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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 September 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
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The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on October 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:
September 30, 1998....................................... 3
December 31, 1997........................................ 3
Statements of Income:
Three Months Ended September 30, 1998.................... 4
Three Months Ended September 30, 1997.................... 4
Nine Months Ended September 30, 1998..................... 5
Nine Months Ended September 30, 1997..................... 5
Statements of Cash Flows:
Nine Months Ended September 30, 1998..................... 6
Nine Months Ended September 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......................................... 17
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)
September 30, December 31,
1998 1997
------------- ------------
ASSETS
Cash and due from banks $ 11,330 $ 10,928
Interest-bearing balances with banks 7,670 -
Federal funds sold 9,125 7,650
------------- ------------
Cash and Cash Equivalents 28,125 18,578
Investment securities:
Available-for-sale, at fair value 94,138 114,942
Held-to-maturity (fair value of $ 7,123
and $10,102, respectively) 7,244 10,106
------------- ------------
Total Investment Securities 101,382 125,048
Loans, net of unearned income 289,955 272,046
Less: Allowance for loan losses 2,830 2,600
------------- ------------
Loans, Net 287,125 269,446
Bank premises and equipment 11,891 8,646
Other real estate owned 147 339
Accrued interest receivable 3,586 3,895
Other assets 2,118 1,625
------------- ------------
Total Assets $ 434,374 $ 427,577
============= ============
LIABILITIES
Deposits:
Non-interest bearing $ 55,446 $ 46,127
Interest bearing 319,003 328,361
------------- ------------
Total Deposits 374,449 374,488
Other borrowed funds:
Repurchase agreements 11,365 5,922
Short-term borrowings 166 893
Accrued interest payable 2,163 2,524
Other liabilities 918 826
------------- ------------
Total Liabilities 389,061 384,653
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 33,784 31,662
Accumulated other comprehensive income 689 422
------------- ------------
Total Stockholders' Equity 45,313 42,924
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Total Liabilities and Stockholders' Equity $ 434,374 $ 427,577
============= ============
<PAGE>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands of dollars)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 5,757 $ 5,471
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 1,609 1,969
Other securities - -
Interest on Federal funds sold 141 131
Interest on balances with banks 51 -
-------------- ---------------
Total Interest Income 7,558 7,571
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 509 416
Interest on other deposits 2,650 2,719
Interest on other borrowed funds 116 54
-------------- ---------------
Total Interest Expense 3,275 3,189
Net Interest Income 4,283 4,382
Provision for loan losses 75 63
-------------- ---------------
Net Interest Income After Provision for Loan Losses 4,208 4,319
OTHER INCOME
Trust department income 264 244
Service charges on deposit accounts 171 166
Other fee income 1,656 1,527
Other operating income 25 22
Realized gains on securities, net - -
-------------- ---------------
Total Other Income 2,116 1,959
OTHER EXPENSES
Salaries and employee benefits 1,829 1,742
Expense of premises and fixed assets 558 546
Other operating expenses 2,245 1,990
-------------- ---------------
Total Other Expenses 4,632 4,278
-------------- ---------------
Income before income taxes 1,692 2,000
Applicable income taxes 512 624
-------------- ---------------
Net Income 1,180 1,376
Other comprehensive income, net of taxes:
Unrealized securities gains (losses) 362 86
-------------- ---------------
Comprehensive Income $ 1,542 $ 1,462
============== ===============
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.55 $ 0.64
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)
Nine Months Ended Nine Months Ended
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------ -----------------------
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $17,106 $15,756
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 5,156 5,792
Other securities 1 1
Interest on Federal funds sold 441 227
Interest on balances with banks 52 -
----------- ---------------
Total Interest Income 22,756 21,776
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 1,584 1,101
Interest on other deposits 8,116 7,656
Interest on other borrowed funds 276 139
----------- ---------------
Total Interest Expense 9,976 8,896
Net Interest Income 12,780 12,880
Provision for loan losses 285 239
----------- ---------------
Net Interest Income After Provision for Loan Losses 12,495 12,641
OTHER INCOME
Trust department income 756 660
Service charges on deposit accounts 489 487
Other fee income 4,028 3,680
Other operating income 94 72
Realized gains on securities, net - -
----------- ---------------
Total Other Income 5,367 4,899
OTHER EXPENSES
Salaries and employee benefits 5,488 5,177
Expense of premises and fixed assets 1,637 1,666
Other operating expenses 5,757 5,498
----------- ---------------
Total Other Expenses 12,882 12,341
----------- ---------------
Income before income taxes 4,980 5,199
Applicable income taxes 1,505 1,573
----------- ---------------
Net Income 3,475 3,626
Other comprehensive income, net of taxes:
Unrealized securities gains (losses) 267 (173)
----------- ---------------
Comprehensive Income $ 3,742 $ 3,453
=========== ===============
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 1.62 $ 1.69
Cash Dividends Declared Per Common Share $ 0.63 $ 0.60
</TABLE>
<PAGE>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands of dollars)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
-------------------- --------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 3,475 $ 3,626
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 733 748
Provision for loan losses 285 239
Deferred income tax provision (127) 80
Amortization of securities (net of accretion) 144 243
Net (gains) losses on sale of investment securities - -
Loss (gain) on other real estate 16 137
Decrease (increase) in interest receivable 309 (392)
(Increase) decrease in other assets (493) (421)
Increase (decrease) in income taxes payable 89 86
(Decrease) increase in interest payable (361) 229
(Decrease) increase in other liabilities (8) 153
----------- -----------
Net cash provided by operating activities 4,062 4,728
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INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (24,905) (38,297)
Proceeds from sales and maturities of investment securities available-for-sale 46,000 30,000
Proceeds from repayments of investment securities to be held-to-maturity 2,832 1,521
Net loans (originated) repaid (18,006) (30,514)
Proceeds from other real estate 218 415
Investment in premises and equipment (3,978) (2,563)
----------- -----------
Net cash provided (used) by investment activities 2,161 (39,438)
----------- -----------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 4,592 21,356
Net (payments) proceeds on time deposits (4,631) 31,627
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 5,443 3,241
Net (decrease) increase in short-term borrowings (727) 232
Cash dividends paid (1,353) (1,289)
----------- -----------
Net cash provided (used) by financing activities 3,324 55,167
----------- -----------
Net increase (decrease) in cash and cash equivalents 9,547 20,457
----------- -----------
Cash and cash equivalents at January 1 18,578 22,827
----------- -----------
Cash and cash equivalents at September 30 $ 28,125 $ 43,284
=========== ===========
The Company paid interest and income taxes of $ 10,337 and $ 1,453 and $ 8,667
and $ 1,361, for the nine month periods ended September 30, 1998 and 1997,
respectively. September 30, 1998 September 30, 1997
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended September 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 nine month period ended
September 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 September 30, 1998 and for the nine months ended September 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 the expected results 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.
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.
<PAGE>
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 September 30, 1998
and December 31, 1997 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 1998 Cost Gains Losses Value
- ------------------------------------------------------------------------------
U.S. Treasury securities $ 91,284 $ 1,044 $ - $ 92,328
Equity securities 1,810 - - 1,810
- ------------------------------------------------------------------------------
Total Available-for-Sale $ 93,094 $ 1,044 $ - $ 94,138
- ------------------------------------------------------------------------------
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
September 30, 1998 Cost Gains Losses Value
- ------------------------------------------------------------------------------
Obligations of U.S. Agencies:
Mortgage-backed securities $ 7,244 $ - $ 121 $ 7,123
- ------------------------------------------------------------------------------
Total Held-to-Maturity $ 7,244 $ - $ 121 $ 7,123
- ------------------------------------------------------------------------------
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
- ------------------------------------------------------------------------------
<PAGE>
The amortized cost and fair value of debt securities at September 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.
September 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 $ 56,059 $ 56,442 $ - $ -
After one year through five years:
U.S. Treasury securities 35,225 35,886 - -
- --------------------------------------------------------------------------------
Subtotal 91,284 92,328 - -
Mortgage-backed securities - - 7,244 7,123
- --------------------------------------------------------------------------------
Total Debt Securities $ 91,284 $ 92,328 $ 7,244 $ 7,123
- --------------------------------------------------------------------------------
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 September 30, 1998, that the Company and
the Bank meet all capital adequacy requirements to which they are subject.
As of September 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 September 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>
Actual Regulatory Requirements
- ----------------------------------------- -------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of September 30, 1998 Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $47,382 18.33% >$20,677 >8.0% >$25,846 >10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $44,552 17.24% >$10,338 >4.0% >$15,507 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $44,552 10.34% >$ * > * >$21,553 > 5.0%
- - - -
*3.0% ($ 12,932), 4.0% ($ 17,243) or 5.0% ($ 21,553) 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.
<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 September 30, 1998 and September 30, 1997 and for the
nine months ended September 30, 1998 and September 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 $1,180 for the
three months ending September 30, 1998, a decrease of $196 or 14.2% from the
$1,376 reported for the same three month period of 1997. Net income of $3,475
was reported for the nine months ending September 30, 1998, a decrease of $151
or 4.2% from the $3,626 reported for the first nine months of 1997. Both
declines in earnings are attributable to a narrowing of the interest spread.
Loans increased $18.0 million, or 6.6%, while investments decreased $23.6
million, or 18.9% since December 31, 1997. This change was due to strong loan
demand. Funded by maturities of investment securities.
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 $99 to $4,283 for the three months ending
September 30, 1998 from $4,382 in 1997. Similarly, for the first nine months of
1998, net interest income declined $100 to $12,780 from $12,880 in 1997. Both of
these declines are largely due to maturities of the investment portfolio
repricing at lower rates, along with loans refinancing at lower rates, combined
with an increase in funding costs, all due to local competitive conditions.
The net interest margin represents the Company's net yield on its earning assets
and is calculated as net interest income divided by average earning assets. In
the first nine months of 1998, the net interest margin was 4.20%, falling 16
basis points from 4.36% in the same period of 1997, the result of a slight
increase in the yield on earning assets offset by a higher increase in funding
costs.
Changes in the volume and rate of interest bearing liabilities were key
determinants of the decrease in net interest income for both the three months
and nine months ending September 30, 1998 and 1997. Both total average earning
assets and total average interest bearing funds rose in the first nine months of
1998 as compared to 1997. Average earning assets rose $12.0 million, or 3.0%,
from $394.2 million in 1997 to $406.2 million in 1998 and average interest
bearing funds increased $6.6 million, or 2.0%, from $325.2 million to $331.8
million for the same periods. As a percentage of average assets, earning assets
increased from 93.7% in the first nine months of 1997 to 94.2% in 1998. Average
interest bearing funding sources decreased from 77.4% of total funding sources
in the first nine months of 1997 to 77.0% in the same period in 1998.
Changes in the mix of earning assets and funding sources also impacted net
interest income for both the three months and nine months ending September 30,
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 67.0% in 1997 to
70.9% in 1998; average investments fell from 31.6% to 26.0%. Short-term
investments, federal funds sold, and interest on balances with banks, rose from
1.4% of earning assets to 3.1%. Changes in the mix of interest-bearing funds
produced higher interest costs as funds shifted from lower cost deposits into
higher cost funding sources, mainly time deposit accounts. Time deposits
increased $8.5 million, from 47.9% of funding sources to 49.5% 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 and 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
fell 3 basis points, from 7.95% for the first nine months of 1997 to 7.92% in
<PAGE>
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 5.10% in 1997 to 5.65% in 1998. This is the primary cause of the
increase in the total cost of funds from 3.65% in 1997 to 4.00% in 1998.
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 September 30, 1998 and
September 30, 1997.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
September 30, 1998 September 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 $ 97,307 $ 4,754 6.51 $ 113,387 $ 5,243 6.17%
U.S. Agency obligations 7,738 402 6.93% 11,160 549 6.56%
Other 709 1 0.14% 20 1 5.00%
Loans, net of unearned income:
Real estate mortgages 224,417 13,349 7.93% 206,946 12,232 7.88%
Commercial 19,417 1,194 8.20% 14,115 890 8.41%
Consumer and other 44,003 2,563 7.77% 43,114 2,634 8.15%
Federal funds sold 11,330 441 5.19% 5,500 227 5.50%
Interest on balances with banks 1,261 52 5.50% -
- ---------------------------------------------------------------------------------------------------
Total Earning Assets/
Total Interest Income 406,182 $22,756 7.47% 394,242 $21,776 7.36%
- ---------------------------------------------------------------------------------------------------
Cash and due from banks 10,407 9,897
Bank premises and equipment 10,955 8,131
Accrued interest receivable 3,454 3,680
Other assets 2,851 6,830
Less: Allowance for loan losses 2,784 2,495
- ---------------------------------------------------------------------------------------------------
Total Assets $ 431,065 $ 420,285
- ---------------------------------------------------------------------------------------------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 23,687 $ 259 1.46% $ 23,261 $ 261 1.50%
Savings 70,678 1,052 1.98% 72,538 1,087 2.00%
Money markets 63,166 1,425 3.00% 68,340 1,457 2.84%
Time - Over $100 38,393 1,584 5.50% 31,705 1,101 4.63%
Time - Other 125,777 5,380 5.70% 124,014 4,850 5.21%
Federal funds purchased 24 1 4.17% 370 14 5.04%
Repurchase agreements 9,204 251 3.64% 4,433 104 3.12%
Short-term borrowings 851 24 3.76% 542 22 5.41%
- ---------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 331,780 $ 9,976 4.00% 325,203 $ 8,896 3.65%
- ---------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 52,022 49,608
All other liabilities 2,177 2,619
Stockholders' equity 45,086 42,855
- ---------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 431,065 $ 420,285
- ---------------------------------------------------------------------------------------------------
Interest Spread 3.47% 3.71%
- ---------------------------------------------------------------------------------------------------
Net Interest Income $12,780 $ 12,880
- ---------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 4.20% 4.36%
Return on average assets 1.07% 1.15%
Return on average equity 10.28% 11.28%
Average equity to average assets 10.46% 10.20%
Dividend payout ratio 38.89% 35.56%
- ---------------------------------------------------------------------------------------------------
</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 nine months of 1998, the provision for loan losses was $285 an
increase from $239 in the first nine months of 1997. Loans charged-off totaled
$71 and recoveries were $16. In the same period of 1997, recoveries of $104
offset loans charged off of $93.
Other Income
The following table sets forth information by category of other income for the
Company for three months ended September 30, 1998 and September 30, 1997,
respectively:
September 30, September 30,
Three Months Ended : 1998 1997
- -----------------------------------------------------------------------
Trust department income $ 264 $ 244
Service charges on deposit accounts 171 166
Other fee income 1,656 1,527
Other operating income 25 22
Realized gains on securities, net - -
- -----------------------------------------------------------------------
Total Other Income $ 2,116 $ 1,959
- -----------------------------------------------------------------------
Other income increased $157 or 8.0% for the three month period ending September
30, 1998 to $2,116, from $1,959 for the three months ended September 30, 1997.
Largely this increase was due to a $129 or 8.4% improvement in other fee income.
This increased due to improved growth in merchant discounts, by expanding our
customer base, as well as, increases with our existing customers.
