10-Q 1 d332449d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

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 March 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission file number 000-23777

 

 

PENSECO FINANCIAL SERVICES CORPORATION

Incorporated pursuant to the laws of Pennsylvania

 

 

Internal Revenue Service — Employer Identification No. 23-2939222

150 North Washington Avenue, Scranton, Pennsylvania 18503-1848

(570) 346-7741

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The total number of shares of the registrant’s Common Stock, $0.01 par value, outstanding on May 1, 2012 was 3,276,079.

 

 

 


Table of Contents

PENSECO FINANCIAL SERVICES CORPORATION

 

          Page  

Part I — FINANCIAL INFORMATION

  

Item 1. Unaudited Financial Statements - Consolidated

  
  

Balance Sheets:

  
  

March 31, 2012

     3   
  

December 31, 2011

     3   
  

Statements of Income:

  
  

Three Months Ended March 31, 2012

     4   
  

Three Months Ended March 31, 2011

     4   
  

Statements of Comprehensive Income:

  
  

Three Months Ended March 31, 2012

     5   
  

Three Months Ended March 31, 2011

     5   
  

Statements of Changes in Stockholders’ Equity:

  
  

Three Months Ended March 31, 2012

     6   
  

Three Months Ended March 31, 2011

     6   
  

Statements of Cash Flows:

  
  

Three Months Ended March 31, 2012

     7   
  

Three Months Ended March 31, 2011

     7   
  

Notes to Unaudited Consolidated Financial Statements

     8   

Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     29   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     46   

Item 4. Controls and Procedures

     47   

Part II — OTHER INFORMATION

  

Item 1. Legal Proceedings

     47   

Item 1A. Risk Factors

     47   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     47   

Item 3. Defaults Upon Senior Securities

     47   

Item 4. Mine Safety Disclosures

     47   

Item 5. Other Information

     47   

Item 6. Exhibits

     47   

Signatures

     49   

 

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PART I. FINANCIAL INFORMATION, Item 1 — Financial Statements

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED BALANCE SHEETS

(unaudited)

(in thousands, except share and per share amounts)

 

     March 31,      December 31,  
     2012      2011  

ASSETS

     

Cash and due from banks

   $ 12,451       $ 13,184   

Interest bearing balances with banks

     14,648         21,296   

Federal funds sold

     —           —     
  

 

 

    

 

 

 

Cash and Cash Equivalents

     27,099         34,480   

Investment securities:

     

Available-for-sale, at fair value

     169,158         167,486   

Held-to-maturity (fair value of $22,910 and $24,969, respectively)

     21,819         23,722   
  

 

 

    

 

 

 

Total Investment Securities

     190,977         191,208   

Loans, net of unearned income

     637,328         631,522   

Less: Allowance for loan and lease losses

     6,811         6,711   
  

 

 

    

 

 

 

Loans, Net

     630,517         624,811   

Bank premises and equipment

     13,842         13,095   

Other real estate owned

     1,786         1,571   

Accrued interest receivable

     3,177         3,252   

Goodwill

     26,398         26,398   

Bank owned life insurance

     17,229         15,870   

Federal Home Loan Bank stock

     5,545         4,953   

Other assets

     9,552         9,036   
  

 

 

    

 

 

 

Total Assets

   $ 926,122       $ 924,674   
  

 

 

    

 

 

 

LIABILITIES

     

Deposits:

     

Non-interest bearing

   $ 140,982       $ 134,799   

Interest bearing

     583,947         585,719   
  

 

 

    

 

 

 

Total Deposits

     724,929         720,518   

Other borrowed funds:

     

Securities sold under agreements to repurchase

     10,069         9,981   

Short-term borrowings

     —           —     

Long-term borrowings

     54,016         58,220   

Accrued interest payable

     875         1,010   

Other liabilities

     5,765         5,945   
  

 

 

    

 

 

 

Total Liabilities

     795,654         795,674   
  

 

 

    

 

 

 

STOCKHOLDERS’ EQUITY

     

Common stock; $ .01 par value, 15,000,000 shares authorized, 3,276,079 shares issued and outstanding

     33         33   

Surplus

     48,865         48,865   

Retained earnings

     80,901         79,505   

Accumulated other comprehensive income

     669         597   
  

 

 

    

 

 

 

Total Stockholders’ Equity

     130,468         129,000   
  

 

 

    

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 926,122       $ 924,674   
  

 

 

    

 

 

 

(See accompanying Notes to Unaudited Consolidated Financial Statements)

 

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PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except share and per share amounts)

 

     Three Months Ended
March 31, 2012
     Three Months Ended
March 31, 2011
 

INTEREST INCOME

     

Interest and fees on loans

   $ 8,287       $ 8,342   

Interest and dividends on investments:

     

U.S. Treasury securities and U.S. Agency obligations

     639         815   

States & political subdivisions

     715         867   

Other securities

     16         14   

Interest on Federal funds sold

     —           —     

Interest on balances with banks

     2         2   
  

 

 

    

 

 

 

Total Interest Income

     9,659         10,040   
  

 

 

    

 

 

 

INTEREST EXPENSE

     

Interest on time deposits of $100,000 or more

     312         370   

Interest on other deposits

     644         892   

Interest on other borrowed funds

     525         635   
  

 

 

    

 

 

 

Total Interest Expense

     1,481         1,897   
  

 

 

    

 

 

 

Net Interest Income

     8,178         8,143   

Provision for loan and lease losses

     192         369   
  

 

 

    

 

 

 

Net Interest Income After Provision for Loan and Lease Losses

     7,986         7,774   
  

 

 

    

 

 

 

NON-INTEREST INCOME

     

Trust department income

     362         398   

Service charges on deposit accounts

     459         472   

Merchant transaction income

     1,207         1,242   

Brokerage fee income

     57         56   

Other fee income

     403         378   

Bank-owned life insurance income

     118         120   

Other operating income

     250         630   

Impairment losses on investment securities

     —           —     

Realized gains (losses) on securities, net

     47         8   
  

 

 

    

 

 

 

Total Non-Interest Income

     2,903         3,304   
  

 

 

    

 

 

 

NON-INTEREST EXPENSES

     

Salaries and employee benefits

     3,651         3,525   

Expense of premises and equipment, net

     837         1,021   

Merchant transaction expenses

     731         833   

FDIC insurance assessments

     110         242   

Other operating expenses

     1,948         1,829   
  

 

 

    

 

 

 

Total Non-Interest Expenses

     7,277         7,450   
  

 

 

    

 

 

 

Income before income taxes

     3,612         3,628   

Applicable income taxes

     840         859   
  

 

 

    

 

 

 

Net Income

   $ 2,772       $ 2,769   
  

 

 

    

 

 

 

Earnings per Common Share

     

(Based on weighted average shares outstanding of 3,276,079)

   $ 0.85       $ 0.85   

Cash Dividends Declared Per Common Share

   $ 0.42       $ 0.42   

(See accompanying Notes to Unaudited Consolidated Financial Statements)

 

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PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(in thousands)

 

     Three Months Ended
March 31, 2012
     Three Months Ended
March 31, 2011
 

Net Income

   $ 2,772       $ 2,769   
  

 

 

    

 

 

 

Other comprehensive income, net of tax:

     

Unrealized gains (losses) on securities:

     

Unrealized holding gains (losses) arising during the period

     103         (35

Less: reclassification adjustment for gains included in net income

     31         5   
  

 

 

    

 

 

 

Other comprehensive income (loss)

     72         (40
  

 

 

    

 

 

 

Comprehensive Income

   $ 2,844       $ 2,729   
  

 

 

    

 

 

 

(See accompanying Notes to Unaudited Consolidated Financial Statements)

 

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PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED MARCH 31, 2012 AND 2011

(unaudited)

(in thousands, except per share amounts)

 

     Common
Stock
     Surplus      Retained
Earnings
    Accumulated Other
Comprehensive
Income
    Total
Stockholders’
Equity
 

Balance, December 31, 2010

   $ 33       $ 48,865       $ 74,304      $ (1,280   $ 121,922   

Net income

     —           —           2,769        —          2,769   

Other comprehensive income (loss)

             (40     (40

Cash dividends declared ($0.42 per share)

     —           —           (1,376     —          (1,376
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, March 31, 2011

   $ 33       $ 48,865       $ 75,697      $ (1,320   $ 123,275   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, December 31, 2011

   $ 33       $ 48,865       $ 79,505      $ 597      $ 129,000   

Net income

     —           —           2,772        —          2,772   

Other comprehensive income (loss)

             72        72   

Cash dividends declared ($0.42 per share)

     —           —           (1,376     —          (1,376
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, March 31, 2012

   $ 33       $ 48,865       $ 80,901      $ 669      $ 130,468   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

(See accompanying Notes to Unaudited Consolidated Financial Statements)

 

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PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

     Three Months Ended
March 31, 2012
    Three Months Ended
March 31, 2011
 

OPERATING ACTIVITIES

    

Net Income

   $ 2,772      $ 2,769   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     239        283   

Provision for loan and lease losses

     192        369   

Deferred income tax provision (benefit)

     51        72   

Amortization of securities, (net of accretion)

     60        121   

Net realized (gains) losses on securities

     (47     (8

(Gain) loss on other real estate

     (27     —     

Decrease (increase) in interest receivable

     75        387   

(Increase) decrease in bank owned life insurance

     (117     (120

(Increase) decrease in other assets

     (567     (297

Increase (decrease) in income taxes payable

     789        859   

(Decrease) increase in interest payable

     (135     (22

(Decrease) increase in other liabilities

     (888     (1,341
  

 

 

   

 

 

 

Net cash provided (used) by operating activities

     2,397        3,072   
  

 

 

   

 

 

 

INVESTING ACTIVITIES

    

Purchase of investment securities available-for-sale

     (7,241     (5,255

Purchase of investment securities to be held-to-maturity

     —          —     

Proceeds from investment securities available-for-sale

     4,210        7,541   

Proceeds from repayments of investment securities available-for-sale

     1,469        711   

Proceeds from repayments of investment securities held-to-maturity

     1,888        5,004   

Net loans (originated) repaid

     (6,430     3,889   

Proceeds from other real estate

     227        —     

Investment in premises and equipment

     (986     (268

Purchase of bank owned life insurance

     (1,242     —     

Purchase of Federal Home Loan Bank stock

     (840     —     

Proceeds from Federal Home Loan Bank share buyback

     248        304   
  

 

 

   

 

 

 

Net cash provided (used) by investing activities

     (8,697     11,926   
  

 

 

   

 

 

 

FINANCING ACTIVITIES

    

Net increase (decrease) in demand and savings deposits

     10,210        9,376   

Net (payments) proceeds on time deposits

     (5,799     73   

Increase (decrease) in securities sold under agreements to repurchase

     88        548   

Net (decrease) increase in short-term borrowings

     —          (8,180

Increase in long-term borrowings

     —          —     

Payments on long-term borrowings

     (4,204     (4,124

Cash dividends paid

     (1,376     (1,376
  

 

 

   

 

 

 

Net cash (used) provided by financing activities

     (1,081     (3,683
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (7,381     11,315   

Cash and cash equivalents at January 1

     34,480        14,219   
  

 

 

   

 

 

 

Cash and cash equivalents at March 31

   $ 27,099      $ 25,534   
  

 

 

   

 

 

 

The Company paid interest and income taxes of $1,616 and $0 and $1,919 and $200 for the three months ended March 31, 2012 and 2011, respectively.

(See accompanying Notes to Unaudited Consolidated Financial Statements)

 

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2012

(unaudited)

These Notes to Unaudited Consolidated Financial Statements reflect events subsequent to December 31, 2011, through the date of this Quarterly Report on Form 10-Q. These Notes to Unaudited Consolidated Financial Statements should be read in conjunction with Parts I and II of this Report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission (SEC) on March 14, 2012.

NOTE 1 — Principles of Consolidation

Penseco Financial Services Corporation (Company) is a financial holding company incorporated under the laws of Pennsylvania. It is the parent company of Penn Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.

The Financial Statements of the Company have been consolidated with those of the Bank and its subsidiaries, eliminating all intercompany items and transactions.

The accounting policies of the Company conform with accounting principles generally accepted in the United States of America (GAAP) and with general practices within the banking industry.

NOTE 2 — Basis of Presentation

The unaudited consolidated financial statements have been prepared in accordance with applicable rules and regulations of the Securities and Exchange Commission (SEC), the instructions to SEC Form 10-Q and GAAP for interim financial information. In the opinion of management, all adjustments that are of a normal recurring nature and are considered necessary for a fair presentation have been included. The unaudited consolidated financial statements, as so adjusted, are not, however, necessarily indicative of the results of consolidated operations for a full year or any other period.

All information is presented in thousands of dollars, except per share amounts.

For further information, refer to the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

NOTE 3 — Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses and the valuation of property that is included in “other real estate owned” on our consolidated balance sheet and that was acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and lease losses and valuation of other real estate owned, management obtains independent appraisals for significant properties.

NOTE 4 — Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

NOTE 5 — Investment Securities

Investments in securities are classified in two categories and accounted for as follows:

Securities Held-to-Maturity – Bonds, notes, debentures and mortgage-backed securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts computed on the straight-line basis, which approximates the interest method, over the remaining period to maturity.

Securities Available-for-Sale – Bonds, notes, debentures, mortgage-backed securities not classified as securities to be held to maturity and certain equity securities are classified as available-for-sale and carried at fair value with unrealized holding gains and losses, net of tax, reported as a net amount in a separate component of stockholders’ equity until realized.

 

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The amortization of premiums on mortgage-backed securities is done based on management’s estimate of the lives of the securities, adjusted, when necessary, for advanced prepayments in excess of those estimates.

