SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
ý
Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 30, 2005,
o
Transition report pursuant to Section 13 or 15 (d) of the Exchange Act for the Transition Period from to .
No. 0-17077
(Commission File Number)
PENNS WOODS BANCORP, INC.
(Exact name of Registrant as specified in its charter)
PENNSYLVANIA
23-2226454
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
(Address of principal executive offices)
(Zip Code)
(570) 322-1111
Registrant’s telephone number, including area code
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 Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES ý NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12 b-2 of the Exchange Act)
On July 20, 2005 there were 3,322,089 shares of the Registrant’s common stock outstanding.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Consolidated Statement of Income (unaudited) for the Three and Six Months ended June 30, 2005 and 2004
4
Consolidated Statement of Comprehensive Income (unaudited) For the Three and Six Months ended June 30, 2005 and 2004
6
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the Three and Six Months ended June 30, 2005 and 2004
5
Consolidated Statement of Cash Flows (unaudited) for the Three and Six Months ended June 30, 2005 and 2004
7
Notes to Consolidated Financial Statements (unaudited)
8-12
Item 1. Legal Proceedings
29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
Signatures
31
Exhibit Index and Exhibits
32
2
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
June 30,
December 31,
(In Thousands, Except Share Data)
2005
2004
ASSETS:
Noninterest-bearing balances
$
16,945
12,602
Interest-bearing deposits in other financial institutions
25
24
Total cash and cash equivalents
16,970
12,626
Investment securities, available for sale, at fair value
203,400
184,163
Investment securities held to maturity (fair value of $286 and $561)
268
558
Loans held for sale
4,073
4,624
Loans, net of unearned discount of $1,055 and $1,096
327,870
324,505
Less: Allowance for loan and lease losses
3,492
3,338
Loans, net
331,362
327,843
Premises and equipment, net
5,851
4,882
Accrued interest receivable
2,342
2,246
Bank-owned life insurance
11,163
10,976
Goodwill
3,032
Other assets
2,116
2,429
TOTAL ASSETS
580,577
553,379
LIABILITIES:
Interest-bearing deposits
310,187
282,786
Noninterest-bearing deposits
72,087
74,050
Total deposits
382,274
356,836
Short-term borrowings
21,245
36,475
Long-term borrowings, Federal Home Loan Bank(FHLB)
84,478
75,878
Accrued interest payable
1,050
850
Other liabilities
8,751
3,499
TOTAL LIABILITIES
497,798
473,538
SHAREHOLDERS’ EQUITY:
Common stock, par value $10.00, 10,000,000 shares authorized; 3,332,399 and 3,331,837 shares issued
33,324
33,318
Additional paid-in capital
17,711
17,700
Retained earnings
20,714
18,262
Accumulated other comprehensive gain
4,492
4,331
Less: Treasury stock at cost, 10,310 shares
(446
)
TOTAL SHAREHOLDERS’ EQUITY
75,795
73,165
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
573,593
546,703
See accompanying notes to the unaudited consolidated financial statements.
3
CONSOLIDATED STATEMENT OF INCOME
Three Months EndedJune 30,
Six Months EndedJune 30,
(In Thousands, Except Per Share Data)
INTEREST AND DIVIDEND INCOME:
Loans including fees
5,671
5,137
11,171
10,028
Investment Securities:
Taxable
1,214
1,782
2,478
3,580
Tax-exempt
688
320
1,277
711
Dividend
297
293
595
540
TOTAL INTEREST AND DIVIDEND INCOME
7,870
7,532
15,521
14,859
INTEREST EXPENSE:
Deposits
1,420
1,182
2,614
2,317
144
99
346
236
Long-term borrowings
893
861
1,746
1,713
TOTAL INTEREST EXPENSE
2,457
2,142
4,706
4,266
NET INTEREST INCOME
5,413
5,390
10,815
10,593
PROVISION FOR LOAN LOSSES
180
75
360
150
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
5,233
5,315
10,455
10,443
NON-INTEREST INCOME:
Service charges
536
522
991
998
Securities gains, net
687
583
1,298
1,128
93
90
187
Insurance commissions
652
545
1,295
1,159
Other operating income
329
310
643
622
TOTAL NON-INTEREST INCOME
2,297
2,050
4,414
4,087
NON-INTEREST EXPENSES:
Salaries and employee benefits
2,173
1,886
4,193
3,865
Occupancy expense, net
286
230
577
473
Furniture and equipment expense
234
455
495
Pennsylvania shares tax expense
140
130
279
246
Other operating expenses
1,054
977
2,004
1,847
TOTAL NON-INTEREST EXPENSES
3,887
3,453
7,508
6,926
INCOME BEFORE INCOME TAX PROVISION
3,643
3,912
7,361
7,604
INCOME TAX PROVISION
883
1,108
2,127
NET INCOME
2,760
2,804
5,475
5,477
EARNINGS PER SHARE - BASIC
0.83
0.85
1.65
EARNINGS PER SHARE - DILUTED
WEIGHTED AVERAGE SHARES OUTSTANDING-BASIC
3,311,657
3,319,445
3,311,464
3,320,649
WEIGHTED AVERAGE SHARES OUTSTANDING-DILUTED
3,313,546
3,322,730
3,313,483
3,324,063
DIVIDNEDS PER SHARE
0.46
0.35
0.91
0.70
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
COMMONSTOCK
ADDITIONALPAID-IN
RETAINED
ACCUMULATEDOTHERCOMPREHENSIVE
