UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 30, 2006,
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 x
NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o
NO x
On August 1, 2006 there were 3,931,787 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, 2006 and 2005
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the Six Months ended June 30, 2006 and 2005
Consolidated Statement of Comprehensive Income (unaudited) for the Three and Six Months ended June 30, 2006 and 2005
Consolidated Statement of Cash Flows (unaudited) for the Six Months ended June 30, 2006 and 2005
Notes to Consolidated Financial Statements (unaudited)
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
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
Exhibit Index and Exhibits
2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
June 30,
December 31,
(In Thousands, Except Share Data)
2006
2005
ASSETS
Noninterest-bearing balances
$
14,181
14,065
Interest-bearing deposits in other financial institutions
27
25
Total cash and cash equivalents
14,208
14,090
Investment securities, available for sale, at fair value
180,553
187,018
Investment securities held to maturity (fair value of $284 and $238)
281
265
Loans held for sale
5,777
3,545
Loans
346,569
338,438
Less: Allowance for loan losses
3,995
3,679
Loans, net
342,574
334,759
Premises and equipment, net
6,605
6,409
Accrued interest receivable
2,649
2,828
Bank-owned life insurance
10,896
10,718
Investment in limited partnerships
4,988
3,549
Goodwill
3,032
Other assets
4,742
2,455
TOTAL ASSETS
576,305
568,668
LIABILITIES
Interest-bearing deposits
302,634
281,150
Noninterest-bearing deposits
74,310
71,379
Total deposits
376,944
352,529
Short-term borrowings
40,925
54,003
Long-term borrowings, Federal Home Loan Bank (FHLB)
82,878
84,478
Accrued interest payable
1,171
1,108
Other liabilities
2,755
2,631
TOTAL LIABILITIES
504,673
494,749
SHAREHOLDERS’ EQUITY
Common stock, par value $8.33, 10,000,000 shares authorized; 4,002,159 shares issued
33,351
Additional paid-in capital
17,772
Retained earnings
24,471
22,938
Accumulated other comprehensive income (loss)
(1,273
)
850
Less: Treasury stock at cost, 70,372 and 26,372 shares
(2,689
(992
TOTAL SHAREHOLDERS’ EQUITY
71,632
73,919
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
See accompanying notes to the unaudited consolidated financial statements.
3
CONSOLIDATED STATEMENT OF INCOME
Three Months Ended
Six Months Ended
(In Thousands, Except Per Share Data)
INTEREST AND DIVIDEND INCOME
Loans including fees
6,086
5,455
11,895
10,739
Investment Securities:
Taxable
896
1,214
1,819
2,478
Tax-exempt
1,000
688
1,989
1,277
Dividend
365
297
666
595
TOTAL INTEREST AND DIVIDEND INCOME
8,347
7,654
16,369
15,089
INTEREST EXPENSE
Deposits
1,968
1,420
3,805
2,614
509
144
915
346
Long-term borrowings, FHLB
944
893
1,890
1,746
TOTAL INTEREST EXPENSE
3,421
2,457
6,610
4,706
NET INTEREST INCOME
4,926
5,197
9,759
10,383
PROVISION FOR LOAN LOSSES
198
180
396
360
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
4,728
5,017
9,363
10,023
NON-INTEREST INCOME
Deposit service charges
587
536
1,177
991
Securities gains, net
687
824
1,298
90
93
178
187
Gain on sale of loans
210
368
Insurance commissions
670
652
1,230
1,295
Other
394
329
784
643
TOTAL NON-INTEREST INCOME
2,216
2,475
4,553
4,782
NON-INTEREST EXPENSE
Salaries and employee benefits
2,214
2,135
4,446
4,129
Occupancy, net
275
286
518
577
Furniture and equipment
288
234
585
455
Pennsylvania shares tax
151
140
296
279
1,150
1,054
2,184
2,004
TOTAL NON-INTEREST EXPENSE
4,078
3,849
8,029
7,444
INCOME BEFORE INCOME TAX PROVISION
2,866
3,643
5,887
7,361
INCOME TAX PROVISION
432
883
998
1,886
NET INCOME
2,434
2,760
4,889
5,475
EARNINGS PER SHARE - BASIC
0.63
0.70
1.25
1.38
EARNINGS PER SHARE - DILUTED
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC
3,879,052
3,973,988
3,923,923
3,973,756
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED
3,879,539
3,976,255
3,924,409
3,976,179
DIVIDENDS PER SHARE
0.43
0.38
0.85
0.76
4
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
ACCUMULATED
COMMON
ADDITIONAL
OTHER
TOTAL
STOCK
PAID-IN
RETAINED
COMPREHENSIVE
TREASURY
SHAREHOLDERS’
(In Thousands Except Per Share Data)
SHARES
AMOUNT
CAPITAL
EARNINGS
INCOME (LOSS)
EQUITY
Balance, December 31, 2005
4,002,159
Comprehensive Income:
Net income
Net change in unrealized gain (loss) on investments available for sale, net of tax benefit of $1,094
(2,123
Total comprehensive income
2,766
Dividends declared, ($0.85 per share)
(3,356
