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 June 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
(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 12 b-2 of the Exchange Act)

YES ý                                                           NO o

 

On July 20, 2005 there were 3,322,089 shares 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 June 30, 2005 and December 31, 2004	3
Consolidated Statement of Income (unaudited) for the Three and Six Months ended June 30, 2005 and 2004	4
Consolidated Statement of Comprehensive Income (unaudited) For the Three and Six Months ended June 30, 2005 and 2004	6
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the Three and Six Months ended June 30, 2005 and 2004	5
Consolidated Statement of Cash Flows (unaudited) for the Three and Six Months ended June 30, 2005 and 2004	7
Notes to Consolidated Financial Statements (unaudited)	8-12
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	13-28
Item 3. Quantitative and Qualitative Disclosures About Market Risk	28
Item 4. Controls and Procedures	28
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	29
Item 4. Submission of Matters to a Vote of Security Holders	29
Item 5. Other Information	29
Item 6. Exhibits	29
Signatures	31
Exhibit Index and Exhibits	32

 

2

 

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

 

		June 30,			December 31,
(In Thousands, Except Share Data)		2005			2004
ASSETS:
Noninterest-bearing balances		$	16,945		$	12,602
Interest-bearing deposits in other financial institutions		25			24
Total cash and cash equivalents		16,970			12,626
Investment securities, available for sale, at fair value		203,400			184,163
Investment securities held to maturity (fair value of $286 and $561)		268			558
Loans held for sale		4,073			4,624
Loans, net of unearned discount of $1,055 and $1,096		327,870			324,505
Less: Allowance for loan and lease losses		3,492			3,338
Loans, net		331,362			327,843
Premises and equipment, net		5,851			4,882
Accrued interest receivable		2,342			2,246
Bank-owned life insurance		11,163			10,976
Goodwill		3,032			3,032
Other assets		2,116			2,429
TOTAL ASSETS		$	580,577		$	553,379
LIABILITIES:
Interest-bearing deposits		$	310,187		$	282,786
Noninterest-bearing deposits		72,087			74,050
Total deposits		382,274			356,836
Short-term borrowings		21,245			36,475
Long-term borrowings, Federal Home Loan Bank(FHLB)		84,478			75,878
Accrued interest payable		1,050			850
Other liabilities		8,751			3,499
TOTAL LIABILITIES		497,798			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		20,714			18,262
Accumulated other comprehensive gain		4,492			4,331
Less: Treasury stock at cost, 10,310 shares		(446		)	(446		)
TOTAL SHAREHOLDERS’ EQUITY		75,795			73,165
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	573,593		$	546,703

 

See accompanying notes to the unaudited consolidated financial statements.

 

3

 

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

 

		Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands, Except Per Share Data)		2005			2004			2005			2004
INTEREST AND DIVIDEND INCOME:
Loans including fees		$	5,671		$	5,137		$	11,171		$	10,028
Investment Securities:
Taxable		1,214			1,782			2,478			3,580
Tax-exempt		688			320			1,277			711
Dividend		297			293			595			540
TOTAL INTEREST AND DIVIDEND INCOME		7,870			7,532			15,521			14,859
INTEREST EXPENSE:
Deposits		1,420			1,182			2,614			2,317
Short-term borrowings		144			99			346			236
Long-term borrowings		893			861			1,746			1,713
TOTAL INTEREST EXPENSE		2,457			2,142			4,706			4,266
NET INTEREST INCOME		5,413			5,390			10,815			10,593
PROVISION FOR LOAN LOSSES		180			75			360			150
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,233			5,315			10,455			10,443
NON-INTEREST INCOME:
Service charges		536			522			991			998
Securities gains, net		687			583			1,298			1,128
Bank-owned life insurance		93			90			187			180
Insurance commissions		652			545			1,295			1,159
Other operating income		329			310			643			622
TOTAL NON-INTEREST INCOME		2,297			2,050			4,414			4,087
NON-INTEREST EXPENSES:
Salaries and employee benefits		2,173			1,886			4,193			3,865
Occupancy expense, net		286			230			577			473
Furniture and equipment expense		234			230			455			495
Pennsylvania shares tax expense		140			130			279			246
Other operating expenses		1,054			977			2,004			1,847
TOTAL NON-INTEREST EXPENSES		3,887			3,453			7,508			6,926
INCOME BEFORE INCOME TAX PROVISION		3,643			3,912			7,361			7,604
INCOME TAX PROVISION		883			1,108			1,886			2,127
NET INCOME		$	2,760		$	2,804		$	5,475		$	5,477
EARNINGS PER SHARE - BASIC		$	0.83		$	0.85		$	1.65		$	1.65
EARNINGS PER SHARE - DILUTED		$	0.83		$	0.85		$	1.65		$	1.65
WEIGHTED AVERAGE SHARES OUTSTANDING-BASIC		3,311,657			3,319,445			3,311,464			3,320,649
WEIGHTED AVERAGE SHARES OUTSTANDING-DILUTED		3,313,546			3,322,730			3,313,483			3,324,063
DIVIDNEDS PER SHARE		$	0.46		$	0.35		$	0.91		$	0.70

 

See accompanying notes to the unaudited consolidated financial statements.

