ITEM 1 BUSINESS
BRIEF HISTORY
Peoples Financial Services Corp. (the "Company") was incorporated under the laws of the Commonwealth of Pennsylvania on February 6, 1986, and is a one-bank holding company headquartered in Hallstead, Pennsylvania.
The Company is engaged primarily in commercial and retail banking services and in businesses related to banking services through its sole subsidiary, Peoples National Bank of Susquehanna County ("PNB" or the "Bank"). PNB was chartered in Hallstead, Pennsylvania in 1905 under the name of The First National Bank of Hallstead. In 1965, the Hop Bottom National Bank (chartered in 1910) merged with and into the First National Bank of Hallstead to form PNB. PNB is currently in its 95th year of operation.
SUPERVISION AND REGULATION
The Company and PNB are extensively regulated under federal and state law. Generally, these laws and regulations are intended to protect depositors, not shareholders. The following is a summary description of certain provisions of certain laws which affect the regulation of bank holding companies and banks. This discussion is qualified in its entirety by reference to applicable laws and regulations. Changes in such laws and regulations may have a material effect on the business and prospects of the Company and PNB.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and as such, it is subject to regulation, supervision, and examination by the Federal Reserve Bank ("FRB"). The Company is required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information as the FRB may require. The FRB also conducts examinations of the Company.
With certain limited exceptions, the Company is required to obtain prior approval from the FRB before acquiring direct or indirect ownership or control of more than 5% of any voting securities or substantially all of the assets of a bank or bank holding company, or before merging or consolidating with another bank holding company. Additionally, with certain exceptions, any person or entity proposing to acquire control through direct or indirect ownership of 25% or more of any voting securities of the Company is required to give 60 days written notice of the acquisition to the FRB, which may prohibit the transaction, and to publish notice to the public.
The Company's banking subsidiary is a federally-chartered national banking association regulated by the Office of the Comptroller of the Currency ("OCC"). The OCC may prohibit the institution over which it has supervisory authority from engaging in activities or investments that the agency believes constitute unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law; regulation or a regulatory agreement or which are deemed to constitute unsafe or unsound practices.
Enforcement actions may include: the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employee and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or any other court actions.
PNB is subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third persons dealing with PNB and not involving more than the normal risk of repayment. Other laws tie the maximum amount that may be loaned to any one customer and its related interests to capital levels of the bank.
Limitations on Dividends and Other Payments
The Company's current ability to pay dividends is largely dependent upon the receipt of dividends from its banking subsidiary, PNB. Both federal and state laws impose restrictions on the ability of the Company to pay dividends. The FRB has issued a policy statement that provides that, as a general matter, insured banks and bank holding companies may pay dividends only out of prior operating earnings. Under the National Bank Act, a national bank such as PNB, may pay dividends only out of the current year's net profits and the net profits of the last two years. In addition to these specific restrictions, bank regulatory agencies in general, also have the ability to prohibit proposed dividends by a financial institution that would otherwise be permitted under applicable regulations if the regulatory body determines that such distribution would constitute an unsafe or unsound practice.
Permitted Non-Banking Activities
Generally, a bank holding company may not engage in any activities other than banking, managing, or controlling its bank and other authorized subsidiaries, and providing service to those subsidiaries. With prior approval of the FRB, the Company may acquire more than 5% of the assets or outstanding shares of a company engaging in non-bank activities determined by the FRB to be closely related to the business of banking or of managing or controlling banks. The FRB provides expedited procedures for expansion into approved categories of non-bank activities.
Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions: on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities, and on the use of their securities as collateral for loans to any borrower.
These regulations and restrictions may limit the Company's ability to obtain funds from PNB for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, subject to certain exceptions, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, PNB may not generally require a customer to obtain other services from itself or the Company, and may not require that a customer promise not to obtain other services from a competitor as a condition to an extension of credit to the customer.
Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital injections into a troubled subsidiary bank, and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the holding company does not have the resources to provide it. In addition, depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with the default of or assistance provided to, a commonly controlled FDIC-insured depository institution. Accordingly, in the event that any insured subsidiary of the Company causes a loss to the FDIC, other insured subsidiaries of the Company could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Such cross guarantee liabilities generally are superior in priority to the obligation of the depository institutions to its stockholders due solely to their status as stockholders and obligations to other affiliates.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act has made major changes in the way that the financial services industry has been organized. By eliminating obsolete distinctions between different types of financial institutions and allowing them to merge, the bill enables one company to meet all of its consumers' financial needs. It allows banks and securities firms to own the other. Over the past two decades, the products offered by banks and securities firms have gradually come to resemble each other. Both types of firms offer checking accounts in which idle balances are invested in stocks or bonds and credit cards. The new Act repeals portions of the 1933 Glass-Steagall Act (P.L. 48-162) that prohibit banks and securities firms from owning each other. This Act also protects consumer privacy by allowing customers to know how confidential information will be treated. Instead of hoping a financial services company will treat their personal data as confidential, consumers will receive an explicit disclosure of how such information will be used by the firm. The stated policy must specify how and under what circumstances confidential information, that is not available from other public sources, would be disclosed among the firm's affiliates and other firms. Customers who object to any portion of this policy would be able to take their business to another firm. This Act also allows consumers to control how their personal information is shared. Customers have the explicit right to prohibit financial services companies from sharing their personal confidential information with other non-affiliated firms. Once a consumer makes that decision, financial companies would be prohibited from violating their instructions. Anyone attempting to obtain this information fraudulently by pretending to be the consumer or any similar action could be sent to a federal prison for up to five years.
The goal of this Act is to ensure that the interest of consumers are protected, both by assuring that their personal information is safeguarded and by giving financial institutions the flexibility to serve their needs.
Pennsylvania Law
As a Pennsylvania bank holding company, the Company is subject to various restrictions on its activities as set forth in Pennsylvania law. This is in addition to those restrictions set forth in federal law. Under Pennsylvania law, a bank holding company that desires to acquire a bank or bank holding company that has its principal place of business in Pennsylvania must obtain permission from the Pennsylvania Department of Banking.
Interstate Banking Legislation
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 was enacted into law on September 29, 1994. The law provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies were eliminated effective September 29, 1995. The law also permits interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date.
FIRREA (Financial Institution Reform, Recovery, and Enforcement Act)
FIRREA was enacted into law in order to address the financial condition of the Federal Savings and Loan Insurance Corporation, to restructure the regulation of the thrift industry, and to enhance the supervisory and enforcement powers of the Federal bank and thrift regulatory agencies. As the primary federal regulator of the bank, the OCC is responsible for the supervision of the bank. When dealing with capital requirements, the OCC and FDIC have the flexibility to impose supervisory agreements on institutions that fail to comply with regulatory requirements. The imposition of a capital plan, termination of deposit insurance, and removal or temporary suspension of an officer, director or other institution-affiliated person may cause enforcement actions. There are three levels of civil penalties under FIRREA.
The first tier provides for civil penalties of up to $5,000 per day for any violation of law or regulation. The second tier provides for civil penalties of up to $25,000 per day if more than a minimal loss or a pattern is involved. Finally, civil penalties of up to $1 million per day may be assessed for knowingly or recklessly causing a substantial loss to an institution or taking action that results in a substantial pecuniary gain or other benefit.
Criminal penalties are increased to $1 million per violation and may be up to $5 million for continuing violations or for the actual amount of gain or loss. These penalties may be combined with prison sentences of up to five years.
FDICIA (Federal Deposit Insurance Corporation Improvement Act of 1991) In December 1991, Congress enacted FDICIA which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things: publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants, the establishment of uniform accounting standards by federal banking agencies, the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital, additional grounds for the appointment of a conservator or receiver, and restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements.
FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risk based premiums.
A central feature of FDICIA is the requirement that the federal banking agencies take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories:
"well capitalized," "adequately capitalized," "under capitalized," "significantly undercapitalized," and "critically undercapitalized." PNB is currently classified as "well capitalized." An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity.
FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a cash dividend) or paying any management fees to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. If a depository fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date such institution is determined to be critically under capitalized.
FDICIA provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions that fail to comply with capital or other standards. Such actions may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. FDICIA also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver.
Under FDICIA each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies, including the OCC, have adopted standards covering: internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation fees and benefits.
Any institution that fails to meet these standards may be required by the agency to develop a plan acceptable to the agency, specifying the steps that the institutions will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Company, on behalf of PNB, believes that it meets substantially all the standards that have been adopted. FDICIA also imposed new capital standards on insured depository institutions. Before establishing new branch offices, PNB must meet certain minimum capital stock and surplus requirements and must obtain OCC approval.
Risk-Based Capital Requirements
The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, and recourse agreements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain US Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.
A banking organization's risk based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. "Tier 1", or core capital, includes common equity, perpetual preferred stock (excluding auction rate issues) and minority interest in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions. "Tier 2",or supplementary capital, includes, among other things, limited life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations and less restricted deductions. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies.
Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total capital to risk-weighted assets of at least 8%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. As of December 31, 2000, PNB's ratio of Tier 1 capital to risk-weighted assets stood at 15.90% and its ratio of total capital to risk- weighted assets stood at 16.99%. In addition to risk-based capital, banks and bank holding companies are required to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage capital ratio, of at least 4%. As of December 31, 2000, The Company's leverage capital ratio was 10.04%.
Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions including: limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital, and in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as to the measures described under FDICIA as applicable to under capitalized institutions
In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of PNB to grow and could restrict the amount of profits, if any, available for the payment of dividends to the Company.
Interest Rate Risk
In August 1995 and May 1996, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank's capital adequacy, an assessment of the bank's interest rate risk ("IRR") exposure. The standards for measuring the adequacy and effectiveness of a banking organization's IRR management includes a measurement of Board of Directors and senior management oversight, and a determination of whether a banking organization's procedures for comprehensive risk management are appropriate to the circumstances of the specific banking organization. PNB has internal IRR models that are used to measure and monitor IRR. In addition, an outside source also assesses IRR using its model on a quarterly basis. Additionally, the regulatory agencies have been assessing IRR on an informal basis for several years. For these reasons, the Company does not expect the IRR evaluation in the agencies' capital guidelines to result in significant changes in capital requirements for PNB.
FDIC Insurance Assessments
As a FDIC member institution, PNB's deposits are insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF")that is administered by the FDIC and each institution is required to pay semi-annual deposit insurance premium assessments to the FDIC. The PNB assessment for 2000 was $44,063. These figures can be compared to FDIC assessments in 1999 of $24,307 and in 1998 of $23,500.
Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the Financing Corporate bonds. On September 30, 1996, as part of the Omnibus Budget Act, Congress enacted the Deposit Insurance Funds Act of 1996, which recapitalized the Savings Association Insurance Fund ("SAIF") and provided that BIF deposits would be subject to 1/5 of the assessment to which SAIF deposits are subject for FICO bond payments through 1999. Beginning in 2000, BIF deposits and SAIF deposits were subject to the same assessment for FICO bonds. The FICO assessment for PNB for 2000 was $.0230 for each $100 of BIF deposits.
Community Reinvestment Act
The Community Reinvestment Act of 1977, (the CRA) is designed to create a system for bank regulatory agencies to evaluate a depository institution's record in meeting the credit needs of its community. Until May 1995, a depository institution was evaluated for CRA compliance based on twelve assessment factors.
The CRA regulations were completely revised as of July 1, 1995, (the revised CRA regulation) to establish new performance-based standards for use in examining for compliance. This revised CRA regulation established new tests for evaluating both small and large depository institutions. A small bank is defined as one that has total assets of less than $250 million and is independent or is an affiliate of a holding company with less than $1 billion in assets.
The Bank had its last CRA compliance examination in 1998 and received a "satisfactory" rating.
Concentration
Payment risk is a function of the economic climate in which the Bank's lending activities are conducted. Economic downturns in the economy generally or in a particular sector could cause cash flow problems for customers and make loan payments more difficult. The Bank attempts to minimize this risk by avoiding loan concentrations to a single customer or to a small group of customers whose loss would have a materially adverse effect on the financial condition of the Bank.
Monetary Policy
The earnings of a bank holding company are affected by the policies of regulatory authorities, including the FRB, in connection with the FRB's regulation of the money supply. Various methods employed by the FRB are: open market operations in United States Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits.
These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to do so in the future.
Legislation and Regulatory Changes
From time to time, legislation is enacted that effects the cost of doing business or limits the activities of a financial institution. No prediction can be made as to the likelihood of any major changes or the impact of those changes might have on the Company.
MARKET AREAS
The PNB market areas are in the northeastern part of Pennsylvania with the primary focus being Susquehanna and Wyoming Counties. Since Susquehanna County borders the State of New York, the southern portion of Broome County, New York is also considered part of the market area of PNB. In addition, parts of Lackawanna, Wayne, and Bradford Counties in Pennsylvania that border Susquehanna and Wyoming Counties are also considered part of the PNB market area:
The PNB market area is situated between: the city of Binghamton, Broome County, New York, located to the north the city of Scranton, Lackawanna County, Pennsylvania, to the south, and Wilkes Barre, Luzerne County, Pennsylvania, to the southwest.
Susquehanna County could best be described as a bedroom county with a high percentage of its residents commuting to work in Broome County, New York, or to the Scranton, Pennsylvania, area. The southern part of Susquehanna County tends to gravitate south for both employment and shopping while the northern part of the county goes north to Broome County, New York. The western part of Susquehanna County gravitates south and west to and through Wyoming County. Wyoming County is home to a Proctor & Gamble manufacturing facility. This is an economic stimulus to Wyoming County and the surrounding areas.
Our offices are located in counties that would be considered sparsely populated as they are made up of many small towns and villages. The latest population figures show Susquehanna County at approximately 42,000 and Wyoming County at approximately 30,000 residents. Both counties are experiencing growth, but not robust growth. Interstate 81 runs north and south through the eastern half of Susquehanna County and has brought an influx of people from New Jersey and the Philadelphia area. These people have purchased homes and land to build homes that are used as vacation/recreation retreats and, quite often, become retirement homes.
BUSINESS
Lending Activities
PNB provides a full range of retail and commercial banking services designed to meet the borrowing and depository needs of small and medium sized businesses and consumers in its market areas. Substantially all of PNB's loans are to customers located within its service areas. PNB has no foreign loans or highly leveraged transaction loans, as defined by the FRB. Substantially all of the loans in PNB's portfolio have been originated by PNB. Policies adopted by the Board of Directors are the basis by which PNB conducts its lending activities. These loan policies grant individual lending officers authority to make secured and unsecured loans in specific dollar amounts. Larger loans must be approved by senior officers or by the Board of Directors. PNB's management information systems and loan review policies are designed to monitor lending sufficiently to ensure adherence to PNB's loan policies.
The commercial loans offered by PNB include: commercial real estate loans, working capital, equipment and other commercial loans, construction loans, SBA guaranteed loans, and agricultural loans.
PNB's commercial real estate loans are used to provide financing for retail operations, manufacturing operations, farming operations, multi-family housing units, and churches. Commercial real estate secured loans are generally written for a term of 15 years or less or amortized over a longer period with balloon payments at shorter intervals. Personal guarantees are obtained on nearly all commercial loans. Credit analysis, loan review, and an effective collections process are also used to minimize any potential losses. PNB employs two full-time commercial lending officers. These two people are augmented by branch managers who are authorized to make smaller, less complex, commercial loans.
Risk with respect to PNB's commercial lending activities involves: payment risk, interest rate risk, or collateral risk.
Payment risk is a function of the economic climate in which PNB's lending activities are conducted; economic downturns in the economy generally or in a particular sector could cause cash flow problems for customers and make loan payments more difficult. PNB attempts to minimize this risk by avoiding concentrations of credit to single borrowers or borrowers in a particular industry. Interest rate risk would occur if PNB were to make loans at fixed rates in an environment in which rates were rising thereby preventing PNB from making loans at the higher prevailing rates. PNB attempts to mitigate this risk by making adjustable rate commercial loans and, when extending fixed rate commercial loans, fixing loan maturities at five years or less. Finally, collateral risk can occur if PNB's position in collateral taken as security for loan repayment is not adequately secured. PNB attempts to minimize collateral risk by avoiding loan concentrations to particular borrowers, by perfecting liens on collateral and by obtaining appraisals on property prior to extending loans.
Consumer loans offered by PNB include: residential real estate loans, automobile loans, manufactured housing loans, personal installment loans secured and unsecured for almost any purpose, student loans, and home equity loans (fixed-rate term and open ended revolving lines of credit).
PNB offers credit cards as an agent bank through another correspondent bank.
Risks applicable to consumer lending are similar to those applicable to commercial lending. PNB attempts to mitigate payment risk in consumer lending by limiting consumer lending products to a term of five years or less. To the extent that PNB extends unsecured consumer loans, there is greater collateral risk; however, credit checks and borrower history are obtained in all consumer loan transactions.
Residential mortgage products include adjustable-rate as well as conventional fixed-rate loans. Terms vary from 1, 5, 7 and 10-year adjustable rate loans to 5, 10, 15, 20, and 30-year fully amortized fixed rate loans. Bi-weekly payment plans are also available. The longer term fixed rate loans have been underwritten as conforming and may be sold to the secondary market to reduce interest rate risk. Personal secured and unsecured revolving lines of credit with variable interest rates and principal amounts ranging from $1,000 to $10,000 are offered to credit-worthy customers. The largest segment of PNB's installment loan portfolio is fixed-rate loans. Most are secured either by automobiles, motorcycles, snowmobiles, boats, other personal property, or by liens filed against real estate. These loans are generally available in terms of up to 15 years with automobile loans having maturities of up to 60 months and real estate loans having maturities up to 15 years. Loans secured by other collateral usually require a maturity of less than 60 months. Home equity products include both fixed-rate term products and also an open-end revolving line of credit with a maximum loan-to-value ratio of 80% of current appraisal. A special MGIC program now offered through the Bank, allows for loans of up to 100% of the appreciated value for qualified applicants. Credit checks, credit scoring, and debt-to-income ratios within preset parameters are used to qualify borrowers.