Purchase of treasury stock (44,000 shares)
(1,697
Balance, June 30, 2006
INCOME
Balance, December 31, 2004
3,998,204
33,318
17,700
18,262
4,331
(446
73,165
Net change in unrealized gain on investments available for sale, net of tax of $83
161
5,636
Dividends declared, ($0.76 per share)
(3,023
Stock options exercised
674
6
11
17
Balance, June 30, 2005
3,998,878
33,324
17,711
20,714
4,492
75,795
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Three Months Ended June 30,
Six Months Ended June 30,
(In Thousands)
Net Income
Other comprehensive income (loss):
Net unrealized gains (losses) on available for sale securities
(3,581
4,695
(2,393
1,542
Less: Reclassification adjustment for net gains included in net income
Other comprehensive income (loss) before tax
(3,846
4,008
(3,217
244
Income tax expense (benefit) related to other comprehensive income (loss)
(1,308
1,363
(1,094
83
Other comprehensive income (loss), net of tax
(2,538
2,645
Comprehensive income (loss)
(104
5,405
5
CONSOLIDATED STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
176
271
Provision for loan losses
Accretion and amortization of investment security discounts and premiums
(381
(202
(824
(1,298
Originations of loans held for sale
(17,466
(14,395
Proceeds of loans held for sale
15,594
15,314
(360
(368
Increases in bank-owned life insurance
(178
(187
Other, net
(641
546
Net cash provided by operating activities
1,205
5,516
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from sales
19,680
88,475
Proceeds from calls and maturities
3,702
9,824
Purchases
(19,045
(110,693
Investment securities held to maturity:
—
325
(35
Net increase in loans
(8,262
(3,697
Acquisition of bank premises and equipment
(372
(1,240
Proceeds from the sale of foreclosed assets
61
67
Investment in limited partnership
(1,535
Net cash used for investing activities
(5,771
(16,974
FINANCING ACTIVITIES
Net increase in interest-bearing deposits
21,484
27,401
Net increase (decrease) in noninterest-bearing deposits
2,931
(1,963
Proceeds of long-term borrowings
10,000
Repayment of long-term borrowings
(1,600
(1,400
Net decrease in short-term borrowings
(13,078
(15,230
Dividends paid
Purchase of treasury stock
Net cash provided by financing activities
4,684
15,802
NET INCREASE IN CASH AND CASH EQUIVALENTS
118
4,344
CASH AND CASH EQUIVALENTS, BEGINNING
12,626
CASH AND CASH EQUIVALENTS, ENDING
16,970
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid
6,547
4,506
Income taxes paid
2,000
2,050
Transfer of loans to foreclosed assets
51
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, 2005.
The accounting policies followed in the presentation of interim financial results are the same as those followed on an annual basis. These policies are presented on pages 38 thru 43 of the Annual Report on Form 10-K for the year ended December 31, 2005.
Note 2. Recent Accounting Pronouncements
In June 2006, the FASB issued staff position FIN 48 “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109”. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
In April 2006, the FASB issued Staff Position FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”(Staff Position FIN 46(R)-6). This staff position addresses how an entity should determine the variability to be considered in applying FASB Interpretation No. FIN 46(R) (FIN 46). The variability that is to be considered in applying FIN 46 affects the determination of (a) whether the entity is a variable interest entity (VIE), (b) which interests are “variable interests” in the entity and (c) which party, if any is the primary beneficiary of the VIE. The requirements prescribed by this staff position are to be applied prospectively for all new arrangements at the commencement of the first reporting period that begins after June 15, 2006, or July 1, 2006 for the Company. The new requirements need not be applied to entities that have previously been analyzed under FIN 46 unless a
7
reconsideration event occurs. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
Note 3. 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
3,941,787
3,986,360
3,975,787
3,986,128
Average treasury stock shares
(62,735
(12,372
(51,864
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
487
2,267
486
2,423
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
Options to purchase 8,999 shares and 9,728 shares of common stock at the price of $40.29 were outstanding during the three and six months ended June 30, 2006 and 2005, respectively, 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 June 30, 2006 and 2005, respectively.