TREASURY
TOTALSHAREHOLDERS’
(In Thousands Except Per Share Data)
SHARES
AMOUNT
CAPITAL
EARNINGS
INCOME
STOCK
EQUITY
Balance, December 31, 2004
3,331,837
Net income
Dividends declared, $0.91
(3,023
Unrealized gain on available for sale securities, net of reclassification adjustments and tax of $83
161
Stock options exercised
562
11
17
Balance, June 30, 2005
3,332,399
Balance, December 31, 2003
3,326,560
33,265
17,559
13,022
6,132
(209
69,769
Net income for the six months ended June 30, 2004
Dividends declared, $0.70
(2,324
Treasury Stock acquired (3,000 shares)
(130
Net change in unrealized gain on investments available for sale, net of tax benefit of $2,362
(4,586
897
9
22
Balance, June 30, 2004
3,327,457
33,274
17,581
16,175
1,546
(339
68,237
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Three Months Ended June 30,
(In Thousands)
Net Income
Other comprehensive income:
Net unrealized gains (losses) on available for sale securities
4,695
(6,558
Less: Reclassification adjustment for gain included in net income
Other comprehensive income (loss) before tax
4,008
(7,141
Income tax expense (benefit) related to other comprehensive income (loss)
1,363
(2,428
Other comprehensive income (loss), net of tax
2,645
(4,713
Comprehensive income (loss)
5,405
(1,909
Six Months Ended June 30,
1,542
(5,820
244
(6,948
83
(2,362
Comprehensive income
5,636
891
CONSOLIDATED STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
271
291
Provision for loan losses
Accretion and amortization of investment security discounts and premiums
(202
15
(1,298
(1,128
Originations of loans held for sale
(4,942
(15,624
Proceeds of loans held for sale
5,493
15,269
Earnings on bank-owned life insurance
(187
(180
Pension
307
327
Other, net
239
333
Net cash provided by operating activities
5,516
4,930
INVESTING ACTIVITIES:
Investment securities available for sale:
Proceeds from sales
88,475
83,273
Proceeds from calls and maturities
7,132
15,826
Purchases
(109,007
(94,407
Investment securities held to maturity:
325
42
(35
(14
Net increase in loans
(3,697
(25,042
Acquisition of bank premises and equipment
(1,240
(359
Proceeds from the sale of foreclosed assets
67
Proceeds from redemption of regulatory stock
2,692
2,100
Purchases of regulatory stock
(1,686
(1,690
Net cash used in investing activities
(16,974
(20,127
FINANCING ACTIVITIES:
Net increase in interest-bearing deposits
27,401
33,037
Net (decrease) increase in noninterest-bearing deposits
(1,963
1,395
Proceeds of long-term borrowings
10,000
5,000
Repayment of long-term borrowings
(1,400
—
Net decrease in short-term borrowings
(15,230
(20,781
Dividends paid
Purchase of treasury stock
Net cash provided used in financing activities
15,802
16,228
NET INCREASE IN CASH AND CASH EQUIVALENTS
4,344
1,031
CASH AND CASH EQUIVALENTS, BEGINNING
10,230
CASH AND CASH EQUIVALENTS, ENDING
11,261
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid
4,506
4,243
Income taxes paid
Transfer of loans to foreclosed assets
126
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for the fair presentation of results for such periods. All of those adjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with financial statements and notes thereto contained in the Company’s annual report for the year ended December 31, 2004.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS No. 123R). FAS No. 123R revised FAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. FAS No. 123R covers a wide range o f share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. In April 2005, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R. The Company will adopt FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of FAS No. 123R, and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s financial condition, results of operations, and cash flows.
8
In December 2004, FASB issued FAS No. 153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. FAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of FAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Early application is permitted and companies must apply the standard prospectively. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial condition.
In June 2005, the FASB issued FAS No. 154, Accounting Changes and Errors Corrections, a replacement of APB Opinion No. 20 and FAS No. 3. The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. FAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS No.154 is intended to improve financial reporting because its requirements enhance the consistency of financial reporting between periods.
NOTE 2. Per Share Data
The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive per share computation. There are no convertible securities which would affect the numerator in calculating basic and diluted earnings per share, therefore, net income as presented on the consolidated statement of income will be used as the numerator.
