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PEOPLES FINANCIAL SERVICES CORP. - Quarter Report: 2004 September (Form 10-Q)

Quarterly Report for September 30, 2004


UNITED STATES
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, 2004
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from         to


Commission File Number: 0-23863
 
PEOPLES FINANCIAL SERVICES CORP.
(Exact name of registrant as specified in its charter)
     
     
     
PENNSYLVANIA
 
23-2931852
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
     
     
50 MAIN STREET, HALLSTEAD, PA
 
18822
(Address of principal executive offices)
 
(Zip code)
     
     
(570) 879-2175

(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 the 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 Securities Exchange Act of 1934).
 
Yes
ý
No
o
 


Common Stock, $2 Par Value
 
3,156,307
Title Class
 
Outstanding Shares at September 30, 2004

  
     

 




PEOPLES FINANCIAL SERVICES CORP.
FORM 10-Q
For the Quarter Ended September 30, 2004


TABLE OF CONTENTS

PART I.
 
FINANCIAL INFORMATION
Page
Number
 
Item 1
Financial Statements
 
   
Consolidated Balance Sheets
as of September 30, 2004 (Unaudited) and December 31, 2003 (Audited)
3
   
Consolidated Statements of Income
(Unaudited) for the Three Months and Nine Months Ended September 30, 2004 and 2003
4
   
Consolidated Statements of Stockholders' Equity
(Unaudited) for the Nine Months Ended September 30, 2004 and 2003
5
   
Consolidated Statements of Cash Flows
(Unaudited) for the Nine Months Ended September 30, 2004 and 2003
6-7
   
Notes to Consolidated Financial Statements
8-10
 
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
10-19
 
Item 3
Quantitative and Qualitative Disclosures About Market Risk
20
 
Item 4
Controls and Procedures
20
       
PART II.
 
OTHER INFORMATION
 
 
Item 1
Legal Proceedings
21
 
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
21
 
Item 3
Defaults upon Senior Securities
21
 
Item 4
Submission of Matters to a Vote of  Security Holders
21
 
Item 5
Other Information
21
 
Item 6
Exhibits
21
   
Signatures
22
 
   
Exhibit Index
23
 
   
Exhibits
24-39
 
 
 
 
 
 
 
 
 

 

  
    PAGE 2

 

PART I
ITEM 1.  FINANCIAL STATEMENTS
 

 
PEOPLES FINANCIAL SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
September 30, 2004 (UNAUDITED) and December 31, 2003 (AUDITED)

(In thousands, except per share data)
 
September
December
ASSETS
2004
2003
 
Cash and due from banks
 
$
5,390
 
$
5,882
 
Interest bearing deposits with other banks
   
157
   
174
 
Federal funds sold
   
335
   
0
 
Cash and cash equivalents
   
5,882
   
6,056
 
Securities available for sale
   
114,170
   
116,126
 
Loans
   
243,049
   
236,367
 
Allowance for loan losses
   
(2,750
)
 
(2,093
)
Loans, net
   
240,299
   
234,274
 
Bank premises and equipment, net
   
4,681
   
4,436
 
Accrued interest receivable
   
1,983
   
2,047
 
Intangible assets
   
1,958
   
2,154
 
Other assets
   
8,793
   
6,196
 
Total Assets
 
$
377,766
 
$
371,289
 
LIABILITIES
             
Deposits, non-interest bearing
 
$
42,826
 
$
37,441
 
Deposits, interest bearing
   
237,527
   
242,259
 
Total deposits
   
280,353
   
279,700
 
Accrued interest payable
   
560
   
604
 
Short-term borrowings
   
7,299
   
7,085
 
Long-term borrowings
   
46,267
   
41,952
 
Other liabilities
   
1,112
   
872
 
Total Liabilities
   
335,591
   
330,213
 
STOCKHOLDERS' EQUITY
             
               
Common stock, par value $2 per share;
             
authorized 12,500,000 shares; issued 3,341,250 shares;
             
outstanding 3,156,307 shares and 3,165,623 shares at September 30, 2004 and December 31, 2003, respectively
   
6,683
   
6,683
 
Surplus
   
2,778
   
2,618
 
Retained earnings
   
35,419
   
33,523
 
Accumulated other comprehensive income
   
642
   
995
 
Treasury stock at cost
   
(3,347
)
 
(2,743
)
Total Stockholders' Equity
   
42,175
   
41,076
 
Total Liabilities and Stockholders' Equity
 
$
377,766
 
$
371,289
 
               

See notes to consolidated financial statements.

  
    PAGE 3

 

 
PEOPLES FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

(In thousands, except per share data)
 
Nine Months Ended
 
Three Months Ended
 
   
September 30
 
September 30
 
September 30
 
September 30
 
   
2004
 
2003
 
2004
 
2003
 
INTEREST INCOME
                 
Loans receivable, including fees
 
$
11,237
 
$
11,368
 
$
3,783
 
$
3,748
 
Securities:
                         
Taxable
   
2,368
   
2,406
   
778
   
808
 
Tax exempt
   
1,269
   
996
   
436
   
351
 
Other
   
42
   
33
   
20
   
13
 
Total Interest Income
   
14,916
   
14,803
   
5,017
   
4,920
 
INTEREST EXPENSE
                         
Deposits
   
3,612
   
4,149
   
1,183
   
1,323
 
Short-term borrowings
   
90
   
86
   
30
   
23
 
Long-term borrowings
   
1,603
   
1,516
   
572
   
523
 
Total Interest Expense
   
5,305
   
5,751
   
1,785
   
1,869
 
Net Interest Income
   
9,611
   
9,052
   
3,232
   
3,051
 
PROVISION FOR LOAN LOSSES
   
1,050
   
180
   
150
   
60
 
Net Interest Income after Loan Loss Provision
   
8,561
   
8,872
   
3,082
   
2,991
 
OTHER INCOME
   
   
             