 

4

 

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 

		COMMON STOCK					ADDITIONAL PAID-IN			RETAINED			ACCUMULATED OTHER COMPREHENSIVE			TREASURY			TOTAL 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										5,475									5,475
Dividends declared, $0.91										(3,023		)							(3,023		)
Unrealized gain on available for sale securities, net of reclassification adjustments and tax of $83													161						161
Stock options exercised		562		6			11												17
Balance, June 30, 2005		3,332,399		$	33,324		$	17,711		$	20,714		$	4,492		$	(446	)	$	75,795

 

See accompanying notes to the unaudited consolidated financial statements.

 

		COMMON STOCK					ADDITIONAL PAID-IN			RETAINED			ACCUMULATED OTHER COMPREHENSIVE			TREASURY			TOTAL SHAREHOLDERS’
		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 for the six months ended June 30, 2004										5,477									5,477
Dividends declared, $0.70										(2,324		)							(2,324		)
Treasury Stock acquired (3,000 shares)																(130		)	(130		)
Net change in unrealized gain on investments available for sale, net of tax benefit of $2,362													(4,586		)				(4,586		)
Stock options exercised		897		9			22												31
Balance, June 30, 2004		3,327,457		$	33,274		$	17,581		$	16,175		$	1,546		$	(339	)	$	68,237

 

See accompanying notes to the unaudited consolidated financial statements.

 

5

 

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 

		Three Months Ended June 30,
(In Thousands)		2005			2004
Net Income		$	2,760		$	2,804
Other comprehensive income:
Net unrealized gains (losses) on available for sale securities		4,695			(6,558		)
Less: Reclassification adjustment for gain included in net income		687			583
Other comprehensive income (loss) before tax		4,008			(7,141		)
Income tax expense (benefit) related to other comprehensive income (loss)		1,363			(2,428		)
Other comprehensive income (loss), net of tax		2,645			(4,713		)
Comprehensive income (loss)		$	5,405		$	(1,909	)

 

		Six Months Ended June 30,
(In Thousands)		2005			2004
Net Income		$	5,475		$	5,477
Other comprehensive income:
Net unrealized gains (losses) on available for sale securities		1,542			(5,820		)
Less: Reclassification adjustment for gain included in net income		1,298			1,128
Other comprehensive income (loss) before tax		244			(6,948		)
Income tax expense (benefit) related to other comprehensive income (loss)		83			(2,362		)
Other comprehensive income (loss), net of tax		161			(4,586		)
Comprehensive income		$	5,636		$	891

 

See accompanying notes to the unaudited consolidated financial statements.

 

6

 

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 

		Six Months Ended June 30,
(In Thousands)		2005			2004
OPERATING ACTIVITIES:
Net Income		$	5,475		$	5,477
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		271			291
Provision for loan losses		360			150
Accretion and amortization of investment security discounts and premiums		(202		)	15
Securities gains, net		(1,298		)	(1,128		)
Originations of loans held for sale		(4,942		)	(15,624		)
Proceeds of loans held for sale		5,493			15,269
Earnings on bank-owned life insurance		(187		)	(180		)
Pension		307			327
Other, net		239			333
Net cash provided by operating activities		5,516			4,930
INVESTING ACTIVITIES:
Investment securities available for sale:
Proceeds from sales		88,475			83,273
Proceeds from calls and maturities		7,132			15,826
Purchases		(109,007		)	(94,407		)
Investment securities held to maturity:
Proceeds from calls and maturities		325			42
Purchases		(35		)	(14		)
Net increase in loans		(3,697		)	(25,042		)
Acquisition of bank premises and equipment		(1,240		)	(359		)
Proceeds from the sale of foreclosed assets		67			144
Proceeds from redemption of regulatory stock		2,692			2,100
Purchases of regulatory stock		(1,686		)	(1,690		)
Net cash used in investing activities		(16,974		)	(20,127		)
FINANCING ACTIVITIES:
Net increase in interest-bearing deposits		27,401			33,037
Net (decrease) increase in noninterest-bearing deposits		(1,963		)	1,395
Proceeds of long-term borrowings		10,000			5,000
Repayment of long-term borrowings		(1,400		)	—
Net decrease in short-term borrowings		(15,230		)	(20,781		)
Dividends paid		(3,023		)	(2,324		)
Stock options exercised		17			31
Purchase of treasury stock		—			(130		)
Net cash provided used in financing activities		15,802			16,228
NET INCREASE IN CASH AND CASH EQUIVALENTS		4,344			1,031
CASH AND CASH EQUIVALENTS, BEGINNING		12,626			10,230
CASH AND CASH EQUIVALENTS, ENDING		$	16,970		$	11,261
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid		$	4,506		$	4,243
Income taxes paid		$	2,050		$	2,050
Transfer of loans to foreclosed assets		$	126		$	90

 

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.