Weighted average common shares outstanding
3,321,967
3,327,445
3,321,774
3,327,380
Average treasury stock shares
(10,310
(8,000
(6,731
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
Additional common stock equivalents (stock options) used to calculate diluted earnings per share
1,889
3,285
2,019
3,414
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
Options to purchase 8,107 shares of common stock at the price of $48.35 were outstanding during the three and six months ended June 30, 2005 and 8,713 shares of common stock at the price of $48.35 were outstanding for the three and six months ended June 30, 2004, but were not included in the computation of diluted earnings per share as they were anti-dilutive due to the strike price being greater than the market price as of the end of the quarter.
Note 3. Net Periodic Benefit Cost-Defined Benefit Plans
For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 11 of the Company’s Consolidated Financial Statements included in the 2004 Annual Report on Form 10-K.
The following sets forth the components of net periodic benefit cost of the domestic non-contributory defined benefit plan for the three and six months ended June 30, 2005 and 2004, respectively.
Three Months Ended
Six Months Ended
Service cost
127
120
254
233
Interest cost
113
225
199
Expected return on plan assets
(95
(80
(190
(164
Amortization of transition obligation
(1
Amortization of prior service cost
13
Amortization of net (gain) loss
33
21
Net periodic cost
169
147
334
301
10
Employer Contributions
The Company previously disclosed in its consolidated financial statements included in the 2004 Annual Report on Form 10-K that it expected to contribute $575,000 to its defined benefit plan in 2005. As of June 30, 2005, contributions of $206,000 have been made. The Company presently anticipates contributing an additional $369,000 to fund its pension plan in 2005 for a total of $575,000.
Note 4. Off Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.
Financial instruments whose contract amounts represent credit risk are as follows:
(in thousands)
Commitments to extend credit
56,177
49,524
Standby letters of credit
1,520
786
Certain comparative amounts for the prior periods have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.
CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact. The Company wishes to caution readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein: (i) the effect of changes in laws and regulations, including federal and state
banking laws and regulations, which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; and (v) the effect of changes in the business cycle and downturns in the local, regional or national economies.
12
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Comparison of the Three and Six Months Ended June 30, 2005 and 2004
Summary Results
Net income for the three months ended June 30, 2005 was $2,760,000 compared to $2,804,000 for the same period of 2004. Basic and diluted earnings per share for the three months ended June 30, 2005 were $0.83 as compared to $0.85 for the three months ended June 30, 2004. Return on average assets and return on average equity were 2.02% and 14.81% for the three months ended June 30, 2005 as compared to 2.10% and 15.99% for the corresponding period of 2004. Net income from core operations for the three months ended June 30, 2005, excluding after-tax net securities gains of $453,000, decreased to $2,307,000 from $2,419,000 for the three months ended June 30, 2004.
The six months ended June 30, 2005 generated net income of $5,475,000 compared to $5,477,000 for the same period of 2004. Earnings per share, basic and diluted, for the six months ended June 30, 2005 and 2004 were $1.65. Return on average assets and return on average equity were 2.02% and 14.68% for the six months ended June 30, 2005 as compared to 2.07% and 15.44% for the corresponding period of 2004. Net income from core operations for the six months ended June 30, 2005, excluding after-tax securities gains of $857,000, declined to $4,618,000 from $4,733,000 for the six months ended June 30, 2004. (Management uses the non-GAAP measure of net income from core operations in its analysis of the Company’s performance. This measure, as used by the Company, adjusts net income for significant gains or losses, for any investments, loans, or other assets sales. The impact of these items that result in significant gains or losses on the Company’s performance are difficult to predict, as such management believes the additional presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company’s core businesses. These disclosures should not be viewed as a substitute for financial performance measures based on net income in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.)
Interest Income
During the second quarter of 2005, total interest and dividend income was $7,870,000, an increase of $338,000 over the same quarter in 2004. The increase in total interest and dividend income was primarily the result of a change in the mix of earning assets over the periods being compared. Over this time frame the average balance of investment securities declined $29,265,000 while average loans increased $29,974,000. In addition, the investment portfolio continued to shift from taxable mortgage-backed securities to tax-exempt municipal bonds. The shift in earning assets increased loan interest and fee income by $534,000 while decreasing interest and dividend income on investment securities by $196,000. However, on a taxable equivalent basis, the shift in the investment portfolio resulted in a slight decrease of $7,000, comparing the second quarter of 2005 to the second quarter of 2004,
despite a decline in average balance in excess of $29 million. This shift within the investment securities portfolio was undertaken to better manage cash flows, maintain the interest margin, and to invest at the community level. The increase in dividends received is the result of an increase in the level of dividends from the Federal Home Loan Bank of Pittsburgh coupled with an emphasis on purchasing stocks consistently having an above average dividend yield.
