Peoples Financial Services - 10-Q quarterly report FY

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 nine month period ended September 30, 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, 20 03.

The following table sets forth the computation of basic and diluted earnings per share:

The components of other comprehensive income and related tax effects for the three months and nine months ended September 30, 2004 and 2003 are as follows:

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 in 2004 and 2003. 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 nine months and three months ended September 30, 2004 and 2003, would have been reduced to the pro forma amounts indicated below:

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 $1,737,000 of standby letters of credit as of September 30, 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 September 30, 2004 was $1,737,000 and the approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $951,000. The current amount of the liability as of September 30, 2004, for guarantees under standby letters of credit is not material.

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 is a member of the Federal Reserve System and subject to regulation, supervision, and examination by the Office of the Comptroller of the Currency.

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 looki ng 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 devel opments which could materially affect business and operations.

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.

Net income for the nine months ended September 30, 2004 decreased 13.6% to $3.607 million as compared to $4.175 million for the same period of 2003. Diluted earnings per share decreased 13.7% to $1.13 per share for the third quarter of 2004 from $1.31 per share in the third quarter of 2003. At September 30, 2004 the Company had total assets of $377.766 million, total net loans of $240.299 million, and total deposits of $280.353 million.

At September 30, 2004 cash, federal funds sold, and deposits with other banks totaled $5.882 million as compared to $6.056 million on December 31, 2003.

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 totaled $114.170 million on September 30, 2004, decreasing by $1.956 million over the December 31, 2003 total of $116.126 million. As loan demand increased in the third quarter of 2004, the investment portfolio and Fed Funds have retracted due to the simultaneous decrease in deposits in that same time 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 September 30, 2004 included an unrealized gain of $972 thousand reflected as accumulated other comprehensive income of $642 thousand in stockholders’ equity, net of deferred income taxes of $330 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.

Net loans increased $6.025 million or 2.57% to $240.299 million as of September 30, 2004 from $234.274 million as of December 31, 2003. Of the loan growth experienced in the first nine months of 2004, the most significant growth occurred in commercial loans. Commercial loans increased $4.581 million or 4.07% to $117.198 million as of September 30, 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 increased $2.597 million, or 41.91% to $8.793 million as of September 30, 2004 from $6.196 million as of December 31, 2003. The largest portion of the increase in other assets was due to the purchase of an additional Bank Owned Life Insurance policy in the amount of $2 million in June of 2004.

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 nine month period ended September 30, 2004, total deposits increased by $653 thousand or 0.23% to $280.353 million.

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 September 30, 2004 were $7.299 million as compared to $7.085 million as of December 31, 2003, an increase of $214 thousand or 3.02%. Long-term borrowings were $46.267 million as of September 30, 2004 compared to $41.952 million as of December 31, 2003, an increase of $4.315 million or 10.29%. The increase in long-term borrowings was due to the Bank borrowing an additional $5 million at the FHLB in a move to lock in at historically low long-term borrowing rates. This borrowing was completed in June of 2004.

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 September 30, 2004 regulatory capital to total assets was 10.14% 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 and stock purchase plan.

 

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 14.65% and the total capital ratio to risk weighted assets ratio was 15.69% at September 30, 2004. The Corporation is deemed to be well capitalized under regulatory standards.

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 contractual obligations to make future payments.

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 September 30, 2004, totaled $30.680 million, which consisted of $25.079 million in unfunded commitments of existing loans, $3.874 million to grant new loans and $1.737 million 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 opera tions and therefore, do not represent a significant liquidity risk to the Company.

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 s ome 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 September 30, 2004:

For the three months ended September 30, 2004 total interest income increased by $97 thousand, or 1.97% to $5.017 million as compared to $4.920 million for the three months ended September 30, 2003. This increase was primarily due to the increase in average earnings assets, as yields decreased to 5.51% as compared to 5.58% for the third quarter of 2003. Average earning assets increased to $362.086 million for the three months ended September 30, 2004 as compared to $349.546 million for the three months ended September 30, 2003.

For the nine months ended September 30, 2004 total interest income increased by $113 thousand, or 0.76% to $14.916 million as compared to $14.803 million for the nine months ended September 30, 2003. This was also due to the increase in earning assets as yields decreased to 5.55% for the first three quarters of 2004 as compared to 5.84% for the first three quarters of 2003. Average earning assets increased to $358.895 million for the nine months ended September 30, 2004 as compared to $338.837 million for the nine months ended September 30, 2003.

