UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2004, or( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from ______ to ______
Commission file number 0-23863
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days. Yes X No____
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No _____
PEOPLES FINANCIAL SERVICES CORP.
For the Quarter Ended March 31, 2004
TABLE OF CONTENTS
PART IITEM 1. FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Peoples Financial Services Corp. (the “Corporation” or the “Company”) and its wholly owned subsidiary, Peoples National Bank (the “Bank”). All material intercompany accounts and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
2. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share, as adjusted for the stock split declared April 1, 2003:
3. OTHER COMPREHENSIVE INCOME
The components of other comprehensive income and related tax effects for the three months ended March 31, 2004 and 2003 are as follows:
4. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.” Accordingly, no compensation costs have been recognized for options granted. Had compensation costs for stock options granted been determined based on the fair value at the grant dates for awards under the plan consistent with the provisions of SFAS No. 123, the Company’s net income and earnings per share for the quarter ended March 31, 2004 and 2003, would have been reduced to the proforma amounts indicated below:
5. GUARANTEES
The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Outstanding letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. The Company had $1,770,000 of standby letters of credit as of March 31, 2004. The Bank uses the same credit policies in making conditional obligations as it does for on-balance sheet instruments.
The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Company requires collateral supporting these letters of credit as deemed necessary. The maximum undiscounted exposure related to these commitments at March 31, 2004 was $1,770,000, and the approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $950,000. The current amount of the liability as of March 31, 2004 for guarantees under standby letters of credit is not material.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial statements of the Corporation is presented to provide insight into management’s assessment of financial results. The Corporation’s only subsidiary, Peoples National Bank provides financial services to individuals and businesses within the Bank’s primary market area made up of Susquehanna, Wyoming and northern Lackawanna counties in Pennsylvania, and southern Broome County in New York. The Bank also operates a branch in Conklin, New York. The Bank is a member of the Federal Reserve System and subject to regulation, supervision, and examination by the Office of the Comptroller of the Currency.
CAUTIONARY STATEMENT CONCERNING FORWARD LOOKING INFORMATION
Except for historical information, this Report may be deemed to contain “forward looking” information. Examples of forward looking information may include, but are not limited to (a) projections of or statements regarding future earnings, interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure and other financial terms, (b) statements of plans and objectives of management or the Board of Directors, (c) statements of future economic performance, and (d) statements of assumptions, such as economic conditions in the market areas served by the Corporation and the Bank, underlying other statements and statements about the Corporation and the Bank or their respective businesses. Such forward looking information can be identified by the use of forward looking terminology such as “believes,” “expects,” “may,” “intends,” “will,” “should,” “anticipates,” or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. No assurance can be given that the future results covered by the forward looking information will be achieved. Such statements are subject to risks, uncertainties, and other factors which could cause actual results to differ materially from future results expressed or implied by such forward looking information. Important factors that could impact operating results include, but are not limited to, (i) the effects of changing economic conditions in both the market areas served by the Corporation and the Bank and nationally, (ii) credit risks of commercial, real estate, consumer and other lending activities, (iii) significant changes in interest rates, (iv) changes in federal and state banking laws and regulations which could affect operations, (v) funding costs, and (vi) other external developments which could materially affect business and operations.
CRITICAL ACCOUNTING POLICIES
Disclosure of the Company’s significant accounting policies is included in Note 1 to the consolidated financial statements of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by Management. Additional information is contained on page 18 of this report for the provision and allowance for loan losses.
OVERVIEW
Net income for the quarter increased ..2% to $1.297 million as compared to $1.294 million for the first quarter of 2003. Diluted earnings per share remained the same at $.41 per share for the first quarter of 2004 compared to $.41 per share in the first quarter of 2003, as adjusted for the stock split declared April 1, 2003. At March 31, 2004, the Company had total assets of $372.684 million, total net loans of $237.859 million, and total deposits of $278.073 million.