Mortgage loans have historically had a longer average life than commercial or consumer loans. Accordingly, payment and interest rate risks are greater in some respects with mortgage loans than with commercial or consumer lending. Deposits, which are used as the primary source to fund mortgage lending, tend to be of shorter duration than the average maturities on residential mortgage loans and are more susceptible to interest rate changes. As a result of the relatively long life of mortgage products, mortgages are written as either conforming or nonconforming. In an effort to minimize interest rate and payment risk, only conforming mortgage loans, which can be sold in the secondary mortgage market, are written for periods of 30 years. Nonconforming mortgages are made with adjustable rates or fixed rates with maturities shorter than 30 years. Nonconforming mortgages also historically have higher interest rates. Mortgage lending is also subject to economic downturns, in that increases in unemployment could adversely affect the ability of borrowers to repay mortgage loans and decreases in property values could affect the value of the real estate serving as collateral for the loan.
The general good economy allowed good growth in loans that ended 2000 up 13.03% from year-end 1999. Industry standard debt-to-income ratios and credit checks are used to qualify borrowers on all consumer loans. Managers, assistant managers, and customer service officers have retail lending authorities at each of the full-service branch office locations. PNB has centralized loan administration at its operations/administrative offices where mortgage underwriting and loan review and analysis take place.
Loan Approval
Individual loan authorities are established by PNB's Board of Directors upon recommendation by the senior credit officer. In establishing an individual's loan authority, the experience of the lender is taken into consideration, as well as the type of lending in which the individual is involved. The President of PNB has the authority to approve loans up to $500,000 following an analysis and review by loan administration and a written recommendation by the Chief Credit Officer. The full Board of Directors reviews on a monthly basis, all loans approved by individual lenders and the officers loan committee. All loan requests which are either complex in nature or exceed $500,000 must be analyzed and reviewed by loan administration and presented with a recommendation to the full Board of Directors for approval or denial.
PNB generally requires that loans secured by first mortgages or real estate have loan-to-value ratios within specified limits, ranging from 50% for loans secured by raw land to 80% for improved property, with the exception of secondary market programs which allow loan-to-value ratios as high as 95%. In addition, in some instances for qualified borrowers, private mortgage insurance is available for purchase that allows loan-to-value ratios to go as high as 95%. PNB also participates in a guaranteed mortgage insurance program. This allows PNB to make loans secured by second mortgages on real estate up to 100% of the value of the property. Adjustable rate mortgage products, as well as conventional fixed-rate products, are also available at PNB.
Deposit Activities
PNB also offers a full range of deposit and personal banking services insured by the FDIC, including commercial checking and small business checking products, cash management services, retirement accounts such as Individual Retirement Accounts ("IRA"), retail deposit services such as certificates of deposit, money market accounts, saving accounts, a variety of checking account products, automated teller machines ("ATM's"), point of sale and other electronic services such as automated clearing house ("ACH") originations, and other personal miscellaneous services. These miscellaneous services would include: safe deposit boxes, night depository services, traveler's checks, merchant credit cards, direct deposit of payroll and other checks, U.S. Savings Bonds, official bank checks, and money orders. The principal sources of funds for PNB are core deposits that include demand deposits, interest bearing transaction accounts, money market accounts, savings deposits, and certificates of deposit. These deposits are solicited from individuals, businesses, non-profit entities, and government authorities. Substantially all of PNB's deposits are from the local market areas surrounding each of its offices.
Investment Products
In 1999, PNB entered into an agreement with T.H.E. Financial Services to hire a joint employee to sell investment products. An agent was hired and has an office located in the Bank's Hallstead Plaza building.
Investment Portfolio and Activities PNB's investment portfolio has several objectives. A key objective is to provide a balance in PNB's asset mix of loans and investments consistent with its liability structure, and to assist in management of interest rate risk. The investments augment PNB's capital position in the risk-based capital formula, providing the necessary liquidity to meet fluctuations in credit demands of the community and also fluctuations in deposit levels.
In addition, the portfolio provides collateral for pledging against public funds, and a reasonable allowance for control of tax liabilities.
Finally, the investment portfolio is designed to provide income for PNB.
In view of the above objectives, the portfolio is treated conservatively by management and only securities that pass those criteria are purchased.
Competition
PNB operates in a fairly competitive environment, competing for deposits and loans with commercial banks, thrifts, credit unions, and finance and mortgage companies. Some of these competitors possess substantially greater financial resources than those available to PNB. Also, certain of these institutions have significantly higher lending limits then PNB and may provide various services for their customers, such as trust services, that are not presently available at PNB.
Financial institutions generally compete on the basis of rates and service. PNB is subject to increasing competition from credit unions, finance companies, and mortgage companies that may not be subject to the same regulatory restrictions and taxations as commercial banks.
PNB will seek to remain competitive with interest rates that it charges on its loans and offers on deposits. It also believes that its success has been, and will continue to be, due to its emphasis on community involvement, customer services, and relationships. With consolidation continuing in the financial industry, and particularly in PNB's markets, smaller profitable banks are gaining opportunities where larger institutions exit markets that are only marginally profitable for them.
SEASONALITY
Management does not feel that the deposits or the business of PNB in general are seasonal in nature. The deposits may, however, vary with local and national economic conditions but should not have a material effect on planning and policy making.
ITEM 2
ITEM 2 PROPERTIES
PNB has four full-service banking offices in Susquehanna County that are located in: Borough of Susquehanna Depot, Hallstead Plaza, Great Bend Township, Borough of Hop Bottom, Montrose office in Bridgewater Township.
PNB's presence in Wyoming County, Pennsylvania had been limited to a de novo branch in Nicholson which reopened in 1992, until the purchase of the two Mellon offices in 1997. The Wyoming County locations are: Borough of Nicholson, Meshoppen Township, Tunkhannock Borough
The administrative/operations office of the Company and PNB is located at 50 Main Street, Hallstead, Pennsylvania. The following departments are located at that office: commercial, mortgage and consumer lending operations, executive offices, marketing department, human resources office, deposit account support services, data processing services
All offices are owned in fee title by PNB with the exception of the Hallstead Plaza office and the Meshoppen office. The Hallstead Plaza and Meshoppen offices are subject to ground leases. Each lease is either long-term or includes renewal options. Current lease payments range from $2,535 to $17,760 annually. Six of the seven offices provide drive-up banking services and five offices have 24-hour ATM services.
PNB is obligated under non-cancelable lease agreements for certain bank premises expiring in September 2028. The leases contain a renewal option and provide that the Bank pay property taxes, insurance, and maintenance costs. See Note 12 of Notes to Consolidated Financial Statements for further information on this subject.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS
The nature of the Company's business generates a certain amount of litigation involving matters arising out of the ordinary course of business. In the opinion of management, there are no legal proceedings that might have a material effect on the results of operations, liquidity, or the financial position of the Company at this time.
ITEM 4
ITEM 4 Submissions of Matters to a Vote of Security Holders
None
PART 11
ITEM 5
ITEM 5 Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is not listed on an exchange or quoted on the National Association of Securities Dealers, Inc. Automated Quotation system (NASDAQ). The Company's Common Stock is traded sporadically in the over-the-counter market and, accordingly, there is no established public trading market at this time. The Company's stock is listed on the OTC Bulletin Board under the symbol PFIS. The cusip number is 711040-10-5. The investment firms of Tucker Anthony Company Incorporated from Lancaster, Pennsylvania, and Ferris, Baker Watts, Incorporated from Baltimore, Maryland, make a limited market in the Company's Common Stock. The Company and previously the Bank has continuously paid dividends for more than 90 years and it is the intention to pay dividends in the future. However, future dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions, and other factors at the time that the Board of Directors considers dividend payments. As of December 31, 2000, there were 32,893 outstanding options or warrants to purchase. See Note 9 of the Consolidate Financial Statements for more information. Book value of common stock at December 31, 2000, was $14.31 and on December 31, 1999, it was $12.36. As of December 31, 2000, the Company had approximately 774 shareholders of record. At such date, 2,149,835 shares of Common Stock were outstanding.
The following table reflects high bid and low asked prices for shares of the Company's Common Stock to the extent such information is available, and the dividends declared with respect thereto during the preceding two years.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
The following table shows the Consolidated Financial Highlights as seen in the Quarterly Report for the Fourth Quarter 2000. Amounts are in thousands except for per share data.
ITEM 7
ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operation
This consolidated review and analysis of Peoples Financial Services Corp. (the Company) is intended to assist the reader in evaluating the Company's performance for the years ending December 2000 and 1999. The information should be read in conjunction with the consolidated financial statements and the accompanying notes to those statements.
Peoples Financial Services Corp. is the one-bank holding company of Peoples National Bank (the Bank), which is wholly owned by the Company. The Company and the Bank derive their primary income from the operation of a commercial bank, including earning interest on loans and investment securities. The Bank incurs interest expense in relation to deposits and other borrowings. The Bank operates seven full-service branches in the Hallstead Shopping Plaza, Hop Bottom, Montrose, Susquehanna, Nicholson, Tunkhannock, and Meshoppen, PA. The Bank has on-site automated teller machines at all offices except Hop Bottom and Meshoppen. The administrative offices and operations offices are located in Hallstead, PA. Principal market areas are Susquehanna and Wyoming Counties in PA and the bordering areas of those counties. As of December 31, 2000, the Bank employed 78 full-time employees and 22 part-time employees.
Results of Operations
Net Interest Income
Net interest income is the main source of the Company's income. It is the difference between interest earned on assets and interest paid on liabilities. The discussion of net interest income should be read in conjunction with Table 3: "Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rate and Interest Differential", and Table 2: "Rate/Volume Analysis of Changes in Net Interest Income."
