Acquisition of Luzerne National Bank Corporation

6 Months Ended

Jun. 30, 2013

Acquisition of Luzerne National Bank Corporation

Acquisition of Luzerne National Bank Corporation

Note 14.  Acquisition of Luzerne National Bank Corporation

On June 1, 2013, the Company closed on a merger transaction pursuant to which Penns Woods Bancorp, Inc. acquired Luzerne National Bank Corporation in a stock and cash transaction.  The acquisition extended the Company’s footprint into Luzerne and Lackawanna Counties, Pennsylvania.

Luzerne National Bank Corporation was the holding company for Luzerne Bank, a Pennsylvania bank that conducted its business from a main office in Luzerne, Pennsylvania with eight branch offices in Luzerne County and one loan production office in Lackawanna County, all in northeastern Pennsylvania.

Under the terms of the merger agreement, the Company acquired all of the outstanding shares of Luzerne National Bank Corporation for a total purchase price of approximately $42,612,000.  As a result of the acquisition, the Company issued 978,977 common shares, or 20.31% of the total shares outstanding as of June 30, 2013, to former shareholders of Luzerne National Bank Corporation.  Luzerne Bank is operating as an independent bank under the Penns Woods Bancorp, Inc. umbrella.

The acquired assets and assumed liabilities were measured at estimated fair values. Management made significant estimates and exercised significant judgment in accounting for the acquisition.  Management measured loan fair values based on loan file reviews, appraised collateral values, expected cash flows, and historical loss factors of Luzerne Bank.  Real estate acquired through foreclosure was primarily valued based on appraised collateral values.  The Company also recorded an identifiable intangible asset representing the core deposit base of Luzerne Bank based on management’s evaluation of the cost of such deposits relative to alternative funding sources.  The Company also recorded an identifiable intangible asset representing the trade name of Luzerne Bank based on management’s evaluation of the value of the name in the market.  Management used significant estimates including the average lives of depository accounts, future interest rate levels, and the cost of servicing various depository products. Management used market quotations to determine the fair value of investment securities.

The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration. Luzerne Bank’s loans were deemed impaired at the acquisition date if the Company did not expect to receive all contractually required cash flows due to concerns about credit quality.  Such loans were fair valued and the difference between contractually required payments at the acquisition date and cash flows expected to be collected was recorded as a non-accretable difference. At the acquisition date, the Company recorded $1,211,000 of purchased credit-impaired loans subject to a non-accretable difference of $842,000. The method of measuring carrying value of purchased loans differs from loans originated by the Company (originated loans), and as such, the Company identifies purchased loans and purchased loans with a credit quality discount and originated loans at amortized cost.

Luzerne’s loans without evidence of credit deterioration were fair valued by discounting both expected principal and interest cash flows using an observable discount rate for similar instruments that a market participant would consider in determining fair value.  Additionally, consideration was given to management’s best estimates of default rates and payment speeds.  At acquisition, Luzerne’s loan portfolio without evidence of deterioration totaled $249,789,000 and was recorded at a fair value of $249,500,000.

The following table summarizes the purchase of Luzerne National Bank Corporation as of June 1, 2013:

(In Thousands, Except Per Share Data)
Purchase Price Consideration in Common Stock
Luzerne National Bank Corporation common shares settled for stock	630,216
Exchange Ratio	1.5534
Penns Woods Bancorp, Inc. shares issued	978,977
Value assigned to Penns Woods Bancorp, Inc. common share	$	40.59
Purchase price assigned to Luzerne National Bank Corporation common shares exchanged for Penns Woods Bancorp, Inc.				$	39,736
Purchase Price Consideration - Cash for Common Stock
Luzerne National Bank Corporation shares exchanged for cash	46,480
Purchase price paid to each Luzerne National Bank Corporation common share exchanged for cash	$	61.86
Purchase price assigned to Luzerne National Bank Corporation common shares exchanged for cash				2,876
Total Purchase Price				42,612
Net Assets Acquired:
Luzerne National Bank Corporation shareholders’ equity	$	27,371
Adjustments to reflect assets acquired at fair value:
Investments	33
Loans
Interest rate	2,680
General credit	(3,206		)
Specific credit - non-amortizing	(58		)
Specific credit - amortizing	(40		)
Core deposit intangible	1,882
Trade name intangible	133
Owned premises	1,138
Leased premises contracts	122
Deferred tax assets	(603		)
Adjustments to reflect liabilities acquired at fair value:
Time deposits	(912		)
				28,540
Goodwill resulting from merger				$	14,072

