SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

ý         Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended September 30, 2005,

 

o         Transition report pursuant to Section 13 or 15 (d) of the Exchange Act for the Transition Period from               to               .

 

No. 0-17077

(Commission File Number)

 

PENNS WOODS BANCORP, INC.

(Exact name of Registrant as specified in its charter)

 

PENNSYLVANIA		23-2226454
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
300 Market Street, Williamsport, Pennsylvania		17701-0967
(Address of principal executive offices)		(Zip Code)

 

(570) 322-1111

Registrant’s telephone number, including area code

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES ý      NO o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

 

YES ý      NO o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

 

YES o      NO ý

 

On October 27, 2005 there were 3,320,414 of the Registrant’s common stock outstanding.

 

 

PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

 

		Page
		Number
Part I Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet (unaudited) as of September 30, 2005 and December 31, 2004		3
Consolidated Statement of Income (unaudited) for the Three and Nine Months ended September 30, 2005 and 2004		4
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) For the Nine Months ended September 30, 2005 and 2004		5
Consolidated Statement of Comprehensive Income (unaudited) for the Three and Nine Months ended September 30, 2005 and 2004		6
Consolidated Statement of Cash Flows (unaudited) for the Nine Months ended September 30, 2005 and 2004		7
Notes to Consolidated Financial Statements(unaudited)		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3. Quantitative and Qualitative Disclosures About Market Risk		29
Item 4. Controls and Procedures		29
Part II Other Information		29
Item 1. Legal Proceedings		29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 3. Defaults Upon Senior Securities		30
Item 4. Submission of Matters to a Vote of Security Holders		30
Item 5. Other Information		30
Item 6. Exhibits		30
Signatures		31
Exhibit Index and Exhibits		32

 

2

 

PENNS WOODS BANCORP, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

 

		September 30,			December 31,
(In Thousands, Except Share Data)		2005			2004
ASSETS:
Noninterest-bearing balances		$	13,113		$	12,602
Interest-bearing deposits in other financial institutions		27			24
Total cash and cash equivalents		13,140			12,626
Investment securities, available for sale, at fair value		192,039			184,163
Investment securities held to maturity (fair value of $241 and $561)		266			558
Loans held for sale		3,908			4,624
Loans, net of unearned discount of $1,025 and $1,096		330,651			324,505
Less: Allowance for loan and lease losses		3,492			3,338
Loans, net		327,159			321,167
Premises and equipment, net		6,141			4,882
Accrued interest receivable		2,520			2,246
Bank-owned life insurance		10,627			10,976
Goodwill		3,032			3,032
Other assets		11,587			2,429
TOTAL ASSETS		$	570,419		$	546,703
LIABILITIES:
Interest-bearing deposits		$	291,137		$	282,786
Noninterest-bearing deposits		72,053			74,050
Total deposits		363,190			356,836
Short-term borrowings		40,410			36,475
Long-term borrowings, Federal Home Loan Bank(FHLB)		84,478			75,878
Accrued interest payable		1,118			850
Other liabilities		6,733			3,499
TOTAL LIABILITIES		495,929			473,538
SHAREHOLDERS’ EQUITY:
Common stock, par value $10.00, 10,000,000 shares authorized; 3,332,399 and 3,331,837 shares issued		33,324			33,318
Additional paid-in capital		17,711			17,700
Retained earnings		22,102			18,262
Accumulated other comprehensive gain		1,914			4,331
Less: Treasury stock at cost, 12,810 and 10,310 shares		(561		)	(446		)
TOTAL SHAREHOLDERS’ EQUITY		74,490			73,165
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	570,419		$	546,703

 

See accompanying notes to the unaudited consolidated financial statements.