During the six months ended June 30, 2005, total interest and dividend income was $15,521,000, an increase of $662,000 over the same period in 2004. The increase in total interest income was primarily the result of a change in the mix of earning assets over the periods being compared. The average balance of investment securities declined $33,434,000 while average loans increased $38,859,000 when comparing the six month periods of 2005 and 2004. In addition, the investment portfolio continued to shift from taxable mortgage-backed securities to tax-exempt municipal bonds. The shift in earning assets increased loan interest and fee income by $1,143,000 while decreasing interest and dividend income on investment securities by $481,000. On a taxable equivalent basis, the shift in the investment portfolio resulted in a decrease of $190,000 and an average balance decrease in excess of $33 million from the first half of 2004 to the first half of 2005.
Interest income composition for the three and six months ended June 30, 2005 and 2004 is as follows:
For The Three Months Ended
June 30, 2005
June 30, 2004
Change
Amount
% Total
72.1
%
68.2
534
10.4
Investment securities:
15.4
23.7
(568
(31.9
8.7
4.2
368
115.0
3.8
3.9
1.4
Total interest income
100.0
338
4.5
For The Six Months Ended
72.0
67.5
1,143
11.4
16.0
24.1
(1,102
(30.8
8.2
4.8
566
79.6
3.6
55
10.2
662
Interest Expense
Interest expense during the second quarter of 2005 increased $315,000 to $2,457,000 from $2,142,000 for the second quarter of 2004. The increased expense associated with deposits is primarily the result of rate increases for money market and time deposit accounts from the second quarter of 2004 to the corresponding period of 2005. Factors that led to the rate increases include, but are not limited to, prime rate increases, competitive pressure, attracting municipal deposits, and a time deposit campaign run in conjunction with the opening of the North Atherton
14
Street, State College branch discussed in more detail under “Net Interest Margin” below. Short-term borrowing costs increased due to a 225 basis point increase in the federal funds rate over the past year. This increase affected the rate paid on FHLB overnight borrowings, FHLB short-term borrowings, and the rate paid to customers utilizing repurchase agreements. Long-term FHLB borrowing expense increased slightly due to a $10 million increase in borrowing from the FHLB at a fixed rate of 3.97% for 5 years with a final maturity of 10 years. This borrowing replaced long-term debt that matured at the end of the first quarter of 2005, and was used to pay off a portion of the short-term borrowings with FHLB.
Interest expense for the six months ended June 30, 2005 increased $440,000 to $4,706,000 from $4,266,000 for the comparable period of 2004. The majority of the increase, $315,000, occurred during the second quarter as discussed above. These rate increases also impact the rate paid on all borrowings as illustrated by the $143,000 increase in interest paid on borrowings, despite average borrowings decreasing $1,207,000 for the respective six month periods ending June 30, 2005 and 2004.
Interest expense composition for the three and six months ended June 30, 2005 and 2004 is as follows:
57.8
55.2
238
20.1
5.9
4.6
45
45.5
36.3
40.2
3.7
Total interest expense
315
14.7
55.5
54.3
12.8
7.4
5.5
110
46.6
37.1
1.9
440
10.3
Net Interest Margin
The net interest margin (NIM) for the three months ended June 30, 2005 was 4.58% as compared to 4.41% for the corresponding period of 2004. The increase in the NIM was the result of the yield on earning assets increasing 41 basis points (bp) to 6.53% for the three months ended June 30, 2005 as compared to 2004 offset by a 33 bp increase in interest bearing liabilities over the same period. The increase in the yield on earning assets is attributable to a change in the mix of earning assets from taxable investment securities to loans and tax-exempt investment securities. Over the time periods being compared, total average loans, yielding 7.03%, increased $29,974,000, while the investment securities portfolio, yielding 5.63%, average balance declined $29,265,000. The NIM impact of the earning asset mix improvement and volume increase in total loans were partially offset by rate increases on interest bearing liabilities. The rates paid on deposit accounts increased to 1.93% as compared to 1.62% for the 2004 period. This increase
was driven by growth in time deposits of $16,749,000 and an increase in the rate paid on time deposits to 2.92% from 2.58% for the three months ended June 30, 2004. A portion of the increase in volume and rate is due to a time deposit campaign that was run in conjunction with the opening of the North Atherton Street, State College branch. The campaign was centered on 13 and 17 month term time deposits with rates slightly above market. Short-term borrowings incurred a rate increase of 114 bp to 2.68% for the three months ended June 30, 2005 as the prime rate increased to 6.25% at June 30, 2005.
Following is a schedule of average balances and associated yields for the three month periods ended June 30, 2005 and 2004:
AVERAGE BALANCES AND INTEREST RATES
Three Months Ended6/30/2005
Three Months Ended6/30/2004
Average Balance
Interest
Average Rate
Tax-exempt loans
4,119
35
3.41
1,388
6.29
All other loans
320,020
5,648
7.08
292,777
5,123
7.02
Total loans
324,139
5,683
7.03
294,165
5,145
US Treasury
93,539
1,164
4.98
150,444
1,748
4.65
State & Political
61,406
1,042
6.79
27,119
485
7.15
Other
26,546
347
5.23
33,193
3.94
Total securities
181,491
2,553
5.63
210,756
2,560
4.86
Total interest-earning assets
505,630
8,236
6.53
504,921
7,705
6.12
38,166
29,573
Total assets
543,796
534,494
Savings
65,912
0.77
70,127
0.82
Super Now deposits
51,571
111
0.86
55,618
96
0.69
Money market deposits
30,252
106
1.41
35,325
97
1.10
Time deposits
148,078
1,077
2.92
131,329
845
2.58
Total Deposits
295,813
1.93
292,399
1.62
21,566
2.68
25,786
1.54
Other borrowings
75,754
4.73
4.55
Total interest bearing liabilities
393,133
2.51
394,063
2.18
Demand deposits
68,784
66,103
7,344
4,205
Shareholders’ equity
74,535
70,123
Interest rate spread
4.02
3.93
Net interest income/margin
5,779
4.58
5,563
4.41
• Information on this table has been calculated using average daily balance sheets to obtain average balances.
• Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
• Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate.
The NIM for the six months ended June 30, 2005 was 4.56% as compared to 4.40% for the corresponding period of 2004. The increase in the NIM was the result of the yield on earning assets increasing 33 bp to 6.44% for the six months ended June 30, 2005 as compared to 2004 offset by a 21 bp increase in interest bearing liabilities over the same period. The increase in the yield on earning assets is attributable to a change in the mix of earning assets. Over the time
16
periods being compared, total average loans increased $38,859,000, while the lower yielding investment securities portfolio average balance decreased $33,434,000. In addition, within the investment portfolio, average tax-exempt investment securities accounted for 30.7% of the portfolio for the six months ended June 30, 2005 as compared to 14.0% during the comparable period of 2004. The NIM impact of the earning asset mix improvement and volume increase in total loans was reduced by rate increases on interest bearing liabilities. The rates paid on deposit accounts increased by 18 bp to 1.82% as compared to 1.64% for the 2004 period as the average balance in time deposits increased $8,932,000 while the rate paid increased to 2.83% from 2.62% for the six months ended June 30, 2005. Short-term borrowings increased 92 bp to 2.40% for the six months ended June 30, 2005 as the prime rate has increased to 6.25% from 4.00% over the time periods being compared.
Following is a schedule of average balances and associated yields for the six month periods ended June 30, 2005 and 2004:
Six Months Ended6/30/2005
Six Months Ended6/30/2004
1,869
57
6.15
1,417
43
6.10
323,617
11,133
6.94
285,210
7.05
Total Loans
325,486
11,190
6.93
286,627
10,043
97,508
2,399
4.92
150,219
3,516
4.68
55,370
1,933
6.98
30,049
1,078
7.17
27,645
675
4.88
33,689
603
3.58
180,523
5,007
5.55
213,957
5,197
506,009
16,197
6.44
500,584
15,240
6.11
36,419
28,867
542,428
529,451
66,418
257
0.78
69,117
284
52,533
218
0.84
49,243
0.61
31,400
197
1.27
35,382
194
138,576
1,942
2.83
129,644
1,689
2.62
288,927
1.82
283,386
1.64
29,242
2.39
32,387
1.47
77,101
4.57
75,163
395,270
2.40
390,936
2.19
68,571
62,899
4,017
4,685
74,570
70,931
4.04
3.92
11,491
4.56
10,974
4.40
The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three and six month periods ended June 30, 2005 and 2004.
For the Three Months EndedJune 30,
For the Six Months EndedJune 30,
Net interest income
Tax equivalent adjustment
366
173
676
381
Net interest income (fully taxable equivalent)
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2005 vs 2004Increase (Decrease)Due to
Volume
Rate
Net
Interest income:
Loans
508
30
538
1,338
(191
1,147
Taxable investment securities
(773
209
(564
(1,410
365
(1,045
Tax-exempt investment securities
(27
556
885
(31
854
318
212
530
813
143
956
Interest expenses:
Savings deposits
(4
(18
(12
(15
(7
59
68
Money Market deposits
(23
26
(651
232
54
253
60
(25
135
(9
Total interest-bearing liabilities
(703
1,018
395
Change in net interest income
1,021
(806
215
768
(252
516
The provision for loan losses is based upon management’s quarterly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served. An external independent loan review is also performed annually for the Bank. Management remains committed to an aggressive program of problem loan identification and resolution.
The allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management’s consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience. In addition, management considers industry standards and trends with respect to nonperforming loans and its knowledge and experience with specific lending segments.