The following table shows the net interest income on a fully tax equivalent basis for each of the three years ending December 2000, 1999, and 1998.
Table 2 analyzes the components contributing to the changes in net interest income in 2000 and indicates the impact in either changes in rate or changes in volume. Table 3 includes the average balances, interest income and expense, and the average rates earned and paid for assets and liabilities.
Interest income on loans increased $1,763,000 from 1999 to 2000. This increase of 14.6% is attributable to growth in the loan portfolio during the Year 2000. Net loans increased 13%. Although interest rates were higher at the end of the year than the beginning, competitive pricing pressures kept this increase at this level. Prime rate increased from 8.5% to 9.5% during the year.
Interest income on taxable investments increased $450,000 from 1999 due to a combination of higher balances and investing at higher interest rates during the year. Beginning in June 1999 and ending in May of 2000, the Federal Reserve Bank increased interest rates 1 3/4%. During most of the Year 2000, interest rates were inverted, meaning that short-term rates were higher than long-term rates. Because of this situation and management's desire to shorten maturities on taxable investments, purchase of taxable securities were limited to those with maturities of 5 years or less.
Interest on tax exempt securities increased $134,000 as a different plan was executed in this segment. A conscious effort was made by management to lengthen the call features on tax exempt securities. When available, longer term issues were purchased with call features in excess of 5 years. Management's desire is to have the taxable side of the portfolio provide more of the liquidity with the tax-exempt side providing more income along with liquidity. This will be especially evident with the advent of lower interest rates.
Interest income from Federal Funds decreased $53,000 from 1999 to 2000 because of lesser volume. Even though rates were increasing, the growth in the loan portfolio did not provide for as much excess funds as previous years.
As previously stated, short-term interest rates increased during the Year 2000. Since deposit accounts are priced off the short end of the treasury curve, the Bank experienced an abnormal increase in interest expense of 23.4% or $1,988,000. Not only did deposits cost more, term borrowings also were more expensive as that line item went from $493,000 in 1999 to $1,201,099 in 2000. Funding loan growth through term borrowing was deemed more economically sensible than through aggressive certificate of deposit rates. Interest on deposits increased $1,280,000 in 2000 due to the increase in short-term rates.
PROVISION FOR LOAN LOSS
The provision and allowance for loan losses are based on management's ongoing assessment of the Corporation's credit exposure and consideration of other relevant factors. The allowance for loan losses is a valuation reserve that is available to absorb future loan charge offs. The provision for loan losses is the amount charged to earnings on an annual basis. The factors considered in management's assessment of the reasonableness of the allowance for loan losses include prevailing and anticipated economic conditions, assigned risk ratings on loan exposures, the results of examinations and appraisals of the loan portfolio conducted by federal regulatory authorities and an independent loan review firm, the diversification and size of the loan portfolio, the level of and inherent risk in non-performing assets, and any other factors deemed relevant by management.
The provision for loan losses remained the same in 2000 as it was in 1999 at $240,000. Net charge-offs for 2000 were $78,000 compared to $198,000 in 1999, so the allowance for loan loss increased 9.23%. The ratio of allowance for loan loss to non-performing loans was 381.43% at year-end 2000 as compared to 654.68% at year-end 1999. As of December 31, 2000, the allowance for loan loss was 1.11% of loans and at December 31, 1999, the ratio was 1.15% of loans.
OTHER INCOME
Non-Interest Income
Non-interest income includes items that are not related to interest rates, but rather, to services rendered and activities conducted in conjunction with the operation of a commercial bank. Service charges earned on deposit accounts is the largest single item in this category and represents fees related to deposit accounts including overdraft fees, minimum balance fees, and transaction fees. Income in this category increased $228,000 in 2000 or 19.2%, while deposits increased 7.12%. Increased volume and adjustments in fee schedules account for the difference. Total other income, which includes gains on securities sales of $20,000 in 2000, was $1,452,000. Service charges on deposit accounts totaling $1,415,000 made up most of this figure.
The following table analyzes the increase in total other income by comparing the years ending 2000 and 1999:
OTHER EXPENSE
Non-Interest Expense
Non-interest expense includes all other expenses associated with the Company. Salaries and related benefits is the largest expense in this category and it increased $285,000 or 11.2% over 1999. New employees and annual salary increases, along with an increase for health insurance, were the reasons for this change. In comparison, the increase in this category from 1998 to 1999 was 5.8% or $139,000.
Occupancy expense increased 4.6% or $15,000 in 2000 as compared to 1999. This was considered a normal increase for taxes, utilities, repairs and maintenance, and depreciation. Furniture and equipment expense also was up a negligible amount with 2000 at $388,000 and 1999 at $383,000. A new image system and an update to the computer system were purchased in 2000. Technology has proven to be expensive and it is the strategic plan of the Company to continue to expand in areas to make our systems more efficient and also to enhance customer service. Professional fees, which includes outside service, continues to increase as management and the Company find it efficient and cost effective to utilize outside services and consultants to facilitate management and operations. Professional fees and outside services were $216,000 in 2000 which compares to $197,000 in 1999.
Computer services and supplies is another component of other expenses and it is as its name implies. This category covers the expense of data processing for the Company. Each year dependence grows as does the resultant expense. In 2000 the expense was $361,000 compared to $306,000 in 1999.
Taxes, other than payroll and income, are another component and in 2000, this expense was $255,000 vs. $247,000 in 1999, an increase considered to be normal.
Every other non-interest expense is in the category of other operating expense. In 2000 this expense increased $12,000 and the total for this year was $1,238,000. The biggest components in this figure were the premiums on the purchase of the Tunkhannock and Meshoppen branch offices at $258,000; operating costs other than salaries for our operation center, $150,000; directors' and associate directors' fees of $124,000; the cost of operating our automated teller machines, $131,000; FDIC insurance and regulator's fees of $116,000; stationery printing and supplies, $122,000; and postage at $112,000. All were deemed to be in line with budget expectations.
The following table is a summary of the other expenses by category for 2000, 19999, and 1998:
Federal Income Taxes
The provision for income taxes in 2000 was $1,096,604 compared to $1,114,538 in 1999. The effective tax rate, which is the ratio of income tax expense to income before taxes, was 21.9% in 2000, down from 22.7% in 1999. The tax rate for both periods was substantially less than the federal statutory rate of 34% primarily due to tax-exempt securities and tax-exempt loan income. Please refer to Note 10 of the Notes to Consolidated Finance Statements included as part of this report for further analysis of federal income tax expense for 2000.
Quarterly Results
Net income improved each of the first three quarters of 2000 with a slight dip in the last quarter due to the larger gain in other income peaking during the third quarter of 2000. Interest expense reached a high of $2,844,000 in the last quarter and other expenses also reached their peak in the same quarter at $1,568,000.
FINANCIAL CONDITION
The Corporation's financial condition can be evaluated in terms of trends in its sources and uses of funds. The following table illustrates how the Corporation has managed its sources and uses of funds that are directly affected by outside economic factors, such as interest rate fluctuations:
Total assets increased 10.07%, to $287,625,000 in the year ending December 31, 2000. There were increases in both borrowed funds and deposits on the liability side which fueled this growth of assets. Loan and investment portfolios on the asset side reflected growth also.
Investments at year-end 2000 totaled $99,678,000 compared to $92,066,000 on December 31, 1999. Of this increase of $7,611,000, almost $3 million was due to less depreciation in the portfolio on December 31, 2000. Due to changing interest rate scenarios, the structure of the investment portfolio changed as municipal bonds were added with longer call features to protect higher coupons. Overall municipal securities increased $1,770,000. The biggest growth was in corporate bonds which increased $8,513,000. Maturities of 5 years or less with good quality and higher coupons were added. Government securities were not replaced as they matured because of declining interest rates; and also for the same reason, government agencies were not replaced as they prepaid principal payments or matured.
Average loans receivable, net of loan reserves, increased $17,099,000 or 11.87% in 2000 compared to an increase of $11,026,000 or 8.29% in 1999.
Loans continued to increase throughout 2000, ending the year at $170,262,000 in net loans compared to $150,630,000 at year-end 1999, an increase of 13.03%. Commercial loans and individual mortgages were the biggest gainers. Commercial loans were up almost 19% to close the year at $50,338,000 compared to $42,362,000 at year-end 1999.
Mortgages were up 10.52% to $92,074,000 vs. $83,308,000 on December 31, 1999, an increase of $8,765,000.
Even with interest rates rising during 2000, there continued to be demand for mortgages. The growth in commercial lending is due, in part, to a concerted effort on our part to increase our exposure to this segment.
To fund loan growth, borrowings from the Federal Home Loan Bank increased $5,500,000. Short-term borrowing stood at $7,245,000 at year-end 2000 compared to $5,851,000 the previous year. As the Year 2000 came to an end, it became evident that interest rates would decline and the short term borrowing position would be liquidated with maturing and called investments.
Loan Maturities
The Bank has 16.7% of its loans maturing within the next year. Of that 16.7%, more than half of the maturing loans are commercial loans with the remainder almost split equally between mortgages and installment loans. In the one to five year maturity range, the Bank has 28.00% of its portfolio. The over 5 year maturity group makes up 55.26% of the portfolio which reflects the Bank's significant investment in mortgages. Mortgages are 54.97% of the total loan portfolio.