Note 4. 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 2005 Annual Report on Form 10-K.
The following sets forth the components of the net periodic benefit cost of the domestic non-contributory defined benefit plan for the three and six months ended June 30, 2006 and 2005, respectively.
8
Service cost
117
127
232
252
Interest cost
108
112
217
223
Expected return on plan assets
(121
(101
(242
(201
Amortization of transition
(1
Amortization of prior service cost
13
Amortization of net loss
16
33
Net periodic cost
116
160
230
319
Employer Contributions
The Company previously disclosed in its consolidated financial statements, included in the 2005 Annual Report on Form 10-K, that it expected to contribute $500,000 to its defined benefit plan in 2006. As of June 30, 2006, there were no contributions made for the 2006 plan year. This is the result of the contributions made during 2005 being above the required minimum in order to benefit from a current tax and future financial perspective and an increase in the market value of plan assets. In effect, the excess 2005 contributions eliminated the requirement for minimum funding during 2006. The Company, however, is evaluating the amount, if any, of funds to contribute during the remainder of 2006.
Note 5. 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 are primarily comprised of 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.
Outstanding financial instruments with off balance sheet risk are as follows:
Commitments to extend credit
78,480
72,583
Standby letters of credit
1,377
2,193
9
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.
During the fourth quarter of 2005 the Company initiated a 6 for 5 stock split. Previously reported share and per share amounts have been adjusted to reflect the split.
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.
10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Comparison of the Three and Six Months Ended June 30, 2006 and 2005
Summary Results
Net income for the three months ended June 30, 2006 was $2,434,000 compared to $2,760,000 for the same period of 2005. Basic and diluted earnings per share for the three months ended June 30, 2006 were $0.63 as compared to $0.70 for the three months ended June 30, 2005. Return on average assets and return on average equity were 1.70% and 13.34% for the three months ended June 30, 2006 as compared to 2.02% and 14.81% for the corresponding periods of 2005. Net income from core operations for the three months ended June 30, 2006 and 2005, excluding after-tax net securities gains of $175,000 and $453,000, respectively, were $2,259,000 and $2,307,000.
The six months ended June 30, 2006 generated net income of $4,889,000 compared to $5,475,000 for the same period of 2005. Earnings per share, basic and diluted, for the six months ended June 30, 2006 were $1.25 as compared to $1.38 for the comparable periods of 2005. Return on average assets and return on average equity were 1.71% and 13.12% for the six months ended June 30, 2006 as compared to 2.02% and 14.68% for the corresponding period of 2005. Net income from core operations for the six months ended June 30, 2006, excluding after-tax securities gains of $544,000, declined to $4,345,000 from $4,618,000 for the six months ended June 30, 2005. (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 by significant gains or losses that are unusual in nature. Because certain of these items and their impact on the Company’s performance are difficult to predict, management believes the 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 net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.)
Interest Income
Interest income for the three months ended June 30, 2006 increased $693,000 to $8,347,000 as compared to $7,654,000 for the same period of 2005. The increase in total interest income was primarily the result of growth in average loans of $24,839,000 for the three months ended June 30, 2006 as compared to 2005. The average loan growth and a 27 basis point increase in loan portfolio yields accounted for $631,000 of the total interest income growth. Over this time frame the average balance of investment securities increased $3,173,000. The average investment portfolio growth coupled with a shift to tax-exempt municipal bonds resulted in interest income from the investment portfolio increasing $62,000. On a taxable equivalent basis the interest income from the investment portfolio increased by $223,000. The shift within the investment
securities portfolio was strategically designed to ladder cash flows and to enhance management’s ability to manage the net interest margin. 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, 2006, interest and dividend income was $16,369,000, an increase of $1,280,000 over the same period in 2005. The reasons for the 8.5% growth in interest income for this six month period are identical to those for the three month period ending June 30, 2006 discussed above. The growth in average loans of $20,593,000 coupled with a 31 basis point increase in the loan portfolio yield resulted in an increase of $1,156,000 in loan interest and fee income. Average investment securities increased to $186,719,000 resulting in interest income on the investment portfolio increasing $124,000 when compared to June 30, 2005, which resulted in taxable equivalent interest income increasing $491,000.