 

3

 

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(In Thousands, Except Per Share Data)		2005			2004			2005			2004
INTEREST AND DIVIDEND INCOME:
Loans including fees		$	5,899		$	5,550		$	17,070		$	15,578
Investment Securities:
Taxable		967			1,698			3,445			5,278
Tax-exempt		969			422			2,246			1,133
Dividend		278			254			873			794
TOTAL INTEREST AND DIVIDEND INCOME		8,113			7,924			23,634			22,783
INTEREST EXPENSE:
Deposits		1,537			1,227			4,151			3,544
Short-term borrowings		199			131			545			367
Long-term borrowings		965			871			2,711			2,584
TOTAL INTEREST EXPENSE		2,701			2,229			7,407			6,495
NET INTEREST INCOME		5,412			5,695			16,227			16,288
PROVISION FOR LOAN LOSSES		180			165			540			315
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,232			5,530			15,687			15,973
NON-INTEREST INCOME:
Service charges		612			499			1,603			1,497
Securities gains, net		556			407			1,854			1,535
Bank-owned life insurance		288			90			475			270
Insurance commissions		507			637			1,802			1,796
Other operating income		321			322			964			944
TOTAL NON-INTEREST INCOME		2,284			1,955			6,698			6,042
NON-INTEREST EXPENSES:
Salaries and employee benefits		2,130			1,948			6,323			5,813
Occupancy expense, net		261			231			838			704
Furniture and equipment expense		262			226			717			721
Pennsylvania shares tax expense		138			131			417			377
Other operating expenses		1,031			973			3,035			2,820
TOTAL NON-INTEREST EXPENSES		3,822			3,509			11,330			10,435
INCOME BEFORE INCOME TAX PROVISION		3,694			3,976			11,055			11,580
INCOME TAX PROVISION		746			1,150			2,632			3,277
NET INCOME		$	2,948		$	2,826		$	8,423		$	8,303
EARNINGS PER SHARE - BASIC		$	0.89		$	0.85		$	2.54		$	2.50
EARNINGS PER SHARE - DILUTED		$	0.89		$	0.85		$	2.54		$	2.50
WEIGHTED AVERAGE SHARES OUTSTANDING-BASIC		3,310,719			3,319,457			3,311,213			3,320,249
WEIGHTED AVERAGE SHARES OUTSTANDING-DILUTED		3,312,464			3,323,608			3,313,141			3,323,908
DIVIDNEDS PER SHARE		$	0.47		$	0.35		$	1.38		$	1.05

 

See accompanying notes to the unaudited consolidated financial statements.

 

4

 

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)

 

													ACCUMULATED
		COMMON					ADDITIONAL						OTHER						TOTAL
		STOCK					PAID-IN			RETAINED			COMPREHENSIVE			TREASURY			SHAREHOLDERS’
(In Thousands Except Per Share Data)		SHARES		AMOUNT			CAPITAL			EARNINGS			INCOME			STOCK			EQUITY
Balance, December 31, 2004		3,331,837		$	33,318		$	17,700		$	18,262		$	4,331		$	(446	)	$	73,165
Net income										8,423									8,423
Dividends declared, $1.38										(4,583		)							(4,583		)
Treasury Stock acquired (2,500 shares)																(115		)	(115		)
Net change in unrealized gain on investments available for sale, net of reclassification adjustment, net of income tax benefit of $1,245													(2,417		)				(2,417		)
Stock options exercised		562		6			11												17
Balance, September 30, 2005		3,332,399		$	33,324		$	17,711		$	22,102		$	1,914		$	(561	)	$	74,490

 

													ACCUMULATED
		COMMON					ADDITIONAL						OTHER						TOTAL
		STOCK					PAID-IN			RETAINED			COMPREHENSIVE			TREASURY			SHAREHOLDERS’
(In Thousands Except Per Share Data)		SHARES		AMOUNT			CAPITAL			EARNINGS			INCOME			STOCK			EQUITY
Balance, December 31, 2003		3,326,560		$	33,265		$	17,559		$	13,022		$	6,132		$	(209	)	$	69,769
Net income										8,303									8,303
Dividends declared, $1.05										(3,486		)							(3,486		)
Treasury Stock acquired (3,000 shares)																(130		)	(130		)
Net change in unrealized gain on investments available for sale, net of tax benefit of $1,084													(2,105		)				(2,105		)
Stock options exercised		897		9			22												31
Balance, September 30, 2004		3,327,457		$	33,274		$	17,581		$	17,839		$	4,027		$	(339	)	$	72,382

 

See accompanying notes to the unaudited consolidated financial statements.