Table 10 reflects the Corporation's non-accrual and past due loans for each of the past five years. A commercial loan is generally placed on non-accrual when the contractual payment of principal or interest has become 90 days past due or when management has serious doubts about further collectibility of principal or interest even though the loan is currently performing. Consumer loans, including mortgages, are generally placed on non-accrual at 120 days. A loan may remain on non-accrual status if it is in the process of collection and is either guaranteed or well secured.
Allowance for Loan Losses
The balance in the allowance for loan losses is based on management's assessment of the risk in the loan portfolio. Allocations to specific commercial loans are made in adherence to SFAS 114, Accounting by Creditors for Impairments of a Loan. These allocations are based upon the present value of expected future cash flows or the fair value of the underlying collateral. In addition, management reviews the other components of the loan portfolio through the loan review function and assigns internal grades to loans based upon the perceived risks inherent in each loan. In that determination, management reviews a number of factors including historical analysis of similar credits, delinquency reports, ratio analysis as compared to peers, concentration of credit risks, local economic conditions, and regulatory evaluation of the allowance for loan losses. This evaluation is reviewed monthly by management and by the Board of Directors. Management believes that on December 31, 2000, the allowance for loan losses was adequate to absorb potential losses in the loan portfolio. However, this judgement is subjective and a significant degradation in loan quality could require a change in the estimates and therefore, a change in net income.
The following is a summary of loans charged off and recoveries to the allowance for loan losses on December 31, 2000 and 1999.
Summary of Loan Loss Experience
Highly leveraged transactions (HLT's) that result in the borrower's debt-to-total assets ratio exceeding the 75%, generally include loans and commitments made in connection with recapitalization, acquisitions, and leveraged buyouts The Corporation had no loans at December 31, 2000 that qualified as HLT's.
Securities
The Corporation's securities portfolio is classified, in its entirety, as "available for sale" as shown in Table 14. Management believes that a portfolio classification of all available for sale allows complete flexibility in the investment portfolio. Using this classification, the Corporation intends to hold these securities for an indefinite amount of time but not necessarily to maturity. Such securities are carried at fair value with the unrealized holding gains or losses, net of taxes, reported as a component of the Corporation's stockholders' equity on the balance sheet. The portfolio is structured to provide maximum return on investments while providing a consistent source of liquidity and meeting strict risk standards. Total investment securities of $101,668,000 include Certificates of Deposits with other banks in the amount of $1,990,000.
Table 14 shows the book value and average yield of securities by maturity or call date at December 31, 2000.
Table 15 shows the balance of securities for the past three years on December 31. More details on Investments by Market Value can be found in Note 15 of the Consolidated Financial Statement.
Deposits
Deposits were harder to obtain during 2000 as customers compared rates and took funds to where they were paid the highest rate. On the other hand, our Bank weighed the costs of deposits against the costs of borrowing from the Federal Home Loan Bank. As interest rates escalated, our Bank did not wish to match the highest certificate rates being paid. As a result, there was no growth in certificates in the year 2000. For the same reason, there was no growth in IRA's. Our Bank obtained a 7% growth in deposits because of a new product which was indexed to the three-month treasury bill rate. The certificate savings account allows unlimited deposits but restricts withdrawals to one per quarter. It proved to be very popular because of these features and because throughout most of the year we were in an inverted yield curve. Although relatively costly to our bottom line in 2000, we feel this account will be a core deposit in the future. At year-end, the certificate savings account had almost $22 million in balances and had grown over $15 million during the course of the year.
Non-interest checking accounts have also grown substantially over the last two years. The average non interest accounts increased 14.7% in 1999 and another 19.3% in 2000. Management considers these accounts a very important part of our balance sheet and will continue to seek ways to encourage growth in non-interest checking accounts.
MATURITIES OF TIME DEPOSITS
The maturities on the time deposits over $100,000 are spread fairly evenly throughout the four categories. The largest percentage, 35.79%, is in the last category of over twelve months.
SHORT AND LONG TERM BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase and Federal Home Loan Bank advances generally represent overnight or less than 30-day borrowings. U.S. Treasury tax and loan notes for collections made by the Bank are payable on demand. Short-term borrowings consisted of the following at December 31, 2000 and 1999:
The Bank has an agreement with Federal Home Loan Bank (FHLB) which allows for borrowings up to a percentage of qualifying assets. At December 31, 2000 and 1999, the Bank had a maximum borrowing capacity of $109,345,000 and $97,471,000, respectively. Advances on the flexible line of credit from the FHLB at December 31, 2000 and 1999 were $2,865,000 and $700,000, respectively. All advances from FHLB are secured by qualifying assets of the Bank.
Securities sold under repurchase agreements were under the Bank's control.
The Bank has a line of credit for the sale of federal funds with Atlantic Central Bankers Bank of which $-0- were outstanding at December 31, 2000 and 1999, respectively. These borrowings are unsecured.
Long-term borrowings were comprised of three long-term borrowings from Federal Home Loan Bank (FHLB) as follows:
o A $5,000,000 term fund with a fixed rate of interest at 6.37% which matures in 2010. This note has a convertible option which allows FHLB, after 1 year, to change the note to an adjustable-rate advance at 3 month LIBOR plus 11 points. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
o A $2,500,000 term fund with a fixed rate of interest at 7.03% which matures in 2005. This note has a convertible option which allows FHLB, after 1 year, to change the note to an adjustable- rate advance at 3 month LIBOR plus 11 points. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
o A $5,000,000 term fund with a fixed rate of interest at 6.1% which matures 2010. This note has a convertible option which allows FHLB, after 3 years, to change the note to an adjustable-rate advance at 3 month LIBOR plus 1 point. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
o A $5,000,000 term fund with a rate of 5.93% which matures in 2005. This note has a convertible option which allows FHLB, after 6 months, to change the note to an adjustable-rate advance at 3 month LIBOR plus 2 points. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
If the Bank prepays any of the above term funds, the prepayment fee applicable to the advance is equal to the present value of the difference between cash flows generated at the advance rate from the date of the prepayment until the original maturity date, and the cash flows that would have resulted from the interest rate posted by the FHLB on the date of prepayment for an advance of comparable maturity.
The notes are secured under terms of a blanket collateral agreement by a pledge of qualifying investment and mortgage backed securities, certain mortgage loans and a lien on FHLB stock.
Capital Accounts
Total stockholders' equity increased 15.08% or $4,042,000 over year-end 1999. This growth is primarily attributable to retained earnings. A common ratio used to determine effective use of capital is the return on average equity. For the year ending December 31, 2000, this ratio was 13.91% compared to 14.08% at December 31, 1999. A strong capital position has always been a goal of the Company, but we also recognize that investors want to see judicious use of capital. At year-end 2000, the equity-to-assets ratio was 10.71% compared to 10.26% at year-end 1999. It is the goal of management to implement ways to better leverage our capital. A capital-to-assets ratio closer to 8% is a target number.
Net Income increased capital by $3,905,000 in 2000 and dividends reduced that number by $1,341,000. The balance of the increase was created by less depreciation in our investment portfolio. Since all of our investments are available for sale, changes in market values adjusted for taxes are reflected in the equity portion of the balance sheet.
From time to time the Company has purchased PFIS stock in the open market or from individuals to leverage the capital account and to provide stock for our dividend reinvestment plan. During the Year 2000, 24,572 shares were purchased in this manner. Also during the year, 6,589 shares of this treasury stock were purchased by individuals exercising options and for our dividend reinvestment plan. The investment banking firms of Tucker Anthony, Inc. and Ferris, Baker Watts, Incorporated are the market makers.
The following table represents the Company's capital position as it compares to the regulatory guidelines at December 31, 2000.
Interest Rate Sensitivity
Interest rate sensitivity refers to the relationship between market interest rates and the earnings volatility of the Company due to the repricing characteristics of assets and liabilities. The responsibility for monitoring interest rate sensitivity and policy decisions has been given to the Asset/Liability Committee (ALCO) of the Bank. 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.
The following is the December 31, 2000, statement:
Statement of Interest Sensitivity Gap
Liquidity
The liquidity of the Company is reflected in its capacity to have sufficient amounts of cash available to fund the needs of customer withdrawal requests, accommodate loan demand, and maintain regulatory reserve requirements; that is to conduct banking business. Additional liquidity is obtained by either increasing liabilities or by decreasing assets. The primary source for increasing liabilities is the generation of additional deposit accounts which are managed through our system of branches. In addition, loan payments on existing loans, sales of loans held for sale, or investments available for sale can generate additional liquidity. Other sources include income from operations, decreases in federal funds sold or interest-bearing deposits in other banks, securities sold under agreements to repurchase, and borrowings from the Federal Home Loan Bank. On December 31, 2000, the Bank had a borrowing capacity from the Federal Home Loan Bank of approximately $109,345,000. During the Year 2000, maturities and sales of investments, increases in deposits, and short term borrowings provided the majority of additional cash with operating activities also contributing to liquidity. The funds were used primarily to grant loans to customers.
LOAN CONCENTRATION AND OFF BALANCE SHEET RISK
Our Bank is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. These financial instruments may include and involve commitments to extend credit, standby letters of credit, elements of credit, and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. Commitments to extend credit are agreements to lend to the customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire in one year or less without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Our exposure to credit loss is essentially the same for these items as that involved in extending loans to customers. We use the same credit policies in making commitments and conditional obligations as we do for on balance sheet instruments. Collateral is obtained based on management's credit assessment of the particular customer.
Please refer to Note 13 in the Notes to Consolidated Financial Statements for a more detailed account.
EFFECTS OF INFLATION
The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from commercial and industrial companies that have significant investments in fixed assets or inventories. The precise impact of inflation upon the Corporation is difficult to measure. Inflation may affect the borrowing needs of consumers, thereby impacting the growth rate of the Corporation's assets. Inflation may also affect the general level of interest rates, which can have a direct bearing on the Corporation.
Management believes that the most significant impact on financial results is the Corporation's ability to react to changes in interest rates. As discussed previously, management is attempting to maintain a position that is within conservative parameters for interest sensitive assets and liabilities in order to be protected against wide interest rate fluctuation.
FASB AND OTHER DISCLOSURES
The following can be found under Note 1 of the Notes to Consolidated Financial Statements:
SFAS No. 130, "Reporting Comprehensive Income" SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 132, "Disclosures about Pension and Other Post-retirement Benefits" SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise" SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities" SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
YEAR 2000 COMPLIANCE
The Company adopted a Year 2000 policy to address the "Year 2000" issue concerning the inability of certain information systems and automated equipment to properly recognize and process dates containing the Year 2000 and beyond. If not corrected, these systems and equipment could have produced inaccurate or unpredictable results. The Company, similar to most financial service providers, was particularly vulnerable to the potential impact of the Year 2000 issue due to the nature of financial information.
In order to address the Year 2000 issue, the company developed and implemented a five-phase compliance plan divided into the following major components: Awareness Assessment Renovation Validation & Testing Implementation
Financial institution regulators intensively focused upon Year 2000 exposure, issuing guidance concerning the responsibilities of senior management and directors. Year 2000 testing and certification was addressed as a key safety and soundness issue in conjunction with regulatory exams. The FFIEC highly prioritized Year 2000 compliance in order to avoid major disruptions to the operations of financial institutions and the country's financial systems when
the new century begins. The Bank is subject to supervision by the Office of the Comptroller of the Currency, which regularly conducted reviews of the safety and soundness of the Banks operations, including Year 2000.
There was no interruption of the company's business due to Year 2000.
Forward Looking Statement
When used in this discussion, the words "believes", "anticipates", "contemplated", "expects", or similar expressions are intended to identify forward looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward looking statements that may be made to reflect events or circumstances after this date or to reflect the occurrence of unanticipated events.
ITEM 7A
ITEM 7A Quantitative and Qualitative Disclosure About Market Risk
The Company is not a party to any forward contract, interest rate swap, option interest, or similar derivation instrument. The Company does not deal in foreign currency. The following table presents average interest rates that relate to assets and liabilities that are sensitive to changes in interest rates.
ITEM 8
ITEM 8 Financial Statements and Supplementary Data
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors Peoples Financial Services Corp. and Subsidiary
We have audited the accompanying consolidated balance sheets of Peoples Financial Services Corp. and Subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Peoples Financial Services Corp. and Subsidiary as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with generally accepted accounting principles.
February 15, 2001
PROCIAK & ASSOCIATES, L.L.C. Wilkes-Barre, Pennsylvania
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont'd) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
See notes to financial statements
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999 AND 1998
Note 1: Summary of Significant Accounting Policies
The accounting and reporting policies of Peoples Financial Services Corp. and Subsidiary, (the "Company") follow generally accepted accounting principles and have been applied on a consistent basis. The more significant accounting policies are summarized below:
Basis of Presentation
The consolidated financial statements include the accounts of Peoples Financial Services Corp. and its wholly owned subsidiary, Peoples National Bank of Susquehanna County. All intercompany accounts and transactions have been eliminated in consolidation.
Nature of Operations
The Company provides a variety of financial services, through the bank, to individuals, small businesses and municipalities through its seven Pennsylvania offices located in Hallstead, Hop Bottom, Susquehanna, Montrose, Nicholson, Meshoppen and Tunkhannock,
which are small communities in a rural setting. The Bank's primary deposit products are checking accounts, savings accounts, and certificates of deposit. Its primary lending products are single-family residential loans and loans to small businesses.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties.
Investment Securities
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," requires investments to be classified and accounted for as either held to maturity, available for sale, or trading account securities based on management's intent at the time of acquisition. Management is required to reassess the appropriateness of such classifications at each reporting date.
The Company classifies debt securities as held to maturity when management has the positive intent and ability to hold such securities to maturity. Held to maturity securities are stated at cost, adjusted for amortization of premium and accretion of discount.
Securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 1: (Cont'd)
Investment Securities (Cont'd)
available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value.
Unrealized gains or losses are reported as increases or decreases in stockholders' equity, net of the related tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Management determines the appropriate classification of securities at the time of purchase and re-evaluates the designations as of each balance sheet date. Equity securities include restricted investments, primarily Federal Home Loan Bank stock which is carried at cost and evaluated for impairment.
Loans
Loans are stated at their outstanding unpaid principal balances net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the contractual life of the related loan as an adjustment to the yield.
A loan is generally considered impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. The accrual of interest is discontinued when the contractual payment of principal and interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Certain non-accrual loans may continue to perform, that is, payments are still being received. Generally, the payments are applied to principal. These loans remain under constant scrutiny and if performance continues, interest income may be recorded on a cash basis based on management's judgment as to collectibility of principal.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses which is charged to operations. Loans, determined to be uncollectible are charged against the allowance account and subsequent recoveries, if any, are credited to the account.
The allowance for loan losses related to impaired loans, that are identified for evaluation, is based on discounted cash flows using the loans' initial effective interest rate or the fair value, less selling costs, of the collateral for certain collateral dependent loans. By the time a loan becomes probable of foreclosure, it has been charged down to fair value, less estimated costs to sell.
The allowance is maintained at a level believed by management to be sufficient to absorb estimated potential credit losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the credit portfolio, the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of expected future cash flows on impaired loans, which may be susceptible to significant change in the near term.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 1: (Cont'd)
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight line and various accelerated methods based on estimated useful lives. Maintenance, repairs and minor replacements are expensed when incurred. Gains and losses on routine dispositions are reflected in current operations.
Intangible Assets
Intangible assets are included in other assets and are being amortized over a period of fifteen years using the straight-line method. Amortization was $258,360 for 2000, 1999 and 1998.
Foreclosed Assets Held for Sale
Foreclosed assets held for sale is comprised of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure and loans classified as in-substance foreclosure. The Company includes such properties in other assets. A loan is classified as in-substance foreclosure when the Company has taken possession of the collateral regardless of whether formal foreclosure proceedings take place. Any excess of the loan balance over the recorded value is charged to the allowance for loan losses. Subsequent declines in the recorded value of the property prior to its disposal and costs to maintain the assets are included in other expense. In addition, any gain or loss realized upon disposal is included in other income or expense.
Income Taxes
The provision for income taxes is based on the current and deferred tax consequences of all transactions that have been recognized in the financial statements using the provisions of the enacted tax laws. Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amount of assets and liabilities and their tax bases.
Advertising Costs
The Company follows the policy of charging marketing and advertising costs to expense as incurred.
Common Stock
Holders of Company Common Stock are entitled to one vote for each share on all matters voted on by shareholders. Holders of Company Common Stock do not have cumulative voting rights in the election of directors.
Holders of Company Common Stock do not have preemptive rights, or any subscription, redemption or conversion privileges. Holders of Company Common Stock are entitled to participate ratably in dividends on the Company Common Stock as declared by the Board of Directors, and are entitled to share ratably in all assets available for distribution to shareholders in the event of liquidation or dissolution of the Company.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 1: (Cont'd)
Earnings per Common Share
The Company computes earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share (SFAS 128)." SFAS 128 eliminates primary and fully diluted earnings per share and requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share exclude dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Prior periods' earnings per share calculations have been restated to reflect the adoption of SFAS No. 128.
On September 15, 1998, the Company effected a 5-for-2 stock split to shareholders of record on August 15, 1998. In connection with the stock split, the Corporation amended it's articles of incorporation to authorize 12,500,000 shares of $2 par value common stock. Earnings per share amounts and weighted average shares outstanding have been restated to give effect to the stock split.
The following data shows the amounts used in computing earnings per share for 2000, 1999 and 1998:
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 1: (Cont'd)
Accounting for Stock Options
The Company accounts for stock-based compensation in accordance with the Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." This method calculates compensation expense using the intrinsic value method which recognizes as expense the difference between the market value of the stock and the exercise price at grant date. The Company has not recognized any compensation expense under this method. The Company adopted the reporting disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," which requires the Company to disclose the pro forma effects of accounting for stock-based compensation using the fair value method as described in the accounting requirements of SFAS No. 123. As permitted by SFAS No. 123, the Company continues to account for stock-based compensation under APB opinion No. 25.
Accounting for Transfers and Servicing of Financial Assets
In September, 2000, SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125, was issued. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of Statement 125's provisions without reconsideration. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. This Statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. Disclosures about securitization and collateral accepted need not be reported for periods ending on or before December 15, 2000, for which financial statements are presented for comparative purposes. The effect of adopting SFAS No. 140 was not material to the Company's financial position or results of operations.
Reporting Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income" requires entities presenting a complete set of financial statements to include details of comprehensive income. Comprehensive income consists of net income or loss for the current period and income, expenses, gains and losses that bypass the income statement and are reported directly in a separate component of equity. The effect of adopting SFAS No. 130 was not material to the Company's financial position or results of operations.
Segment Reporting
During 1998, the Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information". This Statement establishes standards for the way public companies report information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures regarding products and services, geographic areas and major customers. The adoption of this Statement had no impact on the Company's financial position or results of operations.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 1: (Cont'd)
Disclosures about Pension and Other Post-retirement Benefits
During 1998, the Company adopted SFAS No. 132. This Statement: (1) revises employers' disclosures about pension and other post-retirement benefit plans; (2) standardizes the disclosure requirements for benefits of such plans; (3) requires additional information on changes in the benefit obligations and fair value of plan assets that will facilitate financial analysis; and (4) eliminates certain disclosures that are no longer useful. Most of the changes in the disclosure provisions of this Statement address defined benefit plans. The Company's adoption of SFAS No. 132 had no effect on the Company's financial position or results of operations.
Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise
During 1999, the Company adopted SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise". The Statement amends SFAS 65, "Accounting for Certain Mortgage Banking Activities." Statement 65, as amended, requires that after the securitization of a mortgage loan held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed security as a trading security. This Statement further amends SFAS 65 to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interest based on its ability and intent to sell or hold those investments. This Statement conforms the subsequent accounting for securities retained after securitization of mortgage loans by a mortgage banking entity with the subsequent accounting for securities retained after the securitization of other types of assets by nonmortgage banking enterprises. This means that such securities can be classified as held-to-maturity if they conform to the requirements of SFAS 115. The adoption of this statement had no impact on the Company's financial position or results of operations.
Accounting for Derivative Instruments and Hedging Activities
In June 1999, SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the effective date of SFAS No. 133" was issued. This statement defers the effective date of SFAS No. 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The adoption of SFAS No. 133 is not expected to have a material effect on the Company's financial position or results of operations.
Cash Flows
For the purpose of cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and federal funds sold.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 1: (Cont'd)
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year's classifications.
Note 2: Restrictions on Cash and Due from Banks
The Bank is required to maintain average reserve balances with the Federal Reserve Bank based on a percentage of deposits. The required reserve balance at December 31, 2000 and 1999 was $1,534,000 and $1,095,000, respectively.
Note 3: Investment Securities
At December 31, 2000 and 1999, the amortized cost and fair values of securities available for sale are as follows:
The amortized cost and fair value of securities as of December 31, 2000 by contractual maturity or call date, are shown below. Expected maturities will differ from contractual maturities or call dates because borrowers may have the right to prepay obligations with or without call or prepayment penalties. Maturities of mortgage-backed securities have been estimated based on the contractual maturity.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 3: (Cont'd)
Proceeds from sale of available for sale securities during 2000, 1999, and 1998 were $10,878,642, $12,072,318 and $8,110,848, respectively. Gross gains realized on these sales were $34,820, $112,657, and $63,459, respectively. Gross losses on these sales were $14,339, $27,586, and $15,965, respectively. Net unrealized gains (losses) on securities available for sale included in accumulated other comprehensive income net of tax was $(129,759) and $(2,086,929) in 2000 and 1999, respectively.
Securities with a carrying value of $31,261,000 and $26,823,000 at December 31, 2000 and 1999, respectively, were pledged to secure public deposits and repurchase agreements as required or permitted by law.
Note 4: Loans
Loans are summarized as follows:
A summary of the transactions in the allowance for loan losses is as follows:
Information with respect to impaired loans as of and for the years ended December 31, 2000 and 1999 are as follows:
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 4: (Cont'd)
In addition, the Bank had other non-accrual loans of approximately $322,000 and $83,000 at December 31, 2000 and 1999, respectively, for which impairment had not been recognized. Interest income on these loans, which is recorded when received, amounted to $12,400 and $2,800 for the years ended December 31, 2000 and 1999, respectively.
Interest income that would have been recorded under the original terms of the loan agreements amounted to $52,000 and $27,500 for the years ended December 31, 2000 and 1999, respectively.
The Bank has no commitments to loan additional funds to borrowers with impaired or non-accrual loans.
Loans outstanding to directors, executive officers, principal stockholders or to their affiliates totaled $615,149 at December 31, 2000 and $591,571 at December 31, 1999. Advances and repayments during 2000 totaled $142,975 and $119,397, respectively. These loans are made during the ordinary course of business at the Company's normal credit terms. There were no related party loans that were classified as non-accrual, past due, restructured or considered a potential credit risk at December 31, 2000 and 1999.
Note 5: Premises and Equipment
Premises and equipment at December 31, 2000 and 1999 are comprised of:
Note 6: Deposits
The carrying amounts of deposits at December 31, 2000 and 1999 consisted of the following:
At December 31, 2000 the time remaining to maturity of time certificates of deposit of $100,000 or more was as follows:
Interest expense related to time deposits of $100,000 or more was $776,588 in 2000, $697,248 in 1999 and $659,044 in 1998.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 7: Short-term Borrowings
Federal funds purchased, securities sold under agreements to repurchase and Federal Home Loan Bank advances generally represent overnight or less than 30-day borrowings. U.S. Treasury tax and loan notes for collections made by the Bank are payable on demand. Short-term borrowings consisted of the following at December 31, 2000 and 1999:
The Bank has an agreement with Federal Home Loan Bank (FHLB) which allows for borrowings up to a percentage of qualifying assets. At December 31, 2000 and 1999, the Bank had a maximum borrowing capacity of $109,345,000 and $97,471,000, respectively. Advances on the flexible line of credit from the FHLB at December 31, 2000 and 1999 were $2,865,000 and $700,000, respectively. All advances from FHLB are secured by qualifying assets of the Bank.
Securities sold under repurchase agreements were under the Bank's control.
The Bank has a line of credit for the sale of federal funds with Atlantic Central Bankers Bank of which $-0- were outstanding at December 31, 2000 and 1999, respectively. These borrowings are unsecured.
Note 8: Long-term Borrowings
Long-term borrowings were comprised of three long-term borrowings from Federal Home Loan Bank (FHLB) as follows:
o A $5,000,000 term fund with a fixed rate of interest at 6.37% which matures in 2010. This note has a convertible option which allows FHLB, after 1 year, to change the note to an adjustable-rate advance at 3 month LIBOR plus 11 points. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
o A $2,500,000 term fund with a fixed rate of interest at 7.03% which matures in 2005. This note has a convertible option which allows FHLB, after 1 year, to change the note to an adjustable- rate advance at 3 month LIBOR plus 11 points. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
o A $5,000,000 term fund with a fixed rate of interest at 6.1% which matures 2010. This note has a convertible option which allows FHLB, after 3 years, to change the note to an adjustable-rate advance at 3 month LIBOR plus 1 point. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 8: (Cont'd)
o A $5,000,000 term fund with a rate of 5.93% which matures in 2005. This note has a convertible option which allows FHLB, after 6 months, to change the note to an adjustable-rate advance at 3 month LIBOR plus 2 points. In that event, the Bank has the option to prepay the loan without penalty. Interest only is payable monthly.
If the Bank prepays any of the above term funds, the prepayment fee applicable to the advance is equal to the present value of the difference between cash flows generated at the advance rate from the date of the prepayment until the original maturity date, and the cash flows that would have resulted from the interest rate posted by the FHLB on the date of prepayment for an advance of comparable maturity.
The notes are secured under terms of a blanket collateral agreement by a pledge of qualifying investment and mortgage backed securities, certain mortgage loans and a lien on FHLB stock.
Note 9: Stock Purchase Plans
A stock option plan covering non-employee directors and a stock incentive plan for all officers and key employees was approved by the shareholders at the annual meeting held on April 25, 1998. The plan will be administered by a committee of the Board of Directors. Under the plan, 125,000 shares of common stock (adjusted for the 5-for-2 stock split on September 15, 1998) are reserved for possible issuance, subject to future adjustment in the event of specified changes in the Company's capital structure. Under the plan, the exercise price cannot be less than 100% of the fair market value on the date of grant. Options granted during 2000, 1999 and 1998 expire in ten years.
A summary of transactions under this plan were as follows:
The following summarizes information about all stock options outstanding at December 31, 2000:
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 9: (Cont'd)
The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for the Option Plan. Accordingly, no compensation expense has been recognized for the Option Plan. Had compensation cost for the Option Plan been determined based on the fair values at the grant dates for awards consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been adjusted to the pro forma amounts indicated below for the year ended December 31, 2000:
For the purposes of the pro forma calculations, the fair value of each option grant is estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants issued in 2000:
During 1999, the Company implemented a Dividend Reinvestment and Stock Purchase plan. Under the plan, the Company registered with the Securities and Exchange Commission 100,000 shares of the common stock to be sold pursuant to the plan. Participation is available to all common stockholders. The Plan provides each participant with a simple and convenient method of purchasing additional common shares without payment of any brokerage commission or other service fees. A participant in the Plan may elect to reinvest dividends on all or part of their shares to acquire additional common stock. A participant may withdraw from the Plan at any time. Stockholders purchased 11,880 and 2,527 shares in 2000 and 1999, respectively, through the Plan.
Note 10: Income Taxes
The components of the provision for income tax are as follows:
The deferred tax assets and liabilities resulting from temporary timing differences have been netted to reflect a net deferred tax asset included in other assets in these consolidated financial statements. The components of the net deferred tax assets at December 31, 2000 and 1999 are as follows:
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 10: (Cont'd)
A reconciliation of the provision for income taxes and the amount that would have been provided at statutory rates for the years ended December 31, are as follows:
Note 11: Pension Plan and Other Employee Benefit Plans
The Bank has an employee stock ownership plan covering substantially all employees. Contributions to the plan are at the discretion of the Board of Directors. Employer contributions are allocated to participant accounts based on their percentage of total compensation for the plan year. Shares of Bank stock owned by the plan are included in the earnings per share calculation and dividends on these shares are deducted from undivided profits. During 2000, 1999, and 1998, contributions to the plan charged to operations were $76,667, $72,442 and $67,931, respectively.
The Bank also maintains a profit sharing plan under the provisions of Section 401 (k) of the Internal Revenue Code. The plan covers substantially all employees who have completed one year of service. Contributions to the plan by the Bank equal 50% of the employee contribution up to a maximum of 6% of annual salary. During 2000, 1999 and 1998, employer contributions to the plan charged to operations were $44,409, $39,071 and $37,499, respectively.
The Bank has an agreement with its chief executive officer to establish an excess benefit retirement plan. The plan is a non-qualified Deferred Compensation Plan in which the Bank is not required to establish a reserve. The Bank has obtained life insurance (designating the Bank as the beneficiary) on the life of the chief executive officer in an amount which is intended to cover the Bank's obligations under the Deferred Compensation Plan, based upon certain actuarial assumptions upon the death of the officer. The cost charged to operations was $-0-, $22,581 and $23,304, for the years ended December 31, 2000, 1999 and 1998, respectively.
In June, 2000, the Bank terminated a noncontributory pension plan covering eligible employees. The plan assets in excess of the projected benefit obligation were allocated to the plan's eligible participants and the prepaid pension cost of $37,490 was charged to expense.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 12: Commitments and Contingencies
Commitments
The Bank is obligated under non-cancelable lease agreements for certain bank premises expiring in September 2028. The leases contain a renewal option and provide that the Bank pay property taxes, insurance and maintenance costs.
The following is a schedule by years of future minimum lease payments required under this non-cancelable lease:
Total rent expense was $17,760, $17,760 and $13,440 for the years ended December 31, 2000, 1999 and 1998, respectively.
Contingencies: -------------
The Company is a defendant in various lawsuits wherein various amounts are claimed. In the opinion of the Company's management, these suits are without merit and should not result in judgments, which in the aggregate, would have a material adverse effect on the Company's consolidated financial statements.
Note 13: Financial Instruments with Off-Balance Sheet Risk and Concentration of Credit Risk
The Bank 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. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. Standby letters of credit commit the Bank to make payments on behalf of customers when certain specified future events occur. Commitments to extend credit are agreements to lend to the customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire in one year or less without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Bank's exposure to credit loss is essentially the same for these items as that involved in extending loans to customers. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments. Collateral is obtained based on management's credit assessment of the particular customer.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 13: (Cont'd)
The contract or notional amounts at December 31, 2000 and 1999 were as follows:
The Bank grants commercial, consumer and residential loans to customers primarily in the Susque- hanna/Wyoming County, PA and Broome County, NY areas. Of the total loan portfolio, 75% is for real estate loans, principally residential. It is the opinion of management that this high concentration does not pose any adverse credit risk. Further, it is management's opinion that the remainder of the loan portfolio is balanced and diversified to the extent necessary to avoid any significant concentration of credit.
Note14: Regulatory Matters
The Company is subject to the dividend restrictions set forth by the Comptroller of the Currency. Under such restrictions, the Company may not, without the prior approval of the Comptroller of the Currency, declare dividends in excess of the sum of the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two years. Under this restriction, the Bank, without prior regulatory approval, can declare dividends to the Company totaling $5,020,000, plus an additional amount equal to the net profit for 2001, up to the date any such dividend is declared.
Under Federal Reserve regulations, the Bank is limited as to the amount it may lend to its affiliates, including the Company, unless such loans are collateralized by specified obligations. At December 31, 2000, the maximum amount available for transfer from the Bank to the Company in the form of loans approximated 20% of capital stock and surplus.
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2000, that the Company and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2000, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank's category.
The Company and Bank's actual capital ratios as of December 31, 2000 and 1999, and the minimum ratios required for capital adequacy purposes and to be well capitalized under the prompt corrective action provisions are as follows:
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 14: (Cont'd)
Note 15: Financial Instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statement of financial condition for cash and cash equivalents approximate those assets fair values.
Investment securities (including trading account securities and mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The carrying amount of accrued interest receivable approximates its fair value.
Deposits: The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value.
Short-term borrowings: The carrying amounts of short-term borrowings approximate their fair values.
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 15: (Cont'd) Long-term borrowings: The fair values of the Bank's long-term debt are estimated using discounted cash flow analyses based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements.
Commitments to extend credit and standby letters of credit: These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented in Note 13.
The estimated fair values of the Company's financial instruments are as follows:
The carrying amounts in the preceding table are included in the balance sheet under the applicable captions.
Note 16: Parent Company
The following is financial information for Peoples Financial Services Corp. (Parent Company only):
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 16: (Cont'd)
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd) DECEMBER 31, 2000, 1999 AND 1998
Note 16: (Cont'd)
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On February 28, 2001, the Board of Directors of the Company approved the engagement of the accounting firm of Beard Miller Company LLP as their independent accountants to replace Prociak & Associates, LLC. Information pertaining to this change can be found in the previously submitted 8-K dated March 7, 2001, and the 8-K/A dated March 12, 2001 and March 16, 2001.
PART III
ITEM 10
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS
This item is incorporated by reference under the previously submitted document DEF 14A filed with the SEC on March 7, 2001.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
This item is incorporated by reference under the previously submitted document DEF 14A filed with the SEC on March 7, 2001.
ITEM 12
ITEM 12 SHARE OWNERSHIP OF MANAGEMENT AND DIRECTORS
This item is incorporated by reference under the previously submitted document DEF 14A filed with the SEC on March 7, 2001.
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is incorporated by reference under the previously submitted document DEF 14A filed with the SEC on March 7, 2001.
PART IV
ITEM 14
ITEM 14 EXHIBITS AND REPORTS ON FORM 8-K
(a) Financial Statement Schedules can be found under Item 8 of this report.
(b) Exhibits required by Item 601 of Regulation S-K that have previously been filed are as follows: (3.1) Articles of Incorporation of Peoples Financial Services Corp. (3.2) By laws of Peoples Financial Service Corp. as amended in the 10-Q filed August 16, 1999 (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. (21) Subsidiaries of Peoples Financial Services Corp. (23) Consent of Independent Auditors
(c) Other events and reports on Form 8-K or 8-K/A that have been previously filed are as follows: Amended submission of 8-K dated March 7, 2001, regarding change in accountants , resubmitted on March 16, 2001 Amended submission of 8-K dated March 7, 2001, regarding change in accountants , resubmitted on March 12, 2001 Letter of Peoples Financial Services Corp. regarding change in accountants dated March 7, 2001, previously submitted as
Exhibit 16 Peoples Financial Services Corp. amended by-laws dated February 9, 2001, previously submitted as Exhibit 99.006 Press Release of Peoples Financial Services Corp. dated January 2, 2001, previously submitted as Exhibit 99.005 Press Release of Peoples Financial Services Corp.dated November 6, 2000, previously submitted as Exhibit 99.004 Press Release of Peoples Financial Services Corp. dated July 18, 2000, previously submitted as Exhibit 99.003 Press Release of Peoples Financial Services Corp. dated May 5, 2000, previously submitted as Exhibit 99.002 Press Release of Peoples Financial Services Corp.dated January 27, 2000, previously submitted as Exhibit 99.001 Press Release of Peoples Financial Services Corp dated October 27, 1999, previously submitted as Exhibit 99.4 Press Release of Peoples Financial Services Corp. dated July 22, 1999, previously submitted as Exhibit 99.3 Press Release of Peoples Financial Services Corp. dated May 5, 1999, previously submitted as Exhibit 99.2 Press Release of Peoples Financial Services Corp. dated April 15, 1999, previously submitted as Exhibit 99.1 Press Release of Peoples Financial Services Corp. dated February 9, 1999, previously submitted as Exhibit 99.1 Press Release of Peoples Financial Services Corp. dated August 28, 1998, previously submitted as Exhibit 99.1
The Corporation filed a Form S-3 on July 30, 1999.
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/ John W. Ord John W. Ord, President and Chief Executive Officer
Debra E. Dissinger Debra E. Dissinger, Executive Vice President
Frederick J. Malloy Frederick J. Malloy, Accounting Officer
Carl F. Pease Carl F. Pease Chairman, Board of Directors
Jack M. Norris Jack M. Norris, Member, Board of Directors
Gerald R. Pennay Gerald R. Pennay, Member, Board of Directors
George H. Stover, Jr. George H. Stover, Jr., Member, Board of Directors
Thomas F. Chamberlain Thomas F. Chamberlain, Member, Board of Directors
Russell Shurtleff Russell Shurtleff, Member, Board of Directors