FINANCIAL CONDITION
Cash and Cash Equivalents:
At March 31, 2004, cash, federal funds sold, and deposits with other banks totaled $9.746 million as compared to $6.056 million on December 31, 2003. The increase over the three months of 2004 has been due to the increase in federal funds sold which had a balance of $0 at the end of 2003 and now has a balance of $3.780 million.
Management believes the liquidity needs of the Corporation are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that matures within one year. The current sources of funds will enable the Corporation to meet all its cash obligations as they come due.
Investments:
Investments totaled $110.284 million on March 31, 2004, decreasing by $5.842 million over the December 31, 2003 total of $116.126 million. This corresponds to the increase in loans and federal funds sold over the same period.
The total investment portfolio is held as available for sale. This strategy was implemented in 1995 to provide more flexibility in using the investment portfolio for liquidity purposes as well as providing more flexibility in selling when market opportunities occur.
Investments available for sale are accounted for at fair value with unrealized gains or losses, net of deferred income taxes, reported as a separate component of stockholders’ equity. The carrying value of investments as of March 31, 2004, included an unrealized gain of $2.780 million reflected as accumulated other comprehensive income of $1.835 million in shareholders’ equity, net of deferred income taxes of $945 thousand. This compares to an unrealized gain of $1.508 million at December 31, 2003, reflected as accumulated other comprehensive income of $995 thousand, net of deferred income taxes of $513 thousand.
Management monitors the earnings performance and effectiveness of liquidity of the investment portfolio on a monthly basis through the Asset/Liability Committee (“ALCO”). The ALCO also reviews and manages interest rate risk for the Corporation. Through active balance sheet management and analysis of the investment securities portfolio, the Corporation maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.
Loans:
Net loans increased $3.585 million or 1.53% to $239.745 million as of March 31, 2004, from $236.367 million as of December 31, 2003. Of the loan growth experienced in the first quarter of 2004, the most significant growth occurred in commercial loans. Commercial loans increased $2.258 million or 2.01% to $114.875 million as of March 31, 2004, compared to $112.617 million as of December 31, 2003.
Increasing the loan to deposit ratio is a goal of the Bank, but loan quality is always considered in this effort. Management has continued its efforts to create good underwriting standards for both commercial and consumer credit. The Bank’s lending continues to consist primarily of retail lending which includes single family residential mortgages and other consumer lending. Most commercial lending is done primarily with locally owned small businesses.
Other Assets:
Other Assets increased $74 thousand or 1.2% to $6.270 million as of March 31, 2004, from $6.196 million as of December 31, 2003.
Deposits:
Deposits are attracted from within the Bank’s primary market area through the offering of various deposit instruments including NOW accounts, money market accounts, savings accounts, certificates of deposit, and IRA’s. During the three-month period ended March 31, 2004, total deposits decreased by $1.627 million or .58% to $278.073 million.
Borrowings:
The Bank utilizes borrowings as a source of funds for its asset/liability management. Advances are available from the FHLB provided certain standards related to credit worthiness have been met. Repurchase and term agreements are also available from the FHLB.
Total short-term borrowings at March 31, 2004, were $8.427 million as compared to $7.085 million as of December 31, 2003, an increase of $1.342 million or 18.94%. Long-term borrowings were $41.725 million as of March 31, 2004, compared to $41.952 million as of December 31, 2003, a decrease of $227 thousand or .54%. The increase in short-term borrowings was due to increased activity in commercial sweep accounts classified as short-term borrowings.
Capital:
The adequacy of the Corporation’s capital is reviewed on an ongoing basis with reference to the size, composition and quality of the Corporation’s resources and regulatory guidelines. Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. As of March 31, 2004, regulatory capital to total assets was 10.06% as compared to 10.22% on December 31, 2003. The Company repurchases its stock in the open market or from individuals as warranted to leverage the capital account and to provide stock for a dividend reinvestment plan. In the three months ended March 31, 2004, the Company did not purchase any shares for the treasury.