 

5

 

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)

 

		Three Months Ended September 30,
(In Thousands)		2005			2004
Net Income		$	2,948		$	2,826
Other comprehensive income:
Net unrealized (losses) gains on available for sale securities		(3,350		)	4,165
Less: Reclassification adjustment for gain included in net income		556			407
Other comprehensive (loss) income before tax		(3,906		)	3,758
Income tax (benefit) expense related to other comprehensive (loss) income		(1,328		)	1,278
Other comprehensive (loss) income, net of tax		(2,578		)	2,480
Comprehensive income		$	370		$	5,306

 

		Nine Months Ended September 30,
(In Thousands)		2005			2004
Net Income		$	8,423		$	8,303
Other comprehensive income:
Net unrealized losses on available for sale securities		(1,808		)	(1,654		)
Less: Reclassification adjustment for gain included in net income		1,854			1,535
Other comprehensive loss before tax		(3,662		)	(3,189		)
Income tax benefit related to other comprehensive (loss)		(1,245		)	(1,084		)
Other comprehensive loss, net of tax		(2,417		)	(2,105		)
Comprehensive income		$	6,006		$	6,198

 

See accompanying notes to the unaudited consolidated financial statements.

 

6

 

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

 

		Nine Months Ended
		September 30,
(In Thousands)		2005			2004
OPERATING ACTIVITIES:
Net Income		$	8,423		$	8,303
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		377			407
Provision for loan losses		540			315
Accretion and amortization of investment security discounts and premiums		(319		)	(28		)
Securities gains, net		(1,854		)	(1,535		)
Originations of loans held for sale		(21,562		)	(27,785		)
Proceeds of loans held for sale		22,278			25,913
Earnings on bank-owned life insurance		(475		)	(270		)
Other, net		200			718
Net cash provided by operating activities		7,608			6,038
INVESTING ACTIVITIES:
Investment securities available for sale:
Proceeds from sales		109,889			131,196
Proceeds from calls and maturities		10,697			22,104
Purchases		(130,575		)	(138,020		)
Investment securities held to maturity:
Proceeds from calls and maturities		327			42
Purchases		(35		)	(14		)
Net increase in loans		(6,918		)	(41,145		)
Acquisition of bank premises and equipment		(1,636		)	(474		)
Proceeds from the sale of foreclosed assets		67			177
Proceeds from redemption of regulatory stock		3,118			2,100
Purchases of regulatory stock		(3,112		)	(1,895		)
Investment in limited partnership		(3,124		)	—
Net cash used in investing activities		(21,302		)	(25,929		)
FINANCING ACTIVITIES:
Net increase in interest-bearing deposits		8,351			33,598
Net (decrease) increase in noninterest-bearing deposits		(1,997		)	5,171
Proceeds of long-term borrowings		10,000			5,000
Repayment of long-term borrowings		(1,400		)	—
Net increase (decrease) in short-term borrowings		3,935			(13,596		)
Dividends paid		(4,583		)	(3,486		)
Stock options exercised		17			31
Purchase of treasury stock		(115		)	(130		)
Net cash provided by financing activities		14,208			26,588
NET INCREASE IN CASH AND CASH EQUIVALENTS		514			6,697
CASH AND CASH EQUIVALENTS, BEGINNING		12,626			10,230
CASH AND CASH EQUIVALENTS, ENDING		$	13,140		$	16,927
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid		$	7,139		$	6,452
Income taxes paid		$	2,475		$	3,250
Transfer of loans to foreclosed assets		$	386		$	106

 

See accompanying notes to the unaudited consolidated financial statements.

 

7

 

PENNS WOODS BANCORP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1.  Basis of Presentation

 

The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., and Jersey Shore State Bank (the “Bank”) and its wholly-owned subsidiary The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  All significant inter-company balances and transactions have been eliminated in the consolidation.

 

The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for the fair presentation of results for such periods.  All of those adjustments are of a normal, recurring nature.  The results of operations for any interim period are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with financial statements and notes thereto contained in the Company’s annual report for the year ended December 31, 2004.

 

The accounting policies followed in the presentation of interim financial results are the same as those followed on an annual basis.  These policies are presented on pages 9 thru 11 of the 2004 Annual Report and Form 10K with additional policies listed below in Note 2, Significant Accounting Policies.