 

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 statements (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.  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. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.  In April 2005, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R.  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.

 

8

 

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 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 condition.

 

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 is intended to improve  financial reporting because its requirements enhance the consistency of financial reporting between periods.

 

NOTE 2. 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. 

 

9

 

		Three Months Ended June 30,				Six Months Ended June 30,
		2005		2004		2005		2004
Weighted average common shares outstanding		3,321,967		3,327,445		3,321,774		3,327,380
Average treasury stock shares		(10,310	)	(8,000	)	(10,310	)	(6,731	)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share		3,311,657		3,319,445		3,311,464		3,320,649
Additional common stock equivalents (stock options) used to calculate diluted earnings per share		1,889		3,285		2,019		3,414
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share		3,313,546		3,322,730		3,313,483		3,324,063

 

Options to purchase 8,107 shares of common stock at the price of $48.35 were outstanding during the three and six months ended June 30, 2005 and 8,713 shares of common stock at the price of $48.35 were outstanding for the three and six months ended June 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.

 

Note 3.  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 plan for the three and six months ended June 30, 2005 and 2004,  respectively.

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2005			2004			2005			2004
Service cost		$	127		$	120		$	254		$	233
Interest cost		113			93			225			199
Expected return on plan assets		(95		)	(80		)	(190		)	(164		)
Amortization of transition obligation		—			—			(1		)	(1		)
Amortization of prior service cost		7			7			13			13
Amortization of net (gain) loss		17			7			33			21
Net periodic cost		$	169		$	147		$	334		$	301

 

10

 

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.  As of June 30, 2005, contributions of $206,000 have been made.  The Company presently anticipates contributing an additional $369,000 to fund its pension plan in 2005 for a total of $575,000.

 

Note 4.  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.

 

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

 

		June 30,
		(in thousands)
		2005			2004
Commitments to extend credit		$	56,177		$	49,524
Standby letters of credit		1,520			786

 

Note 5.  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

 

11

 

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 Six Months Ended June 30, 2005 and 2004

 

Summary Results

 

Net income for the three months ended June 30, 2005 was $2,760,000 compared to $2,804,000 for the same period of 2004.  Basic and diluted earnings per share for the three months ended June 30, 2005 were $0.83 as compared to $0.85 for the three months ended June 30, 2004.  Return on average assets and return on average equity were 2.02% and 14.81% for the three months ended June 30, 2005 as compared to 2.10% and 15.99% for the corresponding period of 2004.  Net income from core operations for the three months ended June 30, 2005, excluding after-tax net securities gains of $453,000, decreased to $2,307,000 from $2,419,000 for the three months ended June 30, 2004.

 

The six months ended June 30, 2005 generated net income of $5,475,000 compared to $5,477,000 for the same period of 2004.  Earnings per share, basic and diluted, for the six months ended June 30, 2005 and 2004 were $1.65.  Return on average assets and return on average equity were 2.02% and 14.68% for the six months ended June 30, 2005 as compared to 2.07% and 15.44% for the corresponding period of 2004.  Net income from core operations for the six months ended June 30, 2005, excluding after-tax securities gains of $857,000, declined to $4,618,000 from $4,733,000 for the six months ended June 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 for significant gains or losses, for any investments, loans, or other assets sales.  The impact of these items that result in significant gains or losses on the Company’s performance are difficult to predict, as such management believes the additional 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 financial performance measures based on net income 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 second quarter of 2005, total interest and dividend income was $7,870,000, an increase of $338,000 over the same quarter in 2004.  The increase in total interest and dividend income was primarily the result of a change in the mix of earning assets over the periods being compared.  Over this time frame the average balance of investment securities declined $29,265,000 while average loans increased $29,974,000.  In addition, 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 $534,000 while decreasing interest and dividend income on investment securities by $196,000.  However, on a taxable equivalent basis, the shift in the investment portfolio resulted in a slight decrease of $7,000, comparing the second quarter of 2005 to the second quarter of 2004,

 

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despite a decline in average balance in excess of $29 million.  This shift within the investment securities portfolio was undertaken to better manage 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 six months ended June 30, 2005, total interest and dividend income was $15,521,000, an increase of $662,000 over the same period in 2004.  The increase in total interest income was primarily the result of a change in the mix of earning assets over the periods being compared.  The average balance of investment securities declined $33,434,000 while average loans increased $38,859,000 when comparing the six month periods of 2005 and 2004.  In addition, 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 $1,143,000 while decreasing interest and dividend income on investment securities by $481,000.  On a taxable equivalent basis, the shift in the investment portfolio resulted in a decrease of $190,000 and an average balance decrease in excess of $33 million from the first half of 2004 to the first half of 2005.