The Corporation has complied with the standards of capital adequacy mandated by the banking regulators. The bank regulators have established “risk-based” capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks of various assets the banks hold in their portfolios. A weight category of either 0% (lowest risk asset), 20%, 50%, or 100% (highest risk assets) is assigned to each asset on the balance sheet. Capital is being maintained in compliance with risk-based capital guidelines. The Company’s Tier 1 capital to risk weighted asset ratio was 14.59% and the total capital ratio to risk weighted assets ratio was 15.33% at March 31, 2004. The Corporation is deemed to be well-capitalized under regulatory standards.
Liquidity:
Liquidity measures an organization’s ability to meet cash obligations as they come due. The consolidated statement of cash flows presented in the accompanying financial statements included in Part I of this Form 10Q provide analysis of the Corporation’s cash and cash equivalents. Additionally, management considers that portion of the loan and investment portfolio that matures within one year as part of the Corporation’s liquid assets.
The Company’s Asset/Liability Committee (ALCO) addresses the liquidity needs of the Bank to see that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio. In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.
The following table represents the aggregate on and off-balance sheet contractural obligations to make future payments.
Off-Balance Sheet Arrangements:
The Company’s financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These commitments consist primarily of commitments to grant new loans and unfunded commitments of existing loans and letters of credit made under the same standards as on-balance sheet instruments. Unused commitments on March 31, 2004, totaled $25.942 million, which consisted of $20.521 million in unfunded commitments of existing loans, $3.651 million to grant new loans and $1.770 thousand in letters of credit. Due to fixed maturity dates and specified conditions within these instruments, many will expire without being drawn upon. Management believes that amounts actually drawn upon can be funded in the normal course of operations and therefore, do not represent a significant liquidity risk to the Company.
Interest Rate Sensitivity:
The management of interest rate sensitivity seeks to avoid fluctuating net interest margins and to provide consistent net interest income through periods of changing interest rates.
The Company’s risk of loss arising from adverse changes in the fair value of financial instruments, or market risk, is composed primarily of interest rate risk. The primary objective of the Company’s asset/liability management activities is to maximize net interest income while maintaining acceptable levels of interest rate risk. The Company’s Asset/Liability Committee (ALCO) is responsible for establishing policies to limit exposure to interest rate risk, and to ensure procedures are established to monitor compliance with those policies. The guidelines established by ALCO are reviewed by the Company’s Board of Directors.
The tools used to monitor sensitivity are the Statement of Interest Sensitivity Gap and the interest rate shock analysis. The Bank uses a software model to measure and to keep track. In addition, an outside source does a quarterly analysis to make sure our internal analysis is current and correct. The statement of Interest Sensitivity Gap is a good assessment of current position and is a very useful tool for the ALCO in performing its job. This report is monitored in an effort to “match” maturities or repricing opportunities of assets and liabilities in order to attain the maximum interest within risk tolerance policy guidelines. The statement does, although, have inherent limitations in that certain assets and liabilities may react to changes in interest rates in different ways with some categories reacting in advance of changes and some lagging behind the changes. In addition, there are estimates used in determining the actual propensity to change of certain items such as deposits without maturities.
The following table sets forth the Company’s interest sensitivity analysis as of March 31, 2004: Statement of Interest Sensitivity Gap
(In thousands)
RESULTS OF OPERATIONS
Net Interest Income:
For the three months ended March 31, 2004, total interest income decreased by $4 thousand, or .08%, to $4.973 million as compared to $4.977 million for the three months ended March 31, 2003. This decrease was primarily due to the continued decrease in yield on earnings assets, which decreased to 5.68% as compared to 6.14 % for the first three months of 2003. Average earning assets increased to $352.351 million for the three months ended March 31, 2004, as compared to $328.774 million for the three months ended March 31, 2003.
Total interest expense decreased by $177 thousand, or 9.13% to $1.762 million for the three months ended March 31, 2004, from $1.939 million for the three months ended March 31, 2003. This decrease was attributable to the decrease in the cost of funds, which decreased to 2.43 % as compared to 2.85 % for the first three months of 2003. Average interest-bearing liabilities increased to $291.242 million for the three months ended March 31, 2004, as compared to $275.796 million for the three months ended March 31, 2003.