 

NOTE 2.  Significant Accounting Policies

 

The M Group (d/b/a Comprehensive Financial Group) Products and Income Recognition

 

The M Group product line is comprised primarily of annuities, life insurance, and mutual funds.  The revenues generated from life insurance sales are commission only as The M Group does not underwrite the policies.  Life insurance sales include permanent and term policies with the majority of the policies written being permanent.  Term life insurance policies are written for 10, 15, 20, and 30 year terms with the majority of the policies being written for 20 years.  None of these products are offered as an integral part of lending activities.

 

Commissions from the sale of annuities is recognized at the time notice is received from the broker/dealer or an insurance company that the transaction is final, which is also the time a commission check is received.  Until this notice is received, the completion of the sale is on hold as the broker/dealer or an insurance company may choose to not accept the application.

 

Life insurance commissions are recognized at varying points based on the payment option chosen by the consumer.  Commissions from monthly and annual payment plans are recognized at the start of each annual period for the life insurance, while quarterly and semi-annual premium payments are recognized quarterly and semi-annually when the earnings process is complete.  For example, semi-annual payments on the first of January and July would result in commission recognition on the first of January and July, while payments on the first of January, April, July,

 

8

 

and October would result in commission recognition on those dates.  The potential for chargebacks only exists for those policies on a monthly payment plan due to the income being recognized at the beginning of the annual period versus at the time of each monthly payment.  No liability is maintained for chargebacks as any chargeback is removed from income at the time of the chargeback.

 

NOTE 3. Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS No. 123R). FAS No. 123R revised FAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.  FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statement (with limited exceptions).  The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued.   Compensation cost will be recognized over the period that an employee provides service in exchange for the award.

 

In April, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R.  The Statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity or liability instruments issued.  FAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The Company will adopt FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.

 

In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of FAS No. 123R, and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s financial condition, results of operations, and cash flows.

 

In December 2004, FASB issued FAS No. 153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. FAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of FAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Early application is permitted and companies must apply

 

9

 

the standard prospectively. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

 

In June 2005, the FASB issued FAS No. 154, Accounting Changes and Errors Corrections, a replacement of APB Opinion No. 20 and FAS No. 3.  The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. FAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impractical.  APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle.  FAS No.154 improves the financial reporting because its requirements enhance the consistency of financial reporting between periods.  The provisions of FAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

 

NOTE 4. Per Share Data

 

The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive per share computation.  There are no convertible securities which would affect the numerator in calculating basic and diluted earnings per share, therefore, net income as presented on the consolidated statement of income will be used as the numerator.

 

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2005		2004		2005		2004
Weighted average common shares outstanding		3,322,089		3,327,457		3,321,880		3,327,406
Average treasury stock shares		(11,370	)	(8,000	)	(10,667	)	(7,157	)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share		3,310,719		3,319,457		3,311,213		3,320,249
Additional common stock equivalents (stock options) used to calculate diluted earnings per share		1,745		4,151		1,928		3,659
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share		3,312,464		3,323,608		3,313,141		3,323,908

 

Options to purchase 8,107 shares of common stock at the price of $48.35 were outstanding during the three and nine months ended September 30, 2005 and 8,713 shares of common stock at the price of $48.35 were outstanding for the three and nine months ended September 30, 2004, but were not included in the computation of diluted earnings per share as they were anti-dilutive due to the strike price being greater than the market price as of the end of the quarter.

 

10

 

Note 5.  Net Periodic Benefit Cost-Defined Benefit Plans

 

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 11 of the Company’s Consolidated Financial Statements included in the 2004 Annual Report on Form 10-K.

 

The following sets forth the components of net periodic benefit cost of the domestic non-contributory defined benefit plans for the three and nine months ended September 30, 2005 and 2004,  respectively.

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(In Thousands)		2005			2004			2005			2004
Service cost		$	125		$	116		$	379		$	349
Interest cost		110			100			335			299
Expected return on plan assets		(112		)	(81		)	(302		)	(245		)
Amortization of transition obligation		(1		)	(1		)	(2		)	(2		)
Amortization of prior service cost		6			6			19			19
Amortization of net (gain) loss		16			10			49			31
Net periodic cost		$	144		$	150		$	478		$	451

 

Employer Contributions

 

The Company previously disclosed in its consolidated financial statements included in the 2004 Annual Report on Form 10-K that it expected to contribute $575,000 to its defined benefit plan in 2005.  However, as of September 30, 2005, contributions of $1,420,000 have been made as the Company determined that contributing an amount above the minimum required was beneficial from a current tax and future financial perspective.  Of the contribution $1,100,000 was related to the 2004 pension period. The Company is evaluating the amount, if any, of additional funds to contribute in the final quarter of 2005.