Total interest expense decreased by $84 thousand, or 4.49% to $1.785 million for the three months ended September 30, 2004 from $1.869 million for the three months ended September 30, 2003. This decrease was attributable to the decrease in the cost of funds, which decreased to 2.38 % as compared to 2.58 % for the third quarter of 2003. Average interest-bearing liabilities increased to $298.890 million for the three months ended September 30, 2004 as compared to $287.370 million for the three months ended September 30, 2003.

For the nine months ended September 30, 2004 total interest expense decreased by $446 thousand, or 7.76% to $5.305 million as compared to $5.751 million for the nine months ended September 30, 2003. Again, the decrease in the cost of funds to 2.39% for the first three quarters of 2004 as compared to 2.73% for the first three quarters of 2003 caused this decrease. Average interest bearing liabilities increased to $296.220 million for the first three quarters of 2004 compared to $282.015 million for the first three quarters of 2003.

Net interest income increased by $181 thousand, or 5.93%, to $3.232 million for the three months ended September 30, 2004 from $3.051 million for the three months ended September 30, 2003. The Bank’s net interest spread increased to 3.14% for the third quarter of 2004 from 3.00% for the third quarter of 2003. The net interest margin increased to 3.55% from 3.46% for the three month periods ended September 30, 2004 and 2003 respectively.

For the nine months ended September 30, 2004 net interest income increased $559 thousand, or 6.18% to $9.611 million as compared to $9.052 million for the nine months ended September 30, 2003. This increase is due to an increase in the volume of average earning assets and an increase in the net interest spread to 3.16% for the nine months ended September 30, 2004 compared to 3.11% for the nine months ended September 30, 2003. The net interest margin also increased to 3.58% from 3.57% for the nine month periods ended September 30, 2004 and 2003, respectively.

Below are the tables which set forth average balances and corresponding yields for both the three month and nine month periods ended September 30, 2004.

For the three month period ended September 30, 2004 the provision for loan loss increased by $90,000 or 150.00% to $150,000 as compared to $60,000 for the three months ended September 30, 2003. This increased provision was due to an increase in classified loans. 

The provision for loan loss for the nine months ended September 30, 2004 was $1,050,000, an increase of $870,000 or 483.33% from $180,000 for the same period in 2003. This increase was due to the provision for an impaired loan relationship recorded in May 2004. This increased provision was due to bankruptcy proceedings entered into by this commercial loan customer. 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 September 30, 2004, charge-offs totaled $29,000 while net charge-offs totaled $14,000 as compared to $20,000 and $1,000 respectively for the same three month period in 2003.

Charge-offs totaled $425,000 for the nine month period ended September 30, 2004 while net charge-offs totaled $393,000 as compared to charge-offs of $62,000 and net charge-offs of $26,000 for the comparable 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.

Total non-interest income was $773 thousand for the three months ended September 30, 2004, a decrease of $181 thousand, or 18.97% over the comparable period in 2003. This is due to a sharp decrease in gains on sales of available for sale securities. In September of 2003, the Bank sold a defaulted World Com bond at a gain of $180,000 for total gains on securities sales of $456 thousand for the third quarter of 2003.

Total non-interest income was $2.014 million for the nine month period ended September 30, 2004, a decrease of $100 thousand, or 4.73% as compared to $2.114 million for the same nine month period in 2003. Again, this difference between the two periods is primarily due to the securities gains previously discussed. Gains on security sales decreased $471 thousand to $181 thousand for the nine month period ended September 30, 2004 as compared to $652 thousand for the same period in 2003. Decreases in security gains in 2004 have been the product of interest rates, which have risen, thus eliminating some of the gain positions in the Bank’s investment portfolio.

Service charges and fees increased 16.12%, or $152 thousand to $1.095 million for the nine month period ended September 30, 2004 from $943 thousand for the nine month period ended September 30, 2003. The increase in service charges and fees income for the three month period and nine month period ended September 30, 2004 was due to the overdraft privilege program started by the Bank in June of 2004, which has increased overdraft fees.

Overdraft fees increased $77 thousand or 38.50% to $277 thousand for the three month period ended September 30, 2004 from $200 thousand for the same period in 2003.

Overdraft fees increased $150 thousand or 24.96% to $751 thousand for the nine month period ended September 30, 2004, from $601 thousand for the nine month period ended September 30, 2003.

Other income was $272 thousand for the three months ended September 30, 2004, from $189 thousand for the same period in 2003. This is an increase of $83 thousand, or 43.92%. Additional commission income from investment division activity of $71 thousand and premiums and fees earned through mortgage sales to the Federal Home Loan Bank of $22 thousand more than accounted for the quarter to date increase in 2004 when compared to 2003 at September 30. The addition of Licensed Bank Employees in the branch network in 2004 has increased the volume of investment sales and related commissions for the Company. The Licensed Bank Employees are licensed to sell life insurance products as well as fixed annuities.

Other income was $738 thousand for the nine month period ended September 30, 2004, an increase of $219 thousand, or 42.20% over the $519 thousand that was reported for this item for the nine month period ended September 30, 2003. Again, additional commission income from investment division activity of $219 thousand and premiums and fees earned through mortgage sales and servicing to the Federal Home Loan Bank of $47 thousand more than accounted for the year to date increases in other income as of September 30, 2004, when compared to the same period in 2003.

Total non-interest expenses increased 16.62%, or $291 thousand to $2.042 million during the three month period ended September 30, 2004 compared to $1.751 million for the comparable period in 2003.

Total other expenses increased 13.50%, or $720 thousand to $6.053 million for the nine month period ended September 30, 2004 as compared to total other expenses of $5.333 million for the nine month period ended September 30, 2003.

Salaries and benefits increased 15.89%, or $143 thousand to $1.043 million for the three month period ended September 30, 2004 compared to $900 thousand for the same period in 2003 due to normal pay increases and increased staff needs.

Salaries and benefits increased 10.05%, or $276 thousand to $3.023 million for the nine month period ended September 30, 2004 as compared to $2.747 million for the comparable period in 2003. The full-time equivalent number of employees was 101 as of September 30, 2004 compared to 96 as of September 30, 2003 due to the addition of staff for 2004, when compared to the same period in 2003.

Occupancy expenses decreased 3.57%, or $4 thousand to $108 thousand for the three month period ended September 30, 2004 compared to $112 thousand for the same period in 2003. Occupancy expenses increased 12.28%, or $41 thousand to $375 thousand for the nine month period ended September 30, 2004 as compared to $334 thousand for the same period in 2003. As with prior periods, the increase in occupancy expenses year-to-date as of September 30, 2004 were due to increased heating costs experienced during the winter months of 2004. Furniture and fixtures was $88 thousand for the third quarter of 2004 compared to $73 thousand for the third quarter of 2003, an increase of 20.55%. Furniture and fixtures expense increased 8.97%, or $20 thousand to $243 thousand for the nine month period ended September 30, 2004 as compar ed to $223 thousand for the nine month period ended September 30, 2003. This increase was due to the increase of depreciation expense during the third quarter of 2004 compared to the same period in 2003. The increased depreciation was on additional computer software and equipment in service for 2004.

All other operating expenses increased $137 thousand, or 20.57% to $803 thousand for the three months ended September 30, 2004 compared to $666 thousand for the same period in 2003. All other operating expense categories increased $383 thousand, or 18.88% to $2.412 million for the nine months ended September 30, 2004. This compares to $2.029 million for the comparable period in 2003. The increase was due in part to additional expenses incurred on foreclosed real estate in the amount of $139 thousand, increased expenditures for advertising in the amount of $21 thousand, additional legal and professional costs of $48 thousand, some of which were due to consulting work performed in connection with a new personal computer network and on-line teller system installed at the Bank’s branch offices, computer and pr oof maintenance costs associated with the personal computer network and on-line teller system (as well as additional software enhancements installed in 2004) in the amount of $27 thousand, and $40 thousand for expenses associated with the accounts receivable financing program due to increased balances financed in 2004 when compared to 2003.

The Fed Funds rate has been increased in 25 basis point increments three times in 2004. Improving economic conditions prompted the Federal Reserve to increase overnight borrowing rates by 25 basis points on June 30, 2004, August 10, 2004, and September 21, 2004. The timing and magnitude of future increases are unknown at the present time. As of September 30, 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 7.44% or $890,000 in a +200 basis point rate shock scenario over a one-year period. A decrease of 10.66% or $1,275,000 is shown in the model at a -200 basis point rate shock. The net interest income risk position of the Bank remains within the guidelin es 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.