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 September 30, 2007.
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 NOx
On November 1, 2007 there were 3,877,534 shares of the Registrant’s common stock outstanding.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Consolidated Balance Sheet (unaudited) as of September 30, 2007 and December 31, 2006
3
Consolidated Statement of Income (unaudited) for the Three and Nine Months ended September 30, 2007 and 2006
4
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the Nine Months ended September 30, 2007 and 2006
5
Consolidated Statement of Comprehensive Income (unaudited) for the Three and Nine Months ended September 30, 2007 and 2006
Consolidated Statement of Cash Flows (unaudited) for the Nine Months ended September 30, 2007 and 2006
6
Notes to Consolidated Financial Statements (unaudited)
7
Item 1.
Legal Proceedings
32
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
33
Signatures
34
Exhibit Index and Exhibits
35
2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
September 30,
December 31,
(In Thousands, Except Share Data)
2007
2006
ASSETS
Noninterest-bearing balances
$
13,228
15,348
Interest-bearing deposits in other financial institutions
15
25
Total cash and cash equivalents
13,243
15,373
Investment securities, available for sale, at fair value
204,758
185,200
Investment securities held to maturity (fair value of $278 and $286)
276
283
Loans held for sale
6,503
3,716
Loans
357,715
360,384
Less: Allowance for loan losses
4,092
4,185
Loans, net
353,623
356,199
Premises and equipment, net
6,841
6,737
Accrued interest receivable
3,274
2,939
Bank-owned life insurance
12,275
11,346
Investment in limited partnerships
4,447
4,950
Goodwill
3,032
Other assets
5,057
2,510
TOTAL ASSETS
613,329
592,285
LIABILITIES
Interest-bearing deposits
331,864
322,031
Noninterest-bearing deposits
72,990
73,160
Total deposits
404,854
395,191
Short-term borrowings
44,793
34,697
Long-term borrowings, Federal Home Loan Bank (FHLB)
86,378
82,878
Accrued interest payable
1,838
1,532
Other liabilities
3,914
3,393
TOTAL LIABILITIES
541,777
517,691
SHAREHOLDERS’ EQUITY
Common stock, par value $8.33, 10,000,000 shares authorized; 4,006,084 and 4,003,514 shares issued
33,384
33,362
Additional paid-in capital
17,869
17,810
Retained earnings
27,552
25,783
Accumulated other comprehensive income (loss):
Net unrealized (loss) gain on available for sale securities
(1,861
)
2,139
Defined benefit plan
(579
Less: Treasury stock at cost, 128,802 and 102,772 shares
(4,813
(3,921
TOTAL SHAREHOLDERS’ EQUITY
71,552
74,594
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
See accompanying notes to the unaudited consolidated financial statements.
CONSOLIDATED STATEMENT OF INCOME
Three Months Ended
Nine Months Ended
(In Thousands, Except Per Share Data)
INTEREST AND DIVIDEND INCOME
Loans including fees
6,621
6,355
19,560
18,250
Investment Securities:
Taxable
964
874
2,711
2,691
Tax-exempt
1,108
1,004
3,271
2,993
Dividend and other interest income
284
314
907
982
TOTAL INTEREST AND DIVIDEND INCOME
8,977
8,547
26,449
24,916
INTEREST EXPENSE
Deposits
2,835
2,447
8,215
6,252
368
306
1,100
1,221
Long-term borrowings, FHLB
909
954
2,735
2,844
TOTAL INTEREST EXPENSE
4,112
3,707
12,050
10,317
NET INTEREST INCOME
4,865
4,840
14,399
14,599
PROVISION FOR LOAN LOSSES
10
89
60
485
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
4,855
4,751
14,339
14,114
NON-INTEREST INCOME
Deposit service charges
546
596
1,654
1,773
Securities gains, net
––
561
619
1,385
109
94
310
272
Gain on sale of loans
282
264
654
624
Insurance commissions
625
502
1,613
1,732
Other
444
370
1,316
1,154
TOTAL NON-INTEREST INCOME
2,006
2,387
6,166
6,940
NON-INTEREST EXPENSE
Salaries and employee benefits
2,330
2,174
6,912
6,620
Occupancy, net
319
308
987
826
Furniture and equipment
267
309
850
894
Pennsylvania shares tax
160
151
482
447
1,354
1,172
3,667
3,356
TOTAL NON-INTEREST EXPENSE
4,430
4,114
12,898
12,143
INCOME BEFORE INCOME TAX PROVISION
2,431
3,024
7,607
8,911
INCOME TAX PROVISION
560
669
1,558
NET INCOME
2,322
2,464
6,938
7,353
EARNINGS PER SHARE - BASIC
0.60
0.63
1.78
1.87
EARNINGS PER SHARE - DILUTED
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC
3,881,488
3,927,261
3,889,310
3,942,533
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED
3,881,676
3,927,740
3,889,573
3,943,016
DIVIDENDS PER SHARE
0.45
0.44
1.33
1.29
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, 2006
4,003,514
1,560
Comprehensive Income:
Net income
Unrealized loss on investments available for sale, net of reclassification adjustment, net of income tax benefit of $2,061
(4,000
Total comprehensive income
2,938
Dividends declared, ($1.33 per share)
(5,169
Purchase of treasury stock (26,030 shares)
(892
Stock options exercised
330
8
Common shares issued for employee stock purchase plan
2,240
19
54
73
Balance, Septamber 30, 2007
4,006,084
(2,440
INCOME
Balance, December 31, 2005
4,002,159
33,351
17,772
22,938
(992
73,919
Unrealized gain on investments available for sale, net of reclassification adjustment, net of income tax of $424
824
8,177
Dividends declared, ($1.29 per share)
(5,083
Purchase of treasury stock (60,000 shares)
(2,303
421
12
Balance, September 30, 2006
4,002,580
33,354
17,784
25,208
1,674
(3,295
74,725
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Three Months Ended September 30,
Nine Months Ended September 30,
(In Thousands)
Net Income
Other comprehensive (loss) income:
Change in net unrealized gains (losses) on available for sale securities
2,415
5,026
(5,442
2,633
Less: Reclassification adjustment for net gains included in net income
Other comprehensive income (loss) before tax
4,465
(6,061
1,248
Income tax expense (benefit) related to other comprehensive income (loss)
821
1,518
(2,061
424
Other comprehensive income (loss), net of tax
1,594
2,947
Comprehensive income
3,916
5,411
CONSOLIDATED STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
523
549
Provision for loan losses
Accretion and amortization of investment security discounts and premiums
(738
(575
(619
(1,385
Originations of loans held for sale
(33,903
(28,031
Proceeds of loans held for sale
31,770
27,454
(654
(624
Earnings on bank-owned life insurance
(310
(272
Other, net
303
132
Net cash provided by operating activities
3,370
5,086
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from sales
39,226
35,879
Proceeds from calls and maturities
4,290
5,445
Purchases
(67,067
(31,938
Investment securities held to maturity:
11
(25
Net decrease (increase) in loans
2,516
(18,288
Acquisition of bank premises and equipment
(627
(767
Proceeds from the sale of foreclosed assets
66
83
Purchase of bank-owned life insurance
(212
Investment in limited partnership
(1,535
Proceeds from redemption of regulatory stock
3,045
3,177
Purchases of regulatory stock
(3,620
(2,034
Net cash used for investing activities
(22,779
(10,190
FINANCING ACTIVITIES
Net increase in interest-bearing deposits
9,833
51,160
Net decrease in noninterest-bearing deposits
(170
(1,730
Proceeds of long-term borrowings, FHLB
20,000
Repayment of long-term borrowings, FHLB
(16,500
(1,600
Net increase (decrease) in short-term borrowings
10,096
(35,977
Dividends paid
Issuance of common stock
Purchase of treasury stock
Net cash provided by financing activities
17,279
4,482
NET DECREASE IN CASH AND CASH EQUIVALENTS
(2,130
(622
CASH AND CASH EQUIVALENTS, BEGINNING
14,090
CASH AND CASH EQUIVALENTS, ENDING
13,468
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid
11,744
9,915
Income taxes paid
1,185
2,075
Transfer of loans to foreclosed real estate
51
NOTES TOCONSOLIDATED 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 on Form 10-K for the year ended December 31, 2006.
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 40 thru 46 of the Annual Report on Form 10-K for the year ended December 31, 2006.
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.
Note 2. Recent Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“FAS”) No. 155, Accounting for Certain Hybrid Instruments, as an amendment of FASB Statements No. 133 and 140. FAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. This statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 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 March 2006, the FASB issued FAS No. 156, Accounting for Servicing of Financial Assets. This Statement, which is an amendment to FAS No. 140, will simplify the accounting for servicing assets and liabilities, such as those common with mortgage securitization activities. Specifically, FAS No. 156 addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. FAS No. 156 also clarifies when an obligation to service financial assets
should be separately recognized as a servicing asset or a servicing liability, requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable, and permits an entity with a separately recognized servicing asset or servicing liability to choose either of the amortization or fair value methods for subsequent measurement. The provisions of FAS No. 156 are effective as of the beginning of the first fiscal year that begins after September 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 September 2006, the FASB issued FAS No. 157, Fair Value Measurements, which provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. FAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
In September 2006, the FASB issued FAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R). FAS No. 158 requires that a company recognize the overfunded or underfunded status of its defined benefit post retirement plans (other than multiemployer plans) as an asset or liability in its statement of financial position and that it recognize changes in the funded status in the year in which the changes occur through other comprehensive income. FAS No. 158 also requires the measurement of defined benefit plan assets and obligations as of the fiscal year end, in addition to footnote disclosures. On December 31, 2006, the Company adopted FAS No. 158, except for the measurement provisions, which are effective for fiscal years ending after December 15, 2008. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115, which provides all entities with an option to report selected financial assets and liabilities at fair value. The objective of the FAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply the complex provisions of hedge accounting. FAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of FAS No. 157, Fair Value Measurements. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FAS No. 109, Accounting for Income Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN No. 48 requires expanded disclosure with respect to the uncertainty in income taxes and 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 September 2006, the FASB reached consensus on the guidance provided by Emerging Issues Task Force Issue 06-4 (“EITF 06-4”), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. The guidance is applicable to endorsement split-dollar life insurance arrangements, whereby the employer owns and controls the insurance policy, that are associated with a postretirement benefit. EITF 06-4 requires that for a split-dollar life insurance arrangement within the scope of the Issue, an employer should recognize a liability for future benefits in accordance with FAS No. 106 (if, in substance, a postretirement benefit plan exists) or Accounting Principles Board Opinion No. 12 (if the arrangement is, in substance, an individual deferred compensation contract) based on the substantive agreement with the employee. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition.
In September 2006, the FASB reached consensus on the guidance provided by Emerging Issues Task Force Issue 06-5 (“EITF 06-5”), Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations or financial condition.
In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 (“EITF 06-10”), Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements. EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition.
In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11 (“EITF 06-11”), Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. EITF 06-11 applies to share-based payment arrangements with dividend protection features that entitle employees to receive (a) dividends on equity-classified nonvested shares, (b) dividend equivalents on equity-classified nonvested share units, or (c) payments equal to the dividends paid on the underlying shares while an equity-classified share option is outstanding, when those dividends or dividend equivalents are charged to retained earnings under FAS No. 123R, Share-Based Payment, and result in an income tax deduction for the employer. A consensus was
9
reached that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity-classified nonvested equity shares, nonvested equity share units, and outstanding equity share options should be recognized as an increase in additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The impact of the adoption of the EITF will not have an impact on the Company’s financial condition.
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
4,005,583
4,002,340
4,004,778
4,002,220
Average treasury stock shares
(124,095
(75,079
(115,468
(59,687
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
Additional common stock equivalents(stock options) used to calculatediluted earnings per share
188
479
263
483
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
Options to purchase 8,276 and 9,002 shares of common stock at the price of $40.29 were outstanding during the three and nine months ended September 30, 2007 and 2006, 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 September 30, 2007 and 2006, 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 Annual Report on Form 10-K for the year ended December 31, 2006.
The following sets forth the components of the net periodic benefit cost of the domestic non-contributory defined benefit plan for the three and nine months ended September 30, 2007 and 2006, respectively:
Service cost
117
350
Interest cost
121
108
364
325
Expected return on plan assets
(140
(121
(421
(364
Amortization of transition
(1
(2
Amortization of prior service cost
Amortization of net loss
—
17
Net periodic cost
103
115
345
Employer Contributions
The Company previously disclosed in its consolidated financial statements, included in the Annual Report on Form 10-K for the year ended December 31, 2006, that it expected to contribute $500,000 to its defined benefit plan in 2007. As of September 30, 2007, a contribution in the amount of $580,000 was made for the 2006 plan year with no additional contributions anticipated.
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
71,588
61,736
Standby letters of credit
1,345
1,033
Certain comparative amounts for the prior period have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.
Effective April 26, 2006, the Company implemented the Penns Woods Bancorp, Inc. 2006 Employee Stock Purchase Plan (“Plan”). The Plan is intended to encourage employee participation in the ownership and economic progress of the Company. The Plan allows for up to 1,000,000 shares to be purchased by employees. The purchase price of the shares is 95% of market value with an employee eligible to purchase up to the lesser of 15% of base compensation or $12,000 in market value annually. During the nine months ended September 30, 2007 and 2006, there were 2,240 and 421 shares issued under the plan, respectively.
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, with 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.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Comparison of the Three and Nine Months Ended September 30, 2007 and 2006
Summary Results
Net income for the three months ended September 30, 2007 was $2,322,000 compared to $2,464,000 for the same period of 2006. Basic and diluted earnings per share for the three months ended September 30, 2007 were $0.60 as compared to $0.63 for the three months ended September 30, 2006. Return on average assets and return on average equity were 1.57% and 13.21% for the three months ended September 30, 2007 as compared to 1.71% and 13.41% for the corresponding period of 2006. Net income from core operations (“operating earnings”) for the three months ended September 30, 2007 and 2006, which excludes net after-tax securities gains of $370,000 for the 2006 period, increased $228,000 to $2,322,000 for the three months ended September 30, 2007 as compared to $2,094,000 for the same period of 2006. Operating earnings per share for the three months ended September 30, 2007 increased 13.2% or $0.07 to $0.60 basic and dilutive as compared to the three months ended September 30, 2006. Operating earnings per share for the three months ended September 30, 2007 represent a $0.05 basic and dilutive increase from the previous three month period as core earnings continued to build upon the $0.02 increase from the first to second quarters of 2007.
The nine months ended September 30, 2007 generated net income of $6,938,000 compared to $7,353,000 for the same period of 2006. Earnings per share, basic and diluted, for the nine months ended September 30, 2007 were $1.78 as compared to $1.87 for the comparable period of 2006. Return on average assets and return on average equity were 1.57% and 12.63% for the nine months ended September 30, 2007 as compared to 1.71% and 13.20% for the corresponding period of 2006. Operating earnings for the nine months ended September 30, 2007 and 2006, which excludes net after-tax securities gains of $409,000 and $914,000, respectively, increased $90,000 to $6,529,000 for the 2007 period compared to $6,439,000 for the 2006 period. Operating earnings per share, basic and dilutive, increased 3.1% to $1.68 for the nine months ended September 30, 2007 as compared to $1.63 for the comparable period of 2006.
(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. For purposes of this Quarterly Report on Form 10-Q, net income from core operations means net income adjusted to exclude after-tax net securities gains. 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.)
13
Interest Income
Interest income for the three months ended September 30, 2007 increased $430,000 to $8,977,000 as compared to $8,547,000 for the same period of 2006. The increase in interest income was primarily the result of growth in average loans of $5,736,000 coupled with an 18 basis point (“bp”) increase in loan portfolio yields for the three months ended September 30, 2007 over the same period of 2006. Over the same time frame, the average balance of investment securities and interest bearing deposits increased $5,693,000 with the portfolio yield increasing 28 bp resulting in a $164,000 increase in interest income. On a taxable equivalent basis, the interest income from the investment portfolio and interest bearing deposits increased $218,000 due to the investment portfolio being strategically shifted toward tax-exempt instruments. The decrease in dividends received is the result of a decrease in equity investments.
During the nine months ended September 30, 2007, interest income was $26,449,000, an increase of $1,533,000 over the same period in 2006. The reasons for the 6.2% growth in interest income for the nine month period are identical to those for the three month period ending September 30, 2007 discussed above. The growth in average loans of $11,727,000 coupled with a 26 bp increase in the loan portfolio yield resulted in an increase of $1,310,000 in loan interest and fee income. Average investment securities and interest bearing deposits remained stable, however, interest income increased $223,000 due to a 24 bp increase in yield. The increase in yield was due to an increase in yield on taxable securities as portfolio cash flow was reinvested into higher yielding bonds over the past year. The asset allocation between loans and the investment portfolio composition resulted in taxable equivalent interest income increasing $1,673,000 for the nine months ended September 30, 2007 as compared to the same period of 2006.
Interest income composition for the three and nine months ended September 30, 2007 and 2006 was as follows:
14
For The Three Months Ended
September 30, 2007
September 30, 2006
Change
Amount
% Total
%
73.8
74.4
266
4.2
Investment securities:
10.7
10.2
90
10.3
12.3
11.7
104
10.4
3.2
3.7
(30
(9.6
Total interest income
100.0
430
5.0
For The Nine Months Ended
74.0
73.3
1,310
7.2
10.8
20
0.7
12.4
12.0
278
9.3
3.4
3.9
(75
(7.6
1,533
6.2
Interest Expense
Interest expense for the three months ended September 30, 2007 increased $405,000 to $4,112,000 as compared to $3,707,000 for the same period of 2006. 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 September 30, 2006 to the corresponding period of 2007. Factors that led to the rate increases include, but are not limited to, competitive market pricing pressure and campaigns conducted to attract 8 to 12 month maturity CDs that provide greater funding flexibility. The increase in CD interest rates has 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. Borrowing interest expense on FHLB advances and customer repurchase accounts increased $17,000 as rates paid increased 4 bp, while the average balance of borrowed funds remained constant.
Interest expense for the nine months ended September 30, 2007 increased $1,733,000 to $12,050,000 from $10,317,000 for the comparable period of 2006. Interest on deposits accounted for $1,963,000 of the increase due to the reasons noted in the above three month analysis. Borrowing costs declined primarily due to the previously noted CD campaigns that allowed for average FHLB advances to be reduced for the nine months ended September 30, 2007 as compared to the same period of 2006.
Interest expense composition for the three and nine months ended September 30, 2007 and 2006 was as follows:
68.9
66.0
388
15.9
9.0
8.3
62
20.3
22.1
25.7
(45
(4.7
Total interest expense
405
10.9
68.2
60.6
1,963
31.4
9.1
11.8
(9.9
22.7
27.6
(109
(3.8
1,733
16.8
Net Interest Margin
The net interest margin (“NIM”) for the three months ended September 30, 2007 was 3.98% as compared to 4.00% for the corresponding period of 2006 and increased slightly from 3.95% for the three months ended June 30, 2007. The decrease in the NIM for the three months ended September 30, 2007 compared to the same period in 2006 was due to the cost of interest bearing liabilities continuing to increase at a rate greater than the increase in the yield on earning assets as has been the trend over the past twelve months. The negative impact of the disparity between the asset yield increases and the liability rate increases, however, declined for the three months ended September 30, 2007 as compared to the same period of 2006. Average loan growth of $5,736,000 and a shift in the investment portfolio toward tax-exempt bonds paved the way for the increase in yield on earning assets of 21 bp for the three month period ended September 2007 as compared to 2006. The average investment securities portfolio increased by $6,088,000, as the tax-exempt segment increased to $95,383,000 at September 30, 2007 as compared to $91,234,000 at September 30, 2006. The growth in tax-exempt bonds was part of the Company’s tax strategy and was strategically undertaken to provide the cash flow and yield desired from the portfolio as a whole. The increase in the cost of interest bearing liabilities to 3.67% from 3.42% was driven primarily by the cost of time deposits increasing 48 bp for the three months ended September 30, 2007 as compared to the previous year, while the average balance of time deposits increased $17,503,000. The increase in cost of time deposits was impacted by the Federal Open Market Committee rate increases during 2006 of 100 bp, utilization of brokered deposits, and our strategic decision to gather time deposits as part of marketing campaigns associated with a branch opening and branch anniversaries in 2006 and 2007
The NIM for the nine months ended September 30, 2007 was 3.96% as compared to 4.06% for the corresponding period of 2006. The decrease in the NIM was the result of the previously mentioned growth and change in mix of the earnings assets offset by increased rates paid on interest bearing liabilities and growth in the average CD portfolio of $29,282,000.
16
Following is a schedule of average balances and associated yields for the three and nine month periods ended September 30, 2007 and 2006:
AVERAGE BALANCES AND INTEREST RATES
Average Balance
Interest
Average Rate
Assets:
Tax-exempt loans
7,652
118
6.12
8,275
127
6.09
All other loans
354,032
6,543
7.33
347,673
6,271
7.16
Total loans
361,684
6,661
7.31
355,948
6,398
7.13
Taxable investment securities
91,788
1,247
5.43
89,849
1,181
5.26
Tax-exempt investment securities
95,383
1,679
7.04
91,234
1,521
6.67
Total securities
187,171
2,926
6.25
181,083
2,702
5.97
Interest bearing deposits
40
1
9.92
435
6.38
Total interest-earning assets
548,895
9,588
6.95
537,466
9,107
6.74
43,706
42,042
Total assets
592,601
579,508
Liabilities:
Savings
60,262
114
0.75
63,081
142
0.89
Super Now deposits
46,531
153
1.30
47,071
170
1.43
Money market deposits
23,183
131
2.24
23,300
2.23
Time deposits
203,690
2,437
4.75
186,187
2,004
4.27
333,666
3.37
319,639
3.04
32,910
4.44
27,255
4.45
77,791
4.64
4.57
Total borrowings
110,701
1,277
4.58
110,133
1,260
4.54
Total interest-bearing liabilities
444,367
3.67
429,772
3.42
Demand deposits
70,689
69,660
7,249
6,596
Shareholders’ equity
70,296
73,480
Total liabilities and shareholders’ equity
Interest rate spread
3.28
3.32
Net interest income/margin
5,476
3.98
5,400
4.00
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.
7,913
365
6.17
8,155
377
6.18
353,219
19,320
341,250
18,001
7.05
361,132
19,685
7.29
349,405
18,378
7.03
Taxable securities
85,930
3,600
5.59
93,848
3,664
5.21
Tax-exempt securities
99,497
4,956
6.64
90,972
4,535
6.65
185,427
8,556
6.15
184,820
8,199
5.91
431
18
5.58
161
7.47
546,990
28,259
6.90
534,386
26,586
42,390
39,747
589,380
574,133
59,726
329
0.74
63,150
398
0.84
46,309
455
1.31
47,835
488
1.36
24,362
414
2.27
24,190
367
2.03
198,401
7,017
4.73
169,119
4,999
3.95
Total Deposits
328,798
3.34
304,294
2.75
32,443
4.53
37,761
4.32
Other borrowings
78,818
83,359
4.56
111,261
3,835
4.61
121,120
4,065
4.49
440,059
3.66
425,414
3.24
69,203
69,219
6,866
5,245
73,252
74,255
3.41
16,209
3.96
16,269
4.06
For the Three Months Ended
For the Nine Months Ended
Net interest income
Tax equivalent adjustment
611
1,810
1,670
Net interest income (fully taxable equivalent)
2007 vs 2006
Increase (Decrease)
Due to
Volume
Rate
Net
Interest income:
Loans, tax-exempt
(10
(9
(11
(12
154
642
677
1,319
41
(419
355
(64
71
87
158
425
(4
(6
198
481
652
1,021
1,673
Interest expense:
Savings deposits
(22
(28
(21
(48
(69
(15
(17
(16
(33
44
47
197
236
433
939
1,079
2,018
63
(184
(59
(159
50
191
214
562
1,171
Change in net interest income
69
76
(150
(60
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 for loan losses is determined 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 September 30, 2007, 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, charge-offs, 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 decreased from $4,185,000 at December 31, 2006 to $4,092,000 at September 30, 2007. At September 30, 2007, the allowance for loan losses was 1.14% of total loans compared to 1.16% of total loans at December 31, 2006. 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 $10,000 and $60,000 for the three and nine months ended September 30, 2007, respectively, as compared to $89,000 and $485,000 for the same periods in 2006. The decrease in the provision was the result of several continuing positive factors, including but not limited to, a ratio of annualized net charge offs to average loans of 0.06% for the nine months ended September 30, 2007, a ratio of nonperforming loans to total loans of 0.28% at September 30, 2007, and a ratio of the allowance for loan losses to nonperforming loans of 403.95% at September 30, 2007. In addition, gross loans have declined $2,669,000 since December 31, 2006 due to a softening of the loan market and the payoff of several commercial loans.
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 three months ended September 30, 2007 compared to the same period in 2006 decreased $381,000 to $2,006,000 primarily as a result of the amount of net securities gains realized during the three month period ended September 30, 2006. Excluding net securities gains, non-interest income would have increased $180,000 as compared to the 2006 period. Deposit service charges declined $50,000 as overdraft protection fees declined and customers migrated to new checking accounts having reduced or no service charges. Other income increased due primarily to revenue generated from increased debit card transactions, merchant card commissions, and commissions generated by The M Group for securities transactions.
Insurance commissions for the three months ended September 30, 2007 increased $123,000 as compared to the same period in 2006 due to a shift in product mix. Management of The M Group continues to pursue new and build upon current relationships. The sales call program continues to expand to other financial institutions, which results in additional revenue for The M Group. However, the addition of another sales outlet for The M-Group can take up to a year or more to be completed.
Total non-interest income for the nine months ended September 30, 2007 compared to the same period in 2006 decreased $774,000. Excluding net securities gains, non-interest income would have remained stable as compared to the 2006 period. The decrease in non-interest income for the nine month period is the result of the same items noted in the three month discussion.
Non-interest income composition for the three and nine months ended September 30, 2007 and 2006 were as follows:
21
27.2
25.0
(50
(8.4
)%
23.5
(561
(100.0
Bank owned life insurance
5.4
16.0
14.1
11.1
6.8
31.2
21.0
123
24.5
15.5
74
19.9
Total non-interest income
(381
(16.0
26.8
25.5
(119
(6.7
10.0
20.0
(766
(55.3
38
14.0
10.6
30
4.8
26.2
(6.9
21.4
16.6
162
(774
(11.2
Non-interest Expense
Total non-interest expense increased $316,000 for the three months ended September 30, 2007 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 benefit costs. Occupancy expense increased due to the new branch in Montoursville, which opened in the third quarter of 2006, and increased cost of maintenance and property taxes. Other expenses increased primarily due to normal anticipated inflationary adjustments to ongoing business operating costs and the amortization related to a low income housing partnership that began operation during the fourth quarter of 2006.
Total non-interest expenses increased $755,000 for the nine months ended September 30, 2007 as compared to the same period of 2006. As noted above in the three month discussion, the new Montoursville branch in addition to normal increases in general business expenses and the amortization of a low income housing partnership, impacted the level of non-interest expenses.
Non-interest expense composition for the three and nine months ended September 30, 2007 and 2006 were as follows:
22
52.6
52.8
156
7.5
3.6
6.0
(42
(13.6
30.6
28.5
182
Total non-interest expense
316
7.7
53.6
54.5
292
4.4
19.5
6.6
7.4
(44
(4.9
7.8
28.4
311
755
Provision for Income Taxes
Income taxes decreased $451,000 and $889,000 for the three and nine month periods ended September 30, 2007 compared to the same periods of 2006. The effective tax rates for the three and nine months ended September 30, 2007 were 4.48% and 8.79%, respectively, as compared to 18.52% and 17.48% for the same periods of 2006. 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, additional tax credits related to investments in low income housing projects, and greater than anticipated tax losses on the housing projects. The current effective tax rate has resulted in a deferred tax asset due to the low income housing tax credits. Management has reviewed the deferred tax asset and has determined that the asset will be utilized within the appropriate carry forward period and therefore does not require a valuation allowance.
Cash and cash equivalents decreased $2,130,000 from $15,373,000 at December 31, 2006 to $13,243,000 at September 30, 2007 primarily as a result of the following activities during the nine months ended September 30, 2007:
Activity regarding loans held for sale resulted in loan originations exceeding sale proceeds, less $654,000 in realized gains, by $2,787,000 for the nine months ended September 30, 2007.
23
Gross loans decreased $2,669,000 since December 31, 2006 due to the early payoff of several large commercial loans coupled with increased competition for commercial loans and a softening of the market.
The allocation of the loan portfolio, by category, as of September 30, 2007 and December 31, 2006 is presented below:
Commercial, financial, and agricultural
35,868
36,995
(1,127
(3.0
Real estate mortgage:
Residential
162,163
158,219
3,944
2.5
Commercial
129,726
135,404
(5,678
(4.2
Construction
17,492
16,749
743
Installment loans to individuals
13,400
14,035
(635
(4.5
Less: Net deferred loan fees
934
1,018
(84
(8.3
Gross loans
(2,669
(0.7
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 $1,195,000 at September 30, 2007, as compared to $574,000 at December 31, 2006. The valuation allowance related to impaired loans amounted to $98,000 at September 30, 2007 and $42,000 at December 31, 2006. The increase in impaired loans is primarily from a single commercial relationship that accounted for $523,000 of the increase, while the increase in valuation allowance is the result of a second commercial relationship that had a specific collateral weakness.
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 estimated fair value of the investment securities portfolio in total has increased $19,550,000 since December 31, 2006, while the amortized cost increased $25,613,000. The majority of the changes in value incurred within the state and municipal segment of the portfolio. The amortized cost position in state and political securities increased $6,115,000 as the Bank continued its strategy to build call protection, maintain taxable equivalent yields, reduce the effective federal
24
income tax rate, and invest in communities across the Commonwealth of Pennsylvania and the country. The amortized cost position of other debt securities increased $13,806,000 as the Bank began a leverage transaction to enhance earning asset yields in a softening loan market. The increased level of unrealized losses, which offset the increase in amortized cost, was the result of changes in the yield curve, not credit quality, as the credit quality of the portfolio remains sound.
The amortized cost of investment securities and their estimated fair values are as follows:
Gross
Estimated
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available for sale (AFS)
U.S. Government and agency securities
60,732
(714
60,087
State and political securities
110,773
(2,287
109,047
Other debt securities
15,799
36
(173
15,662
Total debt securities
187,304
666
(3,174
184,796
Equity securities
20,274
1,000
(1,312
19,962
Total investment securities AFS
207,578
1,666
(4,486
Held to maturity (HTM)
262
Total investment securities HTM
December 31, 2006
54,949
(821
54,152
104,658
1,646
(358
105,946
1,998
37
2,024
161,605
1,707
(1,190
162,122
20,353
2,883
(158
23,078
181,958
4,590
(1,348
26
28
257
258
286
Total deposits increased 2.4% or $9,663,000 from December 31, 2006 to September 30, 2007. The mix of deposits has shifted from December 31, 2006 to September 30, 2007 as brokered deposits have decreased substantially and customer time deposits have increased. The shift is the result of the Bank strategically attracting short-term customer time deposits and utilizing the funds gathered to replace maturing brokered time deposits and higher cost short-term FHLB advances. The amount of brokered deposits is continuously monitored and is used to supplement deposits, not as a primary source of deposits.
18.0
18.5
(0.2
NOW accounts
47,129
11.6
46,156
973
2.1
22,295
5.5
23,137
5.9
(842
(3.6
59,883
14.8
59,289
15.0
594
1.0
189,313
46.8
168,420
42.6
20,893
Time deposits - brokered
13,244
3.3
25,029
6.3
(11,785
(47.1
9,663
2.4
Total borrowed funds increased 11.6% to $131,171,000 at September 30, 2007 as compared to $117,575,000 at December 31, 2006. The increase in borrowed funds is primarily the result of an investment portfolio leverage strategy that was initiated during September 2007. The leverage program at September 30, 2007 accounted for $20,000,000 in borrowings split evenly between short-term and long-term FHLB borrowings. Off setting the increase related to the leverage strategy were the previously discussed time deposit gathering campaigns that were utilized to provide funds to reduce the level of higher cost short-term borrowings and to assist in replacing long-term borrowing maturities. Long-term borrowings increased due to the maturity of four borrowings totaling $16,500,000 that carried an average rate of 3.99% offset by two new $10,000,000 FHLB borrowings that mature in 2017 and carry a rate of 4.28% and 4.15%, respectively.
27
Short-term borrowings:
FHLB repurchase agreements
12,870
9.8
18,706
(5,836
(31.2
Short-term borrowings, FHLB
15,000
11.4
Securities sold under agreement to repurchase
16,923
12.9
15,991
13.6
932
5.8
Total short-term borrowings
34.1
29.5
29.1
65.9
70.5
3,500
Total borrowed funds
131,171
117,575
13,596
Capital ratios as of September 30, 2007 and December 31, 2006 were as follows:
Ratio
Total Capital
(to Risk-weighted Assets)
Actual
72,574
18.6
73,098
20.5
For Capital Adequacy Purposes
31,149
8.0
28,515
To Be Well Capitalized
38,937
35,643
Tier I Capital
68,482
17.6
67,869
19.0
15,575
4.0
14,257
23,362
21,386
(to Average Assets)
23,714
22,591
29,643
28,239
The following liquidity measures are monitored for compliance within the limits cited:
1. Net Loans to Total Assets, 85% 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
29
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 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, FHLB borrowings, and brokered deposits. 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 FHLB of $218,872,000. In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $29,535,000. Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. FHLB borrowings totaled $114,248,000 as of September 30, 2007.
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 year ended December 31, 2006.
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk for the Company is comprised primarily of 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, 2006. 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 September 30, 2007. There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
31
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, 2006. 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
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 (July 1-July 31, 2007)
6,000
34.06
133,570
Month#2 (August 1-August 31, 2007)
5,000
31.75
128,570
Month#3 (September 1-September 30, 2007)
On April 24, 2007, the Board of Directors extended the authorization to repurchase up to 197,000 shares, or approximately 5%, of the outstanding shares of the Company for an additional year to April 25, 2008. The repurchase plan was originally for a one year period expiring on April 25, 2007. To date, there have been 68,430 shares repurchased under this plan.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
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, 2006).
(3) (ii)
Bylaws of the Registrant’s 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).
(31) (i)
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.
(31) (ii)
Rule 13a-14(a)/Rule 15d-14(a) Certification of Principal Financial Officer.
(32) (i)
Certification of Chief Executive Officer Section 1350.
(32) (ii)
Certification of Principal Financial 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: November 7, 2007
/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)
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 Financial Officer
Exhibit 32(i)
Section 1350 Certification of Chief Executive Officer
Exhibit 32(ii)
Section 1350 Certification of Principal Financial Officer