 

Note 6.  Off Balance Sheet Risk

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet.  The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.

 

The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

 

11

 

Financial instruments whose contract amounts represent credit risk are as follows:

 

		September 30,
(In Thousands)		2005			2004
Commitments to extend credit		$	74,483		$	54,313
Standby letters of credit		1,537			760

 

Note 7.  Reclassification of Comparative Amounts

 

Certain comparative amounts for the prior periods have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.

 

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

 

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

 

12

 

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

EARNINGS SUMMARY

 

Comparison of the Three and Nine Months Ended September 30, 2005 and 2004

 

Summary Results

 

Net income for the three months ended September 30, 2005 was $2,948,000 compared to $2,826,000 for the same period of 2004.  Basic and diluted earnings per share for the three months ended September 30, 2005 were $0.89 as compared to $0.85 for the three months ended September 30, 2004.  Return on average assets and return on average equity were 2.12% and 16.54% for the three months ended September 30, 2005 as compared to 2.06% and 16.07% for the corresponding period of 2004.  Net income from core operations for the three months ended September 30, 2005, excluding after-tax securities gains of $367,000, increased to $2,581,000 from $2,557,000 for the three months ended September 30, 2004.

 

The nine months ended September 30, 2005 generated net income of $8,423,000 compared to $8,303,000 for the same period of 2004.  Earnings per share, basic and diluted, for the nine months ended September 30, 2005 were $2.54 as compared to $2.50 for the comparable period of 2004.  Return on average assets and return on average equity were 2.05% and 14.94% for the nine months ended September 30, 2005 as compared to 2.07% and 15.62% for the corresponding period of 2004.  Net income from core operations for the nine months ended September 30, 2005, excluding after-tax securities gains of $1,224,000, declined to $7,199,000 from $7,290,000 for the nine months ended September 30, 2004.  (Management uses the non-GAAP measure of net income from core operations in its analysis of the Company’s performance.  This measure, as used by the Company, adjusts net income by significant gains or losses that are unusual in nature.  Because certain of these items and their impact on the Company’s performance are difficult to predict, management believes the presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company’s core businesses.  These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.)

 

Interest Income

 

During the third quarter of 2005, interest and dividend income was $8,113,000, an increase of $189,000 over the same quarter of 2004.  The increase in total interest income was primarily the result of growth in average loans of $18,671,000 for the third quarter of 2005 as compared to 2004.  Over this time frame the average balance of investment securities declined $10,503,000, while the investment portfolio continued to shift from taxable mortgage-backed securities to tax-exempt municipal bonds. The shift in earning assets increased loan interest and fee income by $349,000 while decreasing interest and dividend income on investment securities by $160,000.  On a taxable equivalent basis, the shift in the investment portfolio resulted in an increase of $122,000 in interest and dividend income despite a decline in average balance of $10,503,000.

 

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This shift within the investment securities portfolio was undertaken to ladder cash flows, maintain the interest margin, and to invest at the community level.  The increase in dividends received is the result of an increase in the level of dividends from the Federal Home Loan Bank of Pittsburgh coupled with an emphasis on purchasing stocks consistently having an above average dividend yield.

 

During the nine months ended September 30, 2005, interest and dividend income was $23,634,000, an increase of $851,000 over the same period in 2004.  The reasons for the 3.7% growth in interest income for the nine month period are identical to those for the three month period discussed above.  The growth in average loans of $32,089,000 offset a 7 basis point (bp) decline in the loan yield resulting in an increase of $1,492,000 in loan interest and fee income.   Average investment securities declined $21,682,000 causing total investment security interest and dividend income to decline $641,000.  The change in the mix of investment securities offset the effect on interest income of the average balance decrease as taxable equivalent interest remained flat at $7,721,000 for the nine month period ended September 30, 2005.