Customer service fees
   
1,095
   
943
   
396
   
309
 
Other income
   
738
   
519
   
272
   
189
 
Net realized gains on sales of securities available for sale
   
181
   
652
   
105
   
456
 
Total Other Income
   
2,014
   
2,114
   
773
   
954
 
OTHER EXPENSES
   
   
             
Salaries and benefits
   
3,023
   
2,747
   
1,043
   
900
 
Occupancy
   
375
   
334
   
108
   
112
 
Equipment
   
243
   
223
   
88
   
73
 
FDIC insurance and assessments
   
105
   
101
   
35
   
34
 
Professional fees and outside services
   
223
   
175
   
69
   
62
 
Computer services and supplies
   
453
   
392
   
155
   
134
 
Taxes, other than payroll and income
   
290
   
261
   
96
   
86
 
Other
   
1,341
   
1,100
   
448
   
350
 
Total Non-Interest Expense
   
6,053
   
5,333
   
2,042
   
1,751
 
Income Before Income Taxes
   
4,522
   
5,653
   
1,813
   
2,194
 
INCOME TAXES
   
915
   
1,478
   
394
   
591
 
Net Income
 
$
3,607
 
$
4,175
 
$
1,419
 
$
1,603
 
EARNINGS PER SHARE, BASIC
 
$
1.14
 
$
1.32
 
$
0.45
 
$
0.51
 
EARNINGS PER SHARE, DILUTED
 
$
1.13
 
$
1.31
 
$
0.44
 
$
0.50
 

See notes to consolidated financial statements.
 
  
    PAGE 4

 

PEOPLES FINANCIAL SERVICES CORP.
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
 
                           
                           
                           
(In thousands)
                         
 
             
Accumulated
         
               
Other
         
 
 
Common
 
Surplus
 
Retained
 
Comprehensive
 
Treasury
 
Total
 
   
Stock
     
Earnings
 
Income
 
Stock
     
BALANCE-DECEMBER 31, 2003
 
$
6,683
 
$
2,618
 
$
33,523
 
$
995
   
($2,743
)
$
41,076
 
Comprehensive income
                                     
Net income
   
0
   
0
   
3,607
   
0
   
0
   
3,607
 
Net change in unrealized gains (losses) on
                     
   
   
 
securities available for sale, net of taxes
   
0
   
0
   
0
   
(353
)
 
0
   
(353
)
Total Comprehensive Income
   
 
   
 
   
 
   
 
 
 
 
   
3,254
 
Cash dividends, ($0.54 per share)
   
0
   
0
   
(1,711
)
 
0
   
0
   
(1,711
)
Treasury stock purchase (20,500 shares)
   
0
   
0
   
0
   
0
   
(703
)
 
(703
)
Treasury stock issued for dividend
        reinvestment plan  and stock option plan
        (11,184 shares)
   
0
   
160
   
0
   
0
   
99
   
259
 
BALANCE-SEPTEMBER 30, 2004
 
$
6,683
 
$
2,778
 
$
35,419
 
$
642
   
($3,347
)
$
42,175
 
                                       
BALANCE-DECEMBER 31, 2002
 
$
4,455
 
$
4,617
 
$
30,016
 
$
2,096
   
($2,861
)
$
38,323
 
Comprehensive income
                                     
Net income
   
0
   
0
   
4,175
   
0
   
0
   
4,175
 
Net change in unrealized gains (losses) on
                     
   
   
 
securities available for sale, net of taxes
   
0
   
0
   
0
   
(1,329
)
 
0
   
(1,329
)
Total Comprehensive Income
   
 
   
 
   
 
   
 
 
 
 
   
2,846
 
Cash dividends, ($0.48 per share)
   
0
   
0
   
(1,518
)
 
0
   
0
   
(1,518
)
Treasury stock purchase (1,671 shares)
   
0
   
0
   
0
   
0
   
(34
)
 
(34
)
Treasury stock issued for dividend
        reinvestment plan  and stock option plan
       (16,918 shares)
   
0
   
226
   
0
   
0
   
149
   
375
 
Three-for-two stock split, 2,227,500 shares
   
2,228
   
(2,228
)
 
0
   
0
   
0
   
0
 
BALANCE-SEPTEMBER 30, 2003
 
$
6,683
 
$
2,615
 
$
32,673
 
$
767
   
($2,746
)
$
39,992
 

See notes to consolidated financial statements.
 
 
 
 

  
    PAGE 5

 

 
PEOPLES FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
 
Nine Months Ended
 
   
September 30, 2004
 
September 30, 2003
 
CASH FLOWS FROM OPERATING ACTIVITIES
         
Net income
 
$
3,607
 
$
4,175
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation and amortization
   
480
   
243
 
Provision for loan losses
   
1,050
   
180
 
Loss on sale of equipment
   
0
   
18
 
Loss on sale of foreclosed real estate
   
0
   
6
 
Amortization of securities' premiums and accretion of discounts
   
416
   
629
 
(Gains) on sales of investment securities, net
   
(181
)
 
(652
)
Proceeds from the sale of mortgage loans
   
2,977
   
0
 
Net gain on sale of loans
   
(43
)
 
0
 
Loans originated for sale
   
(2,934
)
 
0
 
Net earnings on investment in life insurance
   
(169
)
 
(153
)
Decrease in accrued interest receivable
   
64
   
178
 
(Increase)Decrease in other assets
   
(80
)
 
1,070
 
(Decrease) in accrued interest payable
   
(44
)
 
(24
)
Increase in other liabilities
   
240
   
230
 
Net Cash Provided by Operating Activities
   
5,383
   
5,900
 
CASH FLOWS FROM INVESTING ACTIVITIES
             
Proceeds from sale of available for sale securities
   
22,022
   
22,360
 
Proceeds from maturities of available for sale securities
   
2,639
   
4,734
 
Purchase of available for sale securities
   
(29,182
)
 
(59,557
)
Principal payments on mortgage-backed securities
   
5,707
   
23,411
 
Net increase in loans
   
(7,408
)
 
(10,398
)
Purchase of premises and equipment
   
(529
)
 
(855
)
Proceeds from sale of other real estate
   
167
   
102
 
Purchase of Investment in Life Insurance
   
(2,000
)
 
0
 
Net Cash Used in Investing Activities
   
(8,584
)
 
(20,203
)
CASH FLOWS FROM FINANCING ACTIVITIES
             
Increase in deposits
   
653
   
16,551
 
Proceeds from long-term borrowing
   
5,000
   
8,000
 
Repayment of long-term borrowings
   
(685
)
 
(568
)
Increase(Decrease) in short-term borrowing
   
214
   
(7,389
)
Purchase of treasury stock
   
(703
)
 
(34
)
Issuance of common stock
   
259
   
375
 
Cash dividends paid
   
(1,711
)
 
(1,518
)
Net Cash Provided by Financing Activities
   
3,027
   
15,417
 
Net Increase/Decrease in Cash and Cash Equivalents
   
(174
)
 
1,114
 
 
See notes to consolidated financial statements
 
    PAGE 6

 
 
 
PEOPLES FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(UNAUDITED)
(In thousands)
 
Nine Months Ended
 
   
September 30, 2004
 
September 30, 2003
 
               
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR
 
$
6,056
 
$
6,340
 
CASH AND CASH EQUIVALENTS - ENDING OF YEAR
 
$
5,882
 
$
7,454
 
               
SUPPLEMENTAL DISCLOSURES OF CASH PAID
             
Interest paid
 
5,349
  $ 
5,751
 
Income taxes paid
  $ 
720
  $ 
1,339
 
NON-CASH INVESTING AND FINANCING ACTIVITIES
             
Transfers from loans to foreclosed real estate
  $ 
333
  $ 
35
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See notes to consolidated financial statements.




  
    PAGE 7

 

PEOPLES FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1.  BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Peoples Financial Services Corp. (the "Corporation" or the "Company") and its wholly owned subsidiary, Peoples National Bank (the "Bank"). All material intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Operating results for the nine month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.


NOTE 2.  EARNINGS PER SHARE

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

(In thousands, except per share data)
 
Nine Months Ended
 
Three Months Ended
 
   
September 30
 
September 30
 
September 30
 
September 30
 
   
2004
 
2003
 
2004
 
2003
 
                   
Net income applicable to common stock
 
$
3,607,000
 
$
4,175,000
 
$
1,419,000
 
$
1,603,000
 
                           
Weighted average common shares outstanding
   
3,168,939
   
3,160,129
   
3,168,895
   
3,165,248
 
Effect of dilutive securities, stock options
   
21,915
   
26,168
   
20,951
   
33,988
 
                           
Weighted average common shares outstanding used to
calculate diluted earnings per share
   
3,190,854
   
3,186,297
   
3,189,846
   
3,199,236
 
                           
Basic earnings per share
 
$
1.14
 
$
1.32
 
$
0.45
 
$
0.51
 
Diluted earnings per share
 
$
1.13
 
$
1.31
 
$
0.44
 
$
0.50
 


 
 
 
 

 

  
    PAGE 8

 

NOTE 3.  OTHER COMPREHENSIVE INCOME

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

(In thousands)
 
Nine Months Ended
 
Three Months Ended
 
   
September 30
 
September 30
 
September 30
 
September 30
 
   
2004
 
2003
 
2004
 
2003
 
                   
Unrealized holding gains (losses) on available for sale
securities
 
$
(355 
)
$
(1,361
)
$
2,859
 
$
(2,310
)
Less classification adjustment for gains (losses) realized in net
 income
   
181
   
652
   
105
   
456
 
Net unrealized gains (losses)
   
(536
)  
(2,013
)
 
2,754
   
(2,766
)
Tax effect
   
183
 
 
684
   
(936
)
 
940
 
                           
Other comprehensive income (loss)
 
$
(353
)
$
(1,329
)
$
1,818
 
$
(1,826
)



NOTE 4.  STOCK-BASED COMPENSATION

The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation costs have been recognized for options granted in 2004 and 2003. Had compensation costs for stock options granted been determined based on the fair value at the grant dates for awards under the plan consistent with the provisions of SFAS No. 123, the Company’s net income and earnings per share for the nine months and three months ended September 30, 2004 and 2003, would have been reduced to the pro forma amounts indicated below:

(In thousands, except per share data)
 
Nine Months Ended
 
Three Months Ended
 
   
September 30
 
September 30
 
September 30
 
September 30
 
   
2004
 
2003
 
2004
 
2003
 
                   
Net income as reported
 
$
3,607
 
$
4,175
 
$
1,419
 
$
1,603
 
Total stock-based compensation cost, net of tax, that would
have been included in the determination of net income if
the fair value based method had been applied to all awards
   
(3
)
 
(1
)
 
(1
)
 
(1
)
Pro forma net income
 
$
3,604
 
$
4,174
 
$
1,418
 
$
1,602
 
                           
Basic earnings per share:
                         
As reported
 
$
1.14
 
$
1.32
 
$
0.45
 
$
0.51
 
Pro forma
 
$
1.14
 
$
1.32
 
$
0.45
 
$
0.51
 
Diluted earnings per share
                         
As reported
 
$
1.13
 
$
1.31
 
$
0.44
 
$
0.50
 
Pro forma
 
$
1.13
 
$
1.31
 
$
0.44
 
$
0.50
 

 

  
    PAGE 9

 
NOTE 5.  GUARANTEES

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Outstanding letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. The Company had $1,737,000 of standby letters of credit as of September 30, 2004. The Bank uses the same credit policies in making conditional obligations as it does for on-balance sheet instruments.

The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Company requires collateral supporting these letters of credit as deemed necessary. The maximum undiscounted exposure related to these commitments at September 30, 2004 was $1,737,000 and the approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $951,000. The current amount of the liability as of September 30, 2004, for guarantees under standby letters of credit is not material.


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the consolidated financial statements of the Corporation is presented to provide insight into management’s assessment of financial results. The Corporation’s only subsidiary, Peoples National Bank provides financial services to individuals and businesses within the Bank’s primary market area made up of Susquehanna, Wyoming and northern Lackawanna counties in Pennsylvania, and southern Broome County in New York. The Bank is a member of the Federal Reserve System and subject to regulation, supervision, and examination by the Office of the Comptroller of the Currency.


CAUTIONARY STATEMENT CONCERNING FORWARD LOOKING INFORMATION

Except for historical information, this Report may be deemed to contain "forward looking" information. Examples of forward looking information may include, but are not limited to (a) projections of or statements regarding future earnings, interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure and other financial terms, (b) statements of plans and objectives of management or the Board of Directors, (c) statements of future economic performance, and (d) statements of assumptions, such as economic conditions in the market areas served by the Corporation and the Bank, underlying other statements and statements about the Corporation and the Bank or their respective businesses. Such forward looking information can be identified by the use of forward looking terminology such as "believes", "expects", "may", "intends", "will", "should", "anticipates", or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. No assurance can be given that the future results covered by the forward looking information will be achieved. Such statements are subject to risks, uncertainties, and other factors which could cause actual results to differ materially from future results expressed or implied by such forward looking information. Important factors that could impact operating results include, but are not limited to, (i) the effects of changing economic conditions in both the market areas served by the Corporation and the Bank and nationally, (ii) credit risks of commercial, real estate, consumer and other lending activities, (iii) significant changes in interest rates, (iv) changes in federal and state banking laws and regulations which could affect operations, (v) funding costs, and (vi) other external developments which could materially affect business and operations.
 
 
 

  
    PAGE 10

 
CRITICAL ACCOUNTING POLICIES

Disclosure of the Company’s significant accounting policies is included in Note 1 to the consolidated financial statements of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by Management. Additional information is contained on page 18 of this report for the provision and allowance for loan losses.


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


FINANCIAL CONDITION

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

Management believes the liquidity needs of the Corporation are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that matures within one year. The current sources of funds will enable the Corporation to meet all its cash obligations as they come due.

Investments:
Investments totaled $114.170 million on September 30, 2004, decreasing by $1.956 million over the December 31, 2003 total of $116.126 million. As loan demand increased in the third quarter of 2004, the investment portfolio and Fed Funds have retracted due to the simultaneous decrease in deposits in that same time period.

The total investment portfolio is held as available for sale. This strategy was implemented in 1995 to provide more flexibility in using the investment portfolio for liquidity purposes as well as providing more flexibility in selling when market opportunities occur.
 
Investments available for sale are accounted for at fair value with unrealized gains or losses, net of deferred income taxes, reported as a separate component of stockholders’ equity. The carrying value of investments as of September 30, 2004 included an unrealized gain of $972 thousand reflected as accumulated other comprehensive income of $642 thousand in stockholders’ equity, net of deferred income taxes of $330 thousand. This compares to an unrealized gain of $1.508 million at December 31, 2003 reflected as accumulated other comprehensive income of $995 thousand, net of deferred income taxes of $513 thousand.

Management monitors the earnings performance and effectiveness of liquidity of the investment portfolio on a monthly basis through the Asset/Liability Committee (ALCO). The ALCO also reviews and manages interest rate risk for the Corporation. Through active balance sheet management and analysis of the investment securities portfolio, the Corporation maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.
 
 
 

 
  
    PAGE 11

 
Loans:
Net loans increased $6.025 million or 2.57% to $240.299 million as of September 30, 2004 from $234.274 million as of December 31, 2003. Of the loan growth experienced in the first nine months of 2004, the most significant growth occurred in commercial loans. Commercial loans increased $4.581 million or 4.07% to $117.198 million as of September 30, 2004 compared to $112.617 million as of December 31, 2003.

Increasing the loan to deposit ratio is a goal of the Bank, but loan quality is always considered in this effort. Management has continued its efforts to create good underwriting standards for both commercial and consumer credit. The Bank’s lending continues to consist primarily of retail lending which includes single family residential mortgages and other consumer lending. Most commercial lending is done primarily with locally owned small businesses.

Other Assets:
Other Assets increased $2.597 million, or 41.91% to $8.793 million as of September 30, 2004 from $6.196 million as of December 31, 2003. The largest portion of the increase in other assets was due to the purchase of an additional Bank Owned Life Insurance policy in the amount of $2 million in June of 2004.

Deposits:
Deposits are attracted from within the Bank’s primary market area through the offering of various deposit instruments including NOW accounts, money market accounts, savings accounts, certificates of deposit, and IRA’s. During the nine month period ended September 30, 2004, total deposits increased by $653 thousand or 0.23% to $280.353 million.

Borrowings:
The Bank utilizes borrowings as a source of funds for its asset/liability management. Advances are available from the FHLB provided certain standards related to credit worthiness have been met. Repurchase and term agreements are also available from the FHLB.

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

Capital:
The adequacy of the Corporation’s capital is reviewed on an ongoing basis with reference to the size, composition and quality of the Corporation’s resources and regulatory guidelines. Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. As of September 30, 2004 regulatory capital to total assets was 10.14% as compared to 10.22% on December 31, 2003. The Company repurchases its stock in the open market or from individuals as warranted to leverage the capital account and to provide stock for a dividend reinvestment and stock purchase plan.
 
The Corporation has complied with the standards of capital adequacy mandated by the banking regulators. The bank regulators have established "risk-based" capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks of various assets the banks hold in their portfolios. A weight category of either 0% (lowest risk asset), 20%, 50%, or 100% (highest risk assets) is assigned to each asset on the balance sheet. Capital is being maintained in compliance with risk-based capital guidelines. The Company’s Tier 1 capital to risk weighted asset ratio was 14.65% and the total capital ratio to risk weighted assets ratio was 15.69% at September 30, 2004. The Corporation is deemed to be well capitalized under regulatory standards.


 
 

 

  
    PAGE 12

 

Liquidity:
Liquidity measures an organization’s ability to meet cash obligations as they come due. The consolidated statement of cash flows presented in the accompanying financial statements included in Part I of this Form 10Q provide analysis of the Corporation’s cash and cash equivalents. Additionally, management considers that portion of the loan and investment portfolio that matures within one year as part of the Corporation’s liquid assets.

The Company’s Asset/Liability Committee (ALCO) addresses the liquidity needs of the Bank to see that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio. In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.
The following table represents the aggregate on and off-balance sheet contractual obligations to make future payments.

CONTRACTUAL OBLIGATIONS  
 
 
(In thousands)
 
September 30, 2004
 
   
Maturity or Repricing In:
 
   
Less than 1 year
 
1-3 Years
 
4-5 Years
 
Over 5 years
 
Total
 
                       
Time deposits
 
$
47,491
 
$
47,531
 
$
11,005
 
$
1,996
 
$
108,023
 
Long-term debt
   
3,441
   
14,484
   
842
   
27,500
   
46,267
 
Operating leases
   
32
   
63
   
27
   
417
   
539
 
                                 
 
 
$
50,964
 
$
62,078
 
$
11,874
 
$
29,913
 
$
154,829
 


Off-Balance Sheet Arrangements:
The Company’s financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These commitments consist primarily of commitments to grant new loans and unfunded commitments of existing loans and letters of credit made under the same standards as on-balance sheet instruments. Unused commitments on September 30, 2004, totaled $30.680 million, which consisted of $25.079 million in unfunded commitments of existing loans, $3.874 million to grant new loans and $1.737 million in letters of credit. Due to fixed maturity dates and specified conditions within these instruments, many will expire without being drawn upon. Management believes that amounts actually drawn upon can be funded in the normal course of operations and therefore, do not represent a significant liquidity risk to the Company.


Interest Rate Sensitivity:
The management of interest rate sensitivity seeks to avoid fluctuating net interest margins and to provide consistent net interest income through periods of changing interest rates.

The Company’s risk of loss arising from adverse changes in the fair value of financial instruments, or market risk, is composed primarily of interest rate risk. The primary objective of the Company’s asset/liability management activities is to maximize net interest income while maintaining acceptable levels of interest rate risk. The Company’s Asset/Liability Committee (ALCO) is responsible for establishing policies to limit exposure to interest rate risk, and to ensure procedures are established to monitor compliance with those policies. The guidelines established by ALCO are reviewed by the Company’s Board of Directors.
 
    The tools used to monitor sensitivity are the Statement of Interest Sensitivity Gap and the interest rate shock analysis. The Bank uses a software model to measure and to keep track. In addition, an outside source does a quarterly analysis to make sure our internal analysis is current and correct. The statement of Interest Sensitivity Gap is a good assessment of current position and is a very useful tool for the ALCO in performing its job. This report is monitored in an effort to "match" maturities or repricing opportunities of assets and liabilities in order to attain the maximum interest within risk tolerance policy guidelines. The statement does, although, have inherent limitations in that certain assets and liabilities may react to changes in interest rates in different ways with some categories reacting in advance of changes and some lagging behind the changes. In addition, there are estimates used in determining the actual propensity to change of certain items such as deposits without maturities.
 

  
    PAGE 13

 

 
The following table sets forth the Company’s interest sensitivity analysis as of September 30, 2004:

 INTEREST RATE SENSITIVITY ANALYSIS  
 
 
   
September 30
 
 (In thousands)  
Maturity or Repricing In:
 
   
3 Months
 
3-6 Months
 
6-12 Months
 
1-5 Years
 
Over 5 Years
 
RATE SENSITIVE ASSETS
                     
Loans
 
$
44,199
 
$
10,840
 
$
28,786
 
$
118,910
 
$
37,564
 
Securities
   
6,531
   
8,890
   
11,092
   
47,006
   
40,651
 
Federal funds sold
   
335
   
0
   
0
   
0
   
0
 
Total Rate Sensitive Assets
   
51,065
   
19,730
   
39,878
   
165,916
   
78,215
 
Cumulative Rate Sensitive Assets
   
51,065
   
70,795
   
110,673
   
276,589
   
354,804
 
RATE SENSITIVE LIABILITIES
                               
Interest bearing checking
   
825
   
825
   
1,651
   
13,206
   
11,005
 
Money market deposits
   
1,138
   
1,138
   
2,277
   
18,213
   
15,177
 
Regular savings
   
2,727
   
1,897
   
3,793
   
30,345
   
25,287
 
CDs and IRAs
   
21,231
   
8,483
   
17,777
   
58,536
   
1,996
 
Short-term borrowings
   
7,299
   
0
   
0
   
0
   
0
 
Long-term borrowings
   
0
   
0
   
3,441
   
15,326
   
27,500
 
Total Rate Sensitive Liabilities
   
33,220
   
12,343
   
27,998
   
136,567
   
80,965
 
Cumulative Rate Sensitive Liabilities
   
33,220
   
45,563
   
73,561
   
210,128
   
291,093
 
                                 
Period gap
   
17,845
   
7,387
   
11,880
   
29,349
   
(2,750
Cumulative gap
   
17,845
   
25,232
   
37,112
   
66,461
   
63,711
 
                                 
Cumulative RSA to RSL
   
153.72
%
 
155.38
%
 
150.45
%
 
131.63
%
 
121.89
%
Cumulative gap to total assets
   
4.72
%
 
6.68
%
 
9.82
%
 
17.59
%
 
16.87
%




 
 
 
 

 


  
    PAGE 14

 
RESULTS OF OPERATIONS

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

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

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

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

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

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


 
 
 
 

 
 
 
 

  
    PAGE 15

 
Below are the tables which set forth average balances and corresponding yields for both the three month and nine month periods ended September 30, 2004.
Distribution of Assets, Liabilities and Stockholders' Equity;
 
Interest Rates and Interest Differential (Year to Date)
 
   
September 2004
 
September 2003
 
(in thousands)
 
Average
 
Yield/
Average
 
Yield/
ASSETS
Balance
Interest
Rate
Balance
Interest
Rate
 
Loans
                         
Real estate
 
$
107,810
 
$
5,289
   
6.55
%
$
108,093
 
$
5,807
   
7.18
%
Installment
   
17,530
   
874
   
6.66
%
 
17,976
   
941
   
7.00
%
Commercial
   
100,215
   
4,629
   
6.17
%
 
92,314
   
4,330
   
6.27
%
Tax exempt
   
13,962
   
411
   
3.93
%
 
8,423
   
257
   
4.08
%
Other loans
   
666
   
34
   
6.82
%
 
627
   
33
   
7.04
%
Total Loans
   
240,183
   
11,237
   
6.25
%
 
227,433
   
11,368
   
6.68
%
Investment Securities (AFS)
                                     
Taxable
   
72,908
   
2,368
   
4.34
%
 
78,999
   
2,406
   
4.07
%
Non-taxable
   
41,187
   
1,269
   
4.12
%
 
28,612
   
996
   
4.65
%
Total Securities
   
114,095
   
3,637
   
4.26
%
 
107,611
   
3,402
   
4.23
%
Time deposits with other banks
   
0
   
0
         
0
   
0
       
Fed funds sold
   
4,617
   
42
   
1.22
%
 
3,793
   
33
   
1.16
%
Total Earning Assets
   
358,895
   
14,916
   
5.55
%
 
338,837
   
14,803
   
5.84
%
Less: Allowance for loan losses
   
(2,283
)
             
(2,002
)
           
Cash and due from banks
   
6,686
   
   
   
6,340
   
   
 
Premises and equipment, net
   
4,593
               
4,291
             
Other assets
   
10,900
               
10,581
             
Total Assets
 
$
378,791
             
$
358,047
             
                                       
LIABILITIES AND STOCKHOLDERS' EQUITY
                                     
Deposits
                                     
Interest bearing demand
 
$
26,579
 
$
146
   
0.73
%
$
24,152
 
$
165
   
0.91
%
Regular savings
   
63,152
   
454
   
0.96
%
 
58,717
   
589
   
1.34
%
Money market savings
   
40,270
   
419
   
1.39
%
 
34,857
   
408
   
1.56
%
Time
   
113,188
   
2,593
   
3.06
%
 
114,826
   
2,987
   
3.48
%
Total Interest Bearing Deposits
   
243,189
   
3,612
   
1.98
%
 
232,552
   
4,149
   
2.39
%
Other borrowings
   
53,031
   
1,693
   
4.26
%
 
49,463
   
1,602
   
4.33
%
Total Interest Bearing
   
296,220
   
5,305
   
2.39
%
 
282,015
   
5,751
   
2.73
%
Liabilities
                                     
Net interest spread
         
9,611
   
3.16
%
       
9,052
   
3.11
%
Non-interest bearing demand deposits
   
40,356
               
35,386
             
Accrued expenses and other liabilities
   
1,443
               
1,538
             
Stockholder's Equity
   
40,772
               
39,108
             
Total Liabilities and Stockholders' Equity
 
$
378,791
             
$
358,047
             
Interest income/earning assets
               
5.55
%
             
5.84
%
Interest expense/earning assets
               
1.97
%
             
2.27
%
Net interest margin
               
3.58
%
             
3.57
%
     
    PAGE 16


Distribution of Assets, Liabilities and Stockholders' Equity;
 
Interest Rates and Interest Differential (Quarter to Date)
 
   
September 2004
         
September 2003
         
(in thousands)
 
Average
 
 
 
Yield/
 
Average
 
 
 
Yield/
 
ASSETS
 
Balance
 
Interest
 
Rate
 
Balance
 
Interest
 
Rate
 
Loans
                         
Real estate
 
$
107,770
 
$
1,737
   
6.41
%
$
107,321
 
$
1,901
   
7.03
%
Installment
   
17,371
   
288
   
6.60
%
 
17,687
   
301
   
6.75
%
Commercial
   
100,444
   
1,571
   
6.22
%
 
94,906
   
1,451
   
6.07
%
Tax exempt
   
17,229
   
175
   
4.04
%
 
8,501
   
84
   
3.92
%
Other loans
   
656
   
12
   
7.28
%
 
588
   
11
   
7.42
%
Total Loans
   
243,470
   
3,783
   
6.18
%
 
229,003
   
3,748
   
6.49
%
Investment Securities (AFS)
                                     
Taxable
   
70,367
   
778
   
4.40
%
 
83,943
   
808
   
3.82
%
Non-taxable
   
42,993
   
436
   
4.03
%
 
31,732
   
351
   
4.39
%
Total Securities
   
113,360
   
1,214
   
4.26
%
 
115,675
   
1,159
   
3.98
%
Time deposits with other banks
   
0
   
0
         
0
   
0
       
Fed funds sold
   
5,256
   
20
   
1.51
%
 
4,868
   
13
   
1.06
%
Total Earning Assets
   
362,086
   
5,017
   
5.51
%
 
349,546
   
4,920
   
5.58
%
Less: Allowance for loan losses
   
(2,618
)
             
(2,053
)
           
Cash and due from banks
   
6,600
   
   
   
7,227
   
   
 
Premises and equipment, net
   
4,705
               
4,456
             
Other assets
   
12,982
               
9,792
             
Total Assets
 
$
383,755
             
$
368,968
             
                                       
LIABILITIES AND STOCKHOLDERS' EQUITY
                                     
Deposits
                                     
Interest bearing demand
 
$
28,586
 
$
54
   
0.75
%
$
25,847
 
$
58
   
0.89
%
Regular savings
   
64,999
   
158
   
0.97
%
 
60,509
   
181
   
1.19
%
Money market savings
   
39,439
   
138
   
1.39
%
 
35,488
   
127
   
1.42
%
Time
   
109,924
   
833
   
3.01
%
 
115,587
   
957
   
3.28
%
Total Interest Bearing Deposits
   
242,948
   
1,183
   
1.94
%
 
237,431
   
1,323
   
2.21
%
Other borrowings
   
55,942
   
602
   
4.28
%
 
49,939
   
546
   
4.34
%
Total Interest Bearing
   
298,890
   
1,785
   
2.38
%
 
287,370
   
1,869
   
2.58
%
Liabilities
                                     
Net interest spread
         
3,232
   
3.14
%
       
3,051
   
3.00
%
Non-interest bearing demand deposits
   
43,679
               
39,804
             
Accrued expenses and other liabilities
   
1,529
               
1,518
             
Stockholder's Equity
   
39,657
               
40,276
             
Total Liabilities and Stockholders' Equity
 
$
383,755
             
$
368,968
             
Interest income/earning assets
               
5.51
%
             
5.58
%
Interest expense/earning assets
               
1.96
%
             
2.12
%
Net interest margin
               
3.55
%
             
3.46
%

  
    PAGE 17

 
 

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

The provision for loan loss for the nine months ended September 30, 2004 was $1,050,000, an increase of $870,000 or 483.33% from $180,000 for the same period in 2003. This increase was due to the provision for an impaired loan relationship recorded in May 2004. This increased provision was due to bankruptcy proceedings entered into by this commercial loan customer. One of the Bank’s main goals is to increase the loan to deposit ratio without jeopardizing loan quality. To reach its goal, management has continued its efforts to create strong underwriting standards for both commercial and consumer credit. The Bank’s lending consists primarily of retail lending which includes single family residential mortgages and other consumer lending and commercial lending primarily to locally owned small businesses.

In the three month period ended September 30, 2004, charge-offs totaled $29,000 while net charge-offs totaled $14,000 as compared to $20,000 and $1,000 respectively for the same three month period in 2003.

Charge-offs totaled $425,000 for the nine month period ended September 30, 2004 while net charge-offs totaled $393,000 as compared to charge-offs of $62,000 and net charge-offs of $26,000 for the comparable period in 2003.

Monthly, senior management uses a detailed analysis of the loan portfolio to determine loan loss reserve adequacy. The process considers all "problem loans" including classified, criticized, and monitored loans. Prior loan loss history and current market trends, both nationally and locally, are taken into consideration. A watch list of potential problem loans is maintained and monitored on a monthly basis by the board of directors. The Bank has not had nor presently has any foreign loans. Based upon this analysis, senior management has concluded that the allowance of loan loss is adequate.

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

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

Service charges and fees increased 28.16%, or $87 thousand to $396 thousand for the three month period ended September 30, 2004, from $309 thousand in the same period in 2003. 

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

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

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




  
    PAGE 18

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

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


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

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

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

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

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

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

Income Tax Provision:
The Corporation recorded an income tax provision of $394 thousand, or 21.73% of income, and $591 thousand, or 26.94% of income, for the quarters ended September 30, 2004 and 2003 respectively.  The decline in the effective tax rate is due to increased tax-exempt income. 

The income tax provision recorded was $915 thousand, or 20.23% of income, and $1.478 million, or 26.15% of income, for the nine month periods ended September 30, 2004 and 2003 respectively. The decline in the effective tax rate is due to increased tax-exempt income.
 

