposit accounts 318 321
Other fee income 2,372 2,154
Other operating income 69 49
Realized gains on securities, net - -
--------- ---------
Total Other Income 3,251 2,940
OTHER EXPENSES
Salaries and employee benefits 3,659 3,435
Expense of premises and fixed assets 1,079 1,120
Other operating expenses 3,512 3,508
--------- ---------
Total Other Expenses 8,250 8,063
--------- ---------
Income before income taxes 3,288 3,200
Applicable income taxes 993 949
--------- ---------
Net Income 2,295 2,251
Other comprehensive income, net of taxes:
Unrealized securities losses (95) (259)
--------- ---------
Comprehensive Income $ 2,200 $ 1,992
========= =========
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 1.07 $ 1.05
Cash Dividends Declared Per Common Share $ 0.42 $ 0.40
</TABLE>
<PAGE>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1998 June 30, 1997
---------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 2,295 $ 2,251
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 478 487
Provision for loan losses 210 176
Deferred income tax provision 11 (89)
Amortization of securities (net of accretion) 85 165
Net (gains) losses on sale of investment securities - -
Loss (gain) on other real estate 16 137
Decrease (increase) in interest receivable 298 8
(Increase) decrease in other assets (553) (256)
Increase (decrease) in income taxes payable 9 114
(Decrease) increase in interest payable (337) (106)
(Decrease) increase in other liabilities (183) (114)
--------- ---------
Net cash provided by operating activities 2,329 2,773
--------- ---------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (12,092) (4,964)
Proceeds from sales and maturities of investment securities available-for-sale 31,000 13,000
Proceeds from repayments of investment securities to be held-to-maturity 1,986 926
Net loans (originated) repaid (14,284) (18,000)
Proceeds from other real estate 217 395
Investment in premises and equipment (2,258) (2,109)
--------- ---------
Net cash provided (used) by investment activities 4,569 (10,752)
--------- ---------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 2,015 (9,053)
Net (payments) proceeds on time deposits (7,193) 14,041
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 1,610 2,185
Net (decrease) increase in short-term borrowings (139) 422
Cash dividends paid (902) (859)
--------- ---------
Net cash (used) provided by financing activities (4,609) 6,736
--------- ---------
Net increase (decrease) in cash and cash equivalents 2,289 (1,243)
--------- ---------
Cash and cash equivalents at January 1 18,578 22,827
--------- ---------
Cash and cash equivalents at June 30 $ 20,867 $ 21,584
========= =========
</TABLE>
The Company paid interest and income taxes of $7,038 and $1,090 and $5,813 and
$964, for the six month periods ended June 30, 1998 and 1997, respectively.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended June 30, 1998
(unaudited)
These Notes to Financial Statements reflect events subsequent to December 31,
1997, the date of the most recent Report of Independent Auditors, through the
date of this Quarterly Report on Form 10-Q for the six month period ended June
30, 1998. These Notes to Financial Statements should be read in conjunction with
Financial Information and Other Information required to be furnished as part of
this Report, in particular, (1) Management's Discussion and Analysis of
Financial Condition and Results of Operations for the three months ended June
30, 1998 and for the six months ended June 30, 1998, in 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 on Form 10-K for the year ended December 31,
1997, incorporated herein by reference.
The financial statements furnished are unaudited. However, in the opinion of
management, the financial statements include all adjustments, consisting of
normal recurring accruals, necessary for a fair presentation of the interim
periods presented. Operating results for these interim periods are not
necessarily indicative of results to be expected for the entire year.
NOTE 1 -- Principles of Consolidation
Penseco Financial Services Corporation (Company) is a bank holding company,
incorporated under the laws of Pennsylvania. It is the parent company of Penn
Security Bank and Trust Company (Bank), a state chartered bank.
Intercompany transactions have been eliminated in preparing the consolidated
financial statements.