Realized gains and losses on the sale of securities available-for-sale are determined using the specific identification method and are reported as a separate component of other income in the Statements of Income. Unrealized gains and losses are included as a separate item in computing comprehensive income.

Investment securities are evaluated periodically to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

The amortized cost and fair value of investment securities at March 31, 2012 and December 31, 2011 are as follows:

Available-for-Sale

 

March 31, 2012

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

U.S. Agency securities

   $ 77,118       $ 803       $ 8       $ 77,913   

Mortgage-backed securities

     27,027         879         27         27,879   

States & political subdivisions

     58,246         4,060         1         62,305   

Corporate securities

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Debt Securities

     162,391         5,742         36         168,097   

Equity securities

     709         363         11         1,061   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Available-for-Sale

   $ 163,100       $ 6,105       $ 47       $ 169,158   
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

 

December 31, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

U.S. Agency securities

   $ 77,150       $ 847       $ 12       $ 77,985   

Mortgage-backed securities

     21,270         896         —           22,166   

States & political subdivisions

     61,405         3,987         4         65,388   

Corporate securities

     1,002         2         —           1,004   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Debt Securities

     160,827         5,732         16         166,543   

Equity securities

     709         288         54         943   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Available-for-Sale

   $ 161,536       $ 6,020       $ 70       $ 167,486   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-Maturity

 

March 31, 2012

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Mortgage-backed securities

   $ 20,008       $ 1,056       $ —         $ 21,064   

States & political subdivisions

     1,811         35         —           1,846   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Held-to-Maturity

   $ 21,819       $ 1,091       $ —         $ 22,910   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Held-to-Maturity

 

December 31, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Mortgage-backed securities

   $ 21,912       $ 1,207       $ —         $ 23,119   

States & political subdivisions

     1,810         40         —           1,850   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Held-to-Maturity

   $ 23,722       $ 1,247       $ —         $ 24,969   
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities at March 31, 2012 and December 31, 2011 consisted primarily of common stock of companies in the financial services industry.

A summary of transactions involving available-for-sale debt securities for the three months ended March 31, 2012 and 2011 are as follows:

 

     March 31,      March 31,  
     2012      2011  

Proceeds from sales

   $ —         $ —     

Gross realized gains

     —           —     

Gross realized losses

     —           —     

The amortized cost and fair value of debt securities at March 31, 2012 by contractual maturity are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

March 31, 2012

   Available-for-Sale      Held-to-Maturity  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Due in one year or less:

           

U.S. Agency securities

   $ 14,023       $ 14,141       $ —         $ —     

After one year through five years:

           

U.S. Agency securities

     63,095         63,772         —           —     

States & political subdivisions

     379         387         —           —     

After five years through ten years:

           

States & political subdivisions

     3,727         3,874         1,811         1,846   

After ten years:

           

States & political subdivisions

     54,140         58,044         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     135,364         140,218         1,811         1,846   

Mortgage-backed securities

     27,027         27,879         20,008         21,064   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Debt Securities

   $ 162,391       $ 168,097       $ 21,819       $ 22,910   
  

 

 

    

 

 

    

 

 

    

 

 

 

The gross fair value and unrealized losses of the Company’s investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2012 and December 31, 2011 are as follows:

 

     Less than twelve months      Twelve months or more      Totals  

March 31, 2012

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

U.S. Agency securities

   $ 3,005       $ 8       $ —         $ —         $ 3,005       $ 8   

Mortgage-backed securities

     7,165         27         —           —           7,165         27   

States & political subdivisions

     493         1         —           —           493         1   

Equities

     —           —           89         11         89         11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 10,663       $ 36       $ 89       $ 11       $ 10,752       $ 47   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

10


Table of Contents
     Less than twelve months      Twelve months or more      Totals  

December 31, 2011

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

U.S. Agency securities

   $ 13,001       $ 12       $ —         $ —         $ 13,001       $ 12   

States & political subdivisions

     489         4         —           —           489         4   

Equities

     136         29         100         25         236         54   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 13,626       $ 45       $ 100       $ 25       $ 13,726       $ 70   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2012, three securities had unrealized losses for less than twelve months and two securities had been in an unrealized loss position for twelve or more months. At December 31, 2011, ten securities had unrealized losses for less than twelve months and five securities had been in an unrealized loss position for twelve or more months.

U.S. Agency Securities

The unrealized losses on the Company’s investments in U.S. Agency securities were caused by interest rate fluctuations and not credit quality. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.

Mortgage-backed Securities

The unrealized losses on the Company’s investments in mortgage-backed securities were caused by interest rate fluctuations and not credit quality. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that these securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.

States and Political Subdivisions

The unrealized losses on the Company’s investments in states and political subdivisions were caused by interest rate fluctuations and not credit quality. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.

Marketable Equity Securities

The unrealized losses on the Company’s investments in marketable equity securities were caused by interest rate fluctuations and general market conditions. The Company’s investments in marketable equity securities consist primarily of investments in common stock of companies in the financial services industry. The Company has analyzed its equity portfolio and determined that the market value fluctuation in these equity securities is not a cause for recognition of a current loss. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their cost bases, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.

 

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NOTE 6 — Loan Portfolio

Details regarding the Company’s loan portfolio during the periods indicated are as follows:

 

As of:

   March 31,
2012
     December 31,
2011
 

Loans secured by real estate:

     

Construction and land development

     

Residential real estate

   $ 5,305       $ 5,064   

Commercial real estate

     20,339         20,541   

Secured by 1-4 family residential properties:

     

Revolving, open-end loans

     30,198         30,897   

Secured by first liens

     205,295         214,198   

Secured by junior liens

     20,772         21,858   

Secured by multi-family properties

     9,448         9,626   

Secured by non-farm, non-residential properties

     186,027         188,334   

Commercial and industrial loans to U.S. addressees

     60,129         55,482   

Loans to individuals for household, family and other personal expenditures:

     

Credit card and related plans

     3,025         3,242   

Other (installment and student loans, etc.)

     49,188         49,574   

Obligations of states & political subdivisions

     38,287         23,110   

All other loans

     9,315         9,596   
  

 

 

    

 

 

 

Gross Loans

     637,328         631,522   

Less: Unearned income on loans

     —           —     
  

 

 

    

 

 

 

Loans, net of unearned income

   $ 637,328       $ 631,522   
  

 

 

    

 

 

 

The Company has not engaged in any sub-prime residential mortgage lending. Therefore, the Company is not subject to any credit risks associated with such loans. The Company’s loan portfolio consists primarily of residential and commercial mortgage loans secured by properties located in Northeastern Pennsylvania and subject to what the Company believes are conservative underwriting standards.

Age Analysis of Past Due Loans

As of March 31, 2012

 

     30-59
Days
Past Due
     60-89
Days
Past Due
     Greater
Than 90
Days
     Total
Past Due
     Current      Total Loans      Recorded
Investment
> 90 Days
and
Accruing
 

Commercial

   $ 3       $ —         $ 427       $ 430       $ 107,301       $ 107,731       $ —     

Commercial real estate:

                    

Commercial real estate - construction

     —           —           —           —           20,339         20,339         —     

Commercial real estate - other

     746         —           348         1,094         184,933         186,027         —     

Consumer:

                    

Consumer - credit card

     15         10         13         38         2,987         3,025         13   

Consumer - other

     36         —           10         46         5,094         5,140         —     

Consumer - auto

     116         23         18         157         29,928         30,085         2   

Student loans - TERI

     63         5         33         101         6,618         6,719         —     

Student loans - other

     93         39         209         341         6,903         7,244         209   

Residential:

                    

Residential - prime

     3,179         532         2,383         6,094         264,924         271,018         774   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,251       $ 609       $ 3,441       $ 8,301       $ 629,027       $ 637,328       $ 998   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Age Analysis of Past Due Loans

As of December 31, 2011

 

     30-59
Days
Past Due
     60-89
Days
Past Due
     Greater
Than 90
Days
     Total
Past Due
     Current      Total Loans      Recorded
Investment
> 90 Days
and
Accruing
 

Commercial

   $ 23       $ —         $ 477       $ 500       $ 87,688       $ 88,188       $ —     

Commercial real estate:

                    

Commercial real estate construction

     —           —           —           —           20,541         20,541         —     

Commercial real estate - other

     331         —           602         933         187,401         188,334         11   

Consumer:

                    

Consumer - credit card

     34         11         6         51         3,191         3,242         6   

Consumer - other

     28         —           10         38         6,825         6,863         —     

Consumer - auto

     156         5         24         185         29,889         30,074         3   

Student loans - TERI

     14         62         61         137         6,117         6,254         —     

Student loans - other

     243         103         113         459         5,924         6,383         113   

Residential:

                    

Residential - prime

     2,429         1,155         2,647         6,231         275,412         281,643         641   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,258       $ 1,336       $ 3,940       $ 8,534       $ 622,988       $ 631,522       $ 774   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks certain credit quality indicators, including trends related to loan delinquency, the level of classified commercial loans, net charge-offs, non-performing loans (see details above) and the general economic conditions in the Company’s market area.

The Bank utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 8. A description of the general characteristics of the 8 risk grades is as follows:

Pass 1 (Minimal Risk)

This classification includes loans which are fully secured by liquid collateral or loans to very high quality borrowers who demonstrate exceptional credit fundamentals, including stable and predictable profit margins and cash flows, strong liquidity, a conservative balance sheet, superior asset quality and good management with an excellent track record.

Pass 2 (Average Risk)

This classification includes loans which have no identifiable risk of collection and conform in all aspects to the Bank’s policies and procedures as well as federal and state regulations. Documentation exceptions are minimal, in the process of correction and not of a type that could subsequently introduce loan loss risk.

Pass 3 (Acceptable Risk)

This classification includes loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Pass 2 in terms of secondary sources of repayment or lesser stature in other key credit metrics in that they may be over-leveraged, undercapitalized, inconsistent in performance or in an industry that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy.

Pass 4 (Watch List)

This classification is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term. It is assigned to loans where, for example, the financial condition of the company has taken a negative turn and may be temporarily strained; borrowers may exhibit excessive growth, declining earnings, strained cash flow, increasing leverage and/or weakening market position that indicate above-average risk. Interim losses and/or adverse trends may occur (but not to the level that would affect the Bank’s position) and cash flow may be weak but minimally acceptable.

Criticized 5 (Other Assets Especially Mentioned)

This classification is also intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.

 

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Table of Contents

Classified 6 (Substandard)

This classification includes loans with well-defined weaknesses that are inadequately protected by current net worth, repayment capacity or pledged collateral of the borrower. Loans are substandard when they have one or more weaknesses that could jeopardize debt repayment and/or liquidation, primarily resulting in the possibility that the Bank may sustain some loss if the deficiencies are not corrected.

Classified 7 (Doubtful)

This classification includes loans that have all weaknesses inherent in the substandard category and where collection or liquidation in full is highly improbable. The possibility of loss is high, but because of certain important and reasonably specific pending factors, its classification as an estimated loss is deferred until its more exact status may be determined.

Classified 8 (Loss)

This classification includes loans considered uncollectible and of such little value that continuance as bankable assets is not warranted and, therefore, should be charged-off. This classification does not mean that the loans have absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these assets even though partial recovery may occur in the future.

Credit Quality Indicators as of March 31, 2012

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category

 

     Commercial      Commercial
Real Estate -
Construction
     Commercial
Real Estate -
Other
 

Pass / Watch

   $ 104,040       $ 15,747       $ 174,254   

Criticized

     2,724         4,592         4,406   

Substandard

     967         —           7,367   
  

 

 

    

 

 

    

 

 

 

Total

   $ 107,731       $ 20,339       $ 186,027   
  

 

 

    

 

 

    

 

 

 

Consumer Credit Exposure

Credit Risk Profile by Payment Activity

 

     Residential
Real Estate
     Consumer -
Credit Card
     Consumer -
Other
     Consumer -
Auto
     Student
Loans -
TERI
     Student
Loans -
Other
 

Performing

   $ 269,409       $ 3,025       $ 5,130       $ 30,069       $ 6,686       $ 7,244   

Non-performing

     1,609         —           10         16         33         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 271,018       $ 3,025       $ 5,140       $ 30,085       $ 6,719       $ 7,244   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-performing loans are those past due 90 days or more and not accruing.

Credit Quality Indicators as of December 31, 2011

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category

 

     Commercial      Commercial
Real Estate -
Construction
     Commercial
Real Estate -
Other
 

Pass / Watch

   $ 84,431       $ 18,036       $ 172,072   

Criticized

     2,790         2,505         7,811   

Substandard

     967         —           8,451   
  

 

 

    

 

 

    

 

 

 

Total

   $ 88,188       $ 20,541       $ 188,334   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Consumer Credit Exposure

Credit Risk Profile by Payment Activity

 

     Residential
Real Estate
     Consumer -
Credit Card
     Consumer -
Other
     Consumer -
Auto
     Student
Loans -
TERI
     Student
Loans -
Other
 

Performing

   $ 278,996       $ 3,236       $ 6,853       $ 30,050       $ 6,193       $ 6,270   

Non-performing

     2,647         6         10         24         61         113   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 281,643       $ 3,242       $ 6,863       $ 30,074       $ 6,254       $ 6,383   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Impaired Loans

March 31, 2012

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Commercial real estate

   $ 145       $ 145       $ —         $ 368       $ —     

Commercial

     34         34         —           17         —     

Consumer - TERI

     33         33         —           47         —     

Consumer - other

     10         10         —           10         —     

Consumer - auto

     16         16         —           18         —     

Residential real estate

     971         971         —           888         —     

With an allowance recorded:

              

Commercial real estate - construction

     —           —           —           —           —     

Commercial real estate - other

     2,640         2,640         500         1,320         16   

Commercial

     756         756         413         800         4   

Residential real estate

     638         638         215         919         21   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

   $ 5,243       $ 5,243       $ 1,128       $ 4,387       $ 41   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commercial real estate

   $ 2,785       $ 2,785       $ 500       $ 1,688       $ 16   

Commercial

   $ 790       $ 790       $ 413       $ 817       $ 4   

Consumer

   $ 59       $ 59       $ —         $ 75       $ —     

Residential real estate

   $ 1,609       $ 1,609       $ 215       $ 1,807       $ 21   

 

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Table of Contents

Impaired Loans

December 31, 2011

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Commercial real estate

   $ 591       $ 591       $ —         $ 390       $ —     

Commercial

     —           —           —           —           —     

Consumer - TERI

     61         61         —           65         —     

Consumer - other

     10         10         —           10         —     

Consumer - auto

     21         21         —           32         —     

Residential real estate

     806         806         —           1,081         —     

With an allowance recorded:

              

Commercial real estate - construction

     —           —           —           —           —     

Commercial real estate - other

     —           —           —           —           —     

Commercial

     845         845         443         1,000         28   

Residential real estate

     1,200         1,200         215         1,057         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

   $ 3,534       $ 3,534       $ 658       $ 3,635       $ 28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commercial real estate

   $ 591       $ 591       $ —         $ 390       $ —     

Commercial

   $ 845       $ 845       $ 443       $ 1,000       $ 28   

Consumer

   $ 92       $ 92       $ —         $ 107       $ —     

Residential real estate

   $ 2,006       $ 2,006       $ 215       $ 2,138       $ —     

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest income is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured with the minimum of a six month positive payment history.

Period-end non-accrual loans, segregated by class of loans, were as follows:

 

     March 31,
2012
     December 31,
2011
 

Commercial

   $ 427       $ 477   

Commercial real estate:

     

Commercial real estate - construction

     —           —     

Commercial real estate - other

     348         591   

Consumer:

     

Student loans - TERI

     33         61   

Student loans - other

     —           —     

Consumer - other

     10         10   

Consumer - auto

     16         21   

Residential:

     

Residential real estate

     1,609         2,006   
  

 

 

    

 

 

 

Total

   $ 2,443       $ 3,166   
  

 

 

    

 

 

 

 

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Table of Contents

The Allowance for Loan and Lease Losses and Recorded Investment in Loans for the three months ended March 31, 2012 is as follows:

 

     Commercial     Commercial
Real Estate
    Consumer     Residential      Credit Card     Unallocated      Total  

Allowance for Loan and Lease Losses:

                

Beginning balance 12/31/11

   $ 793      $ 2,294      $ 450      $ 2,855       $ 319      $ —         $ 6,711   

Charge-offs

     (5     (33     (55     —           (8     —           (101

Recoveries

     —          5        3        1         —          —           9   

Provision

     8        64        103        1         16        —           192   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance 03/31/12

   $ 796      $ 2,330      $ 501      $ 2,857       $ 327      $ —         $ 6,811   

Ending balance: Individually evaluated for impairment

     413        500        —          215         —          —           1,128   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance: Collectively evaluated for impairment

   $ 383      $ 1,830      $ 501      $ 2,642       $ 327      $ —         $ 5,683   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance: Loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —         $ —        $ —         $ —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Loans:

                

Ending balance

   $ 107,731      $ 206,366      $ 49,188      $ 271,018       $ 3,025      $ —         $ 637,328   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance: Individually evaluated for impairment

     790        2,785        59        1,609         —          —           5,243   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance: Collectively evaluated for impairment

   $ 106,941      $ 203,581      $ 49,129      $ 269,409       $ 3,025      $ —         $ 632,085   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance: Loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —         $ —        $ —         $ —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Allowance for Loan and Lease Losses and Recorded Investment in Loans for the year ended December 31, 2011 is as follows:

 

     Commercial     Commercial
Real Estate
    Consumer     Residential     Credit Card     Unallocated      Total  

Allowance for Loan and Lease Losses:

               

Beginning balance 12/31/10

   $ 1,957      $ 2,067      $ 1,380      $ 753      $ 343      $ —         $ 6,500   

Charge-offs

     (100     (663     (153     (1,275     (109     —           (2,300

Recoveries

     3        18        45        58        6        —           130   

Provision

     (1,067     872        (822     3,319        79        —           2,381   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance 12/31/11

   $ 793      $ 2,294      $ 450      $ 2,855      $ 319      $ —         $ 6,711   

Ending balance: Individually evaluated for impairment

     443        —          —          215        —          —           658   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance: Collectively evaluated for impairment

   $ 350      $ 2,294      $ 450      $ 2,640      $ 319      $ —         $ 6,053   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance: Loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —        $ —        $ —         $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Loans:

               

Ending balance

   $ 88,188      $ 208,875      $ 49,574      $ 281,643      $ 3,242      $ —         $ 631,522   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance: Individually evaluated for impairment

     845        591        92        2,006        —          —           3,534   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance: Collectively evaluated for impairment

   $ 87,343      $ 208,284      $ 49,482      $ 279,637      $ 3,242      $ —         $ 627,988   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance: Loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —        $ —        $ —         $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents

The Company had one commercial loan whose terms had been modified in a troubled debt restructuring as of March 31, 2012 and December 31, 2011; monthly payments were lowered to accommodate the borrower’s financial needs for a period of time.

Modification

March 31, 2012

 

     Number of
Contracts
   Pre-Modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding Recorded
Investment
 

Troubled Debt Restructurings Commercial

   1    $ 808       $ 363   

There were no troubled debt restructurings that subsequently defaulted during the three months ended March 31, 2012.

Modification

December 31, 2011

 

     Number of
Contracts
   Pre-Modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding Recorded
Investment
 

Troubled Debt Restructurings Commercial

   1    $ 808       $ 368   

The loan above, classified as a Troubled Debt Restructuring (TDR), was charged down during 2010 to a balance of $401 and the entire pre-modification balance was split into two notes. The customer is currently paying principal and interest on one note and interest only on the other note. Nonetheless, the loan is fully reserved based on management’s evaluation of both the customer’s ability to maintain its cash flow and the value of the underlying collateral.

NOTE 7 — Loan Servicing

The Company generally retains the right to service mortgage loans sold to third parties. The cost allocated to the mortgage servicing rights retained has been recognized as a separate asset within other assets and is amortized in proportion to and over the period of estimated net servicing income.

Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest and expected future prepayment rates. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized mortgage servicing rights based on the product type, interest rate and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed the fair value.

NOTE 8 — Goodwill

Goodwill represents the excess of the purchase price over the underlying fair value of merged entities. Goodwill is assessed for impairment at least annually and as triggering events occur. In making this assessment, management considers a number of factors including, but not limited to, operating results, business plans, economic projections, anticipated future cash flows, and current market data. There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of goodwill impairment. Changes in economic and operating conditions, as well as other factors, could result in goodwill impairment in future periods.

 

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Table of Contents

NOTE 9 — Other Intangible Assets

Intangible assets include the premium assigned to the core deposit relationships acquired in connection with our acquisition of Old Forge Bank in 2009. The core deposit intangible is being amortized over ten years from the date of acquisition on a sum-of-the-years-digits basis. Amortization expense is expected to be as follows:

 

March 31,

      

2013

   $ 258   

2014

     221   

2015

     184   

2016

     147   

2017

     111   

Thereafter

     111   
  

 

 

 

Total

   $ 1,032   
  

 

 

 

NOTE 10 — Long-Term Debt

The Company has established credit facilities with the Federal Home Loan Bank of Pittsburgh, which are secured by all of the Company’s assets. Additionally, in connection the credit facilities, the Company has agreed to maintain sufficient qualifying collateral to fully secure the borrowings below.

A summary of long-term debt, including amortizing principal and interest payments, at March 31, 2012 is as follows:

 

Monthly Installment

   Fixed Rate     Maturity Date      Balance  

Amortizing loans

       

$  29

     1.84     08/28/12       $ 142   

    90

     3.10     02/28/13         976   

  430

     3.74     03/13/13         5,058   

    18

     2.66     08/28/14         500   

    67

     3.44     03/02/15         2,230   

    13

     3.48     03/31/15         458   

    10

     3.83     04/02/18         653   

  186

     4.69     03/13/23         19,199   
       

 

 

 

Total amortizing

          29,216   
       

 

 

 

Non-amortizing loans

       
     3.49     02/28/13         7,000   
     2.89     11/28/14         2,000   
     2.58     05/18/15         6,300   
     3.32     11/27/15         3,000   
     2.36     09/22/17         6,500   
       

 

 

 

Total non-amortizing

          24,800   
       

 

 

 

Total long-term debt

        $ 54,016   
       

 

 

 

Aggregate maturities of long-term debt at March 31, 2012 are as follows:

 

March 31,

   Principal  

2013

   $ 15,729   

2014

     2,659   

2015

     4,577   

2016

     10,981   

2017

     1,761   

Thereafter

     18,309   
  

 

 

 

Total

   $ 54,016   
  

 

 

 

 

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Table of Contents

NOTE 11 — Employee Benefit Plans

The Company provides an Employee Stock Ownership Plan (ESOP), a Retirement Profit Sharing 401(k) Plan, an Employees’ Pension Plan, unfunded supplemental executive defined benefit and defined contribution plans, a Postretirement Life Insurance Plan, a Stock Appreciation Rights Plan (SAR), and a Long-Term Incentive Plan.

The components of the net periodic benefit cost are as follows:

 

     Pension Benefits     Other Benefits  

Three months ended March 31,

   2012     2011     2012      2011  

Service cost

   $ —        $ —        $ 2       $ 2   

Interest cost

     168        175        6         6   

Expected return on plan assets

     (202     (226     —           —     

Amortization of prior service cost

     —          —          —           2   

Amortization of net loss (gain)

     34        21        1         —     
  

 

 

   

 

 

   

 

 

    

 

 

 

Net periodic pension cost

   $ —        $ (30   $ 9       $ 10   
  

 

 

   

 

 

   

 

 

    

 

 

 

The Company previously disclosed in the financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2011 that it expected to contribute $350 to its pension plan in 2012. As of March 31, 2012, the Company expects to contribute $363 to its pension plan and $36 to its post-retirement plan during 2012. Readers should refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for further details on the Company’s defined benefit pension plan.

The Company sponsors a 401(k) profit sharing plan for all eligible employees. The Company’s profit sharing expense for the three months ended March 31, 2012 and 2011 was $119 and $108, respectively.

The Company granted restricted stock awards during the three months ended March 31, 2012 and 2011 valued at $0 and $55, respectively.

NOTE 12 — Comprehensive Income

Changes in each component of accumulated other comprehensive income for the three months ended March 31, 2012 and 2011 were as follows:

 

     Unrealized
Gains on
Investment
Securities
    Defined
Benefit
Pension
Plans
    Total  

Balance, December 31, 2011

   $ 3,927      $ (3,330   $ 597   

Current period change

     72        —          72   
  

 

 

   

 

 

   

 

 

 

Balance. March 31, 2012

   $ 3,999      $ (3,330   $ 669   
  

 

 

   

 

 

   

 

 

 

Balance, December 31, 2010

   $ 1,100      $ (2,380   $ (1,280

Current period change

     (40     —          (40
  

 

 

   

 

 

   

 

 

 

Balance. March 31, 2011

   $ 1,060      $ (2,380   $ (1,320
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Other Comprehensive Income

The components of other comprehensive income are reported net of related tax effects in the Consolidated Statements of Comprehensive Income.

A reconciliation of other comprehensive income for the three months ended March 31, 2012 and 2011 is as follows:

 

Three Months Ended March 31, 2012

   Pre-Tax
Amount
    Tax
(Expense)
Benefit
    Net-of-Tax
Amount
 

Unrealized gains on securities

      

Unrealized holding gains arising during the period

   $ 156      $ (53   $ 103   

Reclassification adjustment for gains recognized in net income

     (47     16        (31
  

 

 

   

 

 

   

 

 

 

Net unrealized gains

     109        (37     72   
  

 

 

   

 

 

   

 

 

 

Other comprehensive income

   $ 109      $ (37   $ 72   
  

 

 

   

 

 

   

 

 

 

 

Three Months Ended March 31, 2012

   Pre-Tax
Amount
    Tax
(Expense)
Benefit
     Net-of-Tax
Amount
 

Unrealized losses on securities

       

Unrealized holding losses arising during the period

   $ (53   $ 18       $ (35

Reclassification adjustment for gains recognized in net income

     (8     3         (5
  

 

 

   

 

 

    

 

 

 

Net unrealized losses

     (61     21         (40
  

 

 

   

 

 

    

 

 

 

Other comprehensive income

   $ (61   $ 21       $ (40
  

 

 

   

 

 

    

 

 

 

NOTE 13 — Regulatory Matters

The Company and the Bank are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation (FDIC) and the Board of Governors of the Federal Reserve System (Federal Reserve Board). Failure to meet minimum capital requirements can initiate certain mandatory–and possibly additional discretionary–actions by regulators that, if undertaken, could have a direct material effect on the Company and the Bank’s Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following Capital Adequacy table) of Tier 1 and Total Capital to risk-weighted assets and of Tier 1 Capital to average assets (Leverage ratio). The table also presents the Company’s actual capital amounts and ratios. Management believes, as of March 31, 2012, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of March 31, 2012, the most recent regulatory notifications categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, the Bank must maintain

 

21


Table of Contents

minimum Tier 1 Capital, Total Capital and Leverage ratios as set forth in the Capital Adequacy table. There are no conditions or events since that notification that management believes have changed the Company’s categorization by the FDIC.

The Company and Bank are also subject to minimum capital levels, which could limit the payment of dividends. As of March 31, 2012, the Company and Bank have capital levels that are in excess of the minimum capital level ratios required.

The Pennsylvania Banking Code restricts capital funds available for payment of dividends to the retained earnings of the Bank. The balances in the capital stock and surplus accounts are unavailable for dividends. Dividends from the Bank are the Company’s primary source of funds.

In addition, the Bank is subject to restrictions imposed by Federal law on certain transactions with the Company’s affiliates. These transactions include extensions of credit, purchases of or investments in stock issued by an affiliate, purchases of assets subject to certain exceptions, acceptance of securities issued by an affiliate as collateral for loans, and the issuance of guarantees, acceptances, and letters of credit on behalf of affiliates. These restrictions prevent the Company’s affiliates from borrowing from the Bank unless the loans are secured by obligations of designated amounts. Further, the aggregate value of such transactions between the Bank and a single affiliate is limited in amount to 10 percent of the Bank’s capital stock and surplus, and the aggregate value of such transactions with all affiliates is limited to 20 percent of the Bank’s capital stock and surplus. The Federal Reserve System has interpreted “capital stock and surplus” to include undivided profits.

 

Actual

           Regulatory Requirements  
                         For Capital
Adequacy Purposes
           To Be
“Well Capitalized”
 

As of March 31, 2012

   Amount      Ratio            Amount             Ratio            Amount             Ratio  

Total Capital (to Risk Weighted Assets)

                           

PFSC (Company)

   $ 107,940         17.10   ³         $ 50,510       ³           8.0   ³           N/A       ³           N/A   

PSB (Bank)

   $ 104,193         16.52   ³         $ 50,464       ³           8.0   ³         $ 63,080       ³           10.0

Tier 1 Capital (to Risk Weighted Assets)

                           

PFSC (Company)

   $ 100,971         15.99   ³         $ 25,255       ³           4.0   ³           N/A       ³           N/A   

PSB (Bank)

   $ 97,382         15.44   ³         $ 25,232       ³           4.0   ³         $ 37,848       ³           6.0

Tier 1 Capital (to Average Assets)

                           

PFSC (Company)

   $ 100,971         11.26   ³         $ *       ³           *      ³           N/A       ³           N/A   

PSB (Bank)

   $ 97,382         10.91   ³         $ *       ³           *      ³         $ 44,610       ³           5.0

PFSC - *3.0% ($26,893), 4.0% ($35,857) or 5.0% ($44,821) depending on the bank’s CAMELS Rating and other regulatory risk factors.

PSB - *3.0% ($26,766), 4.0% ($35,688) or 5.0% ($44,610) depending on the bank’s CAMELS Rating and other regulatory risk factors.

 

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Table of Contents

Actual

           Regulatory Requirements  
                         For Capital
Adequacy Purposes
           To Be
“Well Capitalized”
 

As of December 31, 2011

   Amount      Ratio            Amount             Ratio            Amount             Ratio  

Total Capital (to Risk Weighted Assets)

                           

PFSC (Company)

   $ 105,259         17.03   ³         $ 49,434       ³           8.0   ³           N/A       ³           N/A   

PSB (Bank)

   $ 101,603         16.46   ³         $ 49,388       ³           8.0   ³         $ 61,734       ³           10.0

Tier 1 Capital (to Risk Weighted Assets)

                           

PFSC (Company)

   $ 98,443         15.93   ³         $ 24,717       ³           4.0   ³           N/A       ³           N/A   

PSB (Bank)

   $ 94,892         15.37   ³         $ 24,694       ³           4.0   ³         $ 37,040       ³           6.0

Tier 1 Capital (to Average Assets)

                           

PFSC (Company)

   $ 98,443         10.92   ³         $ *       ³           *      ³           N/A       ³           N/A   

PSB (Bank)

   $ 94,892         10.63   ³         $ *       ³           *      ³         $ 44,648       ³           5.0

PFSC - *3.0% ($27,053), 4.0% ($36,071) or 5.0% ($45,089) depending on the bank’s CAMELS Rating and other regulatory risk factors.

PSB - *3.0% ($26,789), 4.0% ($35,718) or 5.0% ($44,648) depending on the bank’s CAMELS Rating and other regulatory risk factors.

 

23


Table of Contents

NOTE 14 — Merger

An Agreement and Plan of Merger (the “Agreement”) by and between the Company, the Bank and Old Forge Bank, was entered into on December 5, 2008. The Agreement provided for, among other things, the Company to acquire 100% of the outstanding common shares of Old Forge Bank through a two-step merger transaction. The Company consummated the acquisition of Old Forge Bank on April 1, 2009, at which time Old Forge Bank was merged with and into the Bank (the “Merger”). Following the Merger, the Bank continues to operate as a banking subsidiary of the Company.

In connection with its acquisition of Old Forge Bank, the Company acquired loans with evidence of credit deterioration that have been accounted for under ASC 310-30. As of March 31, 2012, there were two such loans remaining with a carrying value of $208 and a credit fair value adjustment of $208. As of December 31, 2011, these same loans had a carrying value of $211 and a credit fair value adjustment of $211. As of March 31, 2011, these loans had a carrying value of $228 with a credit fair value adjustment of $228. There is no accretable yield for the specific loans accounted for under Accounting Standard Codification 310-30-30. There were no significant prepayment estimates by management in the determination of contractual cash flows and cash flows expected to be collected.

Changes in the credit fair value adjustment on specific loans purchased are as follows:

 

Three Months Ended March 31, 2012

 
     Carrying
Value
    Credit
Fair Value

Adjustment
    Net
Amount
 

Balance, December 31, 2011

      

Residential Mortgages

   $ —        $ —        $ —     

Commercial

     211        211        —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 
     211        211        —     

Charge-offs

      

Residential Mortgages

     —          —          —     

Commercial

     —          —          —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total Charge-offs

     —          —          —     

Loans transferred to other real estate owned

      

Residential Mortgages

     —          —          —     

Commercial

     —          —          —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total loans transferred to other real estate owned

     —          —          —     

Payments

      

Residential Mortgages

     —          —          —     

Commercial

     (3     (3     —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total Payments

     (3     (3     —     
  

 

 

   

 

 

   

 

 

 

Balance, March 31, 2012

   $ 208      $ 208      $ —     
  

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

Three Months Ended March 31, 2011

 
     Carrying
Value
    Credit
Fair Value

Adjustment
    Net
Amount
 

Balance, December 31, 2010

      

Residential Mortgages

   $ —        $ —        $ —     

Commercial

     229        229        —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 
     229        229        —     

Charge-offs

      

Residential Mortgages

     —          —          —     

Commercial

     —          —          —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total Charge-offs

     —          —          —     

Loans transferred to other real estate owned

      

Residential Mortgages

     —          —          —     

Commercial

     —          —          —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total loans transferred to other real estate owned

     —          —          —     

Payments

      

Residential Mortgages

     —          —          —     

Commercial

     (1     (1     —     

Consumer / Other

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total Payments

     (1     (1     —     
  

 

 

   

 

 

   

 

 

 

Balance, March 31, 2011

   $ 228      $ 228      $ —     
  

 

 

   

 

 

   

 

 

 

Note 15 — Fair Value Measurements

The following table sets forth the Company’s financial assets that were accounted for at fair value and are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Level I–Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level II–Observable inputs other than Level I prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices in markets that are not active for identical or similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level III–Unobservable inputs that are supported by little or no market activity and significant to the fair value of the assets or liabilities that are developed using the reporting entities’ estimates and assumptions, which reflect those that market participants would use.

Assets Measured at Fair Value on a Recurring Basis

A description of the valuation methodologies used for financial assets measured at fair value on a recurring basis, as well as the classification of the assets pursuant to the valuation hierarchy, are as follows:

Securities Available-for-Sale

Securities classified as available-for-sale are reported using Level I, Level II and Level III inputs. Level I instruments generally include equity securities valued in accordance with quoted market prices in active markets. Level II instruments include U.S. government agency obligations, state and municipal bonds, mortgage-backed securities and corporate bonds. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Level III instruments include certain non-public equity securities and real estate sold under contract. See Note 5 – Investment Securities for additional information.

 

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Table of Contents

Assets and liabilities measured at fair value on a recurring basis are summarized as follows:

 

     March 31, 2012  
     Level I      Level II      Level III      Total  

Assets:

           

Securities available-for-sale

           

U.S. Agency securities

   $ —         $ 77,913       $ —         $ 77,913   

Mortgage-backed securities:

           

Residential

     —           27,879         —           27,879   

States & political subdivisions:

           

Bank qualified tax exempt

     —           62,305         —           62,305   

Corporate securities:

           

Aaa credit rating

     —           —           —           —     

Equity securities:

           

Financial services industry

     1,061         —           —           1,061   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 1,061       $ 168,097       $ —         $ 169,158   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2011  
     Level I      Level II      Level III      Total  

Assets:

           

Securities available-for-sale

           

U.S. Agency securities

   $ —         $ 77,985       $ —         $ 77,985   

Mortgage-backed securities:

           

Residential

     —           22,166         —           22,166   

States & political subdivisions:

           

Bank qualified tax exempt

     —           65,388         —           65,388   

Corporate securities:

           

Aaa credit rating

     —           1,004         —           1,004   

Equity securities:

           

Financial services industry

     943         —           —           943   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 943       $ 166,543       $ —         $ 167,486   
  

 

 

    

 

 

    

 

 

    

 

 

 

Assets Measured at Fair Value on a Nonrecurring Basis

Certain non-financial assets and non-financial liabilities, measured at fair value on a non-recurring basis, include foreclosed and non-performing assets, goodwill and intangible assets.

A description of the valuation methodologies and classification levels used for non-financial assets and non-financial liabilities measured at fair value on a nonrecurring basis are listed as follows:

Goodwill and Other Identifiable Intangibles

The Company employs general industry practices in evaluating the fair value of its goodwill and other identifiable intangibles. The Company calculates the fair value, with the assistance of a third party specialist, using a combination of the following valuation methods: dividend discount analysis under the income approach, which calculates the present value of all excess cash flows plus the present value of a terminal value and market multiples (pricing ratios) under the market approach. Management performed a review of goodwill and other identifiable intangibles as of December 31, 2011. Goodwill and other identifiable intangibles were not evaluated during the three months ended March 31, 2012 as a result of management’s determination that no evidence of impairment was present during the period.

 

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Impaired Loans

At March 31, 2012 certain impaired loans were re-measured and reported at fair value through a specific valuation allowance allocation of the allowance for loan and lease losses based upon the fair value of the underlying collateral and the evaluation of expected future cash flows. Impaired loans with a carrying value of $5,243 were reduced by a specific valuation allowance allocation totaling $1,263, to a total reported fair value of $3,980 based on collateral valuations utilizing Level III valuation inputs.

Federal Home Loan Bank Stock

Federal Home Loan Bank of Pittsburgh (FHLB) stock is a required investment in order for the Company to participate in a FHLB line of credit program. The FHLB stock is stated at par value as it is restricted to purchases and sales with the FHLB.

Other Real Estate Owned

Foreclosed real estate, which is considered to be non-financial assets, has been valued using a market approach. The values were determined using market prices of similar real estate assets, which the Company considered to be Level II inputs.

Certain assets measured at fair value on a non-recurring basis as of March 31, 2012 is as follows:

 

     Fair Value Measurement Using  
     Quoted Prices in
Active Markets
for Identical
Assets/Liabilities
     Significant
Other
Observable
Inputs
     Significant
Unobservable
Inputs
     Balance
March 31,

2012
 
     Level I      Level II      Level III      Total  

Assets

           

Core deposit intangible

   $ —         $ —         $ 1,032       $ 1,032   

Goodwill

     —           —           26,398         26,398   

Impaired loans

     —           —           4,115         4,115   

Federal Home Loan Bank stock

     —           —           5,545         5,545   

Other real-estate owned

     —           1,786         —           1,786   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-financial assets

   $ —         $ 1,786       $ 37,090       $ 38,876   
  

 

 

    

 

 

    

 

 

    

 

 

 

Certain assets measured at fair value on a non-recurring basis as of December 31, 2011 is as follows:

 

     Fair Value Measurement Using  
     Quoted Prices in
Active Markets
for Identical
Assets/Liabilities
     Significant
Other
Observable
Inputs
     Significant
Unobservable
Inputs
     Balance
December 31,

2011
 
     Level I      Level II      Level III      Total  

Assets

           

Core deposit intangible

   $ —         $ —         $ 1,106       $ 1,106   

Goodwill

     —           —           26,398         26,398   

Impaired loans

     —           —           2,876         2,876   

Federal Home Loan Bank stock

     —           —           4,953         4,953   

Other real-estate owned

     —           1,571         —           1,571   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-financial assets

   $ —         $ 1,571       $ 35,333       $ 36,904   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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A reconciliation of items in Level III for the three month period ended March 31, 2012 is as follows:

 

     Core
deposit
intangible
    Goodwill      Impaired
Loans
    Federal
Home
Loan Bank
Stock
    Total  

Balance, December 31, 2011

   $ 1,106      $ 26,398       $ 2,876      $ 4,953      $ 35,333   

Amortization of core deposit intangible

     (74     —           —          —          (74

Increase in impaired loans

     —          —           2,089        —          2,089   

Decrease in impaired loans

     —          —           (570     —          (570

Purchase of FHLB stock

     —          —           —          840        840   

Payments received

     —          —           (280     (248     (528
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Balance, March 31, 2012

   $ 1,032      $ 26,398       $ 4,115      $ 5,545      $ 37,090   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

A reconciliation of items in Level III for the year ended December 31, 2011 is as follows:

 

     Core
deposit
intangible
    Goodwill      Impaired
Loans
    Federal
Home
Loan Bank
Stock
    Total  

Balance, December 31, 2010

   $ 1,410      $ 26,398       $ 3,078      $ 6,082      $ 36,968   

Amortization of core deposit intangible

     (304     —           —          —          (304

Increase in impaired loans

     —          —           2,586        —          2,586   

Decrease in impaired loans

     —          —           (2,178     —          (2,178

Payments received

     —          —           (610     (1,129     (1,739
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Balance, December 31, 2011

   $ 1,106      $ 26,398       $ 2,876      $ 4,953      $ 35,333   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Disclosures about Fair Value of Financial Instruments

General Accepted Accounting Principles require disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities, except for certain loans and investments. Therefore, the Company had to use significant estimates and present value calculations to prepare this disclosure.

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodologies used at March 31, 2012 and December 31, 2011 are outlined below. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed in the fair value measurements section above. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest and the bank owned life insurance policies. The methodologies for other financial assets and financial liabilities are discussed below:

Short-term financial instruments

The carrying value of short-term financial instruments including cash and due from banks, federal funds sold, interest-bearing deposits in banks and other short-term investments and borrowings, approximates the fair value of these instruments. These financial instruments generally expose the Company to limited credit risk and have no stated maturities or have short-term maturities with interest rates that approximate market rates.

 

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Investment securities held-to-maturity

The estimated fair values of investment securities held to maturity are based on quoted market prices provided by independent third parties that specialize in those investment sectors. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments.

Loans

The loan portfolio, net of unearned income, has been valued by a third party specialist using quoted market prices, if available. When market prices were not available, a credit risk-based discounted cash flow analysis was utilized. The primary assumptions utilized in this analysis are the discount rate based on the LIBOR curve, adjusted for credit risk, and prepayment estimates based on factors such as refinancing incentives, age of the loan and seasonality. These assumptions were applied by loan category and different spreads were applied based upon prevailing market rates by category.

Deposits

The estimated fair values of demand deposits (interest and non-interest bearing checking accounts, savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (their carrying amounts). The fair value for certificates of deposit was calculated by an independent third party by discounting contractual cash flows using current market rates for instruments with similar maturities, using a credit based risk model. The carrying amount of accrued interest receivable and payable approximates fair value.

Long-term borrowings

The amounts assigned to long-term borrowings were based on quoted market prices, when available, or based on discounted cash flow calculations using prevailing market interest rates for debt of similar terms.

The carrying and fair values of certain financial instruments are as follows:

 

     March 31, 2012     December 31, 2011  
     Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 

Cash and cash equivalents

   $ 27,099      $ 27,099      $ 34,480      $ 34,480   

Investment securities held-to-maturity

     21,819        22,910        23,722        24,969   

Loans, net

     630,517        644,839        624,811        637,976   

Bank owned life insurance

     17,229        17,229        15,870        15,870   

Demand deposits

     516,000        516,000        505,790        505,790   

Time deposits

     208,929        212,199        214,728        218,163   

Short-term borrowings

     10,069        10,069        9,981        9,981   

Long-term borrowings

     54,016        57,649        58,220        62,125   

Standby Letters of Credit

   $ (190   $ (190   $ (191   $ (191

Note 16 — Subsequent Event

The largest property in other real estate owned with a carrying value of $792 was sold on April 24, 2012 with a total consideration of $900.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD LOOKING INFORMATION

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Penseco Financial Services Corporation and its direct and indirect subsidiaries. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. Penseco Financial Services Corporation’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations include, but are not limited to, changes in

 

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interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in Penseco Financial Services Corporation’s market area, changes in the values of real estate and other collateral, particularly in our market area, changes in relevant accounting principles and guidelines and inability of third party service providers to perform.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, Penseco Financial Services Corporation does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Unless the context indicates otherwise, all references in this Quarterly Report to “Company,” “we,” “us” and “our” refer to Penseco Financial Services Corporation and its direct and indirect subsidiaries.

The following commentary provides an overview of the financial condition at March 31, 2012, including any significant changes from December 31, 2011, and significant changes in the results of our operations for the three month periods ended March 31, 2012 and March 31, 2011.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Provision and Allowance for loan and lease losses–The provision for loan and lease losses charged to operating expense represents the adjustment that, in management’s judgment, is necessary to maintain the allowance for loan and lease losses at a level that is adequate to absorb probable losses inherent in the Company’s loan portfolio. The allowance for loan and lease losses is determined based on a documented and consistently applied methodology. This methodology considers all significant factors that affect the collectability of the loans within our portfolio, including past loan loss experience, management’s evaluation of the probable loss in the current loan portfolio under current economic conditions and such other factors as, in management’s best judgment, merit recognition in estimating loan and lease losses.

Actuarial assumptions associated with pension, post-retirement and other employee benefit plans–These assumptions include discount rate, rate of future compensation increases and expected return on plan assets.

Income taxes–The calculation of the provision for federal income taxes is complex and requires the use of estimates and judgments. Deferred federal income tax assets or liabilities represent the estimated impact of temporary differences between the recognition of assets and liabilities under GAAP, and how such assets and liabilities are recognized under the federal tax code. The Company uses an estimate of future earnings to support management’s position that the benefit of the deferred tax assets will be realized. If projected income is not recognized, at all or in the amounts predicted, the asset may not be realized and net income will be reduced. Deferred tax assets are described further in Note 18 of the “Notes to Consolidated Financial Statements” in the Company’s most recent Annual Report on Form 10-K.

The Company and its subsidiary file income tax and other returns in the U.S. Federal jurisdiction, Pennsylvania state jurisdiction and certain local jurisdictions.

Management evaluated the Company’s tax positions and concluded that the aggregate liabilities related to taxes are appropriately reflected in the consolidated financial statements. With few exceptions, the Company is no longer subject to income tax examinations by the U.S. Federal, state or local tax authorities for years before 2008.

Fair Value Measurements–Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayment speeds and other factors. Changes in assumptions or in market conditions could significantly affect the estimates. Fair value measurements are classified within one of three levels within a valuation hierarchy based on the transparency of inputs to each valuation as of the fair value measurement date. The three levels are defined as follows:

Level I–quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

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Level II–inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level III–inputs that are unobservable and significant to the fair value measurement. Financial instruments are considered Level III when values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable.

Other-than-temporary impairment of investments–Investments are evaluated periodically to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Premium amortization–The amortization of premiums on mortgage-backed securities is done based on management’s estimate of the lives of the securities, adjusted, when necessary, for advanced prepayments in excess of those estimates.

Loans purchased–Loans purchased as a result of the Merger were recorded at the acquisition date fair value. Management made three different types of fair value adjustments in order to record the loans at fair value. An interest rate fair value adjustment was made comparing current weighted average rates of the acquired loans to stated market rates of similar loan types. A general credit fair value adjustment was made on similar loan types based on historical loss projections plus a discount for the weak economic environment. A specific credit fair value adjustment was made to loans identified by management as being problematic. The specific loans have been discounted by management based on collateral values and expected cash flows. The interest rate and general credit fair value adjustments are being accreted over an eight year period based on a sum-of-the-years-digits basis. The specific credit fair value adjustment is reduced only when cash flows are received or loans are charged-off or transferred to other real estate owned.

Loan servicing rights–Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest and expected future prepayment rates. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized mortgage servicing rights based on the product type, interest rate and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed the fair value.

Time deposits–Time deposits acquired through the Merger have been recorded at their acquisition date fair value. The fair value of time deposits represents the present value of the time deposits’ expected contractual payments discounted by market rates for similar deposits. The fair value adjustment is amortized monthly based on a level yield methodology.

Securities sold under agreements to repurchase–The Company also offers securities sold under agreements to repurchase as an alternative to conventional savings deposits for its customers. The securities sold under agreements to repurchase are accounted for as a collateralized borrowing with a one day maturity and are collateralized by U.S. Agency securities.

Core deposit intangible–The fair value assigned to the core deposit intangible asset represents the future economic benefit of the potential cost savings from acquiring core deposits in the Merger compared to the cost of obtaining alternative funding, such as brokered deposits, from market sources. Management utilized an income approach to present value the expected after tax cash flow benefits of the acquired core deposits. The core deposit intangible is being amortized over ten years on a sum-of-the-years-digits basis.

 

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Goodwill–Goodwill is reviewed by management for possible impairment at least annually or more frequently upon the occurrence of an event or when circumstances indicate that its carrying amount exceeds fair value. Management has obtained a professionally prepared qualitative test for goodwill impairment as of December 31, 2011. Market conditions that could negatively impact the value of goodwill in the future are essentially those Risk Factors discussed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. As a result of such qualitative impairment test, management has determined that goodwill was not impaired at December 31, 2011.

Depreciation–Provision for depreciation and amortization, computed principally on the straight-line method, is charged to operating expenses over the estimated useful lives of the assets.

Comparison of Operating Results

 

     Three Months Ended March 31  
     2012     2011  

Interest Income

   $ 9,659      $ 10,040   

Interest Expense

     1,481        1,897   
  

 

 

   

 

 

 

Net Interest Income

     8,178        8,143   

Non-Interest Income

     2,903        3,304   

Non-Interest Expenses

     7,277        7,450   

Net Income

   $ 2,772      $ 2,769   

Total Revenue

   $ 12,562      $ 13,344   

Net Interest Margin

     4.19     4.16

Return on Assets (ROA)

     1.20     1.21

Return on Equity (ROE)

     8.48     8.96

The Company reported net income for the three months ended March 31, 2012 of $2,772, or $0.85 per weighted average share, compared with $2,769, or $0.85 per weighted average share, from the year ago period, an increase of $3 or 0.1%. Pre-provision net interest income increased $35, or 0.4%. Net interest income, after provision for loan and lease losses, increased $212, or 2.7%, during the 2012 period, due to a reduction in interest expense of $416, or 21.9%, from lower funding costs and a $177, or 48.0%, decrease in the provision for loan and lease losses, offset by a decrease in interest income of $381, or 3.8%. The decrease in interest income was primarily attributable to investment and loan cash flows being reinvested at historically low yields, including excess reserve deposits held at the Federal Reserve Bank of Philadelphia. Non-interest income decreased $401, or 12.1%, largely due to the reversal of a contingent liability of $500 during the quarter ended March 31, 2011 recorded in connection with the 2009 acquisition of Old Forge Bank. Non-interest expenses decreased $173, or 2.3%, due to lower FDIC insurance expense and merchant transaction expenses offset by higher compensation expenses.

We have defined our “core operations” to exclude the reversal, in the three months ended in March 31, 2011, of a contingent liability recorded in connection with the acquisition of Old Forge Bank. Net income from core operations increased $333 for the three months ended March 31, 2012 to $2,772, compared to $2,439 for the same period in 2011. Net income from core operations is a non-GAAP measure of net income. A reconciliation of the net income from core operations and disclosure of the non-GAAP return on assets, return on equity and dividend payout ratio derived from that measure are described in the non-GAAP reconciliation included in this Quarterly Report on Form 10-Q.

 

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The following table reflects net income from accretion and amortization, net of taxes, of acquisition date fair value adjustments relating to the Merger included in the Company’s financial results during the periods indicated.

 

     Three Months Ended  
     March 31,
2012
    March 31,
2011
 

Homogeneous loan pools

   $ 121      $ 151   

Time deposits

     11        30   

Core deposit intangible expense

     (49     (55
  

 

 

   

 

 

 

Net income from acquisition fair value adjustment

   $ 83      $ 126   
  

 

 

   

 

 

 

Accretion of the loan pools credit fair value adjustment and market rate fair value adjustment is calculated on a sum-of-the-years-digits basis over an eight year period. The fair value market rate adjustment of the time deposits is amortized monthly based on a level yield methodology over five years. The core deposit intangible established in connection with the 2009 acquisition of Old Forge Bank is being amortized over ten years from the date of acquisition on a sum-of-the-years-digits basis.

Net Interest Income and Net Interest Margin

Net interest income, the principal component of the Company’s earnings, is defined as the difference between interest and fees earned on interest-earning assets and interest paid on deposits and other borrowings. Average interest-earning assets are composed primarily of loans and investments while deposits and short-term and long-term borrowings represent interest-bearing liabilities. Variations in the volume and mix of these assets and liabilities, as well as changes in the yields earned and rates paid, are determinants of changes in net interest income.

Net interest income (before the provision for loan and lease losses) increased $35, or 0.4%, to $8,178 for the three months ended March 31, 2012 compared to $8,143 for the three months ended March 31, 2011. The average yield on interest-earning assets decreased 16 basis points, or 3.2%.

The net interest margin represents the Company’s net yield on its average interest-earning assets and is calculated as net interest income divided by average interest-earning assets. For the three months ended March 31, 2012, net interest margin increased 3 basis points to 4.19% from 4.16% in the same period of 2011.

The most significant impact on net interest income between periods is derived from the interaction of changes in the volume of, and rates earned or paid on, interest-earning assets and interest-bearing liabilities. The volume of earning dollars in loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in net interest income between periods.

Total average interest-earning assets and average interest-bearing liabilities decreased from the three months ended March 31, 2012. Average interest-earning assets decreased $4.1 million or 0.5%, from $840.6 million in 2011 to $836.5 million in 2012 and average interest-bearing liabilities decreased $22.1 million, or 3.3%, from $669.4 million to $647.3 million for the same period. As a percentage of average assets, average interest-earning assets, including bank-owned life insurance (BOLI), decreased for the three months ended March 31, 2012 and 2011, respectively, to 92.2% from 93.6%.

Changes in the mix of both interest-earning assets and funding sources also impacted net interest income in the three months ended March 31, 2012 and 2011. Average loans as a percentage of average interest-earning assets increased from 73.2% in 2011 to 76.0% in 2012. Average investment securities decreased $21.6 million, or 10.1%, year over year, and as a percentage of interest-earning assets, decreased to 22.9% at March 31, 2012 from 25.4% at March 31, 2011. Average short-term investments, federal funds sold, FHLB stock and interest-bearing balances with banks, decreased as a percentage of average assets to 0.9% at March 31, 2012 from 1.3% at March 31, 2011. Average time deposits decreased $37.7 million, or 15.2%, from $248.6 million, or 37.1%, of interest-bearing liabilities in 2011 to $210.9 million, or 32.6%, of interest-bearing liabilities for the 2012 period. Also, during the three months ended March 31, 2012, average securities sold under agreements to repurchase decreased $9.4 million, or 49.0%, and average long-term borrowings decreased $10.7 million, or 15.9%.

 

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Shifts in the interest rate environment to lower rates and local competition for loans and deposits affected the rates paid for funds as well as the yields earned on assets. The investment securities tax equivalent yield decreased 39 basis points from 4.02% for the three months ended March 31, 2011 to 3.63% for the three months ended March 31, 2012. Also, average loan yields decreased 21 basis points from 5.42% for the three months ended March 31, 2011 to 5.21% for the three months ended March 31, 2012.

The average time deposit costs decreased 19 basis points from 1.49% for the three months ended March 31, 2011 to 1.30% for the three months ended March 31, 2012. In addition, the average cost of money market accounts decreased 14 basis points from 0.51% for the three months ended March 31, 2011 to 0.37% for the three months ended March 31, 2012.

Interest expense for the three months ended March 31, 2012 totaled $1,481, compared to $1,897 in 2011, a decrease of $416 or 21.9%. The average rate paid on interest-bearing liabilities for the three months ended March 31, 2012 decreased to 0.92%, compared to 1.13% in 2011. Average interest-bearing liabilities decreased $22.1 or 3.3% to $647.3 from $669.4 in 2011. Average savings deposits increased $6.4, or 5.6%. Average time deposits decreased $37.7, or 15.2%, for the three months ended March 31, 2012 due primarily to the redemption of brokered certificates of deposit. Average time deposits represented 32.6% of average interest-bearing liabilities for the three months ended March 31, 2012, compared to 37.1% in 2011. Average demand non-interest bearing deposits increased $24.9, or 21.7%.

The historically low interest rates continue to stress our margin as funding costs have reached a low point and asset yields for the most part continue to price downward. The Dodd-Frank Act, which was enacted in July 2010, and the regulations that have been and will be promulgated under the Act, are expected to reduce our non-interest income, such as overdraft fees, and also increase compliance and regulatory costs.

 

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Distribution of Assets, Liabilities and Stockholders’ Equity / Interest Rates and Interest Differential

The table below presents average balances, interest income on a taxable equivalent basis and interest expense, as well as average rates earned and paid on the Company’s major asset and liability items for the three months ended March 31, 2012 and March 31, 2011.

 

     March 31, 2012     March 31, 2011  
     Average
Balance
     Revenue/
Expense
     Yield/
Rate
    Average
Balance
     Revenue/
Expense
     Yield/
Rate
 

ASSETS

                

Investment Securities

                

Available-for-sale:

                

U.S. Agency obligations

   $ 103,071       $ 425         1.65   $ 105,401       $ 533         2.02

States & political subdivisions

     64,155         691         6.53     62,637         712         6.89

Other

     1,707         15         3.51     5,038         14         1.11

Held-to-maturity:

                

U.S. Agency obligations

     21,001         214         4.08     27,790         282         4.06

States & political subdivisions

     1,810         24         7.96     12,443         155         7.55

Loans, net of unearned income:

                

Real estate mortgages

     296,959         3,853         5.19     318,396         4,110         5.16

Commercial real estate

     185,719         2,123         4.57     174,345         2,134         4.90

Commercial

     54,400         721         5.30     38,559         571         5.92

Consumer and other

     99,063         1,590         7.32     84,185         1,527         7.95

Federal funds sold

     —           —           —          —           —           —     

Federal Home Loan Bank stock

     5,201         1         0.08     5,957         —           —     

Interest on balances with banks

     3,393         2         0.24     5,893         2         0.14
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total Interest-Earning Assets/Total Interest Income

     836,479       $ 9,659         4.90     840,644       $ 10,040         5.06
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Cash and due from banks

     24,896              10,381         

Bank premises and equipment

     13,705              13,438         

Accrued interest receivable

     3,035              3,395         

Goodwill

     26,398              26,398         

Bank owned life insurance

     16,352              15,427         

Other assets

     11,076              11,652         

Less: Allowance for loan and lease losses

     6,685              6,479         
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total Assets

   $ 925,256            $ 914,856         
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Deposits:

                

Demand-Interest bearing

   $ 88,387       $ 64         0.29   $ 70,154       $ 72         0.41

Savings

     121,134         55         0.18     114,726         77         0.27

Money markets

     159,618         148         0.37     147,306         186         0.51

Time - Over $100

     83,938         313         1.49     84,077         370         1.76

Time - Other

     126,958         376         1.18     164,555         557         1.35

Federal funds purchased

     100         —           —          —           —           —     

Securities sold under agreements to repurchase

     9,774         8         0.33     19,228         24         0.50

Short-term borrowings

     997         1         0.40     2,212         3         0.54

Long-term borrowings

     56,443         516         3.66     67,101         608         3.62
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total Interest Bearing Liabilities/Total Interest Expense

     647,349       $ 1,481         0.92     669,359       $ 1,897         1.13
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Demand - Non-interest bearing

     139,795              114,873         

All other liabilities

     7,282              7,008         

Stockholders’ equity

     130,830              123,616         
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 925,256            $ 914,856         
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Interest Spread

           3.98           3.93
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net Interest Income

      $ 8,178            $ 8,143      
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

FINANCIAL RATIOS

                

Net interest margin (1)

           4.19           4.16

Return on average assets

           1.20           1.21

Return on average equity

           8.48           8.96

Average equity to average assets

           14.14           13.51

Dividend payout ratio

           49.41           49.41

 

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Table of Contents
(1) The net interest margin is equal to tax equivalent net interest income divided by average interest-earning assets. In order to make pre-tax income on tax-exempt investments and loans comparable to taxable investments and loans, a tax equivalent adjustment is made to interest income. This adjustment increased interest income by $590 and $594 for the three months ended March 31, 2012 and 2011, respectively. The Company believes that the tax equivalent presentation is consistent with industry practice. Although the Company believes that these financial measures enhance investors’ understanding of our business and performance, these measures should not be considered an alternative to GAAP.

Provision for Loan and Lease Losses

The provision for loan and lease losses represents the charge to operating expense necessary to maintain the allowance for loan and lease losses at a level which management determines is adequate to absorb probable losses inherent in the Company’s loan portfolio.

During the three months ended March 31, 2012, the local economy continued to struggle. The local housing market remained weak and the unemployment rate in Northeastern Pennsylvania was at 8.9% at February 29, 2012. The Company continues to proactively evaluate probable loan and lease losses and address delinquent loans by, among other things, obtaining current appraisals of collateral, increasing communication with clients and placing loans on non-accrual status when collection is in doubt and the loan is moving toward foreclosure.

The Bank’s methodology for determining the allowance for loan and lease losses (ALLL) is based on a documented and consistently applied analysis of its loan portfolio. This analysis considers all significant factors that affect the collectability of the loans within our portfolio and supports the credit losses estimated by this process. Our ALLL methodology includes procedures for a review by a party who is independent of the Bank’s credit approval and ALLL estimation processes.

The Bank applies its allowance methodology in accordance with the Federal Financial Institutions Examination Council (“FFIEC”) Interagency Policy Statements, as amended, and GAAP to assess the adequacy of its allowance for loan and lease losses. Under GAAP, the adequacy of the allowance for loan and lease losses is determined based on the provisions of FASB ASC 310 for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450 for large groups of smaller balance homogeneous loans to be collectively evaluated for impairment. Loans are identified by the Bank’s rating system, past due reports, watch list and sensitivity to economic factors and are then collectively evaluated for impairment compared to other loans utilizing standard criteria. Consideration is given to current local economic conditions which the Company continues to classify as recessionary.

The Bank’s historical analysis of loss factors, which utilizes a rolling twenty quarters, but assigns greater weight to the four quarters of the previous five years that reflected the greatest loan loss allowances calculated by dollar amount. This change in our methodology is designed to better address deterioration in local economic conditions. In addition, and in view of the concentration of the Bank’s loan portfolio in real estate – approximately 80% of the portfolio is secured by real estate mainly in the counties in which the Bank operates – the Bank also took into account the decline in real estate sales and new construction in our market area and drop in real estate values within the market area. The Bank’s provision for loan and lease losses for the quarter ended March 31, 2012 was allocated primarily to commercial real estate and consumer portfolios. Reference should be made to the information about the Company’s provision for loan and lease losses under the heading “General Notes to Financial Statements – Note 6 – Loan Portfolio”.

There were no changes in the methodology of determining the allowance for loan losses during the three months ended March 31, 2012. Management continues to focus on trends in real estate delinquencies related to the poor labor and housing markets locally, in determining the allowance for loan losses. Management also continually compares the probable losses estimated in accordance with our allowance for loan loss methodology with actual losses.

 

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Table of Contents

Based on this methodology, management made a provision for loan and lease losses of $192 for the three month period ended March 31, 2012, compared to a $369 provision for the comparable prior year period, resulting in an allowance for loan and lease losses of $6,811 at March 31, 2012 compared to $6,800 at March 31, 2011. The amount and number of charge-offs and foreclosures during the periods indicated are as follows:

 

At:

   At and For The
Three Months
Ended
March 31,
2012
    At and For The
Twelve Months
Ended
December 31,
2011
    At and For The
Three Months
Ended
March 31,
2011
 

Provision for loan and lease losses

   $ 192      $ 2,381      $ 369   

Allowance for loan and lease losses to non-performing loans

     278.80     211.97     137.85

Non-performing loans to period end loans

     0.38     0.50     0.81

Ratio of charged-off loans to average loans

     0.02     0.37     0.02

Ratio of foreclosed loans to average loans

     0.08     0.38     0.01

 

At:

   At and For The
Three Months Ended
March 31, 2012
            At and For The
Twelve Months Ended
December 31, 2011
            At and For The
Three Months Ended
March 31, 2011
        
     Amount      (#)      Amount      (#)      Amount      (#)  

Charge-offs

   $ 101         17       $ 2,300         90       $ 115         15   

Foreclosures completed

     479         5         2,370         14         80         3   

Non-performing loans

     2,443         71         3,166         77         4,933         79   

The Company had one commercial loan whose terms had been modified in a troubled debt restructuring as of March 31, 2012 and December 31, 2011; monthly payments were lowered to accommodate the borrower’s financial needs for a period of time.

The following table presents loans whose terms were modified in a TDR at the dates indicated below:

 

     March 31,
2012
     December 31,
2011
 

Restructured Loans on Accrual Status and Not Past Due 90 Days or More

   $ 363       $ 368   

Restructured Loans Included in Non-Accrual Loans or Accruing Loans

     

Past Due 90 Days or More

     —           —     
  

 

 

    

 

 

 

Total Restructured Loans

   $ 363       $ 368   
  

 

 

    

 

 

 

The Company believes that the judgments used in determining the allowance for loan and lease losses are based on reliable information. In assessing the adequacy of the allowance for loan and lease losses, management considers how well prior estimates have related to actual experience. The Company continually monitors the risk elements, historical rates and other data used in determining the allowance on a periodic basis. Based on this ongoing evaluation, a provision for loan and lease losses is made in the amount necessary to maintain an appropriate allowance.

The methodology for determining the adequacy of the allowance is necessarily judgmental and subject to changes in external conditions. Accordingly, there can be no assurance that existing levels of the allowance will ultimately prove adequate to cover actual loan and lease losses. Although management uses available information to establish the appropriate level of the allowance for loan and lease losses, future additions or reductions to the allowance may be necessary as a result of changes in economic conditions and other factors. As a result, our allowance for loan and lease losses may not be sufficient to cover actual loan and lease losses, and future provisions for loan and lease losses could materially adversely affect the Company’s operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Discussions with these regulatory agencies may result in adjustments to the Company’s allowance based on judgments about information available to the agencies at the time of their examination.

 

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Table of Contents

Other than the risks associated with the geographic concentration of our customers, facilities and the collateral securing some of our loans, there are no particular risk elements in the local economy that put a group or category of loans at increased risk. However, the Company has increased its portfolio of commercial loans over the last five years, which typically bear a higher risk. These loans are typically secured by real estate to minimize this risk. At March 31, 2012, management believes the allowance for loan and lease losses is adequate to absorb probable loan and lease losses inherent in the loan portfolio.

Non-Interest Income

The following table sets forth information by category of non-interest income for the Company for the three months ended March 31, 2012 and March 31, 2011, respectively:

 

Three Months Ended:

   March 31,
2012
     March 31,
2011
 

Trust department income

   $ 362       $ 398   

Service charges on deposit accounts

     459         472   

Merchant transaction income

     1,207         1,242   

Brokerage fee income

     57         56   

Other fee income

     403         378   

Bank-owned life insurance income

     118         120   

Other operating income

     250         630   

Realized gains (losses) on securities, net

     47         8   
  

 

 

    

 

 

 

Total Non-Interest Income

   $ 2,903       $ 3,304   
  

 

 

    

 

 

 

Total non-interest income decreased $401, or 12.1%, to $2,903 for the three months ended March 31, 2012, compared with $3,304 for the same period in 2011. This decrease was primarily attributable to a decrease of $380 in other operating income due to the reversal of a contingent liability of $500 during the quarter ended March 31, 2011 recorded in connection with the Merger, as well as a decrease in trust department income due to lower estate fees, a decrease in service charges on deposit accounts due to decreased overdraft activity and a decrease in merchant transaction income due to lower volume. The decrease in total non-interest income for the three months ended March 31, 2012 was offset by an increase in other fee income resulting from increased debit card revenue due to an increased number of accounts as well as an increase in net realized gains on securities.

Non-Interest Expenses

The following table sets forth information by category of non-interest income for the Company for the three months ended March 31, 2012 and March 31, 2011, respectively:

 

Three Months Ended:

   March 31,
2012
     March 31,
2011
 

Salaries and employee benefits

   $ 3,651       $ 3,525   

Expense of premises and equipment, net

     837         1,021   

Merchant transaction expenses

     731         833   

FDIC insurance assessments

     110         242   

Other operating expenses

     1,948         1,829   
  

 

 

    

 

 

 

Total Non-Interest Expenses

   $ 7,277       $ 7,450   
  

 

 

    

 

 

 

Total non-interest expenses decreased $173, or 2.3%, to $7,277 for the three months ended March 31, 2012 compared with $7,450 for the same period in 2011. Salaries and employee benefits increased $126, or 3.6%, primarily attributable to merit-based increases, as well as an increase of $119, or 6.5%, in operating expenses resulting from increased Pennsylvania shares tax expense and other real estate owned expenses. These increases in total non-interest expenses were partially offset by a decrease in FDIC insurance assessments of $132, or 54.5%, resulting from new FDIC bank pricing methodology that affected the three months ended March 31, 2012; a decrease in merchant transaction expenses of $102, or 12.2%, due to lower volume and a decrease in premises and fixed asset expenses due primarily to lower occupancy and depreciation expense.

 

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Table of Contents

Income Taxes

Applicable income taxes decreased $19, or 2.2%, primarily due to lower taxable income for the three months ended March 31, 2012.

Cash Equivalents and Investments

The Company’s investment portfolio has two primary functions: to provide liquidity and to contribute to earnings. To provide liquidity, the Company may invest in short-term securities such as Federal funds sold and interest-bearing deposits with banks, which are classified as cash equivalents, as well as U.S. Treasury securities and U.S. Agency securities with maturities of one year or less. These funds are invested on a short-term basis to ensure the availability of funds to meet customer demand for credit needs.

The Company enhances interest income by securing long-term investments within its investment portfolio by means of U.S. Treasury securities, U.S. Agency securities, municipal securities and mortgage-backed securities, generally with maturities greater than one year. The Company’s mortgage-backed securities portfolio does not contain any sub-prime or Alt-A credits.

The following table presents the carrying value, by security type and by maturity, for the Company’s investment portfolio:

 

     March 31,
2012
     December 31,
2011
 

U.S. Agency obligations

   $ 77,913       $ 77,985   

Mortgage-backed securities

     47,887       $ 44,078   

States & political subdivisions

     64,116         67,198   

Corporate securities

     —           1,004   
  

 

 

    

 

 

 

Total Debt Securities

     189,916         190,265   

Equity Securities

     1,061         943   
  

 

 

    

 

 

 

Total Investment Securities

   $ 190,977       $ 191,208   
  

 

 

    

 

 

 

Loan Portfolio

Details regarding the Company’s loan portfolio are as follows:

 

As of:

   March 31,
2012
     December 31,
2011
 

Construction and land development

     

Residential real estate

   $ 5,305       $ 5,064   

Commercial real estate

     20,339         20,541   

Commercial secured by real estate

     186,027         188,334   

Residential real estate

     265,713         276,579   

Commercial loans

     60,129         55,482   

Credit card and related plans

     3,025         3,242   

Installment and other

     58,503         59,170   

Obligations of states & political subdivisions

     38,287         23,110   
  

 

 

    

 

 

 

Loans, net of unearned income

     637,328         631,522   

Less: Allowance for loan and lease losses

     6,811         6,711   
  

 

 

    

 

 

 

Loans, net

   $ 630,517       $ 624,811   
  

 

 

    

 

 

 

There were no purchased loans during the three months ended March 31, 2012, other than loan participations with local banks in the Bank’s primary market area. Originations of new loans in 2012 were primarily commercial and municipal loans.

The Company has not engaged in any sub-prime residential mortgage lending. Therefore, the Company is not subject to any credit risks associated with such loans. The Company’s loan portfolio consists primarily of residential and commercial mortgage loans secured by properties located in Northeastern Pennsylvania and subject to what we believe are conservative underwriting standards.

 

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Table of Contents

Loans secured by real estate continue to be the largest component of the loan portfolio, representing 75% and 78% of total loans at March 31, 2012 and December 31, 2011, respectively. Recent economic conditions and recessionary concerns have resulted in lower levels of loan demand. The decline ratio on loan applications has remained consistent with our historical experience. As we expect these conditions and concerns to continue for the near term, we expect that loan growth may be slower than historically expected.

Loan Quality

Our lending activities are guided by a comprehensive lending policy approved by our board of directors. Loans must meet certain criteria relating to the character, capacity and capital of the borrower, collateral provided for the loan, and prevailing economic conditions. Our non-performing assets and charge-offs are well below industry levels due to the consistent application of our conservative underwriting standards.

Regardless of credit standards, there is risk of loss inherent in every loan portfolio. The allowance for loan and lease losses is an amount that management believes will be adequate to absorb probable losses on existing loans. The evaluations take into consideration such factors as change in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, industry experience, collateral value and current economic conditions that may affect the borrower’s ability to pay. Management believes that the allowance for loan and lease losses was adequate at March 31, 2012. Management uses available information to estimate probable losses on loans, while future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to recognize additions to the allowance based on their judgment of information available to them at the time of their examination.

The allowance for loan and lease losses is increased by periodic charges against earnings as a provision for loan and lease losses, and decreased periodically by charge-offs of loans (or parts of loans) that management has determined to be uncollectible, net of actual recoveries on loans previously charged-off.

The allowance for loan and lease losses as a percentage of loans was 1.07% at March 31, 2012, compared to 1.06% at December 31, 2011 and 1.11% at March 31, 2011.

Market Area

The Northeastern Pennsylvania economy in which we operate has been affected by the economic decline that has affected the U.S. economy as a whole. The unemployment rate for the Scranton/Wilkes-Barre metropolitan area was 8.9% at February 29, 2012. The region still leads the state’s 14 metro areas with the highest unemployment rate for twenty-two consecutive months, according to the data released recently by the State Department of Labor and Industry. The high unemployment rate can be attributed to a gradual decline in manufacturing in Northeastern Pennsylvania, and much like the rest of the country, a slowdown in construction of residential and commercial property.

High unemployment in Northeastern Pennsylvania will continue to put pressure on the local economy and on our loan portfolio. Average home prices nationally during 2012 were down 4.0% from the first quarter of 2011, according to the latest Case-Shiller House Price Index, which is a leading measure for the U.S. residential housing market. We believe that our focus on identifying borrowers who are facing cash flow problems before they are unable to make their payments will significantly improve our ability to help these borrowers maintain their debt service through difficult times.

 

40


Table of Contents

Non-Performing Assets

Non-performing assets consist of non-accrual loans and other real estate owned. The following table sets forth information regarding non-performing assets and loans past due 90 days or more and still accruing interest as of the dates indicated:

 

As of:

   March 31,
2012
     December 31,
2011
     March 31,
2011
 

Non-accrual loans

        

Residential real estate

   $ 1,609       $ 2,006       $ 2,477   

Commercial real estate

     348         591         1,235   

Commercial loans

     427         477         1,154   

Consumer loans

     59         92         67   
  

 

 

    

 

 

    

 

 

 

Total non-performing loans

   $ 2,443       $ 3,166       $ 4,933   
  

 

 

    

 

 

    

 

 

 

Other real estate owned

     1,786         1,571         883   
  

 

 

    

 

 

    

 

 

 

Total non-performing assets

   $ 4,229       $ 4,737       $ 5,816   
  

 

 

    

 

 

    

 

 

 

Loans past due 90 days or more and accruing:

        

Residential real estate

   $ 774       $ 641       $ 903   

Commercial real estate

     —           11         85   

Guaranteed student loans

     209         113         60   

Credit card loans

     13         6         26   

Commercial loans

     —           —           —     

Consumer loans

     2         3         34   
  

 

 

    

 

 

    

 

 

 

Total loans past due 90 days or more and accruing

   $ 998       $ 774       $ 1,108   
  

 

 

    

 

 

    

 

 

 

Loans are generally placed on non-accrual status when principal or interest is past due 90 days and when payment in full is not anticipated. For commercial loans, an appraisal is obtained if the loan has been downgraded and the appraisal on file is at least one year old. When a loan is placed on non-accrual status, all interest previously accrued but not collected is charged against current income. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured with the minimum of a six month positive payment history.

During the second quarter of 2008, the Company was notified that The Education Resources Institute, Inc. (TERI), a guarantor of a portion of our student loan portfolio, had filed for reorganization under Chapter 11 of the United States Bankruptcy Code. As of March 31, 2012, the Company had $6,719 of TERI-guaranteed loans out of a total student loan portfolio of $13,963. The Company does not anticipate that TERI’s bankruptcy filing will significantly impact the Company’s financial statements. These loans are placed on non-accrual status when they become more than 90 days past due. As of March 31, 2012, $33 of such loans were on non-accrual status.

Loans on which the accrual of interest has been discontinued or reduced amounted to $2,443 and $4,933 at March 31, 2012 and 2011, respectively. We believe that the 2012 decrease in non-accrual loans reflects management’s focused efforts to proactively address delinquent accounts. The decrease in loans that are 90 days or more and accruing reflects, in part, the decision to place more loans on non-accrual status when there is a likelihood that such loans will proceed to foreclosure. Further, the decrease in non-accrual loans was due in part to the completion of certain foreclosure actions that increased the level of other real estate owned to $1,786 at March 31, 2012 compared to $883 at March 31, 2011.

Real estate loans of $774 that are past due 90 days or more and still accruing are primarily 1-4 family residential loans with favorable loan-to-value ratios and that are in the process of collection.

If interest on non-accrual loans had been accrued, such income would have been $53 and $91 for the three months ended March 31, 2012 and March 31, 2011, respectively. Interest income on non-accrual loans, which is recorded only when received, amounted to $0 for each of the three months ended March 31, 2012 and March 31, 2011, respectively. There are no commitments to lend additional funds to borrowers whose loans are in non-accrual status.

 

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Table of Contents

Management’s process for evaluating the adequacy of the allowance for loan and lease losses includes reviewing each month’s loan committee reports which list all loans that do not meet certain internally developed criteria as to collateral adequacy, payment performance and overall credit risk. These reports also address the current status and actions in process on each listed loan. This information is used in our ALLL methodology and resulting adjustments are made to the allowance for loan and lease losses. Such adjustments include both specific loss allocation amounts and general provisions by loan category based on present and past collection experience, nature and volume of the loan portfolio, overall portfolio quality, and current economic conditions that may affect the borrower’s ability to pay.

Estimated “low” and “high” allowances for loan and lease loss amounts are derived by accumulating the loss estimates for specific loans and general pools. The actual allowance for loan and lease losses, situated within the estimated low-to-high range, is approved on a quarterly basis by our board of directors.

As of March 31, 2012, the Company had total impaired loans of $5,243. Of the total allowance for loan and lease losses, $1,128 was specifically related to these impaired loans at March 31, 2012.

Most of the Company’s lending activity is with customers located in the Company’s geographic market area and repayment thereof is affected by economic conditions in this market area.

Loan Loss Experience

The following table presents the Company’s allowance for loan and lease losses during the periods indicated:

 

Three Months Ended:

   March 31,
2012
    March 31,
2011
 

Balance at beginning of period

   $ 6,711      $ 6,500   

Charge-offs:

    

Residential real estate mortgages

     —          61   

Commercial real estate

     33        —     

Commercial loans

     5        —     

Credit card and related plans

     8        20   

Installment loans

     55        34   
  

 

 

   

 

 

 

Total charge-offs

     101        115   
  

 

 

   

 

 

 

Recoveries:

    

Residential real estate mortgages

     1        18   

Commercial real estate

     5        —     

Commercial loans

     —          1   

Credit card and related plans

     —          1   

Installment loans

     3        26   
  

 

 

   

 

 

 

Total recoveries

     9        46   
  

 

 

   

 

 

 

Net charge-offs (recoveries)

     92        69   
  

 

 

   

 

 

 

Provision charged to operations

     192        369   
  

 

 

   

 

 

 

Balance at End of Period

   $ 6,811      $ 6,800   
  

 

 

   

 

 

 

Ratio of net charge-offs (recoveries) to average loans outstanding

     0.01     0.01
  

 

 

   

 

 

 

The allowance for loan and lease losses at March 31, 2012 was $6,811 or 1.07% of total loans compared to $6,800 or 1.11% of total loans at March 31, 2011.

The allowance for loan and lease losses was allocated as follows:

 

As of:

   March 31, 2012     December 31, 2011     March 31, 2011  
     Amount      %*     Amount      %*     Amount      %*  

Residential real estate

   $ 2,857         43   $ 2,855         44   $ 788         49

Commercial real estate and all others

     3,126         49     3,087         47     4,209         42

Credit card and related plans

     327         0     319         1     359         1

Personal installment loans

     501         8     450         8     1,444         8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,811         100   $ 6,711         100   $ 6,800         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

* Percent of loans in each category to total loans

 

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The entire ALLL is available for losses in any loan category, notwithstanding the allocation above.

Our non-performing loans decreased from $4,933, at March 31, 2011, to $2,433 at March 31, 2012. As of March 31, 2012, our non-performing loans were comprised of thirty-nine loans of which eleven loans were in excess of one hundred thousand dollars in size and the remainder of which were less than one hundred thousand dollars each. The decrease in the non-performing loans can be attributed, to a large extent, to a large land development credit, which was transferred to OREO in the third quarter of 2011.

As of March 31, 2012, the total of the allowance for loan and lease losses was $6,811. Through the application of our ALLL methodology, the allowance reflects management’s conservative view of the local economic conditions.

As a result of the local and national weakness in the residential real estate industry, and to evaluate a potential loan loss, the Bank orders a current appraisal of the collateral securing such loan after it is 90 days delinquent to assess the current loan to value ratio. An appraisal is ordered in the case of commercial loans, if a loan has been downgraded and the current appraisal on file is at least one year old. Both residential and commercial appraisals continue to be discounted appropriately to the current loan to value requirements in the Bank’s loan policy, in view of the weak real estate market.

Other Real Estate Owned

The Bank has eleven properties in other real estate owned as of March 31, 2012. Of the eleven properties, two are commercial with a carrying value of $892; the remaining nine properties are residential. As of March 31, 2011 the Bank had five properties in other real estate owned, which represented four relationships. Three of the properties were commercial and two were residential.

The largest property in other real estate owned with a carrying value of $792 was sold on April 24, 2012 with a total consideration of $900.

Presently, there are thirteen properties in the process of foreclosure. Twelve of these properties are residential with the largest having a balance of $207. The commercial property has a balance of $155.

Deposits

Details regarding the Company’s deposit portfolio at the dates indicated are as follows:

 

     March 31,
2012
     December 31,
2011
 

Demand - Non-interest bearing

   $ 140,982       $ 134,799   

Demand - Interest bearing

     90,165         85,111   

Savings

     123,261         120,269   

Money markets

     161,592         165,611   

Time - Over $100,000

     83,729         84,828   

Time - Other

     125,200         129,900   
  

 

 

    

 

 

 

Total Deposits

   $ 724,929       $ 720,518   
  

 

 

    

 

 

 

The Company largely relies on its core deposit base of checking and savings accounts to fund operations. Management has competitively priced its deposit products in checking, savings, money market and time deposits to provide a stable source of funding.

In general, as interest rates in the economy change, some deposits migrate towards investments with higher anticipated yields. Historically, the Bank’s core deposits have been stable.

As of March 31, 2012, the Company had Certificate of Deposit Account Registry Service (“CDARS”) reciprocal deposits in the amount of $23.2 million. The Bank also currently issues brokered certificates of deposit as an alternative to wholesale funding due to their favorable terms. The balance of this funding as of March 31, 2012 and December 31, 2011 was $23.0 million and $23.2 million, respectively. The brokered certificates of deposit issued were generally a low cost alternative to wholesale funding with the majority offered having a call feature optionality not provided by wholesale funding. As of March 31, 2012, the dollar amount of brokered deposits, exclusive of CDARS reciprocal deposits, was $23.0 million, or 3.2%, of total deposits, compared to $23.2 million, or 3.2%, at December 31, 2011.

 

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Liquidity

The objective of liquidity management is to maintain a balance between sources and uses of funds in such a way that the cash requirements of customers for loans and deposit withdrawals are met in the most economical manner. Management monitors its liquidity position continuously in relation to trends of loans and deposits for short-term as well as long-term requirements. Liquid assets are monitored on a daily basis to assure maximum utilization. Management also manages its liquidity requirements by maintaining readily marketable assets and access to short-term funding sources. Management does not foresee any adverse trends in liquidity.

The Company remains in a highly liquid condition both in the short and long term. Sources of liquidity include the Company’s U.S. Agency bond portfolios, additional deposits, earnings, overnight loans to and from other companies (Federal Funds) and lines of credit at the Federal Reserve Bank and the Federal Home Loan Bank (FHLB). The Company is not a party to any commitments, guarantees or obligations that could materially affect its liquidity.

The Company offers collateralized securities sold under agreements to repurchase, which have a one day maturity, as an alternative deposit option for its customers. The securities sold under agreements to repurchase are accounted for as a collateralized borrowing with a one day maturity and are collateralized by U.S. Agency securities. The Company also has long-term debt outstanding to the FHLB, which was used to purchase a Freddie Mac pool of residential mortgages. At March 31, 2012, the Company had $204,744 of available borrowing capacity with the FHLB, a Borrower-In-Custody (BIC) line of credit of $34,422 with the Federal Reserve Bank of Philadelphia, available borrowing capacity at the Discount Window of $16,571, an overnight Federal funds line of credit of $19,000 with PNC Bank, an overnight Federal funds line of credit of $5,000 with Wells Fargo and an overnight Federal funds line of credit of $5,000 with Atlantic Central Bankers Bank.

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company’s primary source of funds is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company is generally restricted under Pennsylvania law to the retained earnings of the Bank.

Commitments and Contingent Liabilities

In the normal course of business, there are outstanding commitments and contingent liabilities, created under prevailing terms and collateral requirements such as commitments to extend credit, financial guarantees and letters of credit, which are not reflected in the accompanying Financial Statements. The Company does not anticipate any losses as a result of these transactions. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Balance Sheets.

The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have expiration dates of one year or less or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Various actions and proceedings are presently pending to which the Company is a party. Management is of the opinion that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the financial position of the Company.

In January 2012, the Bank purchased land in Scranton, Pennsylvania to be used for construction of a new branch facility. The Bank has received regulatory approval for the establishment of this new branch office, which is expected to be operational during the fourth quarter of 2012.

 

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Capital Resources

A strong capital position is important to the continued profitability of the Company and promotes depositor and investor confidence. The Company’s capital provides a basis for future growth and expansion and also provides additional protection against unexpected losses.

Additional sources of capital are retained earnings from the operations of the Company and proceeds from the sale of additional shares of common stock. Management has no plans to offer additional shares of common stock at this time.

The Company’s total risk-based capital ratio was 17.10% at March 31, 2012. The Bank’s total risk-based capital ratio was 16.52% at March 31, 2012, which is more than the 10.00% ratio that Federal regulators use as the “well capitalized” threshold under the Federal prompt corrective action regulations. This is the current criteria which the FDIC uses in determining the lowest insurance rate for deposit insurance. The Bank’s risk-based capital ratio is more than double the 8.00% minimum threshold, which determines whether a company is “adequately capitalized”. Under these rules, the Bank could significantly increase its assets and still comply with these capital requirements without the necessity of increasing its equity capital.

Non-GAAP Financial Measures

Core Earnings Calculation

Certain financial measures for 2011 reported herein exclude the effect of the reversal of a contingent liability recorded in the 2009 Merger. Management of the Company believes that investors’ understanding of the Company’s performance is enhanced by disclosing these non-GAAP financial measures as a reasonable basis for comparison of the Company’s ongoing results of operations. These non-GAAP measures should not be considered a substitute for GAAP-basis measures and results. Our non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Non-GAAP Reconciliation Schedule provides a disclosure of these non-GAAP financial measures to the most closely analogous measure determined in accordance with GAAP.

The following table presents the reconciliation of non-GAAP financial measures to reported GAAP financial measures:

 

     Three Months Ended
March 31,
       
     2012     2011     Change  

Unadjusted (GAAP)

      

Net interest income after provision for loan and lease losses

   $ 7,986      $ 7,774      $ 212   

Non-interest income

     2,903        3,304        (401

Non-interest expense

     (7,277     (7,450     173   

Income tax (provision) benefit

     (840     (859     19   
  

 

 

   

 

 

   

 

 

 

Net income

     2,772        2,769        3   

Adjustments

      

Non-interest income

      

Reversal of a contingent liability recorded in the Merger

     —          (500     500   
  

 

 

   

 

 

   

 

 

 

Total adjustments pre-tax

     —          (500     500   

Income tax provision (benefit)

     —          170        (170
  

 

 

   

 

 

   

 

 

 

After tax adjustments to GAAP

     —          (330     330   
  

 

 

   

 

 

   

 

 

 

Adjusted “net income from core operations”

   $ 2,772      $ 2,439      $ 333   
  

 

 

   

 

 

   

 

 

 

Adjusted Return on Average Assets

     1.20     1.07  

Adjusted Return on Average Equity

     8.48     7.89  

Adjusted Dividend Payout Ratio

     49.41     56.76  

Return on average equity (ROE) and return on average assets (ROA) for the three months ended March 31, 2012 was 8.48% and 1.20%, respectively. ROE was 8.96% (7.89% excluding the reversal of a contingent liability) and

 

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1.21% (1.07% excluding the reversal of a contingent liability) for the same period last year. The dividend payout ratio was 49.41% for the three months ended March 31, 2012 and 49.41% (56.76% excluding the reversal of a contingent liability) for the same period last year.

Allowance for Loan and Lease Losses and Credit Fair Value Adjustment

The Company has provided for anticipated loan losses through the allowance for loan and lease losses and a credit fair value adjustment on loans acquired, as shown below:

 

00000000 00000000 00000000
     March 31,
2012
    December 31,
2011
    March 31,
2011
 

Loans, net of unearned income

   $ 637,328      $ 631,522      $ 611,021   

Credit fair value adjustment on purchased loans

     2,144        2,343        3,290   
  

 

 

   

 

 

   

 

 

 

Total adjusted loans

   $ 639,472      $ 633,865      $ 614,311   
  

 

 

   

 

 

   

 

 

 
     March 31,
2012
    December 31,
2011
    March 31,
2011
 

Allowance for loan and lease losses

   $ 6,811      $ 6,711      $ 6,800   

Credit fair value adjustment on purchased loans

     2,144        2,343        3,290   
  

 

 

   

 

 

   

 

 

 

Total adjusted allowance

   $     8,955      $     9,054      $   10,090   
  

 

 

   

 

 

   

 

 

 

Total adjusted allowance to adjusted loans

     1.40     1.43     1.64

Management believes that the above information, as to the Company’s evaluation of probable credit losses and its effect on results of operations and financial condition, is useful to investors.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

The Company currently does not enter into derivative financial instruments, which include futures, forwards, interest rate swaps, option contracts and other financial instruments with similar characteristics. However, the Company is party to traditional financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, financial guarantees and letters of credit. These traditional instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions.

Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Company until the instrument is exercised.

The Company’s exposure to market risk is reviewed on a regular basis by the Company’s board of directors. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. Tools used by management include the standard GAP report and an interest rate shock simulation report. The Company has no market risk sensitive instruments held for trading purposes. Management believes the Company’s market risk is reasonable at this time.

For a discussion of the Company’s asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Company’s financial instruments, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and market value of the Company’s portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since December 31, 2011.

 

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Item 4. Controls and Procedures

Under the supervision and with the participation of the Company’s management, including our Chief Executive Officer (our principal executive officer) and Finance Division Head (our principal financial officer), we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934. Based upon this evaluation, the Company’s Chief Executive Officer and the Company’s Finance Division Head concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

No changes in our internal control over financial reporting occurred during the quarter ended March 31, 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

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, 2011, which was filed with the Securities and Exchange Commission (SEC) on March 14, 2012. 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

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

Period

  Total Number of
Shares Purchased (1)
    Average Price Paid
per Share
    Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
    Maximum Number
(or Approximate
Dollar Value) of
Shares that May
Yet Be Purchased
Under the Plans or
Programs
 

January 1 – January 31, 2012

    —          —          —          —     

February 1 – February 29, 2012

    800      $ 38.62        —          —     

March 1 – March 31, 2012

    —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    800      $ 38.62        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) These shares were purchased through the Trust department of the Bank in open-market transactions, other than through a publicly announced plan, in order to partially fund an award of restricted stock under the Company’s 2008 Long Term Incentive Plan.

Item 3 — Defaults Upon Senior Securities

None.

Item 4 — Mine Safety Disclosures

None.

Item 5 — Other Information

None.

Item 6 — Exhibits

 

  3.1

   Amended and Restated Bylaws of Penseco Financial Services Corporation, effective February 21, 2012 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s current report on Form 8-K filed with the SEC on February 27, 2012).

 

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    3.2

   Articles of Amendment to the Articles of Incorporation of Penseco Financial Services Corporation, effective February 23, 2012 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s current report on Form 8-K filed with the SEC on February 27, 2012).

  31.1

   Rule 13a-14(a) / 15-d-4(a) Certifications of the Principal Executive Officer

  31.2

   Rule 13a-14(a) / 15-d-4(a) Certifications of the Principal Financial Officer

  32

   Section 1350 Certifications

101

   Interactive Data File (Quarterly Report on Form 10-Q, for the quarter ended March 31, 2012, furnished in XBRL (eXtensible Business Reporting Language)).

 

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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.

 

PENSECO FINANCIAL SERVICES CORPORATION
By  

/s/    CRAIG W. BEST        

  Craig W. Best
  President and CEO
  (Principal Executive Officer)

Dated: May 7, 2012

 

By  

/s/    PATRICK SCANLON        

  Patrick Scanlon
  Senior Vice President, Finance Division Head
  (Principal Financial Officer)

Dated: May 7, 2012

 

49