Interest income composition for the three and six months ended June 30, 2006 and 2005 were as follows:
For The Three Months Ended
June 30, 2006
June 30, 2005
Change
Amount
% Total
%
72.9
71.2
631
11.6
Investment securities:
10.7
15.9
(318
(26.2
12.0
9.0
312
45.3
4.4
3.9
68
22.9
Total interest and dividend income
100.0
693
9.1
For The Six Months Ended
72.7
1,156
10.8
11.1
16.4
(659
(26.6
12.1
8.5
712
55.8
4.1
71
11.9
1,280
Interest Expense
Interest expense for the three months ended June 30, 2006 increased $964,000 to $3,421,000 as compared to $2,457,000 for the same period of 2005. The increased expense associated with deposits is primarily the result of rate increases for time deposits, which are comprised of various certificates of deposit (“CD”) accounts, from the three months ended June 30, 2005 to the corresponding period of 2006. Factors that led to the rate increases include, but are not limited to, several period prime rate increases, competitive market pricing pressure, and attracting new deposit customers while retaining existing accounts. The increase in CD interest rates has
12
exceeded the increase for other deposit accounts. This has led to a shift of a portion of the money market and savings deposit portfolios into higher yielding CDs.
Short-term borrowing costs increased as a direct result of the prime rate increases over the past year and an increase in the average balance of $23,227,000. This increase in short-term borrowings was utilized to fund earning asset growth for the three months ended June 30, 2006 as compared to the same period of 2005. Long-term FHLB borrowing expense increased due to $10,000,000 that was borrowed from the FHLB during the latter portion of the second quarter of 2005. The advance was at a fixed rate of 3.97% for 5 years with a final maturity of 10 years and is responsible for the increase in long-term interest expense.
Interest expense for the six months ended June 30, 2006 increased $1,904,000 to $6,610,000 from $4,706,000 for the comparable period of 2005. Interest on deposits accounted for $1,191,000 of the increase due to the reasons noted in the above three month analysis. Borrowing costs increased due to the rate increases over the past year and increased average borrowings that were used to fund the growth in average earning assets.
Interest expense composition for the three and six months ended June 30, 2006 and 2005 were as follows:
57.5
57.8
548
38.6
14.9
5.9
253.5
Long-term borrowings
27.6
36.3
5.7
Total interest expense
964
39.2
57.6
55.5
1,191
45.6
13.8
7.4
569
164.5
28.6
37.1
8.2
1,904
40.5
Net Interest Margin
The net interest margin (“NIM”) for the three months ended June 30, 2006 was 4.12% as compared to 4.41% for the corresponding period of 2005. The decrease in the NIM was the result of the yield on earning assets increasing 33 basis points (“bp”) to 6.69% for the three months ended June 30, 2006, as compared to 2005, however, interest bearing liabilities increased 72 bp over the same period. The increase in the yield on earning assets is attributable to a change in the mix of earning assets as previously discussed in the Interest Income section of this Earnings Summary. The average tax-exempt investment securities portfolio grew by $29,124,000, the direct result of a shift in investment strategy which also resulted in a decline in
taxable investment securities of $25,951,000. The average loan growth of $24,839,000 was predominately comprised of commercial real estate loans. The yield on total loans increased to 7.04% from 6.77% due to the impact of the Federal Open Market Committee rate increases enacted over the past year. The investment portfolio yield increased to 6.01% from 5.63% primarily from the previously noted shift in the portfolio to tax-exempt investments. The average interest rates paid on deposit accounts increased to 2.66% as compared to 1.93% for the 2005 period. This increase was driven by growth in average time deposits of $16,386,000 and an increase in the rate paid on time deposits of 87 bp. A portion of the increase in deposit volume and the average interest yield paid is due to several CD promotions during the past year to attract new customers while retaining existing customers. The promotions were designed to gather deposits that would have maturities of two years or less. In addition, the promotions served as a catalyst to cross sell other deposit products and to implement management’s strategy regarding the CD portfolio allocation among various maturities and therefore, reducing the concentration of time deposit maturities within any single month.
Short-term borrowings realized an increase of 188 bp in interest rates charged for the three months ended June 30, 2006. The prime rate increased to 8.25% at June 30, 2006 from 6.25% at June 30, 2005, as further evidence of the correlation between the Company’s primary source of borrowed funds, the FHLB, and the primary lending rate indicator used on a national basis.
The NIM for the six months ended June 30, 2006 was 4.10% as compared to 4.39% for the corresponding period of 2005. The decrease in the NIM was the result of the before mentioned growth and change in mix of the earnings assets offset by increased rates paid on interest bearing liabilities and growth in total borrowings of $20,360,000.
Following is a schedule of average balances and associated yields for the three and six month periods ended June 30, 2006 and 2005:
14
AVERAGE BALANCES AND INTEREST RATES
Average Balance
Interest
Average Rate
Tax-exempt loans
7,887
123
6.26
4,119
35
3.41
All other loans
341,091
6,005
7.06
320,020
5,432
6.81
Total loans
348,978
6,128
7.04
324,139
5,467
6.77
Taxable investment securities
94,134
1,261
5.36
120,085
1,511
5.03
Tax-exempt investment securities
90,530
1,515
6.69
61,406
1,042
6.79
Total securities
184,664
2,776
6.01
181,491
2,553
5.63
Total interest-earning assets
533,642
8,904
505,630
8,020
6.36
39,175
38,166
Total assets
572,817
543,796
Savings
60,161
125
0.83
65,912
0.77
Super Now deposits
48,282
169
1.40
51,571
111
0.86
Money market deposits
24,165
121
2.01
30,252
106
1.41
Time deposits
164,464
1,553
3.79
148,078
1,077
2.92
297,072
2.66
295,813
1.93
44,793
4.56
21,566
2.68
4.57
75,754
4.73
Total borrowings
127,671
1,453
97,320
1,037
4.27
Total interest-bearing liabilities
424,743
3.23
393,133
2.51
Demand deposits
70,961
68,784
7,344
Shareholders’ equity
72,984
74,535
Total liabilities and shareholders’ equity
Interest rate spread
3.46
3.85
Net interest income/margin
5,483
4.12
5,563
4.41
1. Information on this table has been calculated using average daily balance sheets to obtain average balances.
2. Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
3. 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.
15
6/30/2006
6/30/2005
8,038
248
6.22
1,869
57
6.15
338,041
11,731
7.00
323,617
10,701
6.67
346,079
11,979
6.98
325,486
10,758
Taxable securities
95,880
2,485
5.18
125,153
3,073
4.91
Tax-exempt securities
90,839
3,014
6.64
55,370
1,935
6.99
186,719
5,499
5.89
180,523
5,008
5.55
532,798
17,478
6.60
506,009
15,766
6.27
38,691
36,419
571,489
542,428
60,360
238
0.80
66,418
257
0.78
48,223
318
1.33
52,533
218
0.84
24,642
237
1.94
31,400
197
1.27
163,312
3,012
3.72
138,576
1,942
2.83
Total Deposits
296,537
2.59
288,927
1.82
43,100
4.28
29,242
2.39
Other borrowings
83,603
77,101
126,703
2,805
4.46
106,343
2,092
3.97
423,240
3.15
395,270
2.40
69,381
68,571
4,324
4,017
74,544
74,570
3.45
3.87
10,868
4.10
11,060
4.39
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, 2006 and 2005.
For the Three Months Ended
For the Six Months Ended
Total interest income
Net interest income
Tax equivalent adjustment
557
366
1,109
677
Net interest income (fully taxable equivalent)
2006 vs 2005
Increase (Decrease)
Due to
Volume
Rate
Net
Interest income:
Loans, tax-exempt
42
46
88
190
1
191
207
573
488
542
1,030
(355
105
(250
(768
(588
(14
473
1,168
(89
1,079
540
344
884
1,078
634
1,712
Interest expenses:
Savings deposits
(22
21
(24
(19
(6
64
58
(16
100
(8
23
59
40
128
348
476
383
1,070
201
164
202
367
79
(28
147
(3
372
592
673
1,231
Change in net interest income
168
(248
(80
405
(597
(192
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 non-performing loans and its knowledge and experience with specific lending segments.