 

Interest income composition for the three and nine months ended September 30, 2005 and 2004 were as follows:

 

		For The Three Months Ended
		September 30, 2005					September 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Loans including fees		$	5,899		72.8	%	$	5,550		70.1	%	$	349		6.3	%
Investment securities:
Taxable		967			11.9		1,698			21.4		(731		)	(43.1	)
Tax-exempt		969			11.9		422			5.3		547			129.6
Dividend		278			3.4		254			3.2		24			9.4
Total interest income		$	8,113		100.0	%	$	7,924		100.0	%	$	189		2.4	%

 

		For The Nine Months Ended
		September 30, 2005					September 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Loans including fees		$	17,070		72.2	%	$	15,578		68.3	%	$	1,492		9.6	%
Investment securities:
Taxable		3,445			14.6		5,278			23.2		(1,833		)	(34.7	)
Tax-exempt		2,246			9.5		1,133			5.0		1,113			98.2
Dividend		873			3.7		794			3.5		79			9.9
Total interest income		$	23,634		100.0	%	$	22,783		100.0	%	$	851		3.7	%

 

Interest Expense

 

Interest expense during the third quarter of 2005 increased $472,000 to $2,701,000 from $2,229,000 for the third quarter of 2004.  The increased expense associated with deposits is primarily the result of rate increases for time deposit accounts from the third quarter of 2004 to the corresponding period of 2005.  Factors that led to the rate increases include, but are not limited to, prime rate increases, competitive pressure, attracting municipal deposits, and a CD campaign run in conjunction with the opening of the North Atherton Street, State College branch.  The increase in CD rates has been greater than the increase in rates related to non-

 

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maturity deposits.  This has led to some non-maturity accounts being transferred into higher rate CDs.  For example, the CD campaign related to the North Atherton Street branch opening witnessed approximately a third of the funds being transferred from non-maturity deposit accounts held with the Company. Short-term borrowing costs increased despite a decrease of $3,218,000 in average balances due to the 200 basis point increase in the prime rate over the past year.  This increase affected the rate paid on FHLB overnight borrowings, FHLB short-term borrowings, and the rate paid to cash management customers.  Long-term FHLB borrowing expense increased slightly as during the second quarter of 2005 $10 million was borrowed from the FHLB at a fixed rate of 3.97% for 5 years with a final maturity of 10 years.  This borrowing replaced the debt that matured at the end of the first quarter of 2005 and was used to pay off a portion of the short-term borrowings.

 

Interest expense for the nine months ended September 30, 2005 increased $912,000 to $7,407,000 from $6,495,000 for the comparable period of 2004.  The majority of the increase, $787,000, occurred during the second ($315,000 increase) and third quarters ($472,000 increase) as discussed above.  Total deposits accounted for $607,000 of the increase due to the reasons noted in the above three month analysis.  Borrowing costs increased due to the rate increases over the past year as the borrowing average balance remained table for the 2005 and 2004 nine month periods.

 

Interest expense composition for the three and nine months ended September 30, 2005 and 2004 is as follows:

 

		For The Three Months Ended
		September 30, 2005					September 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Deposits		$	1,537		56.9	%	$	1,227		55.0	%	$	310		25.3	%
Short-term borrowings		199			7.4		131			5.9		68			51.9
Long-term borrowings		965			35.7		871			39.1		94			10.8
Total interest expense		$	2,701		100.0	%	$	2,229		100.0	%	$	472		21.2	%

 

		For The Nine Months Ended
		September 30, 2005					September 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Deposits		$	4,151		56.0	%	$	3,544		54.6	%	$	607		17.1	%
Short-term borrowings		545			7.4		367			5.6		178			48.5
Long-term borrowings		2,711			36.6		2,584			39.8		127			4.9
Total interest expense		$	7,407		100.0	%	$	6,495		100.0	%	$	912		14.0	%

 

Net Interest Margin

 

The net interest margin (NIM) for the three months ended September 30, 2005 was 4.49% as compared to 4.54% for the corresponding period of 2004.  The decrease in the NIM was the result of the yield on earning assets increasing 28 basis points (bp) to 6.52% for the three months ended September 30, 2005 as compared to 2004 offset by a 44 bp increase in interest bearing liabilities over the same period.  The increase in the yield on earning assets is attributable to a change in the mix of earning assets from taxable investment securities to loans and tax-exempt investment securities. Over the time periods being compared, total average loans, yielding

 

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