The accounting policies of the Company conform with generally accepted
accounting principles 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 and Form 10-K" for
the year ended December 31, 1997.
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 over the period to
maturity.
Securities Available-for-Sale. Bonds, notes, debentures, and certain equity
securities not classified as securities to be held to maturity are carried at
fair value with unrealized holding gains and losses, net of tax, reported as a
net amount in a separate component of stockholders' equity until realized.
Gains and losses on the sale of securities available-for-sale are determined
using the specific identification method
<PAGE>
and are reported as a separate component of other income in the Statements of
Income.
The Company has no derivative financial instruments required to be disclosed
under SFAS No. 119.
The amortized cost and fair value of investment securities at June 30, 1998 and
December 31, 1997 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 1998 Cost Gains Losses Value
- -----------------------------------------------------------------------------
U.S. Treasury securities $ 95,310 $ 497 $ 1 $ 95,806
Equity securities 20 - - 20
- -----------------------------------------------------------------------------
Total Available-for-Sale $ 95,330 $ 497 $ 1 $ 95,826
- -----------------------------------------------------------------------------
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 1997 Cost Gains Losses Value
- -----------------------------------------------------------------------------
U.S. Treasury securities $114,283 $ 639 $ - $114,922
Equity securities 20 - - 20
- -----------------------------------------------------------------------------
Total Available-for-Sale $114,303 $ 639 $ - $114,942
- -----------------------------------------------------------------------------
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 1998 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Obligations of U.S. Agencies:
Mortgage-backed securities $ 8,100 $ - $ 68 $ 8,032
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 8,100 $ - $ 68 $ 8,032
- --------------------------------------------------------------------------------
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 1997 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Obligations of U.S. Agencies:
Mortgage-backed securities $10,106 $ 3 $ 7 $10,102
- --------------------------------------------------------------------------------
Total Held-to-Maturity $10,106 $ 3 $ 7 $10,102
- --------------------------------------------------------------------------------
The amortized cost and fair value of debt securities at June 30, 1998 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<PAGE>
June 30, 1998 Available-for-Sale Held-to-Maturity
- --------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- --------------------------------------------------------------------------------
Due in one year or less:
U.S. Treasury securities $ 61,095 $ 61,201 $ - $ -
After one year through five years:
U.S. Treasury securities 34,215 34,605 - -
- --------------------------------------------------------------------------------
Subtotal 95,310 95,806 - -
Mortgage-backed securities - - 8,100 8,032
- --------------------------------------------------------------------------------
Total Debt Securities $ 95,310 $ 95,806 $ 8,100 $ 8,032
- --------------------------------------------------------------------------------
NOTE 5 -- 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's and the Bank's capital amounts and classification 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 1 and Total Capital to
risk-weighted assets and of Tier 1 Capital to average assets (Leverage ratio).
The table also presents the Company's actual capital amounts and ratios. The
Bank's actual capital amounts and ratios are substantially identical to the
Company's. Management believes, as of June 30, 1998, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of June 30, 1998, the most recent notification from the Federal Deposit
Insurance Corporation 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 1 Capital, Total Capital
and Leverage ratios as set forth in the Capital Adequacy table. There are no
conditions or events since that notification that management believes have
changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels which could
limit the payment of dividends, although the Company and Bank currently have
capital levels which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the Retained Earnings of the Bank. Accordingly, at June 30, 1998,
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.
<PAGE>
<TABLE>
<CAPTION>
Actual Regulatory Requirements
- ----------------------------------------------- -------------------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of June 30, 1998 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $ 46,619 18.15% > $ 20,548 > 8.0% > $ 25,684 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 43,819 17.06% > $ 10,274 > 4.0% > $ 15,411 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 43,819 10.26% > $ * > * > $ 21,351 > 5.0%
- - - -
*3.0% ($ 12,811), 4.0% ($ 17,081) or 5.0% ($ 21,351) depending on the bank's
CAMEL Rating and other regulatory risk factors.
Actual Regulatory Requirements
- ----------------------------------------------- -------------------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of December 31, 1997 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 45,102 19.22% > $ 18,776 > 8.0% > $ 23,470 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 42,502 18.11% > $ 9,388 > 4.0% > $ 14,082 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 42,502 10.25% > $ * > * > $ 20,727 > 5.0%
- - - -
*3.0% ($ 12,436), 4.0% ($ 16,581) or 5.0% ($ 20,727) depending on the bank's
CAMEL Rating and other regulatory risk factors.
</TABLE>
<PAGE>
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 the operations of Penseco Financial
Services Corporation and its subsidiary ("Penn Security Bank and Trust Company")
for the three months ended June 30, 1998 and June 30, 1997 and for the six
months ended June 30, 1998 and June 30, 1997. Throughout this review the
subsidiary of Penseco Financial Services Corporation, Penn Security Bank and
Trust Company, is referred to as "the Company". All intercompany accounts and
transactions have been eliminated in preparing the consolidated financial
statements. All information is presented in thousands of dollars, except as
indicated.
Overview of Financial Condition
Penseco Financial Services Corporation reported net income of $2,295 for six
months ending June 30, 1998, an increase of $44 or 2.0% over $2,251 reported for
the second quarter of 1997. The slight improvement in earnings is attributed to
strong loan growth but somewhat offset by a higher cost of funds.
Loans increased $14.3 million, or 5.3%, while investments decreased $21.1
million, or 16.9% since December 31, 1997. This change was due to strong loan
demand, which resulted in repricing assets at higher rates.
Net Interest Income and Net Interest Margin
Net interest income, the largest contributor to the Company's earnings, is
defined as the difference between income on assets and the cost of funds
supporting those assets. Earning assets are composed primarily of loans and
investments while deposits and short-term borrowings, in the form of securities
sold under agreements to repurchase, 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, declined $2 to $8,497 for the first half of 1998 from
$8,499 in 1997. This decline is largely due to maturities of the investment
portfolio repricing at lower rates, along with loans refinancing at lower rates
due to the local competitive environment, offset by a somewhat higher increase
in funding costs.
The net interest margin represents the Company's net yield on its earning assets
and is calculated as net interest income divided by average earning assets. In
the first six months of 1998, the net interest margin was 4.19%, falling 27
basis points from 4.46% in the same period of 1997, the result of a slight
increase in the yield on earning assets and a somewhat higher increase in
funding costs.
A change in the volume of earning assets was the key determinant of the increase
in net interest income in the first half of 1998. Both total average earning
assets and total average interest bearing funds rose in the first half of 1998
as compared to 1997. Average earning assets rose $24.4 million, or 6.4%, from
$381.0 million in 1997 to $405.4 million in 1998 and average interest bearing
funds increased $22.2 million, or 7.2%, from $308.2 million to $330.4 million
for the same periods. As a percentage of average assets, earning assets
decreased from 95.4% in the first half of 1997 to 94.9% in 1998. Average
interest bearing funding sources increased from 77.2% of total funding sources
in the first half of 1997 to 77.4% in the same period in 1998, resulting in a
higher cost of funds.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the first half of both 1998 and 1997; however, the changes in
the mix of earning assets were less significant than the change in composition
of funding sources. Average loans as a percentage of average earning assets
increased slightly from 67.2% in 1997 to 69.3% in 1998; average investments fell
slightly from 31.9% to 28.0%. Short-term investments, federal funds sold, and
interest on balances with banks, rose from 1.0% of earning assets to 2.7%.
Changes in the mix of interest-bearing funds were more pronounced as funds
shifted from lower cost deposits into higher funding sources mainly time deposit
accounts. Time deposits increased $22.1 million, from 46.9% of funding sources
to 50.4% in 1998. This change in deposit composition resulted in an increase in
the cost of funds, which was partially offset by a decrease in the cost of
transaction savings accounts.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. Average loan yields
rose 5 basis points, from 8.03% for the first half of 1997 to 8.08% in 1998.
Investments and federal funds yields remained fairly stable as the market rates
were approximately the same on average in both 1997 and 1998. Competition for
funds, principally from the equity markets via mutual funds, increased in late
1997 and early 1998. Therefore, to compete for customers seeking alternative
repositories for their funds, the average time deposit cost of funds increased
from 5.23% in 1997 to 5.65% in 1998. This is the primary cause of the increase
in the total cost of funds from 3.70% in 1997 to 4.06% in 1998.
<PAGE>
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 June 30, 1998 and June 30,
1997.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
June 30, 1998 June 30, 1997
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment Securities
U.S. Treasury securities $ 104,783 $ 3,263 6.23% $ 109,852 $ 3,449 6.28%
U.S. Agency obligations 8,668 285 6.58% 11,642 375 6.44%
Other 20 1 5.00% 20 1 5.00%
Loans, net of unearned income:
Real estate mortgages 218,733 8,893 8.13% 201,569 8,016 7.95%
Commercial 18,419 774 8.40% 12,571 537 8.54%
Consumer and other 43,880 1,681 7.66% 41,993 1,733 8.25%
Federal funds sold 10,850 300 5.53% 3,400 95 5.59%
Interest on balances with banks 34 1 5.88%
- ---------------------------------------------------------------------------------------------------------
Total Earning Assets/
Total Interest Income 405,387 $15,198 7.50% 381,047 $14,206 7.46%
- ---------------------------------------------------------------------------------------------------------
Cash and due from banks 10,124 8,367
Bank premises and equipment 9,865 8,032
Accrued interest receivable 3,570 3,395
Other assets 780 724
Less: Allowance for loan losses 2,701 2,411
- ---------------------------------------------------------------------------------------------------------
Total Assets $ 427,025 $ 399,154
- ---------------------------------------------------------------------------------------------------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 23,454 $ 169 1.44% $ 23,103 $ 172 1.49%
Savings 70,813 699 1.97% 73,243 724 1.98%
Money markets 62,561 967 3.09% 63,010 948 3.01%
Time - Over $100 38,111 1,075 5.64% 28,337 685 4.83%
Time - Other 128,452 3,631 5.65% 116,206 3,093 5.32%
Federal funds purchased 40 1 5.00% 560 14 5.00%
Repurchase agreements 6,354 143 4.50% 3,057 57 3.73%
Short-term borrowings 600 16 5.33% 640 14 4.37%
- ---------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 330,385 $ 6,701 4.06% 308,156 $ 5,707 3.70%
- ---------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 49,185 46,332
All other liabilities 2,846 2,878
Stockholders' equity 44,609 41,788
- ---------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 427,025 $ 399,154
- ---------------------------------------------------------------------------------------------------------
Interest Spread 3.44% 3.76%
- ---------------------------------------------------------------------------------------------------------
Net Interest Income $ 8,497 $ 8,499
- ---------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 4.19% 4.46%
Return on average assets 1.08% 1.13%
Return on average equity 10.29% 10.77%
Average equity to average assets 10.45% 10.47%
Dividend payout ratio 39.25% 38.10%
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
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 or
reversal necessary to maintain an appropriate allowance.
In the first six months of 1998, the provision for loan losses was $210 an
increase from $176 in the first half in 1997. Loans charged-off totaled $25 and
recoveries were $15. In the same period of 1997, recoveries of $93 offset loans
charged off of $69.
Other Income
The following table sets forth information by category of other income for the
Company for three months and six months ended June 30, 1998 and June 30, 1997,
respectively:
June 30, June 30,
Three Months Ended : 1998 1997
- -----------------------------------------------------------------------
Trust department income $ 274 $ 203
Service charges on deposit accounts 159 158
Other fee income 865 805
Other operating income 42 30
Realized gains on securities, net - -
- -----------------------------------------------------------------------
Total Other Income $ 1,340 $ 1,196
- -----------------------------------------------------------------------
Other income increased $144 or 12.0% for the three month period ending June 30,
1998 to $1,340, from $1,196 for the three months ended June 30, 1997. Largely
this increase was due to a $71 or 35% improvement in fiduciary income, along
with improved growth in merchant discounts, due to increases in our customer
base, as well as, increases with our existing customers.
June 30, June 30,
Six Months Ended : 1998 1997
- -----------------------------------------------------------------------
Trust department income $ 492 $ 416
Service charges on deposit accounts 318 321
Other fee income 2,372 2,154
Other operating income 69 49
Realized gains on securities, net - -
- -----------------------------------------------------------------------
Total Other Income $ 3,251 $ 2,940
- -----------------------------------------------------------------------
Other income increased $311 or 10.6% for the first half of 1998 to $3,251 from
$2,940 for the same period of 1997. Contributing increases came from the trust
department of $76 and $182 from merchant discounts. In both of these areas the
bank realized improved efficiencies, as well as, increases in our customer base.
<PAGE>
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months and six months ended June 30, 1998 and June 30,
1997, respectively:
June 30, June 30,
Three Months Ended : 1998 1997
- -----------------------------------------------------------------------
Salaries and employee benefits $ 1,849 $ 1,727
Expense of premises and fixed assets 529 556
Other operating expenses 1,498 1,609
- -----------------------------------------------------------------------
Total Other Expenses $ 3,876 $ 3,892
- -----------------------------------------------------------------------
Other expenses decreased $16 for the three month period ending June 30, 1998 to
$3,876 from $3,892 for the three month period ending June 30, 1997. The increase
in salary and employee benefits of $122 was offset by a reduction of $143 of
other real estate owned expense from the three month period ending June 30,
1998.
June 30, June 30,
Six Months Ended : 1998 1997
- -----------------------------------------------------------------------
Salaries and employee benefits $ 3,659 $ 3,435
Expense of premises and fixed assets 1,079 1,120
Other operating expenses 3,512 3,508
- -----------------------------------------------------------------------
Total Other Expenses $ 8,250 $ 8,063
- -----------------------------------------------------------------------
Other expenses increased $187 or 2.3% for the six months ended June 30, 1998 to
$8,250 from $8,063 for the six months ended June 30, 1998. Salaries and benefits
increased over the first half of 1997 due to significantly higher health care
coverage provided by the company to its employees, merit increases, and staff
additions. Also, other operating expenses increases were offset by a reduction
of $143 other real estate owned expense from the first half of 1997.
Loan Portfolio
June 30, December 31,
As Of: 1998 1997
- ------------------------------------------------------------------------------
Real estate - construction
and land development $ 2,551 $ 3,731
Real estate mortgages 220,433 213,128
Commercial 19,418 17,177
Credit card and related plans 2,105 2,293
Installment 27,814 26,807
Obligations of states
and political subdivisions 14,001 8,910
- ------------------------------------------------------------------------------
Loans, net of unearned income 286,322 272,046
Less: Allowance for loan losses 2,800 2,600
- ------------------------------------------------------------------------------
Loans, net $ 283,522 $ 269,446
- ------------------------------------------------------------------------------
<PAGE>
Loan Quality
The lending activities of the Company are guided by the basic 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 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 judgement 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 charged-off loans
(or parts of loans) management has determined to be uncollectible, net of actual
recoveries on loans previously charged-off.
Non-Performing Assets
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned. The following
table sets forth information regarding non-performing assets as of the dates
indicated:
June 30, June 30,
Six Months Ended: 1998 1997
- -------------------------------------------------------------------------------
Non-accrual loans $ 1,120 $ 1,139
Loans past due 90 days or more and accruing:
Guaranteed student loans 276 281
Credit card and home equity loans 21 16
- -------------------------------------------------------------------------------
Total non-performing loans 1,417 1,436
Other real estate owned 105 410
- -------------------------------------------------------------------------------
Total non-performing assets $ 1,522 $ 1,846
- -------------------------------------------------------------------------------
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 nonaccrual status, all previously accrued but not collected interest
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 $1,120 and $1,139 at June 30, 1998 and June 30, 1997, respectively. If
interest on those loans had been accrued, such income would have been $110 and
$65 for the six months ended June 30, 1998 and June 30, 1997, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $13 and $23 for June 30, 1998 and June 30, 1997, respectively. There are no
commitments to lend additional funds to individuals whose loans are in
non-accrual status.
The management process for evaluating the adequacy of the allowance for loan
losses includes reviewing each month's loan committee reports which list all
loans that do not meet certain internally developed criteria as to collateral
adequacy, payment performance, economic conditions and overall credit risk.
These reports also address the current status and actions in process on each
listed loan. From this information, adjustments are made to the allowance for
loan losses. Such adjustments include both specific loss allocation amounts and
general provisions by loan category based on present and past collection
experience, nature and volume of the loan portfolio, overall quality, and
current economic conditions that may affect the borrower's ability to pay. As of
June 30, 1998 there are no significant loans as to which management has serious
doubt about their ability to continue to perform in
<PAGE>
accordance with their contractual terms.
At June 30, 1998 and December 31, 1997, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
Loan Loss Experience
The following tables present the Company's loan loss experience during the
periods indicated:
June 30, June 30,
Six Months Ended : 1998 1997
- --------------------------------------------------------------------------------
Balance at beginning of year $ 2,600 $ 2,300
Charge-offs:
Real estate mortgages 6 38
Commercial (time and demand)
and all others 6 10
Credit card and related plans 11 21
Installment loans 2 -
- --------------------------------------------------------------------------------
Total charge-offs 25 69
- --------------------------------------------------------------------------------
Recoveries:
Real estate mortgages 1 74
Commercial (time and demand) and all others - 6
Credit card and related plans 8 12
Installment loans 6 1
- --------------------------------------------------------------------------------
Total recoveries 15 93
- --------------------------------------------------------------------------------
Net charge-offs 10 (24)
- --------------------------------------------------------------------------------
Provision charged to operations 210 176
- --------------------------------------------------------------------------------
Balance at End of Period $ 2,800 $ 2,500
- --------------------------------------------------------------------------------
Ratio of net charge-offs
to average loans outstanding 0.001% (0.001%)
- --------------------------------------------------------------------------------
The allowance for loan losses is allocated as follows:
Six Months Ended: June 30, 1998 June 30, 1997
- --------------------------------------------------------------------------------
Amount % * Amount % *
Real estate mortgages $ 1,450 78% $ 1,275 75%
Commercial (time and demand)
and all others 900 11% 850 13%
Credit card and related plans 150 1% 150 1%
Personal installment loans 300 10% 225 11%
- --------------------------------------------------------------------------------
Total $ 2,800 100% $ 2,500 100%
- --------------------------------------------------------------------------------
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.
<PAGE>
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.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's substantial U.S. Treasury bond
portfolio, additional deposits, earnings, overnight loans to and from other
companies (Federal Funds) and lines of credit at the Federal Reserve Bank. The
designation of securities as "Held-To-Maturity" lessens the ability of banks to
sell securities so classified, except in regard to certain changes in
circumstances or other events that are isolated, non-recurring and unusual.
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 18.15% at June 30, 1998. The
Company's risk based capital ratio is almost double 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.
The Company is constructing a branch office, in the East Stroudsburg area, at an
approximate cost to completion of $1,100,000 as of June 30, 1998. The Company
also has a new branch facility in the Green Ridge section of Scranton
substantially completed which will replace its existing facility. Initially, it
was anticipated that the new branch would be opened in the second quarter of
1998, but as a result of the expansion of the drive-up facility, the opening is
now scheduled for the middle of the third quarter.
Year 2000 Compliance
The "Year 2000" issue is the result of computer programs having been written
using a two-digit field as opposed to a four-digit field, to define the
applicable year. Programs that are time sensitive may recognize a date using
"00" as the year 1900 rather than the year 2000. Computer system failure or
significant miscalculations could result from this problem, if not corrected.
The Company licenses a minor portion of its software, used in conducting its
business, from third party software vendors, while most of the Company's
software has been internally developed. The Company has developed a
comprehensive list of all software and all hardware in use within the
organization. Every vendor has been contacted regarding the Year 2000 issue, and
the Company is closely tracking the progress each vendor is making in resolving
the problems associated with the issue. Software is upgraded as the vendors
resolve Year 2000 problems.
Internally developed software is undergoing modifications and many systems have
already been modified. Testing procedures are being formulated for comprehensive
testing of this software beginning in July, 1998, with completion of testing by
the end of 1998. Additionally, the Company has begun the process of contacting
its borrowers to determine the level of progress they have made in addressing
the impact that the Year 2000 issue will have on their respective businesses.
The Company does not anticipate any significant additional costs, over and above
normal operating costs, as the work will be largely accomplished by the
Company's computer systems and programming staff.
PART II. OTHER INFORMATION
Item 1 -- Legal Proceedings
None.
<PAGE>
Item 2 -- Changes in Securities
None.
Item 3 -- Defaults Upon Senior Securities
None.
Item 4 -- Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of Penseco Financial Services
Corporation was held on May 5, 1998.
The results of the items submitted for a vote are as follows:
The following three Directors, whose term will expire in 2002, were
elected:
% of total
number of votes outstanding
cast for director shares voted
----------------- ------------
D. William Hume 1,969,981 91.71%
James G. Keisling 1,973,601 91.88%
Otto P. Robinson, Jr. 1,972,209 91.82%
Item 5 -- Other Information
None.
Item 6 -- Exhibits and Reports on Form 8-K
a. Exhibits
27.0 Financial Data Schedule
b. Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended June 30, 1998.
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
By /s/ RICHARD E. GRIMM
------------------------------
Richard E. Grimm
Executive Vice-President
Dated: August 10, 1998
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: August 10, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 10,519
<INT-BEARING-DEPOSITS> 448
<FED-FUNDS-SOLD> 9,900
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 95,826
<INVESTMENTS-CARRYING> 8,100
<INVESTMENTS-MARKET> 8,032
<LOANS> 286,322
<ALLOWANCE> 2,800
<TOTAL-ASSETS> 424,621
<DEPOSITS> 369,310
<SHORT-TERM> 8,286
<LIABILITIES-OTHER> 2,802
<LONG-TERM> 0
0
0
<COMMON> 21
<OTHER-SE> 44,202
<TOTAL-LIABILITIES-AND-EQUITY> 424,621
<INTEREST-LOAN> 11,349
<INTEREST-INVEST> 3,547
<INTEREST-OTHER> 302
<INTEREST-TOTAL> 15,198
<INTEREST-DEPOSIT> 6,701
<INTEREST-EXPENSE> 6,701
<INTEREST-INCOME-NET> 8,497
<LOAN-LOSSES> 210
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 8,250
<INCOME-PRETAX> 3,288
<INCOME-PRE-EXTRAORDINARY> 3,288
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,295
<EPS-PRIMARY> 1.07
<EPS-DILUTED> 1.07
<YIELD-ACTUAL> 4.19
<LOANS-NON> 1,120
<LOANS-PAST> 1,417
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,600
<CHARGE-OFFS> 25
<RECOVERIES> 15
<ALLOWANCE-CLOSE> 2,800
<ALLOWANCE-DOMESTIC> 2,800
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