18
Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate at June 30, 2005, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Bank’s loan loss allowance. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.
While determining the appropriate allowance level management has attributed the allowance for loan losses to various portfolio segments; however, the allowance is available for the entire portfolio as needed.
The allowance for loan losses increased from $3,338,000 at December 31, 2004 to $3,492,000 at June 30, 2005. At June 30, 2005, the allowance for loan losses was 1.05% of total loans compared to 1.01% of total loans at December 31, 2004. Management’s conclusion is that the allowance for loan losses is adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date.
The provision for loan losses totaled $180,000 and $360,000 for the three and six months ended June 30, 2005 compared to $75,000 and $150,000 the same periods in 2004. The increases were the result of gross loan growth of $26,817,000, primarily in the commercial category, from June 2004 to June 2005.
As of June 30, 2005, non accrual loans totaled $816,000, an overall decrease of $564,000 from December 31, 2004. This decrease was due to a foreclosure in the commercial category. This decrease was due to the foreclosure in the commercial category.
Based upon this analysis, as well as the others noted above, management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in its loan portfolio.
Non-interest Income
Total non-interest income for the quarter ended June 30, 2005 compared to the same period in 2004 increased $247,000. Excluding net securities gains, the increase from period to period was $143,000. Insurance commissions increased as The M Group continued to gather new and build upon existing relationships. The M Group’s growth of business is a direct result of business referrals and a calling program geared toward the community financial institution. In conjunction therewith, The M Group continues to strategically add service representatives for each geographic market that the Company has expanded into. Service charges on deposit accounts increased due to the implementation of a Bounce Protection product during May 2005. This product provides overdraft protection up to a
19
predetermined amount to non-commercial customers. Fees are charged when such customer transactions occur.
Non-interest income composition for the three months ended June 30, 2005 and 2004 is as follows:
June 20, 2004
Service charge on deposit accounts
23.3
25.5
2.7
Net security gains
30.0
28.4
104
17.8
Bank owned life insurance
4.0
4.4
3.3
26.6
107
19.6
Other income
14.3
15.1
6.1
Total non-interest income
247
12.0
Total non-interest income for the six months ended June 30, 2005 compared to the same period in 2004 increased $327,000. Excluding net securities gains, the increase from period to period was $157,000. Insurance commissions represented the majority of the increase as The M Group continued to expand in terms of customer base and geographic area
Non-interest income composition for the six months ended June 30, 2005 and 2004 is as follows:
22.5
24.4
(0.7
)%
29.4
27.6
170
29.3
136
11.7
14.6
15.2
3.4
8.0
Non-interest Expenses
Total non-interest expenses increased $434,000 from the three months ended June 30, 2004 as compared to the same period of 2005. The increase in salaries and employee benefits was attributable to several items, including: standard cost of living salary increases for employees, staffing for the new State College branch, and increased accruals related to incentive payments. Occupancy expenses increased due to the new branch and due to general increases in utility costs, property taxes, and depreciation. Advertising costs increased 30% from June 30, 2005 due to opening of a new branch in State College. Other expenses increased primarily due to normal increases in business expenses and expenses surrounding the opening of the new branch.
20
Non-interest expense composition for the three months ended June 30, 2005 and 2004 is as follows:
55.8
54.6
287
6.7
56
24.3
Furniture and equipment expenses
6.0
1.7
Advertising expense
115
3.0
88
2.5
27
30.7
Pennsylvania shares tax
7.7
Other expense
939
24.2
889
25.7
50
5.6
Total non-interest expense
434
12.6
Total non-interest expenses increased $582,000 from the six months ended June 30, 2004 as compared to the same period of 2005. As noted in the three month discussion, the new State College branch impacted the level of non-interest expenses. In addition, normal increases in business expenses aided the increase in occupancy and other expenses. Furniture and equipment expenses declined as amortization of software, depreciation of equipment, and maintenance on equipment declined as compared to the 2004 period.
Non-interest expense composition for the six months ended June 30, 2005 and 2004 is as follows:
328
8.5
6.8
22.0
7.1
(40
(8.1
2.8
36
20.8
13.4
1,795
23.9
1,674
121
7.2
582
8.4
Provision for Income Taxes
Income taxes decreased $225,000 and $241,000 for the three and six month periods ended June 30, 2005 compared to the same periods of 2004. The effective tax rates for the three months ended June 30, 2005 and 2004 were 24.2% and 28.3%, respectively. The six months ended June 30, 2005 had an effective tax rate of 25.6% as compared to 28.0% for the comparable period of 2004. The decreasing effective tax rate is consistent with management’s repositioning of the investment portfolio from taxable investment securities to tax-exempt investment securities.
Cash and cash equivalents increased $4,344,000 from $12,626,000 at December 31, 2004. The increase was the result of an increase in the cash letter (items in process of clearing between the bank and other financial institutions).
The allocation of the loan portfolio, by category, as of June 30, 2005 and December 31, 2004 is presented below:
June 302005
December 312004
Commercial and agricultural
33,371
30,103
Real estate mortgage:
Residential
142,362
147,461
Commercial
125,825
123,757
Construction
10,420
8,364
Installment loans to individuals
16,947
15,915
Less: Net deferred loan fees
1,055
1,096
Gross loans
324,504
Investments
Total investment securities increased $18,947,000 as deposit growth in excess of loan growth funded the purchase of tax-exempt investment securities. Since December 31, 2004, tax-exempt bond holdings have increased $43,540,000 as the cash flows from mortgage-backed investment
securities coupled with deposit growth funded the increase. The growth in tax-exempt investment securities was strategically driven by the overall tax equivalent yields available for these instruments versus those yields available for taxable alternatives.
During the six months ended June 30, 2005, $1,298,000 in net securities gains were recognized from the $6,563,000 in net unrealized gains at December 31, 2004 for the entire investment portfolio. The bond portfolio incurred a net realized gain of $53,000 as a result of the realignment of the portfolio in light of the current rising rate environment and the desire to increase the use of investment securities as a vehicle to manage the overall earning asset tax equivalent yield and to reduce the effective corporate tax rate. The equity portfolio had recognized gains of $1,245,000 during the six months ended June 30, 2005. The recognized gains were the result of management’s strategy to diversify, based in part on an entity’s dividend and operational performance potential.
The amortized cost of investment securities and their approximate fair values are as follows:
AmortizedCost
GrossUnrealizedGains
GrossUnrealizedLosses
FairValue
Available for Sale (AFS)
U.S. Government and agency securities
82,959
506
(19
83,446
State and political securities
87,891
2,799
(82
90,608
Other debt securities
1,426
1,413
Total debt securities
172,276
3,332
(141
175,467
Equity securities
24,317
3,849
(233
27,933
Total Investment Securities AFS
196,593
7,181
(374
Held to Maturity (HTM)
34
237
252
Total Investment Securities HTM
December 31, 2004
104,248
207
(430
104,025
46,829
766
(527
47,068
1,302
47
1,342
152,379
1,020
(964
152,435
25,221
6,579
(72
31,728
177,600
7,599
(1,036
248
251
278
561
23
At June 30, 2005, total deposits were $382,274,000, an increase of $25,438,000 from December 31, 2004. Time deposits increased by approximately $30 million as a result of efforts made to succeed in obtaining short term municipal funds as well as a certificate of deposit promotion conducted in conjunction with the opening of a new office in State College, Pennsylvania.
18.9
(2.7
NOW Accounts
54,977
14.4
55,211
15.5
(234
(0.4
Insured MMDA
29,745
7.8
32,377
9.1
(2,632
70,073
18.3
69,807
266
0.4
155,392
40.6
125,391
35.0
30,001
25,438
Borrowed Funds
Total borrowed funds decreased to $105,873,000 at June 30, 2005 as compared to December 31, 2004. The decrease of $6,630,000 was the result of decreased reliance on short-term overnight funding due to deposit growth coupled with a maturity of a long-term borrowing of $1,400,000. Short-term borrowings are being utilized as an alternative source of funds to deposits, and are
used for short term investing and lending purposes. Long-term borrowings have increased in order to lock in future borrowing costs in light of the current rising rate environment.
Short-term borrowings:
FHLB repurchase agreements
4,965
22,630
Securities sold under agreement to repurchase
16,280
13,845
Total short-term borrowings
Long-term borrowings, FHLB
Total borrowed funds
105,723
112,353
Capital ratios as of June 30, 2005 and 2004 were as follows:
Ratio
Total Capital(to Risk-weighted Assets)
Actual
73,376
21.5
68,360
22.1
For Capital Adequacy Purposes
27,301
24,749
To Be Well Capitalized
34,126
10.0
30,937
Tier I Capital(to Risk-weighted Assets)
68,257
20.0
62,792
20.3
13,650
12,375
21,075
18,562
Tier I Capital(to Average Assets)
11.9
21,547
21,179
26,934
5.0
26,474
The following liquidity measures are monitored for compliance within the limits cited.
1. Net Loans to Total Assets, 70% maximum
2. Net Loans to Total Deposits, 92.5% maximum
3. Net Loans to Core Deposits, 100% maximum
4. Investments to Total Assets, 40% maximum
5. Investments to Total Deposits, 50% maximum
6. Total Liquid Assets to Total Assets, 25% minimum
7. Total Liquid Assets to Total Liabilities, 25% minimum
8. Net Core Funding Dependence, 35% maximum
Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk. The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers, and shareholders. Additionally, it provides funds for normal operating expenditures and business opportunities as they arise. The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.
The Bank, like other financial institutions, must have sufficient funds available to meet its liquidity needs for deposit withdrawals, loan commitments, and expenses. In order to control cash flow, the Bank estimates future flows of cash from deposits, loan payments, and investment security payments. The primary sources of funds are deposits, principal and interest payments on loans and investment securities, as well as Federal Home Loan Bank borrowings. Funds generated are used principally to fund loans and purchase investment securities. Management believes the Company has adequate resources to meet its normal funding requirements.
Management monitors the Company’s liquidity on both a long and short-term basis, thereby providing management necessary information to react to current balance sheet trends. Cash flow needs are assessed and sources of funds are determined. Funding strategies consider both customer needs and cost. Both short-term and long-term funding needs are addressed by maturities and sales of available for sale investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold. The use of these resources, in conjunction with access to credit provides core ingredients to satisfy depositor, borrower, and creditor needs.
Federal Home Loan Bank advances totaled $89,443,000 as of June 30, 2005. The Company has a current borrowing capacity at the Federal Home Loan Bank of $246,755,000. In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $10,500,000. Management believes that it has sufficient liquidity to satisfy estimated short-term and long-term funding needs.
Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities. Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them. Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process is affected by segmenting both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities, for a specific time period to determine the “gap”, or difference. Once known, the gap is managed based on predictions about future market interest rates. Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted. However, if market rates behave in a manner contrary to predictions, net interest
income will suffer. Gaps, therefore, contain an element of risk and must be prudently managed. In addition to gap management, the Company has an asset/liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders’ equity and a simulation analysis to monitor the effects of interest rate changes on the Company’s balance sheets.
There have been no substantial changes in the Company’s GAP analyses or simulation analyses compared to the information provided in the Company’s Form 10-K for the period ended December 31, 2004.
Generally, management believes the Company is well positioned to respond in a timely manner when the market interest rate outlook changes.
The asset and liability structure of a financial institution is primarily monetary in nature. Therefore, interest rates rather than inflation have a more significant impact on the Company’s performance. Interest rates are not always affected in the same direction or magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index.
In reference to the attached financial statements, all adjustments are of a normal recurring nature pursuant to Rule 10-01 (b) (8) of Regulation S-X.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Market risk for the Company is comprised primarily from interest rate risk exposure and liquidity risk. Interest rate risk and liquidity risk management is performed at the Bank level as well as the Company level. The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced by an independent third party. There have been no substantial changes in the Company’s GAP analyses or simulation analyses compared to the information provided in the Company’s Annual Report on Form 10-K filed with the SEC for the period ended December 31, 2004. Additional information and details are provided in the Liquidity and Interest Rate Sensitivity section of Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Generally, management believes the Company is positioned to respond in a timely manner if the market interest rate environment changes.
Item 4. Controls and Procedures
An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Principal Accounting Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Principal Accounting Officer concluded that the Company’s disclosure controls and procedures were effective as of
28
June 30, 2005. There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2005, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
None.
The Company announced a repurchase program on August 10, 2000 which was approved by the Board of Directors on August 8, 2000 for the repurchase of 171,600 shares which was set to expire on August 8, 2005. However, on July 27, 2005, the Company announced that the Board of Directors had elected to extend the terms of the repurchase program by one year with a new expiration date of August 8, 2006. There were no repurchases of the Company’s common stock during the quarter ended June 30, 2005.
None
Penns Woods Bancorp, Inc.’s annual meeting of the shareholders was held on April 27, 2005. The results of the items voted on are listed below:
Issue
Description
For
Withhold
1.
Election of Directors for a Three Year Term
Lynn S. Bowes
2,683,711
3,268
H. Thomas Davis, Jr.
2,678,544
8,435
Jay H. McCormick
2,681,349
5,630
Against
Abstain
2.
Ratification of S.R. Snodgrass A.C., Certified Public Accountants as independent auditors
2,672,286
12,499
2,194
(3)
(i)
Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form S-4, No. 333-65821).
(ii)
Bylaws of the Registrant as presently in effect (incorporated by reference to Exhibit 3.2 of the Registrant’s Registration Statement on Form S-4, No. 333-65821).
(31)
Rule 13a-14(a) Certification of Chief Executive Officer
Rule 13a-14(a) Certification of Principal Accounting Officer
(32)
Certification of Chief Executive Officer Section 1350
Certification of Principal Accounting Officer Section 1350
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.
(Registrant)
Date:
August 9, 2005
/s/ Ronald A. Walko
Ronald A. Walko, President and Chief Executive Officer
/s/ Brian L. Knepp
Brian L. Knepp, Vice President of Finance
EXHIBIT INDEX
Exhibit 31(i)
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer
Exhibit 31(ii)
Rule 13a-14(a)/Rule 15d-14(a) Certification of Principal Accounting Officer
Exhibit 32(i)
Section 1350 Certification of Chief Executive Officer
Exhibit 32(ii)
Section 1350 Certification of Principal Accounting Officer