The following table sets forth information by category of other income for the
Company for the nine months ended September 30, 1998 and September 30, 1997,
respectively:
September 30, September 30,
Nine Months Ended : 1998 1997
- -----------------------------------------------------------------------
Trust department income $ 756 $ 660
Service charges on deposit accounts 489 487
Other fee income 4,028 3,680
Other operating income 94 72
Realized gains on securities, net - -
- -----------------------------------------------------------------------
Total Other Income $ 5,367 $ 4,899
- -----------------------------------------------------------------------
<PAGE>
Other income increased $468 or 9.6% for the first nine months of 1998 to $5,367
from $4,899 for the same period of 1997. Contributing increases came from the
trust department of $96 and $301 from merchant discounts.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended September 30, 1998 and September 30, 1997,
respectively:
September 30, September 30,
Three Months Ended : 1998 1997
- -----------------------------------------------------------------------
Salaries and employee benefits $ 1,829 $ 1,742
Expense of premises and fixed assets 558 532
Other operating expenses 2,245 2,004
- -----------------------------------------------------------------------
Total Other Expenses $ 4,632 $ 4,278
- -----------------------------------------------------------------------
Other expenses increased $354 for the three month period ending September 30,
1998 to $4,632 from $4,278 for the three month period ending September 30, 1997.
The increase in salary and employee benefits, was largely due to increased costs
of healthcare coverage. Other operating expenses increased $241 or 12.0%, due to
improved growth in merchant discounts and costs associated in opening our new
branch office in the Green Ridge section of Scranton, for the three month period
ending September 30, 1998.
The following table sets forth information by category of other expenses for the
Company for the nine months ended September 30, 1998 and September 30, 1997,
respectively:
September 30, September 30,
Nine Months Ended : 1998 1997
- -----------------------------------------------------------------------
Salaries and employee benefits $ 5,488 $ 5,177
Expense of premises and fixed assets 1,637 1,623
Other operating expenses 5,757 5,541
- -----------------------------------------------------------------------
Total Other Expenses $ 12,882 $ 12,341
- -----------------------------------------------------------------------
Other expenses increased $541 or 4.4% for the nine months ended September 30,
1998 to $12,882 from $12,341 for the nine months ended September 30, 1997.
Salaries and benefits increased over the first nine months of 1997 due to
significantly higher health care coverage provided by the company to its
employees, merit increases, and staff additions, along with costs associated
with our new branch office in the Green Ridge section of Scranton. Other
operating expenses increased $216 or 3.9% due to improved growth in merchant
discounts for the nine month period ending September 30, 1998. This increase was
offset by a reduction in other real estate owned expense from the first nine
months of 1997.
Loan Portfolio
September 30, December 31,
As Of: 1998 1997
- --------------------------------------------------------------------------
Real estate - construction
and land development $ 3,107 $ 3,731
Real estate mortgages 223,301 213,128
Commercial 19,067 17,177
Credit card and related plans 2,154 2,293
Installment 28,303 26,807
Obligations of states
and political subdivisions 14,023 8,910
- --------------------------------------------------------------------------
Loans, net of unearned income 289,955 272,046
Less: Allowance for loan losses 2,830 2,600
- --------------------------------------------------------------------------
Loans, net $ 287,125 $ 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:
September 30, September 30,
Nine Months Ended: 1998 1997
- -----------------------------------------------------------------------------
Non-accrual loans $ 1,111 $ 1,210
Loans past due 90 days or more and accruing:
Guaranteed student loans 282 401
Credit card and home equity loans 26 10
- -----------------------------------------------------------------------------
Total non-performing loans 1,419 1,621
Other real estate owned 147 390
- -----------------------------------------------------------------------------
Total non-performing assets $ 1,566 $ 2,011
- -----------------------------------------------------------------------------
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 $1,111 and $1,210 at September 30, 1998 and September 30, 1997, respectively.
If interest on those loans had been accrued, such income would have been $122
and $87 for the nine months ended September 30, 1998 and September 30, 1997,
respectively. Interest income on those loans, which is recorded only when
received, amounted to $27 and $33 for September 30, 1998 and September 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
September 30, 1998 there are no significant loans as to which management has
serious doubt about their ability to continue to perform in accordance with
their contractual terms.
At September 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:
September 30, September 30,
Nine Months Ended : 1998 1997
- -------------------------------------------------------------------------------
Balance at beginning of year $ 2,600 $ 2,300
Charge-offs:
Real estate mortgages 31 38
Commercial (time and demand) and all others 6 -
Credit card and related plans 21 37
Installment loans 13 18
- -------------------------------------------------------------------------------
Total charge-offs 71 93
- -------------------------------------------------------------------------------
Recoveries:
Real estate mortgages 1 79
Commercial (time and demand) and all others - 1
Credit card and related plans 9 16
Installment loans 6 8
- -------------------------------------------------------------------------------
Total recoveries 16 104
- -------------------------------------------------------------------------------
Net charge-offs 55 (11)
- -------------------------------------------------------------------------------
Provision charged to operations 285 239
- -------------------------------------------------------------------------------
Balance at End of Period $ 2,830 $ 2,550
- -------------------------------------------------------------------------------
Ratio of net charge-offs
to average loans outstanding 0.019% -0.004%
- -------------------------------------------------------------------------------
The allowance for loan losses is allocated as follows:
Nine Months Ended: September 30, 1998 September 30, 1997
- --------------------------------------------------------------------------------
Amount % * Amount % *
Real estate mortgages $ 1,450 78% $ 1,300 77%
Commercial (time and demand)
and all others 930 11% 850 12%
Credit card and related plans 150 1% 150 1%
Personal installment loans 300 10% 250 10%
- --------------------------------------------------------------------------------
Total $ 2,830 100% $ 2,550 100%
- --------------------------------------------------------------------------------
* 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.
<PAGE>
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 and
Federal Home Loan 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 18.33% at September 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 remaining cost to completion of $600,000 as of September 30, 1998.
In August of 1998, the Company also opened a replacement branch facility for the
Green Ridge section of Scranton.
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 have been formulated for comprehensive
testing of this software which began in July, 1998, with completion of testing
expected by the end of 1998. Additionally, the Company is continuing the process
of contacting its borrowers and suppliers 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 also has begun testing with
counterparties such as the MAC ATM network.
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. Y2K upgrades to software by
vendors is largely covered by ordinary annual software maintenance costs.
PART II. OTHER INFORMATION
Item 1 -- Legal Proceedings
None.
Item 2 -- Changes in Securities
None.
<PAGE>
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
27.0 Financial Data Schedule
b. Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended September 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: November 13, 1998
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: November 13, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 11,330
<INT-BEARING-DEPOSITS> 7,670
<FED-FUNDS-SOLD> 9,125
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 94,138
<INVESTMENTS-CARRYING> 7,244
<INVESTMENTS-MARKET> 7,123
<LOANS> 289,955
<ALLOWANCE> 2,830
<TOTAL-ASSETS> 434,374
<DEPOSITS> 374,449
<SHORT-TERM> 11,531
<LIABILITIES-OTHER> 3,081
<LONG-TERM> 0
0
0
<COMMON> 21
<OTHER-SE> 45,292
<TOTAL-LIABILITIES-AND-EQUITY> 434,374
<INTEREST-LOAN> 17,106
<INTEREST-INVEST> 5,157
<INTEREST-OTHER> 493
<INTEREST-TOTAL> 22,756
<INTEREST-DEPOSIT> 9,976
<INTEREST-EXPENSE> 9,976
<INTEREST-INCOME-NET> 12,780
<LOAN-LOSSES> 285
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 12,882
<INCOME-PRETAX> 4,980
<INCOME-PRE-EXTRAORDINARY> 4,980
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,475
<EPS-PRIMARY> 1.62
<EPS-DILUTED> 1.62
<YIELD-ACTUAL> 7.47
<LOANS-NON> 1,111
<LOANS-PAST> 1,419
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,600
<CHARGE-OFFS> 71
<RECOVERIES> 16
<ALLOWANCE-CLOSE> 2,830
<ALLOWANCE-DOMESTIC> 2,830
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