The following condensed statement reflects the values assigned to Luzerne National Bank Corporation’s net assets as of the acquisition date:

(In Thousands)
Total purchase price				$	42,612
Net assets acquired:
Cash	$	20,296
Federal funds sold	67
Securities available for sale	21,783
Loans	250,377
Premises and equipment, net	8,014
Accrued interest receivable	726
Bank-owned life insurance	7,419
Intangibles	2,015
Deferred tax liability	(76		)
Other assets	2,636
Time deposits	(79,223		)
Deposits other than time deposits	(197,733		)
Borrowings	(2,766		)
Accrued interest payable	(103		)
Other liabilities	(4,892		)
				28,540
Goodwill resulting from Luzerne National Bank Corporation Merger				$	14,072

The Company recorded goodwill and other intangibles associated with the purchase of Luzerne National Bank Corporation totaling $16,086,000.  Goodwill is not amortized, but is periodically evaluated for impairment.  The Company did not recognize any impairment during the six months ended June 30, 2013.  The carrying amount of the goodwill at June 30, 2013 related to the Luzerne acquisition was $14,072,000.

Identifiable intangibles are amortized to their estimated residual values over the expected useful lives. Such lives are also periodically reassessed to determine if any amortization period adjustments are required.  During the six months ended June 30, 2013, no such adjustments were recorded.  The identifiable intangible assets consist of a core deposit intangible and trade name intangible which are being amortized on an accelerated basis over the useful life of such assets.  The gross carrying amount of the core deposit intangible and trade name intangible at June 30, 2013 was $1,882,000 and $132,000, respectively, with $29,000 and $2,000 accumulated amortization as of that date.

As of June 30, 2013, the current year and estimated future amortization expense for the core deposit and trade name intangible was:

(In Thousands)
2013	$	214
2014	345
2015	308
2016	272
2017	235
2018	198
2019	162
2020	125
2021	89
2022	52
2023	15
	$	2,015

Results of operations for Luzerne National Bank Corporation prior to the acquisition date are not included in the Consolidated Statement of Income for the three and six month periods ended June 30, 2013.  Due to the significant amount of fair value adjustments, historical results of Luzerne National Bank Corporation are not relevant to the Company’s results of operations.  Therefore, no pro forma information is presented.

The following table presents financial information regarding the former Luzerne National Bank Corporation operations included in our Consolidated Statement of Income from the date of acquisition through June 30, 2013 under the column “Actual from acquisition date through June 30, 2013”.  In addition, the following table presents unaudited pro forma information as if the acquisition of

Luzerne National Bank Corporation had occurred on January 1, 2012 under the “Pro Forma” columns.  The table below has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative of future results. Furthermore, the unaudited proforma information does not reflect management’s estimate of any revenue-enhancing opportunities nor anticipated cost savings as a result of the integration and consolidation of the acquisition.  Merger and acquisition integration costs and amortization of fair value adjustments are included in the numbers below.

			Pro Formas
	Actual from Acquisition Date		Six Months Ended June 30,
(In Thousands, Except Per Share Data)	Through June 30, 2013		2013		2012
Net interest income	$	1,049	$	21,546	$	20,771
Non-interest income	137		7,090		5,995
Net income	299		6,212		8,292
Pro forma earnings per share:
Basic			$	1.29	$	1.72
Diluted			1.29		1.72

CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact.  The Company cautions readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein:  (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the  increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; (v) the effect of changes in the business cycle and downturns in the local, regional or national economies; and (vi) our ability to successfully integrate the business of Luzerne.

You should not put undue reliance on any forward-looking statements.  These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by the Company on its website or otherwise.  The Company undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.