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, 2006, 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, employment, 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 $3,679,000 at December 31, 2005 to $3,995,000 at June 30, 2006. At June 30, 2006, the allowance for loan losses was 1.15% of total loans compared to 1.09% of total loans at December 31, 2005. Management’s conclusion is that the allowance for loan losses is adequate to provide for possible losses inherent in the loan portfolio as of the balance sheet date.
The provision for loan losses totaled $198,000 and $396,000 for the three and six months ended June 30, 2006, respectively, as compared to $180,000 and $360,000 for the same periods in 2005. The increase was the result of loan growth of $18,699,000.
An overall increase of $381,000 was experienced in non-performing loans (non-accrual and 90 days past due) from December 31, 2005 to $983,000 at June 30, 2006.
Based upon this analysis, as well as the others noted above, senior 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, 2006 compared to the same period in 2005 decreased $259,000 to $2,216,000. Excluding net security gains, an increase of $163,000 was realized in non-interest income. Deposit service charges increased due to the
18
implementation of Bounce Protection during May 2005. This product provides overdraft protection up to a predetermined amount to non-commercial customers for a per event fee which resulted in an approximate $68,000 increase in service income over the 2005 period. Gain on the sale of loans from secondary market originations increased due to an increase in volume.
Insurance commissions increased slightly due to increased volume offset by a reduction in the overall commission earned from the underwriter that The M Group receives on each insurance contract written. The management of The M Group continued to gather new and build upon current relationships. The sales cycle for insurance and investment products can take typically from six months to one year or more to complete. The sales call program continues to expand to other financial institutions, and results in shared revenue with The M Group.
Other income increased due primarily to revenue generated from increased debit card transactions, title insurance fees, and the income recognized related to the origination of secondary market residential loans.
Total non-interest income for the six months ended June 30, 2006 compared to the same period in 2005 decreased $229,000. Excluding net security gains, the increase from period to period was $245,000. The implementation of Bounce Protection during May 2005 as noted above, resulted in an increase of $209,000 in service fees. The increase in other income is the result of the items noted above for the three month period discussion.
Non-interest income composition for the three and six months ended June 30, 2006 and 2005 were as follows:
26.5
21.7
9.5
Security gains, net
27.7
(422
(61.4
3.8
(3.2
7.2
32
18.0
30.1
26.3
2.8
17.8
13.3
65
19.8
Total non-interest income
(259
(10.5
)%
25.9
20.7
186
18.8
18.1
27.2
(474
(36.5
(9
(4.8
7.9
7.7
(2.2
27.0
27.1
(65
(5.0
17.2
13.4
141
21.9
(229
19
Non-interest Expenses
Total non-interest expenses increased $229,000 from the three months ended June 30, 2005 as compared to the same period of 2006. The increase in salaries and employee benefits was attributable to several items including: standard cost of living wage adjustments for employees, new additions to our staff and increased health insurance cost. Furniture and equipment expense increased due to the new branch in State College and increased cost of maintenance. The decrease in occupancy expenses was attributable to a reduction in leasehold improvements amortization and facilities maintenance amounts. Other expenses increased primarily due to normal anticipated inflationary adjustments to ongoing business operating costs and the Company’s share of operating results incurred through a limited partnership arrangement which was initiated during the fourth quarter of 2005 for the purposes of funding the construction of affordable housing in the Company’s primary market area.
Total non-interest expenses increased $585,000 from the six months ended June 30, 2005 as compared to the same period of 2006. As noted in the three month discussion, the new State College branch and normal increases in general business expenses impacted the level of non-interest expenses. Decreased amortization of leasehold improvements resulted in occupancy expense declining for the six month period ended June 30, 2006 as compared to 2005. Furniture and equipment expenses increased due in part to the new State College branch.
Non-interest expense composition for the three and six months ended June 30, 2006 and 2005 were as follows:
54.3
3.7
6.7
(11
(3.8
7.1
6.1
54
23.1
3.6
28.2
27.4
96
Total non-interest expense
229
55.3
317
6.5
7.8
(59
(10.2
7.3
130
26.9
20
Provision for Income Taxes
Income taxes decreased $451,000 and $888,000 for the three and six month periods ended June 30, 2006 compared to the same periods of 2005. The effective tax rate for the three months ended June 30, 2006 and 2005 were 15.1% and 24.2%, respectively. The six months ended June 30, 2006 had an effective tax rate of 17.0% as compared to 25.6% for the comparable period of 2005. The decline in the effective tax rate is consistent with management’s repositioning of the investment portfolio from taxable investment securities to tax-exempt investment securities and tax credits related to investments in low income housing projects.
Cash and cash equivalents increased $118,000 from $14,090,000 at December 31, 2005, and are the results of the following activities which have occurred during the six months ended June 30, 2006:
The significant components of operating activities are net income and the origination and proceeds of loans held for sale. Cash provided by net income, as adjusted for loans held for sale activity, amounted to $3,077,000. Activity regarding loans held for sale resulted in sale proceeds, less $360,000 in realized gains, exceeding loan origination disbursements by $2,232,000 for the period.
Gross loans increased $8,131,000 since December 31, 2005 as residential real estate mortgages increased 3.5% or $5,282,000 in part due to the active marketing of a new home equity line of credit product during 2006. Residential real estate loans increased due to promotion of home equity loans and lines. The growth in commercial real estate mortgages is part of the Company’s strategy to originate high quality, well secured commercial loans.
The allocation of the loan portfolio, by category, as of June 30, 2006 and December 31, 2005 is presented below:
Commercial and agricultural
33,838
34,407
(569
(1.7
Real estate mortgage:
Residential
155,282
150,000
5,282
3.5
Commercial
128,986
127,131
1,855
1.5
Construction
11,996
10,681
1,315
12.3
Installment loans to individuals
17,517
17,281
236
1.4
Less: Net deferred loan fees
1,050
1,062
(12
(1.1
Gross loans
8,131
2.4
The recorded investment in loans for which impairment has been recognized in accordance with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, amounted to $572,000 at June 30, 2006, as compared to no impaired loans at December 31, 2005. The valuation allowance related to impaired loans amounted to $60,000 at June 30, 2006.
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.
Investments
The amortized cost and fair market value of the investment securities portfolio in total has declined modestly since December 31, 2005. Over the first six months of 2006, the amortized cost of state and political securities has increased $1,955,000, while U.S. Government and agency securities decreased $4,228,000. This shift is the result of a repositioning of the security portfolio that began during 2005. The shift from taxable to tax exempt bonds has been undertaken as a strategy to build call protection, maintain the taxable equivalent yield, reduce the effective federal income tax rate, and to invest in communities across the Commonwealth of Pennsylvania and the country.
The amortized cost of investment securities and their approximate fair values are as follows:
22
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available for Sale (AFS)
U.S. Government and agency securities
61,268
(3,201
58,067
State and political securities
95,724
950
(1,924
94,750
Other debt securities
1,924
(103
1,825
Total debt securities
158,916
954
(5,228
154,642
Equity securities
23,575
2,718
(382
25,911
Total Investment Securities AFS
182,491
3,672
(5,610
Held to Maturity (HTM)
29
254
255
Total Investment Securities HTM
284
December 31, 2005
65,496
30
(1,573
63,953
93,769
1,390
(1,068
94,091
1,750
(43
1,719
161,015
1,432
(2,684
159,763
24,715
2,951
(411
27,255
185,730
4,383
(3,095
28
(29
208
Total deposits increased 6.9% or $24,415,000 from December 31, 2005 as both interest and noninterest bearing deposit categories increased from December 31, 2005 to June 30, 2006. The mix of deposits has remained constant from December 31, 2005 to June 30, 2006 with demand deposits holding steady at 19.7% of total deposits. During the second half of 2005 the Bank began utilizing brokered deposits (time deposits) to supplement the funding of loan originations and investment purchases. These time deposits are generally for a term of either four or thirteen weeks with interest rates presently at or below the cost of alternative funding sources, such as short term borrowing instruments from the FHLB. The amount of brokered deposits is continuously monitored and is used to supplement deposits, not as a primary source of deposits.
19.7
20.2
NOW Accounts
48,739
12.9
48,678
0.1
23,712
6.3
24,446
6.9
(734
(3.0
59,619
15.8
61,906
17.6
(2,287
(3.7
160,643
42.7
137,373
39.0
23,270
16.9
Time deposits - brokered
9,921
2.6
8,747
2.5
1,174
24,415
Total borrowed funds decreased 10.6% to $123,803,000 at June 30, 2006 as compared to December 31, 2005. The decrease in borrowed funds is the result of deposit growth that occurred primarily in time deposits since December 31, 2005. FHLB short-term borrowings were utilized during the first six months of 2006; however, there were no such borrowings outstanding at June 30, 2006. Long-term borrowings declined due to a maturity of $1,600,000 that carried a fixed rate of 2.67%.
Short-term borrowings:
FHLB repurchase agreements
25,085
1,740
Short-term borrowings, FHLB
37,000
Securities sold under agreement to repurchase
15,840
15,263
Total short-term borrowings
Total borrowed funds
123,803
138,481
24
Capital ratios as of June 30, 2006 and December 31, 2005 were as follows:
Ratio
Total Capital
(to Risk-weighted Assets)
Actual
72,212
73,210
21.0
For Capital Adequacy Purposes
28,552
8.0
27,937
To Be Well Capitalized
35,691
10.0
34,921
Tier I Capital
67,162
68,388
19.6
14,276
4.0
13,968
21,414
6.0
20,952
(to Average Assets)
12.2
22,603
22,495
28,254
5.0
28,119
The following liquidity measures are monitored for compliance within the limits cited:
1. Net Loans to Total Assets, 100% maximum
2. Net Loans to Total Deposits, 100% maximum
3. Cumulative 90 day Maturity GAP %, +/- 20% maximum
4. Cumulative 1 Year Maturity GAP %, +/- 20%, 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
26
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 originations, 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. Management believes the Bank 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 economical cost. Both short 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.
Management monitors and determines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds. The Company has a current borrowing capacity at the Federal Home Loan Bank of $217,357,000. In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $25,500,000. Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. Federal Home Loan Bank borrowings totaled $107,963,000 as of June 30, 2006.
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 sheet.
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, 2005.
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 Annual Report on Form 10-K for the period ended December 31, 2005. 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.
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 Financial 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 Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2006. There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
There are no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On April 25, 2006 the Board of Directors authorized the repurchase of approximately 5% of the outstanding shares of the Registrant. The repurchase plan is for a one year period and allows for the repurchase of 197,000 shares of the 3,941,787 shares outstanding.
During the three months ended June 30, 2006 there were 10,000 shares of the Company’s common stock repurchased as part of a previously announced repurchase program.
Total
Average
Total Number of
Maximum Number (or
Number of
Price Paid
Shares (or Units)
Approximate Dollar Value)
Shares (or
per Share
Purchased as Part of
of Shares (or Units) that
Units)
(or Units)
Publicly Announced
May Yet Be Purchased
Period
Purchased
Plans or Programs
Under the Plans or Programs
Month#1(April 1-April 30, 2006)
Month#2 (May 1-May 31, 2006)
5,000
38.40
192,000
Month#3 (June 1,-June 30, 2006)
39.15
187,000
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
Penns Woods Bancorp, Inc.’s annual meeting of the shareholders was held on April 26, 2006. The results of the items voted on are listed below:
Issue
Description
For
Withhold
1.
Election of Directors for a Three Year Term
James M. Furey, II
3,252,674
66,623
Leroy H. Keiler, III
3,288,226
31,071
James E. Plummer
3,255,468
63,829
Hubert A. Valencik
3,136,949
182,348
Against
Abstain
Non-Vote
2.
Proposal to Approve the Penns Woods Bancorp, Inc. 2006 Employee Stock Purchase Plan
2,129,270
400,088
18,333
771,606
3.
Ratification of S.R. Snodgrass A.C., Certified Public Accountants as independent auditors
3,285,068
13,513
20,716
Item 6. Exhibits
(3) (i)
Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).
(3) (ii)
Bylaws of the Registrant as presently in effect (incorporated by reference to Exhibit 3 (ii) of the Registrant’s Current Report on Form 8-K filed June 17, 2005).
(10) (i)
Form of First Amendment to the Jersey Shore State Bank Amendment and Restatement of the Director Fee Agreement, dated as of October 1, 2004 (incorporated by reference to Exhibit 10.7 of the Registrant’s Current Report on Form 8-K filed June 29, 2006).
(31) (i)
Rule 13a-14(a) Certification of Chief Executive Officer.
(31) (ii)
Rule 13a-14(a) Certification of Principal Accounting Officer.
(32) (i)
Certification of Chief Executive Officer Section 1350.
(32) (ii)
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 8, 2006
/s/ Ronald A. Walko
Ronald A. Walko, President and Chief Executive Officer
/s/ Brian L. Knepp
Brian L. Knepp, Vice President of Finance (PrincipalFinancial Officer)
31
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