 

Interest income composition for the three and six months ended June 30, 2005 and 2004 is as follows:

 

		For The Three Months Ended
		June 30, 2005					June 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Loans including fees		$	5,671		72.1	%	$	5,137		68.2	%	$	534		10.4	%
Investment securities:
Taxable		1,214			15.4		1,782			23.7		(568		)	(31.9	)
Tax-exempt		688			8.7		320			4.2		368			115.0
Dividend		297			3.8		293			3.9		4			1.4
Total interest income		$	7,870		100.0	%	$	7,532		100.0	%	$	338		4.5	%

 

 

		For The Six Months Ended
		June 30, 2005					June 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Loans including fees		$	11,171		72.0	%	$	10,028		67.5	%	$	1,143		11.4	%
Investment securities:
Taxable		2,478			16.0		3,580			24.1		(1,102		)	(30.8	)
Tax-exempt		1,277			8.2		711			4.8		566			79.6
Dividend		595			3.8		540			3.6		55			10.2
Total interest income		$	15,521		100.0	%	$	14,859		100.0	%	$	662		4.5	%

 

Interest Expense

 

Interest expense during the second quarter of 2005 increased $315,000 to $2,457,000 from $2,142,000 for the second quarter of 2004.  The increased expense associated with deposits is primarily the result of rate increases for money market and time deposit accounts from the second 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 time deposit campaign run in conjunction with the opening of the North Atherton

 

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Street, State College branch discussed in more detail under “Net Interest Margin” below.  Short-term borrowing costs increased due to a 225 basis point increase in the federal funds rate over the past year.  This increase affected the rate paid on FHLB overnight borrowings, FHLB short-term borrowings, and the rate paid to customers utilizing repurchase agreements.  Long-term FHLB borrowing expense increased slightly due to a $10 million increase in borrowing from the FHLB at a fixed rate of 3.97% for 5 years with a final maturity of 10 years.  This borrowing replaced long-term 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 with FHLB.

 

Interest expense for the six months ended June 30, 2005 increased $440,000 to $4,706,000 from $4,266,000 for the comparable period of 2004.  The majority of the increase, $315,000, occurred during the second quarter as discussed above.  These rate increases also impact the rate paid on all borrowings as illustrated by the $143,000 increase in interest paid on borrowings, despite average borrowings decreasing $1,207,000 for the respective six month periods ending June 30, 2005 and 2004.

 

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

 

		For The Three Months Ended
		June 30, 2005					June 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Deposits		$	1,420		57.8	%	$	1,182		55.2	%	$	238		20.1	%
Short-term borrowings		144			5.9		99			4.6		45			45.5
Long-term borrowings		893			36.3		861			40.2		32			3.7
Total interest expense		$	2,457		100.0	%	$	2,142		100.0	%	$	315		14.7	%

 

		For The Six Months Ended
		June 30, 2005					June 30, 2004					Change
(In Thousands)		Amount			% Total		Amount			% Total		Amount			% Total
Deposits		$	2,614		55.5	%	$	2,317		54.3	%	$	297		12.8	%
Short-term borrowings		346			7.4		236			5.5		110			46.6
Long-term borrowings		1,746			37.1		1,713			40.2		33			1.9
Total interest expense		$	4,706		100.0	%	$	4,266		100.0	%	$	440		10.3	%

 

Net Interest Margin

 

The net interest margin (NIM) for the three months ended June 30, 2005 was 4.58% as compared to 4.41% for the corresponding period of 2004.  The increase in the NIM was the result of the yield on earning assets increasing 41 basis points (bp) to 6.53% for the three months ended June 30, 2005 as compared to 2004 offset by a 33 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 7.03%, increased $29,974,000, while the investment securities portfolio, yielding 5.63%, average balance declined $29,265,000.   The NIM impact of the earning asset mix improvement and volume increase in total loans were partially offset by rate increases on interest bearing liabilities.  The rates paid on deposit accounts increased to 1.93% as compared to 1.62% for the 2004 period.  This increase

 

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