Net interest income increased by $173 thousand, or 5.69%, to $3.211 million for the three months ended March 31, 2004, from $3.038 million for the three months ended March 31, 2003. The Bank’s net interest spread decreased to 3.24% for the first three months of 2004 from 3.29% for the first three months of 2003. The net interest margin decreased to 3.67% from 3.75% for the three-month period ended March 31, 2004 and 2003 respectively.
The average loan yield was 6.31% during the first quarter of 2004, a decrease of 8.15% from 6.87% during the comparable period in 2003. Average loan balances increased $12.855 million, or 5.71%, to $238.029 million during the first quarter of 2004 from $225.174 million during the same period in 2003.
Yields on securities were 4.36% for the first quarter of 2004, a decrease of 4.60% from 4.57% during the comparable period in 2003. Average security balances increased $11.186 million, or 10.89%, to $113.946 million during the first quarter of 2004 from $102.760 million during the same period in 2003.
The decrease in yields on earning assets was offset by a decrease in rates paid on deposits and borrowings. Average rates paid on deposits decreased 20.00% to 2.04% for the three months ended March 31, 2004 from 2.55% for the comparable period in 2003. Average rates paid on borrowings increased 1.67% to 4.27% for the first three months of 2004 from 4.20% for the comparable period in 2003.
The quarter to date net interest margin calculation for March 31, 2004 and 2003, is shown below:
Distribution of Assets, Liabilities and Stockholders' EquityInterest Rates and Interest Differential
(In Thousands)
Provision for Loan Loss:
The provision for loan loss for the three months ended March 31, 2004, was $159,000, an increase of $99,000, or 165.00% from $60,000 for the same period in 2003. The Bank’s loan volume continues to be strong. One of the Bank’s main goals is to increase the loan to deposit ratio without jeopardizing loan quality. To reach its goal, management has continued its efforts to create strong underwriting standards for both commercial and consumer credit. The Bank’s lending consists primarily of retail lending which includes single family residential mortgages and other consumer lending and commercial lending primarily to locally owned small businesses.
In the three-month period ended March 31, 2004, charge-offs totaled $379,000 while net charge-offs totaled $366,000 as compared to $19,000 and $11,000 respectively for the same three-month period in 2003.
Monthly, senior management uses a detailed analysis of the loan portfolio to determine loan loss reserve adequacy. The process considers all “problem loans” including classified, criticized, and monitored loans. Prior loan loss history and current market trends, both nationally and locally, are taken into consideration. A watch list of potential problem loans is maintained and monitored on a monthly basis by the board of directors. The Bank has not had nor presently has any foreign loans. Based upon this analysis, senior management has concluded that the allowance of loan loss is adequate.
Other Income:
Total non-interest income was $617 thousand for the three months ended March 31, 2004, an increase of $84 thousand or 15.76% over the comparable period in 2003.
Service charges and fees increased 11.36%, or $35 thousand, to $343 thousand in the first quarter of 2004 from $308 thousand in the first quarter of 2003. Overdraft fees in the first quarter of 2004 were $236 thousand compared to $196 thousand for the same period in 2003. The overdraft fee was increased to $30 from $25 in the fourth quarter of 2003. This accounts for the difference in service charges between the two periods.
Other income was $219 thousand for the three-months ended March 31, 2004, an increase of $51 thousand, or 30.36% over the comparable period in 2003. Additional commission income from investment division activity of $52 thousand and premiums earned through mortgage sales to the Federal Home Loan Bank of $21 thousand more than accounted for the increase in 2004 when compared to the same period in 2003. Conversely, application fee income, Bank Owned Life Insurance income and other service related fees were down slightly in 2004 when compared to the same period in 2003.
Gains on security sales were $55 thousand for the quarter ended March 31, 2004, compared to a gain of $57 thousand for the comparable period in 2003, a decrease of $2 thousand.