  
    PAGE 19

 

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Fed Funds rate has been increased in 25 basis point increments three times in 2004. Improving economic conditions prompted the Federal Reserve to increase overnight borrowing rates by 25 basis points on June 30, 2004, August 10, 2004, and September 21, 2004. The timing and magnitude of future increases are unknown at the present time. As of September 30, 2004, the Bank is currently showing sensitivity to downward rate shift scenarios. The results of the latest financial simulation follow. The simulation shows a possible increase in net interest income of 7.44% or $890,000 in a +200 basis point rate shock scenario over a one-year period. A decrease of 10.66% or $1,275,000 is shown in the model at a -200 basis point rate shock. The net interest income risk position of the Bank remains within the guidelines established by the Bank’s asset/liability policy. The Bank continuously monitors its rate sensitivity.
 
Equity value at risk is monitored regularly and is also within established policy limits. Please refer to the Annual Report on Form 10-K filed with the Securities and Exchange Commission for December 31, 2003, for further discussion of this matter.


ITEM 4.  CONTROLS AND PROCEDURES
(a)
Evaluation of disclosure controls and procedures.

 
The Company's management, including the Company's Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2004. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures were effective in timely alerting them to any material information relating to the Company and its subsidiaries required to be included in the Company's periodic SEC filings.

(b)
Changes in internal controls.

 
There were no changes made in the Company's internal controls over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company's internal controls over financial reporting.

Although as stated above, we have not made any significant changes in our internal controls over financial reporting in the most recent fiscal quarter, based on our documentation and testing to date, we have made improvements in the documentation, design and effectiveness of internal controls over financial reporting, including the purchase of internal control software that allows upper management to view reports and to understand the risks and controls within the entire organization or specific areas of the organization. These reports provide up to date information at all times. However, given the risks inherent in the design and operation of internal controls over financial reporting, we can provide no assurance as to our, or our independent auditor's conclusions at December 31, 2004 with respect to the effectiveness of our internal controls over financial reporting.


 
 



 

 

  
    PAGE 20

 



PART II
ITEM 1.
LEGAL PROCEEDINGS
 
None.
   
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 
PEOPLES FINANCIAL SERVICES CORP   
 
ISSUER PURCHASES OF COMMON STOCK   
 
 
               
Total number
     
               
of shares purchased
 
Maximum number of
 
       
Total number
 
Average
 
as part of publicly
 
shares that may yet be
 
       
of shares
 
price paid
 
announced plans
 
purchased under the
 
MONTH    
purchased
 
per share
 
or programs
 
plans or programs (1)
 
        July 1, 2004 - July 31, 2004
         
0
 
$
0
   
0
   
146,616
 
                       
        August 1, 2004 - August 31, 2004
         
0
 
$
0
   
0
   
146,616
 
                       
        Sept 1, 2004 - Sept 30, 2004
         
20,500
 
$
34.28
   
20,500
   
126,116
 
                       
        TOTAL
         
20,500
 
$
34.28
   
20,500
       
 
 
(1) On December 27,1995, the Board of Directors authorized the repurchase of 187,500 shares of the Corporation's common stock
    from shareholders.  On July 2, 2001, the Board of Directors authorized the repurchase of an additional 5%, or 158,931 shares
    of the Corporation's common stock outstanding.  Neither repurchase program stipulated an expiration date.
 
 
 
   
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
None.
   
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.
   
ITEM 5.
OTHER INFORMATION
 
None.
 

 
    PAGE 21 

 

   
ITEM 6.
EXHIBITS
 
(a)   Exhibits required by Item 601 of Regulation S-K:
(3.1)
 
Articles of Incorporation of Peoples Financial Services Corp. *
(3.2)
 
By laws of Peoples Financial Services Corp.
(10.1)
 
Agreement dated January 14, 1997, between John W. Ord and Peoples Financial Services Corp. *
(10.2)
 
Excess Benefit Plan dated January 14, 1992, for John W. Ord *
(10.4)
 
Termination Agreement dated January 1, 1997, between Debra E. Dissinger and Peoples Financial Services Corp. *
(11)
 
The statement regarding computation of per share earnings required by this exhibit is contained in Note 2
   
to the consolidated financial statements captioned "Earnings Per Share" filed as part of Item 1 of this report.
(21)
 
Subsidiaries of Peoples Financial Services Corp. *
(31.1)
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
(31.2)
 
Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
(32.1)
 
Certification of Chief Executive Officer pursuant to Section 1350 of Sarbanes-Oxley Act of 2002
(32.2)
 
Certification of Principal Financial Officer pursuant to Section 1350 of Sarbanes-Oxley Act of 2002

*
 
Incorporated by reference to the Corporation’s Registration Statement on Form 10 as filed with the U.S.
   
Securities and Exchange Commission on March 4, 1998
     
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
  
    PAGE 22

 



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.
 
 
 
PEOPLES FINANCIAL SERVICES CORP.
     
 
By
 
/s/

Debra E. Dissinger
Debra E. Dissinger, Executive Vice President
 
 
 
 
By
 
/s/
 

Frederick J. Malloy
Frederick J. Malloy, AVP/Controller
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

  
    PAGE 23

 


EXHIBIT INDEX
 

ITEM NUMBER
 
DESCRIPTION
 
PAGE
 3.2   By Laws of Peoples Financial Services Corp., as amended    25-35  
31.1
 
Certification of Chief Executive Officer
 
36
 
31.2
 
Certification of Principal Financial Officer
 
37
 
32.1
 
Sarbanes-Oxley Act of 2002 Section 1350
 
38
 
   
Certification of Chief Executive Officer
     
32.2
 
Sarbanes-Oxley Act of 2002 Section 1350
 
39
 
   
Certification of Principal Financial Officer
     

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
  
    PAGE 24