Other Operating Expenses:
Total other expenses increased 11.97%, or $211 thousand, to $1.974 million during the first quarter of 2004 compared to $1.763 million for the comparable period in 2003.
Salaries and benefits increased 9.50%, or $86 thousand, to $991 thousand for the first quarter of 2004 compared to $905 thousand for the same period in 2003 due to normal pay increases. The full-time equivalent number of employees was 97 as of March 31, 2004, compared to 98 as of March 31, 2003. The variance between periods is in line with the 2004 budget.
Occupancy expenses increased 19.13%, or $22 thousand, to $137 thousand during the first quarter of 2004 compared to $115 thousand for the same period in 2003. Increased heating costs for the first quarter of 2004 and other winter maintenance related items contributed to this increase when compared to the same period in 2003. Furniture and fixtures expense increased 27.87%, or $17 thousand, to $78 thousand for the first quarter of 2004 compared to $61 thousand for the first quarter of 2003. This increase was due to the increase of depreciation expense on computer equipment during the first quarter of 2004 compared to the same period in 2003. During 2003, the Company purchased various components made necessary by technological advancements in the banking industry, the full effect of which is evident in the first quarter of 2004.
All other operating expenses increased $86 thousand, or 12.61%, to $768 thousand in the first quarter of 2004 compared to $682 thousand for the same period in 2003. The increase was due in part to additional expenses incurred on foreclosed real estate in the amount of $37 thousand, additional director fees of $16 thousand in the form of a retainer which was not executed until the second half of 2003 and $27 thousand for expenses associated with the accounts receivable financing program due to increased balances financed in 2004 when compared to 2003.
Income Tax Provision:
The Corporation recorded an income tax provision of $398 thousand, or 23.5% of income, and $454 thousand, or 26.0% of income, for the quarters ended March 31, 2004 and 2003 respectively. The decrease in the effective income tax rate is due to increases in tax-exempt interest income from 2003 to 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Fed Funds rate has remained the same for the first quarter of 2004. Improving economic conditions indicate that the Federal Reserve will begin to increase overnight borrowing rates. The timing and magnitude of the increase(s) are unknown at the present time. As of March 31, 2004, the Bank is currently showing sensitivity to downward rate shift scenarios. The results of the latest financial simulation follow. The simulation shows a possible increase in net interest income of 4.55% or $574,000, in a +200 basis point rate shock scenario over a one-year period. A decrease of 6.39% or $806,000 is shown in the model at a –200 basis point rate shock. The net interest income risk position of the Bank remains within the guidelines established by the Bank’s asset/liability policy. The Bank continuously monitors its rate sensitivity.
Equity value at risk is monitored regularly and is also within established policy limits. Please refer to the Annual Report on Form 10-K filed with the Securities and Exchange Commission for December 31, 2003, for further discussion of this matter.
ITEM 4. CONTROLS AND PROCEDURES
PART II
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASE OF EQUITY SECURITIES
None.
ITEM 3. DEFAULTS IN SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS FOR SECURITY HOLDER VOTE
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PEOPLES FINANCIAL SERVICES CORP
EXHIBIT INDEX
Exhibit 31.1
CERTIFICATION
I, John W. Ord, certify that:
Date: __________________________________
Exhibit 31.2
I, Debra E. Dissinger, certify that:
Date: _____________________________
Exhibit 32.1
In connection with the Quarterly Report on Form 10-Q of Peoples Financial Services Corp. (the “Company”) for the period ended March 31, 2004, as filed with the Securities and Exchange Commission (the “Report”), I, John W. Ord, Chief Executive Officer and President, of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2. To my knowledge, the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report.
Date: _________________________________
Exhibit 32.2
In connection with the Quarterly Report on Form 10-Q of Peoples Financial Services Corp. (the “Company”) for the period ended March 31, 2004, as filed with the Securities and Exchange Commission (the “Report”), I, Debra E. Dissinger, Executive Vice President, of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that: