ITEM 1. BUSINESS
PENNROCK FINANCIAL SERVICES CORP.
PennRock Financial Services Corp. ("PennRock" or the "Registrant") is a Pennsylvania business corporation organized on March 5, 1986. It became a bank holding company when it acquired all of the common stock of Blue Ball National Bank (the "Bank") on August 1, 1986. Effective November 6, 2000, PennRock became a financial holding company as provided by the Gramm-Leach-Bliley Act of 1999.
PennRock is a financial holding company that operates through its bank subsidiary to deliver financial and related services to its customers. PennRock's primary function is to direct the policies and coordinate the financial resources of its bank subsidiary as well as provide various advisory services. PennRock primarily obtains the cash necessary to pay dividends to stockholders from the dividends paid to it by its subsidiary bank.
PennRock is a registered bank holding company under the Bank Holding Company Act of 1956, as amended. It is also subject to regulation by the Federal Reserve Board and by the Pennsylvania Department of Banking.
BLUE BALL NATIONAL BANK
Blue Ball National Bank began operations in 1906. The Bank provides a full range of general commercial and retail banking services to its customers, including several types of checking and savings accounts, certificates of deposit, and commercial, consumer and mortgage loans through 15 full service branches in Lancaster, Berks and Chester Counties in southeastern and south-central Pennsylvania. The Bank also provides personal and corporate trust and agency services to individuals, corporations and others, including trust investment accounts, investment advisory services, mutual funds, estate planning, and management and administration of pension and profit sharing plans.
Commercial lending services provided by the Bank include short and medium term loans, revolving credit loans, letters and lines of credit, real estate mortgage and construction loans and agricultural loans. Consumer lending services include various types of secured and unsecured loans including installment loans, home equity loans and overdraft protection lines of credit. Residential mortgage loans are offered in a wide variety of types including fixed and adjustable-rate loans. The Bank's underwriting guidelines conform to Fannie Mae and Federal Home Loan Mortgage Corporation ("FHLMC") guidelines. The Bank sells most of the conforming fixed-rate residential mortgage loans it originates to either Fannie Mae or FHLMC in the secondary market but retains the servicing. The Bank's business is not considered seasonal.
PENNROCK INSURANCE GROUP, INC.
PennRock Insurance Group, Inc. ("PIGI") is a Pennsylvania corporation formed as a wholly owned subsidiary of Blue Ball National Bank on September 22, 1998. PIGI is an insurance agency organized for the sale of annuities and other types of insurance.
EMPLOYEES
PennRock has no employees. The Bank employed 243 full-time and 64 part-time employees at the end of 2000.
COMPETITION
PennRock originates most of its loans to, and accepts most of its deposits from, residents and businesses located in southeastern and south-central Pennsylvania, primarily Lancaster, Berks and Chester Counties. The financial services industry in PennRock's service area continues to be extremely competitive, both among commercial banks and other financial service providers such as consumer finance companies, thrifts, investment companies, mutual funds and credit unions. Mortgage banking firms, insurance companies, brokerage companies, financial affiliates of commercial companies, and government agencies also provide competition for loans and other financial services.
Some of these competitors are considerably larger and have more resources than PennRock. However, PennRock has made a significant investment in technological resources that allows us to offer a wide variety of products and services and enables us to compete with any size financial institution.
Among the most important factors influencing PennRock's ability to compete successfully for new loans and deposits are interest rates, convenience of office locations, and quality of service. We have attempted to differentiate ourselves from other competitors by emphasizing the local and personalized nature of our services. In an effort to make our community offices more convenient to our existing and potential customers, PennRock has, on average, added one new office per year over the past ten years. We added one office in 2000 and two are scheduled to open in 2001.
PennRock is not dependent upon a single customer or a small number of customers, the loss of which would have a materially adverse effect upon PennRock or its subsidiaries.
SUPERVISION AND REGULATION
General
PennRock is registered as a bank holding company and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Act of 1956, as amended. PennRock has also made an effective election to be treated as a "financial holding company." Financial holding companies are bank holding companies that meet certain minimum capital and other standards and are therefore entitled to engage in financially related activities on an expedited basis; see further discussion below. As a financial holding company, PennRock's activities and those of its bank subsidiary are limited to the business of banking, activities closely related or incidental to banking, and activities that have been determined by statute or the Federal Reserve Board to be financial in nature. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve Board. The Federal Reserve Board has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board, pursuant to such regulations, may require PennRock to stand ready to use its resources to provide adequate capital funds to its bank subsidiary during periods of financial stress or adversity.
The Bank Holding Company Act prohibits PennRock from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of, any bank, or from merging or consolidating with another bank holding company, without prior approval of the Federal Reserve Board. Additionally, the Bank Holding Company Act prohibits PennRock from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non-banking business, unless such business has been determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto or, for financial holding companies, to be financial in nature or incidental thereto.
As a Pennsylvania bank holding company for purposes of the Pennsylvania Banking Code, PennRock is also subject to regulation and examination by the Pennsylvania Department of Banking.
The Bank is a national bank and a member of the Federal Reserve System, and its deposits are insured (up to applicable limits) by the Federal Deposit Insurance Corp oration (the "FDIC"). The Bank is subject to regulation and examination by the Office of the Comptroller of the Currency, and to a much lesser extent, the Federal Reserve Board and the FDIC. The Bank is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. The Community Reinvestment Act requires the Bank to help meet the credit needs of the entire community where the Bank operates, including low and moderate-income neighborhoods. The Bank's rating under the Community Reinvestment Act, assigned by the Comptroller of the Currency pursuant to an examination of the Bank, is important in determining whether the Bank may receive approval for, or utilize certain streamlined procedures in, applications to engage in new activities. Various consumer laws and regulations also affect the operations of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.
Capital Adequacy Guidelines
Bank holding companies are required to comply with the Federal Reserve Board's risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be "Tier 1 capital," consisting principally of common shareholders' equity, less certain intangible assets. The remainder ("Tier 2 capital") may consist of certain preferred stock, a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, and a limited amount of the general loan loss allowance. The risk-based capital guidelines are required to take adequate account of interest rate risk, concentration of credit risk, and risks of nontraditional activities.
In addition to the risk-based capital guidelines, the Federal Reserve Board requires a bank holding company to maintain a leverage ratio of a minimum level of Tier 1 capital (as determined under the risk-based capital guidelines) equal to 3% of average total consolidated assets for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least 1% to 2% above the stated minimum. The Bank is subject to almost identical capital requirements adopted by the Comptroller' s Office.
Prompt Corrective Action Rules
The federal banking agencies have regulations defining the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." The applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a "well-capitalized" institution as "adequately capitalized" or require an "adequately capitalized" or "undercapitalized" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings). PennRock and the Bank each satisfy the criteria to be classified as "well capitalized" within the meaning of applicable regulations.
Regulatory Restrictions on Dividends
The Bank may not, under the National Bank Act, declare a dividend without approval of the Comptroller of the Currency, unless the dividend to be declared by the Bank's Board of Directors does not exceed the total of: (i) the Bank's net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. In addition, the Bank can only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed its bad debts. The Federal Reserve Board, the Comptroller and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks that are not classified as well capitalized or adequately capitalized may not pay dividends.
Under these policies and subject to the restrictions applicable to the Bank, the Bank could declare, during 2001, without prior regulatory approval, aggregate dividends of approximately $9.8 million, plus net profits earned to the date of such dividend declaration.
FDIC Insurance Assessments
The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each depository institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-based assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized group. As of December 31, 2000, the Bank was well capitalized for purposes of calculating insurance assessments.
The Bank Insurance Fund is presently fully funded at more than the minimum amount required by law. Accordingly, the 2001 Bank Insurance Fund assessment rates range from zero for those institutions with the least risk, to $0.27 for every $100 of insured deposits for institutions deemed to have the highest risk. The Bank is in the category of institutions that presently pay nothing for deposit insurance. The FDIC adjusts the rates every six months.
While the Bank presently pays no premiums for deposit insurance, it is subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the Financing Corporation 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 and provided that commercial banks would be subject to 1/5 of the assessment to which thrifts are subject for Financing Corporation bond payments through 1999. Beginning in 2000, commercial banks and thrifts are subject to the same assessment for Financing Corporation bonds. The FDIC sets the Financing Corporation assessment rate every quarter. The Financing Corporation assessment for the Bank (and all other banks) for the first quarter of 2001 is an annual rate of $.0196 for each $100 of deposits.
New Legislation
Landmark legislation in the financial services area was signed into law on November 12, 1999. The Gramm-Leach-Bliley Act dramatically changes certain banking laws that have been in effect since the early part of the 20th century. The most radical changes are that the separation between banking and the securities businesses mandated by the Glass-Steagall Act has now been removed, and the provisions of any state law that prohibits affiliation between banking and insurance entities have been preempted. Accordingly, the new legislation now permits firms engaged in underwriting and dealing in securities, and insurance companies, to own banking entities, and permits bank holding companies (and in some cases, banks) to own securities firms and insurance companies. The provisions of federal law that preclude banking entities from engaging in non-financially related activities, such as manufacturing, have not been changed. For example, a manufacturing company cannot own a bank and become a bank holding company, and a bank holding company cannot own a subsidiary that is not engaged in financial activities, as defined by the regulators.
The new legislation creates a new category of bank holding company called a "financial holding company." In order to avail itself of the expanded financial activities permitted under the new law, a bank holding company must notify the Federal Reserve that it elects to be a financial holding company. A bank holding can make this election if it, and all its bank subsidiaries, are well capitalized, well managed, and have at least a satisfactory Community Reinvestment Act rating, each in accordance with the definitions prescribed by the Federal Reserve and the regulators of the subsidiary banks. Once a bank holding company makes such an election, and provided that the Federal Reserve does not object to such election by such bank holding company, the financial holding company may engage in financial activities (i.e., securities underwriting, insurance underwriting, and certain other activities that are financial in nature as to be determined by the Federal Reserve) by simply giving a notice to the Federal reserve within thirty days after beginning such business or acquiring a company engaged in such business. This makes the regulatory approval process to engage in financial activities much more streamlined than it was under prior law.
The new law also permits certain financial activities to be undertaken by a subsidiary of a national bank. As the Bank is a national bank, some of these provisions apply directly to the Bank. Generally, for financial activities that are conducted as a principal, such as an underwriter or dealer of securities holding an inventory, a national bank must be one of the 100 largest national banks in the United States and have its debt be rated investment grade. Because the Bank is not one of the 100 largest national banks in the United States, it is not authorized under the new law to conduct these financial activities as a principal. However, the Bank may own a securities broker or an insurance agency and certain other financial agency entities under the new law. Under prior law, national banks could only own an insurance agency if it was located in a town of fewer than 5,000 residents, or under certain other conditions. Under the new law, there is no longer any restriction on where the insurance agency subsidiary of a national bank is located or does business.
In addition to the foregoing provisions of the new law that make major changes to the federal banking laws, the new legislation also makes a number of additions and revisions to numerous federal laws that affect the business of banking. For example, there is now a federal law on privacy with respect to customer information held by banks.
The federal banking regulators have adopted rules implementing the new law regarding privacy for customer information. Banks must establish a disclosure policy for non-public customer information, disclose the policy to their customers, and give their customers the opportunity to object to non-public information being disclosed to a third party. Also, the Community Reinvestment Act has been amended by the new law to provide that small banks (those under $250 million in assets) that previously received an "outstanding" on their last CRA exam will not have to undergo another CRA exam for five years, or for four years if their last exam was "satisfactory." In addition, any CRA agreement entered into between a bank and a community group must be disclosed, with both the bank and the group receiving any grants from the bank detailing the amount of funding provided and what it was used for. The new law also requires a bank's policy on fees for transactions at ATM machines by non-customers to be conspicuously posted on the ATM. A number of other provisions affecting other general regulatory requirements for banking institutions were also adopted.
Separately from the Gramm-Leach-Bliley Act, Congress is often considering some financial industry legislation. PennRock cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future.
FOREIGN OPERATIONS
PennRock does not depend on foreign sources for funds, nor does PennRock make foreign loans.
The required Statistical Information for Item 1 can be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Annual Report.
ITEM 2.
ITEM 2. PROPERTIES
PENNROCK FINANCIAL SERVICES CORP.
PennRock's headquarters are located at the main office of Blue Ball National Bank located at 1060 Main Street, Blue Ball, Pennsylvania. PennRock owns no real estate.
BLUE BALL NATIONAL BANK
The principal executive office and main banking office is located in Blue Ball, Pennsylvania. An operations center, also located in Blue Ball, Pennsylvania, accommodates the Bank's data processing, accounting, human resource, and loan and deposit operations departments. These and 12 of the Bank's full service community offices are owned free and clear of any indebtedness. The land on which three of the branch offices are located is leased. The net book value of the Bank's premises and equipment as of December 31, 2000 is $13.4 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Various legal actions or proceedings are pending involving PennRock or its subsidiaries. Management believes that the aggregate liability or loss, if any, will not be material.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 2000.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and positions of all of the executive officers of PennRock as of February 16, 2001, are listed below, along with the positions with PennRock and Blue Ball National Bank held by each of them during the past five years. The Board of Directors elects officers annually.
PENNROCK FINANCIAL SERVICES CORP.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The price of PennRock's common stock ranged from $13.50 to $17.50 in 2000 and from $17.25 to $23.88 in 1999. The book value per share was $12.23 as of December 31, 2000 and $9.97 as of December 31, 1999. The prices listed below represent the high, low and quarter ending prices for stock trades reported during each quarter.
PennRock maintains a Dividend Reinvestment Plan for eligible shareholders who elect to participate in the Plan. A copy of the Prospectus for this Plan may be obtained by writing to:
Glenn H. Weaver, President PennRock Financial Services Corp. P.O. Box 580 Blue Ball, PA 17506
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
In thousands, except per share data
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following section presents management's discussion and analysis of the financial condition and results of operations of PennRock Financial Services Corp., a bank holding company ("PennRock"), its subsidiary, Blue Ball National Bank ("the Bank"), and the Bank's subsidiary, PennRock Insurance Group, Inc. ("PIGI"). This discussion and analysis should be read in conjunction with the financial statements and other financial data presented elsewhere in this Annual Report. The following discussion is intended to focus on certain financial data that might not otherwise be readily apparent.
RESULTS OF OPERATIONS
OVERVIEW
PennRock Financial Services Corp. recorded net income of $9.5 million or $1.60 per share in 2000, a decrease of 10.9% from net income of $10.7 million or $1.79 per share recorded in 1999. Net income was $9.6 million or $1.59 per share in 1998. Return on average assets was 1.09% in 2000, 1.37% in 1999 and 1.39% in 1998. Return on average equity was 14.93% in 2000, 16.39% in 1999 and 14.86% in 1998.
Average earning assets increased $82.1 million or 11.3% during 2000, while average interest bearing liabilities grew $91.9 million or 14.8%. The average yield on earning assets increased from 7.88% in 1999 to 8.29% in 2000, while the average yield on paying liabilities increased from 4.52% in 1999 to 5.19% in 2000. PennRock's net interest income on a fully taxable equivalent basis increased $815,000 or 2.8% during 2000 and $1.0 million or 3.6% in 1999. The net interest margin was 3.71% in 2000, 4.02% in 1999 and 4.36% in 1998.
The provision for loan losses increased from $1.0 million in 1999 to $3.1 million in 2000. The provision for loan losses was $1.2 million in 1998.
Non-interest income from sources other than realized securities gains increased $1.1 million or 24.8% in 2000 compared with an increase of $765,000 or 19.8% in 1999 and an increase of $245,000 or 6.8% in 1998. Fees earned from fiduciary activities and service charges on deposit accounts contributed to these increases. The increase in cash surrender value of Bank Owned Life Insurance ("BOLI") totaling $821, 000 in 2000 and $451,000 in 1999 is included in other non-interest income. There was no income from BOLI in 1998.
Non-interest expenses increased $1.7 million or 9.2% in 2000. Non-interest expenses increased $1.1 million or 6.4% in 1999 and $786,000 or 4.7% in 1998.
NET INTEREST INCOME
Net interest income is the amount by which interest income on loans, investments and other earning assets exceeds interest paid on deposits and other interest bearing liabilities. Net interest income is the primary source of revenue for PennRock. The amount of net interest income is affected by changes in interest rates and the balances of the various types of earning assets and interest bearing liabilities. For comparative purposes, and throughout this discussion unless otherwise noted, net interest income and corresponding yields are shown on a taxable equivalent basis. This adjustment will give effect to the interest earned on tax-exempt loans and investments by an amount equivalent to the federal income taxes, which would have been paid if the income received on these assets were taxable at the statutory rate of 34% for 2000, 1999, and 1998.
Net interest income is the product of the volume of average earning assets and the average rates earned on them, less the volume of average interest bearing liabilities and the average rates paid on them. Table 1 presents average balances, taxable equivalent interest income and expense and rates for PennRock's assets and liabilities.
TABLE 1 - AVERAGE BALANCES, RATES AND INTEREST INCOME AND EXPENSE SUMMARY (Taxable equivalent basis)
(1) Interest income on loans includes fees of $775,000 in 2000, $1,039,000 in 1999 and $961,000 in 1998. Average loan balances exclude non-accrual loans.
(2) Consumer loans outstanding net of unearned income.
Table 2 presents the net interest income on a fully taxable equivalent basis for the years ended December 31, 2000, 1999 and 1998.
TABLE 2 - NET INTEREST INCOME
Net interest income on a fully taxable equivalent basis was $30.1 million in 2000, an increase of $815,000 or 2.8% from the $29.3 million earned in 1999. Taxable equivalent net interest income in 1999 increased $1.0 million or 3.6% from $28.3 million in 1998.
Changes in interest rates as well as changes in average balances (or volumes) of earning assets and paying liabilities have an impact on the amount of net interest income earned and the net interest margins realized by PennRock from year-to-year. By isolating the effect that changes in rates have on net interest income from the effect of changes in volume, we can analyze the degree that each influences the change in net interest income and net interest margins. Table 3 analyzes the changes in the volume and rate components of net interest income. During 2000, net interest income increased $1.8 million due to changes in volume and decreased $958,000 due to changes in interest rates. In 1999, net interest income increased $3.4 million due to changes in volume and decreased by $2.4 million due to changes in interest rates.
TABLE 3 - VOLUME AND RATE ANALYSIS OF CHANGES IN INTEREST INCOME (Taxable equivalent basis)
Another method of analyzing the change in net interest income is to examine the changes between interest rate spread and the net interest margin on earning assets. The interest rate spread as shown in Table 4 is the difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities. The net interest margin takes into account the benefit derived from assets funded by interest free sources such as non-interest bearing demand deposits and capital.
TABLE 4 - INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS
(Taxable equivalent basis)
In thousands
The following discussion analyzes changes in PennRock's spreads and margins in terms of basis points. A basis point is a unit of measure for interest rates equal to .01%. One hundred basis points equal 1%.
Interest rate spreads decreased 26 basis points in 2000 while the net interest margin declined 31 basis points. The yield on earning assets increased 41 basis points but this was more than offset by a 67 basis point increase in the cost of funds. Although the prime rate increased 100 basis points in 2000, loan yields increased only 24 basis points due to continued intense competition for loans in our market area. Fees on loans decreased $264,000 in 2000 from 1999. The yield on securities available for sale increased 62 basis points due in part to the increase in yield of adjustable rate securities purchased in 1999 and to the purchase of higher yielding municipal bonds during 2000. Interest bearing deposit costs increased 62 basis points as the result of various time deposit promotions held during the year in an effort to attract new deposits. A majority of these new deposits mature within the first two months of 2001 and should renew or be replaced by other funds at lower rates. Short-term borrowings costs increased 122 basis points in 2000. Because the Federal Reserve Bank decreased interest rates a total of 100 basis points in January 2001, we expect short-term borrowing costs to be substantially lower in 2001 than in 2000.
Interest rate spreads decreased 23 basis points in 1999 while the net interest margin declined 34 basis points. Both the interest rate spread and margin were negatively impacted by a 40 basis point decline in earning asset yields and helped by a 17 basis point decline in interest bearing liability costs. Loan yields declined 46 basis points despite three separate increases in the prime rate during 1999. The competitive environment for higher quality loans required us to make such loans with rates and related loan fees lower than those realized in prior years. The yield on securities available for sale declined 22 basis points primarily due to the sale of long-term higher yielding municipal bonds and the purchase of lower yielding adjustable rate securities in anticipation of rising interest rates in an attempt to reduce our exposure to interest rate risk. The reduction in liability costs is primarily the result of higher rate certificates of deposit renewing at lower rates during the year.
PROVISION FOR LOAN LOSSES
The amount of provision for loan losses that was charged against earnings was $3.1 million in 2000 compared with $1.0 million in 1999 and $1.2 million in 1998. The amount of the provision is based, among other factors, on the amount of realized net credit losses. Net credit losses totaled $2.6 million in 2000, $409,000 in 1999 and $575,000 in 1998. We review the adequacy of the allowance in light of past loan loss experience, current economic conditions, size and characteristics of the loan portfolio, volume of non-performing and delinquent loans and other relevant information.
The ratio of net charge-offs to average loans decreased from .15% in 1998 to .10% in 1999 but increased to .54% in 2000. Net charge-offs in 2000 totaled 43.81% of the allowance for loan losses compared with 7.42% in 1999 and 11.74% in 1998. Non-performing loans (loans on which we have stopped accruing interest and loans 90 days or more past due which we continue to accrue interest) increased from $2.0 million at the end of 1999 to $4.2 million at the end of 2000. Non-performing loans represented .85% of total loans as of December 31, 2000 and .43% at the end of 1999.
NON-INTEREST INCOME
Total non-interest income increased $1.2 million or 18.8% in 2000 and by $1.1 million or 21.1% in 1999. Excluding net security gains, non-interest income increased $1.1 million or 24.8% in 2000 compared with a $765,000 or 19.8% increase in 1999. Table 5 indicates changes in the major categories of non-interest income.
TABLE 5 - NON-INTEREST INCOME
Net security gains totaled $1.5 million in 2000, $1.5 million in 1999 and $1.2 million in 1998. Securities gains and losses in all three years were attributable to sales of PennRock's equity portfolio and to the sale of other securities for the purpose of adding liquidity, to control interest rate risk and reflect the Bank's active management of the available for sale security portfolio. We continuously monitor PennRock's interest rate sensitivity position and periodically restructure the security portfolio as conditions warrant such as expected changes in liquidity or projected movements in future interest rates. PennRock maintains and actively manages a portfolio of equity securities. Net equity gains totaled $586,000 in 2000, $505,000 in 1999 and $598,000 in 1998.
Fiduciary fees increased $201,000 or 16.7% in 2000 and by $243,000 or 25.4% in 1999. Assets under trust management were $271 million at the end of 2000, an increase of $10 million or 3.8% over assets of $261 million at the end of 1999. Trust assets increased $37 million or 16.5% in 1999.
Other non-interest income increased $733,000 or 56.2% in 2000 and by $755,000 or 137.5% in 1999. In May 1999, the Bank purchased $15 million of Bank Owned Life Insurance ("BOLI"). The increase in the cash surrender value of the BOLI is included in other non-interest income and totaled $821,000 in 2000 and $451,000 in 1999.
NON-INTEREST EXPENSE
Total non-interest expense for 2000 increased $1.7 million or 9.2% compared with a $1.1 million or 6.4% increase in 1999. Salaries and employee benefits increased $950,000 or 8.5% in 2000 and $1.2 million or 12.2% in 1999. Total full-time equivalent employees increased from 255 at year-end 1998 to 271 at the end of 1999 and to 276 in 2000. The ratio of average assets (in millions) per employee was $2.71 in 1998, $2.88 in 1999 and $3.17 in 2000. The average salary expense per employee was $31,000 in 1998 and 1999 and $34,000 in 2000.
Expenses related to occupancy, real estate depreciation and maintenance increased $102,000 or 7.9% in 2000 and decreased by $1,000 or .1% in 1999. Expenses relating to equipment, depreciation and service increased by $44,000 in 2000 and declined by $63,000 in 1999.
Other non-interest expenses decreased $618,000 or 12.5% in 2000 and decreased $35,000 or .7% in 1999. Table 6 summarizes the changes in the major categories of non-interest expense.
TABLE 6 - NON-INTEREST EXPENSE
PROVISION FOR INCOME TAXES
Income tax expense totaled $1.6 million in 2000, $2.5 million in 1999 and $2.0 million in 1998. The statutory federal tax rate was 34% each year. PennRock's effective tax rate was 14.2% in 2000 compared to 18.9% in 1999 and 17.1% in 1998. The primary reason for the change in the effective tax rate is due to the change in tax-exempt income. For a more comprehensive analysis of income tax expense, refer to Note 11 of the Notes to Consolidated Financial Statements.
PennRock accounts for income taxes on the liability method. Under the liability method, a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in PennRock's income tax returns. The deferred tax provision for the year is equal to the net change in the deferred tax asset and liability accounts from the beginning to the end of the year. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
FINANCIAL CONDITION
SOURCES AND USES OF FUNDS
Table 7 examines PennRock's financial condition in terms of its sources and uses of funds. Average funding uses increased $82.0 million or 11.3% in 2000 compared with an increase of $80.0 million or 12.3% in 1999.
TABLE 7 - SOURCES AND USES OF FUNDS
SECURITIES AND SHORT-TERM INVESTMENTS
Table 8 indicates the composition and maturity of the securities available for sale ("AFS") portfolio as of December 31, 2000. Included in the portfolio are callable agencies, state and municipal securities, mortgage-backed securities (including adjustable rate mortgage-backed securities) and CMOs that may be called, prepaid or reprice before final maturity. For mortgage-backed securities, maturity is based on average lives rather than contractual maturity. The average life to call or repricing of the portfolio was 3.2 years as of December 31, 2000 and 5.2 years as of December 31, 1999.
TABLE 8 - ANALYSIS OF SECURITIES AVAILABLE FOR SALE
Measured on an amortized cost basis, securities increased $1.9 million or .6% in 2000 and increased $55.8 million or 20.7% during 1999. As of December 31, 2000, securities available for sale at fair value totaled $323.6 million compared with $309.5 million at the end of 1999. During 2000, PennRock sold $90.4 million and purchased $100.9 million in available for sale securities. During 1999, PennRock sold $79.6 million in securities and purchased $173.6 million. In addition, $11.1 million in 2000 and $40.5 million in 1999 was received from securities that matured or were called and from principal repayments of mortgage-backed securities.
As of December 31, 2000, the AFS portfolio had a net unrealized loss of $3.9 million consisting of gross unrealized gains of $2.4 million and gross unrealized losses of $6.3 million. As of December 31, 1999, the AFS portfolio had a net unrealized loss of $16.1 million consisting of gross unrealized gains of $1.4 million and gross unrealized losses of $17.5 million.
As of December 31, 2000, PennRock had $33.1 million invested in mortgage-backed pass-through securities and CMOs compared with $35.3 million as of December 31, 1999. A mortgage-backed pass-through security depends on an underlying pool of mortgage loans to provide a cash flow pass-through of principal and interest. PennRock had $23.6 million in mortgage-backed pass-through securities as of December 31, 2000 of which $4.7 million were adjustable rate and $18.8 million were fixed rate securities. A CMO is a mortgage-backed security that is comprised of classes of bonds created by prioritizing the cash flows from the underlying mortgage pool in order to meet different objectives of investors. PennRock had $9.6 million in CMO securities at the end of 2000 of which $4.4 million were adjustable rate and $5.2 million were fixed rate. None of the CMOs in the portfolio was considered "high risk CMOs" as defined by banking regulations. All CMOs and mortgage-backed pass-through securities were issued by Federal agencies.
During 2000 and 1999, there were no investments in securities of any single, non-federal issues in excess of 10% of stockholders' equity.
LOANS
Table 9 presents loans outstanding, by type of loan, for the past five years. Loans increased from year-end 1999 to year-end 2000 by $40.0 million or 8.7%, compared with a $53.2 million or 13.1% increase from year-end 1998 to year-end 1999. The largest area of growth in 2000 was in commercial, financial and agricultural loans, which grew $39.8 million or 14.7%. PennRock sold $23.4 million in conforming residential mortgage loans in 2000 and $37.5 million in 1999.
TABLE 9 - LOANS OUTSTANDING, NET OF UNEARNED INCOME
TABLE 10 - LOAN MATURITIES AND INTEREST SENSITIVITY (1)
(1) Excludes residential mortgages and consumer loans.
NON-PERFORMING ASSETS
Table 11 shows PennRock's non-performing loans for the five years ended December 31, 2000. PennRock's policy is to discontinue the accrual of interest on loans for which the principal or interest is past due 90 days or more unless the loan is well-secured and corrective action has begun or the loan is in the process of collection. When a loan is placed on non-accrual status, any unpaid interest is charged against income.
TABLE 11 - NON-PERFORMING ASSETS
As of December 31, 2000, PennRock did not have any loan concentrations exceeding 10% of total loans to any particular economic group or industry. The loan portfolio is well diversified as to industry and companies within each industry which helps minimize risk. Loan quality is maintained through diversification of risk, strict credit
control practices and continued monitoring of the loan portfolio. As of December 31, 2000, PennRock did not have any loans outstanding to any foreign entity or government.
As of December 31, 2000, real estate acquired in foreclosure known as "other real estate owned" ("OREO") totaled $188,000 and was included in other assets on the Consolidated Balance Sheets. As of December 31, 1999, OREO totaled $162,000. Valuation reserves are established for OREO properties whenever estimated current realizable values fall below the original fair value recorded.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses (Table 12) is based on Management's evaluation of historical and anticipated loan loss expense, analysis of non-performing and delinquent loans, prevailing and anticipated economic conditions, and banking industry standards. The allowance is established at a level considered by Management to be adequate to absorb credit losses inherent in the portfolio as of the balance sheet date and is monitored on a continuous basis with independent formal loan reviews conducted on a semiannual basis. Provisions for loan losses charged to operating expense increase the allowance while net charge-offs of loans decrease the allowance.
TABLE 12 - ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses totaled $5.9 million as of December 31, 2000, an increase of 8.3% from 1999. The allowance for loan losses as a percentage of year-end loans was 1.19% as of December 31, 2000 and 1.20% as of December 31, 1999. The provision for loan losses exceeded net charge-offs by $459,000 in 2000, by $617,000 in 1999 and by $650,000 in 1998. The allowance for loan losses as a percentage of non-performing loans was 140.7% as of December 31, 2000 and 280.3% as of December 31, 1999.
Total loans charged-off decreased from $679,000 in 1998 to $493,000 in 1999 and increased to $2.8 million in 2000. The increase in 2000 was due to a large charge-off on one commercial loan customer who declared bankruptcy in 2000. Several courses of corrective action are being pursued currently to resolve this situation. Recoveries of loans previously charged-off decreased from $104,000 in 1998 to $84,000 in 1999 and increased to $223,000 in 2000. The ratio of net charge-offs to average loans was .15% in 1998, decreased to .10% in 1999 and increased to .54% in 2000.
Table 13 presents the allocation of the allowance for loan losses by major loan category for the past five years. The specific allocations in any particular category may prove to be excessive or inadequate to absorb actual future charge-offs so balances may be reallocated in the future to reflect changing conditions. Accordingly, the entire allowance is considered available to absorb losses in any category.
TABLE 13 - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
As of December 31, 2000, PennRock's recorded investment in loans considered to be impaired under Statement of Financial Accounting Standards No. 114 was $3.8 million of which $3.7 million was on non-accrual status. Included in this amount is $2.6 million of impaired loans for which the related allowance is $830,000 and $1.2 million for which there is no related allowance. The average recorded investment in impaired loans for 2000 was $2.7 million and the interest recognized for the year was $111,000.
As of December 31, 1999, PennRock's recorded investment in impaired loans was $1.6 million of which $1.1 million was on non-accrual status. Included in this amount is $628,000 of impaired loans for which the related allowance is $328,000 and $970,000 for which there is no related allowance. The average recorded investment in impaired loans for 1999 was $1.2 million and the interest recognized for the year was $98,000.
LIQUIDITY
The purpose of liquidity management is to ensure that there are sufficient cash flows available to meet a variety of needs. These include financial commitments such as satisfying the credit needs of our borrowers and withdrawals by our depositors, the ability to capitalize on investment and business opportunities as they occur, and the funding of PennRock's own operations. Liquidity is measured by PennRock's ability to convert assets to cash at a reasonable cost or a minimum loss. Maturities and sales of investment securities (Table 8), loan payments and maturities (Table 10), and liquidating money market investments such as federal funds sold all provide liquidity. In addition, PennRock is a member of the Federal Home Loan Bank of Pittsburgh which provides a reliable source of long and short-term funds. However, PennRock's primary source of liquidity lies in our ability to renew, replace and expand its base of core deposits (consisting of demand, NOW, money market and cash management accounts, savings accounts, certificates of deposit, and other time deposits less than $100,000).
Total deposits increased $51.6 million or 8.2% in 2000 compared with $81.4 million or 14.8% in 1999. Table 14 reflects the changes in the major classifications of deposits by comparing the year-end balances for the past five years. Table 15 reflects the maturity of large dollar deposits.
TABLE 14 - DEPOSITS BY MAJOR CLASSIFICATION
TABLE 15 - MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
In thousands December 31, ----------------------------------- 2000 1999 1998 ------- ------- ------- Three months or less $28,208 $19,228 $12,848 Over three months through six months 11,416 9,786 14,151 Over six months through twelve months 13,809 9,374 8,020 Over twelve months 3,646 8,628 2,201 ------- ------- ------- Total $57,079 $47,016 $37,220 ======= ======= =======
The Bank maintains lines of credit with various correspondent banks to use as sources of short-term funds in addition to repurchase agreements with bank customers. Federal funds purchased and securities sold under agreements to repurchase decreased slightly from $51.7 million as of December 31, 1999 to $51.6 million as of December 31, 2000. Of the securities sold under agreements to repurchase, $21.5 million at year-end 2000 were agreements with bank customers compared with $8.1 million at year-end 1999, while $30.0 million and $40.0 million were outstanding at the Federal Home Loan Bank of Pittsburgh ("the FHLB") as of 2000 and 1999. The Bank also maintains a line of credit with the FHLB. There were no line advances outstanding as of December 31, 2000 or 1999. The level of short-term borrowings depends on loan growth, deposit growth, current market rates and other factors. The average cost of short-term borrowings decreased from 5.37% in 1998 to 4.86% in 1999 and increased to 6.08% in 2000. Table 16 shows PennRock's short-term borrowings for the five years ended December 31, 2000.
TABLE 16 - SHORT-TERM BORROWINGS
CAPITAL RESOURCES
On June 27, 2000, PennRock announced that the Board of Directors had authorized the purchase of up to 200,000 shares of PennRock's outstanding common stock. The shares are to be used for general corporate purposes including stock dividends and stock splits, executive compensation plans or for issuance under the dividend reinvestment plan. PennRock began open market repurchases of its outstanding common stock in 1995. In 2000, PennRock purchased 94,857 shares for $1.6 million and reissued 91,151 shares. In 1999, PennRock purchased 130,710 shares for $2.9 million and reissued 65,317 shares. PennRock purchased 112,665 shares for $2.7 million
and reissued 52,850 shares in 1998. There were 139,553 shares with a cost of $2.8 million as of December 31, 2000 and 135,847 shares with a cost of $3.1 million as of December 31, 1999 held as treasury stock.
Total stockholders' equity increased $13.4 million or 22.6% in 2000 compared with a decrease of $7.7 million or 11.5% in 1999. In 2000, stockholders' equity increased by net income of $9.5 million less dividends of $4.2 million. The change in net unrealized gains and losses on securities available for sale increased equity by $8.0 million. In 1999, stockholders' equity increased by net income of $10.7 million less dividends of $3.7 million. The change in net unrealized gains and losses on securities available for sale decreased equity by $13.2 million. The increase in 1998 was due to net income of $9.6 million less dividends of $3.6 million and by the change in net unrealized loss on securities available for sale which caused equity to increase by $1.1 million. The ratio of average equity to average assets was 7.30% in 2000, compared with 8.38% for 1999 and 9.38% in 1998. The ratio of average equity to average assets excluding the SFAS 115 adjustment was 8.38% in 2000, 8.12% in 1999 and 9.11% in 1998. Internal capital generation is calculated by multiplying return on average equity by the percentage of earnings retained. Internal capital generation amounted to 8.41% in 2000, 10.73% in 1999 and 9.26% in 1998.
Bank and bank holding company minimum regulatory capital requirements have been revised to make regulatory capital more sensitive to individual differences in credit risk profiles (including off-balance-sheet risks). Risk based capital is segregated into two components, tier 1 capital and tier 2 capital. Tier 1 capital includes stockholders' equity reduced by certain intangibles and excludes net unrealized holding gains and losses on AFS securities. Net unrealized losses on marketable equity securities will continue to be deducted from Tier 1 capital. Tier 2 capital includes the allowance for loan losses (subject to limitations) and qualifying debt obligations. The minimum leverage capital requirement is 3% and is determined by dividing Tier 1 capital by average assets. Banking organizations must adjust their assets and off-balance sheet exposures by assigning risk-weighted percentages depending on regulatory defined credit risks. Off-balance-sheet assets must be converted to credit equivalents before being risk weighted. These balances are then added to determine total risk weighted assets.
As of December 31, 2000, the most recent notification from the Federal Reserve Bank categorized PennRock as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, PennRock must maintain minimum total risk-based capital of 10%, Tier 1 risk-based capital of 6% and Tier 1 leverage ratios of 5%. There are no conditions or events since that notification that management believes have changed this category. Table 17 shows PennRock's and the Bank's capital resources for the past three years.
TABLE 17 - CAPITAL RESOURCES
INTEREST RATE RISK
Information regarding interest rate risk may be found in Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PennRock's financial performance is impacted by, among other factors, interest rate risk and credit risk. We manage credit risk by relying on strict credit standards, loan review and adequate loan loss reserves. Interest rate risk refers to PennRock's degree of exposure to loss of earnings resulting from changes in market interest rates. The magnitude of this exposure depends on the severity and timing of the market rate changes and on our ability to adjust. PennRock's Asset Liability Management Committee ("the ALCO") addresses this risk. The senior management team comprises the ALCO. The ALCO monitors interest rate risk by modeling the estimated net interest income and net income under various interest rate scenarios. The ALCO attempts to manage the various components of PennRock's balance sheet to minimize the impact of sudden and sustained changes in interest rates on net interest income and net income. However, the ALCO may sometimes structure the balance sheet to take advantage of expected interest rate movements.
PennRock's exposure to interest rate risk is reviewed on a monthly basis by the Board of Directors and the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine PennRock's change in net interest income and net income in the event of hypothetical changes in interest rates. If the potential changes to net interest income and net income resulting from hypothetical interest rate swings are not within the limits established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board-approved limits.
The mismatch of maturities of assets and liabilities within a specific time frame is referred to as a rate sensitivity gap. If more assets than liabilities mature or reprice within the time frame, PennRock is asset sensitive. If more liabilities mature or reprice, PennRock is liability sensitive. An asset sensitive gap will generally benefit PennRock in a period of rising rates while a liability sensitive gap will generally benefit PennRock during declining rates. Gap analysis has certain limitations. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Some types of financial instruments are very sensitive to changes in market rates while others may lag behind such changes. Certain assets such as adjustable-rate loans have limits on the amount of change in interest rates in the short-term and over the life of the loan. Further, changes in interest rates may change the characteristics of certain financial instruments and cause them to react differently than expected. For example, a decrease in market rates could trigger mortgage customers to refinance their mortgages while an increase in market rates may induce customers to redeem their certificates of deposit prior to maturity. These and other changes would likely cause actual results to deviate significantly from the assumptions used in calculating changes in net interest income or net income. While ALCO continuously monitors and adjusts the gap position to maximize profitability, the primary objective is to maintain net interest income and net income within self-imposed parameters for a wide range of possible changes in interest rates. The following table presents an interest sensitivity analysis of PennRock's assets and liabilities as of December 31, 2000. All interest rates are on a tax equivalent basis.
TABLE 18 - INTEREST SENSITIVITY ANALYSIS
(1) Assumes NOW account balances are withdrawn at 5% per year based on prior experience. (2) Assumes passbook and statement savings balances are withdrawn at 5% per year.
While the preceding table helps provide some information about PennRock's interest sensitivity, it does not predict the trends of future earnings. For this reason, we use financial modeling to forecast earnings under different interest rate projections. PennRock's Board of Directors has adopted an interest rate risk policy which establishes maximum decrease in the net interest income and net income in the event of a sudden and sustained increase or decrease in market interest rates of 200 basis points. The following tables present PennRock's projected change in net interest income and net income for 100 and 200 basis point rate shocks as of December 31, 2000 and the Board's established limit. The impact on net interest income and net income relate to the Bank only. The assets and liabilities at the parent company level are not considered in this analysis and its corresponding earnings at risk do not have a significant effect on this analysis.
TABLE 19 - CHANGES IN NET INTEREST INCOME
TABLE 20 - CHANGES IN NET INCOME
The preceding tables indicate that as of December 31, 2000, in the event of a sudden and sustained increase and decrease in prevailing market interest rates, both PennRock's net interest income and net income would be expected to decrease. While this seems contrary to what we would expect given PennRock's gap position in Table 18, this decline occurs due to the impact of various options contained in earning assets which we project would be exercised in the event of a decrease in interest rates and options contained in paying liabilities which would be exercised if rates would rise. At December 31, 2000, PennRock's estimated change in net interest income and net income is within target limits.
Computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions. These include loan and MBS prepayment rates, calls of callable securities, conversions of fixed-rate FHLB advances to adjustable advances, and rates of deposit decay, and should not be relied upon as indicative of actual future results. Even minor changes in these assumptions may significantly alter the results of the model. Further, the computations do not contemplate any actions the ALCO could take to mitigate any negative effects of changes in interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements are set forth in this Annual Report of Form 10-K on the following pages:
PennRock Financial Services Corp. and Subsidiaries
Independent Auditors' Report....................................31 Consolidated Balance Sheets.....................................32 Consolidated Statements of Income...............................33 Consolidated Statements of Stockholders' Equity.................34 Consolidated Statements of Cash Flows...........................35 Notes to Consolidated Financial Statements......................36
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders of PennRock Financial Services Corp.
We have audited the accompanying consolidated balance sheets of PennRock Financial Services Corp. and Subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of PennRock's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial position of PennRock Financial Services Corp. and Subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America.
/s/ SIMON LEVER & COMPANY
February 2, 2001 Lancaster, Pennsylvania
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See notes to consolidated financial statements.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
See notes to consolidated financial statements.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting policies of PennRock Financial Services Corp. and its subsidiaries.
BUSINESS:
PennRock Financial Services Corp. ("PennRock" or the "Company") is a financial holding company incorporated under the laws of Pennsylvania in 1986. Blue Ball National Bank (the "Bank"), a wholly owned subsidiary of PennRock, provides a broad range of banking, trust and other financial services to consumers, small businesses and corporations in south-central and southeastern Pennsylvania. PennRock Insurance Group, Inc. ("PIGI"), a wholly owned subsidiary of the Bank, was organized in 1998 to sell annuities and other types of insurance products. PIGI began operations in the first quarter of 1999.
BASIS OF PRESENTATION:
The consolidated financial statements of PennRock include the accounts of PennRock and its subsidiaries. All significant intercompany balances and transactions have been eliminated.
The accounting and reporting policies of PennRock and its subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.
CASH EQUIVALENTS:
For purposes of the Consolidated Statements of Cash Flows, PennRock defines cash equivalents to include amounts due from banks, federal funds sold and other short-term investments. Generally, federal funds are purchased and sold for one-day periods.
MORTGAGES HELD FOR SALE:
Mortgages held for sale are carried at the lower of aggregate cost or market value with market determined on the basis of open commitments for committed loans. For uncommitted loans, market is determined on the basis of current delivery prices in the secondary mortgage market. Any resulting unrealized losses are included in other income.
SECURITIES:
Securities are classified at the time of purchase, based on management's intention, in one of three categories and are accounted for as follows:
INVESTMENT SECURITIES:
Debt securities are classified as investments if management has both the positive intent and ability to hold these securities to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives.
SECURITIES AVAILABLE FOR SALE:
Debt securities are classified as available for sale if management intends to hold these securities for an indefinite period of time but not necessarily to maturity. All equity securities are classified as available for sale. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in maturity mix of PennRock'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, net of the related deferred tax effect, are reported as other comprehensive income in stockholders' equity.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
TRADING SECURITIES:
Trading securities, which are generally held for the short term, usually less than 30 days, in anticipation of market gains, are carried at fair value. Realized and unrealized gains and losses on trading account assets are included in interest income on trading account securities.
A decline in the market value of any investment or available for sale security below cost that is deemed to be other than temporary is charged to income resulting in the establishment of a new cost basis for the security.
Purchase premiums and discounts on securities are amortized and accreted to interest income using a method, which approximates a level yield over the period to maturity of the related securities. Purchase premiums and discounts on mortgage-backed securities are amortized and accreted to interest income using a method which approximates a level yield over the remaining lives of the securities, taking into consideration assumed prepayment patterns. Interest and dividend income are recognized when earned. Realized gains and losses for securities are included in income and are derived using the specific identification method for determining the costs of securities sold.
LOANS:
Loans are carried at the principal amount outstanding, net of unearned income reduced by any charge-offs or specific valuation accounts. Interest income is accounted for on an accrual basis. Loan fees, net of certain origination costs are deferred and amortized over the lives of the underlying loans using a method, which approximates a level yield. Interest income is generally not accrued when, in the opinion of management, its full collectibility is doubtful or when the loan becomes past due 90 days as to principal or interest. When a loan is designated as non-accrual, any accrued interest receivable is charged against current earnings.
A loan is considered to be impaired when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. In such cases, the amount of impairment and any subsequent changes are recorded as an adjustment to the allowance for loan losses. This analysis applies to all loans, both collateralized and uncollateralized, except for large groups of smaller balance homogeneous loans that are collectively evaluated for impairment, loans held for sale and debt securities. PennRock evaluates a loan for impairment when the loan is internally classified as substandard or doubtful. All non-accrual loans not meeting the definition of smaller balance homogeneous loans are considered impaired. PennRock generally measures impairment based upon the present value of the loan's expected future cash flows, except where foreclosure or liquidation is probable or when the primary source of repayment is provided by real estate collateral. In these circumstances, impairment is based upon the fair value of the collateral. Impairment with regard to substantially all of PennRock's impaired loans has been measured by the fair value of the underlying collateral.
ALLOWANCE FOR LOAN LOSSES:
The allowance for loan losses is maintained at a level believed adequate by Management to absorb losses inherent in the loan portfolio as of the balance sheet date. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current domestic economic conditions, volume, growth and composition of the loan portfolio, 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. The allowance for loan losses on impaired loans is one component of the methodology for determining the allowance for loan losses. Other components of the allowance for loan losses include estimated losses on specific commercial, consumer and real estate loans and general amounts based on historical loss experience. Loan losses are charged directly against the allowance for loan losses, and recoveries on previously charged off loans are added to the allowance. Provisions for loan losses charged against income increase the allowance.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
OTHER REAL ESTATE OWNED:
Other real estate owned represents properties acquired through customers' loan defaults. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized as a loss and charged to the allowance for loan losses. After foreclosure, other real estate is reported at the lower of fair value at acquisition date or fair value less estimated disposal costs. Fair value is determined on the basis of current appraisals obtained from independent sources. Subsequent write-downs are charged to an allowance for other real estate established through provisions for other real estate expenses. Costs of improvements to other real estate are capitalized while costs associated with holding other real estate are charged to operations. Other real estate owned is recorded as other assets in the Consolidated Balance Sheets.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on straight line and accelerated methods based on the estimated useful life of the assets. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income for the period. Maintenance, repairs, and minor improvements are expensed as incurred. Significant renewals and betterments are capitalized.
MORTGAGE SERVICING RIGHTS:
Mortgage loan servicing rights ("MSRs") are capitalized when acquired either through the purchase or origination of mortgage loans that are subsequently sold with servicing rights retained. PennRock recognizes MSRs retained for loans sold by allocating total costs incurred between the loan and the servicing rights based on their relative fair values.
MSRs are periodically evaluated for impairment based on the fair value of these rights. The fair value of MSRs is determined by discounting the estimated future cash flows using a discount rate commensurate with the risks involved. This method of valuation incorporates assumptions that market participants would use in estimating future servicing income and expense, including assumptions about prepayment, default, and interest rates. For purposes of measuring impairment, the loans underlying the MSRs are stratified by type (conventional fixed-rate, conventional adjustable-rate). Impairment is measured by the amount the book value of the MSRs exceeds the fair value of the MSRs. Impairment, if any, is recognized through a valuation allowance and a charge to current operations. The recovery of any previously established impairment reserve is recognized as income in current operations.
MSRs, net of valuation allowances, are amortized in proportion to, and over the period of, the estimated net servicing revenue of the underlying mortgages, which are secured by single family properties. Servicing fee revenue represents fees earned for servicing single family loans for investors and related ancillary income, including late charges. Servicing fee revenue is recognized as earned, unless collection is doubtful. The amortization expense is deducted from the related servicing fee revenue in the Consolidated Statements of Income. The amortization of MSRs is periodically evaluated and adjusted, if necessary, to reflect changes in prepayment rates or other related factors.
DEPOSIT PREMIUM:
The deposit premium is the excess of the value of deposit liabilities over cash received for the assumption of those liabilities for branch offices acquired through business combinations that are recorded using the purchase method of accounting. Included in other assets are $408,000 and $509,000 of deposit premiums as of December 31, 2000 and 1999, respectively. This premium is being amortized using the straight-line method over 10 years.
LONG-LIVED ASSETS:
PennRock evaluates long-lived assets and certain intangibles to be held and used for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. When required, impairment losses on assets to be held and used are recognized based on the fair-value of the asset and long-lived assets to be disposed of are reported at the lower of carrying amount or fair-value less cost to sell.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
TRUST ASSETS:
Assets held by the Bank in a fiduciary or agency capacity are not included in the consolidated financial statements since such assets are not assets of the Bank. In accordance with banking industry practice, income from fiduciary activities is generally recognized on a cash basis which is not significantly different from amounts that would have been recognized on the accrual basis.
FEDERAL INCOME TAXES:
Income taxes are accounted for under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the change is enacted.
TREASURY STOCK:
The purchase of Company's treasury stock is recorded at cost. At the date of subsequent reissue, the treasury stock account is reduced by the cost of such stock on a first-in, first-out method.
PROFIT SHARING PLAN:
Profit sharing contributions are calculated by a formula approved by the Board of Directors and are based on the Bank's return on equity. Costs are funded as accrued.
ADVERTISING:
PennRock expenses advertising costs as incurred. Advertising expenses for 2000, 1999 and 1998 were $694,000, $473,000 and $406,000.
STOCK-BASED COMPENSATION:
PennRock accounts for its stock options and stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Based Compensation." Under this method, no compensation expense is recognized for stock options when the exercise price equals fair value at the date of grant. Under the provisions of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," the fair value of a stock option is recognized as compensation expense over the service period (generally the vesting period). Since we have chosen to continue to account for stock options and stock-based compensation plans in accordance with APB 25, we must provide pro forma net income and earnings per share information as if the fair value approach of SFAS 123 had been adopted.
NET INCOME PER SHARE:
Basic earnings per share ("EPS") is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are computed using the treasury stock method.
SEGMENT DISCLOSURE:
Management measures the performance and allocates the resources of PennRock as a single segment.
MORTGAGE BANKING ACTIVITIES:
Fees for servicing loans for investors are based on the outstanding principal balance on the loans serviced. Fees are recognized as earned and are included in the Consolidated Statements of Income under other income.
NOTE 2: RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain average balances of reserves on deposit with the Federal Reserve Bank based on deposits outstanding. The amount of those required reserves as of December 31, 2000 was approximately $5.4 million. Balances maintained at the Federal Reserve Bank are included in cash and due from banks.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3: SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities available for sale are as follows:
The amortized cost and fair value of debt securities as of December 31, 2000, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call obligations and mortgages underlying the mortgage-backed securities and collateralized mortgage obligations may be prepaid without any penalties.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Gains and losses from sales of securities available for sale are as follows:
In thousands
2000 1999 1998 ------- ------- ------- Debt securities Gross gains $ 708 $ 1,144 $ 781 Gross losses (13) (112) (149) ------- ------- ------- Total debt securities 695 1,032 632 Equity securities, net 852 505 598 ------- ------- ------- Total securities gains $ 1,547 $ 1,537 $ 1,230 ======= ======= =======
Proceeds from sales of securities available for sale are as follows:
In thousands
2000 1999 1998 ------- ------- ------- Debt securities $62,942 $75,071 $78,574 Equity securities 27,431 4,577 4,875 ------- ------- ------- Total proceeds $90,373 $79,648 $83,449 ======= ======= =======
Securities with a carrying value of $130.0 million and $117.3 million as of December 31, 2000 and 1999 were pledged to secure public and trust deposits, repurchase agreements as well as other purposes.
NOTE 4: LOANS
The loan portfolio, net of unearned income and deferred loan fees, as of December 31, 2000 and 1999 is as follows:
In thousands
2000 1999 -------- -------- Commercial, financial and agricultural: Commercial, secured by real estate $223,722 $200,633 Agricultural 6,589 7,408 Other 80,497 62,964 Real estate - construction 22,745 26,669 Real estate - mortgage 151,709 146,500 Consumer 15,878 17,005 -------- -------- Total loans $501,140 $461,179 ======== ========
In the ordinary course of business, the Bank has loan, deposit, and other transactions with its directors, their affiliated companies, executive management and their associates (as defined), collectively referred to as related parties. Such transactions are on substantially the same terms, including interest rates and collateral (with regard to loans), as those prevailing at the time for comparable transactions with others. Activity for the related party loans for the year ended December 31, 2000, was as follows:
In thousands
Balance, January 1, 2000 $ 14,774 New loans 8,662 Repayments (12,120) -------- Balance, December 31, 2000 $ 11,316 ========
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Included in the loan portfolio are loans on which the Bank has ceased the accrual of interest. Such loans amounted to $3.7 million and $1.1 million as of December 31, 2000 and 1999. If interest income had been recorded on all non-accrual loans outstanding during the years 2000, 1999 and 1998, interest income would have been increased as shown in the following table:
In thousands
2000 1999 1998 ---- ---- ---- Interest which would have been recorded under original terms $527 $226 $26 Interest income recorded during the year 31 8 0 ---- ---- ---
Net impact on interest income $496 $218 $26 ==== ==== ===
As of December 31, 2000, PennRock's recorded investment in loans considered to be impaired under Statement of Financial Accounting Standards No. 114 ("SFAS 114") was $3.8 million of which $3.7 million was on non-accrual status. Included in this amount is $2.6 million of impaired loans for which the related allowance is $830,000 and $1.2 million for which there is no related allowance. The average recorded investment in impaired loans for 2000 was $2.7 million and the interest recognized for the year was $111,000.
As of December 31, 1999, PennRock's recorded investment in loans considered to be impaired under Statement of Financial Accounting Standards No. 114 ("SFAS 114") was $1.6 million of which $1.1 million was on non-accrual status. Included in this amount is $628,000 of impaired loans for which the related allowance is $328,000 and $970,000 for which there is no related allowance. The average recorded investment in impaired loans for 1999 was $1.2 million and the interest recognized for the year was $98,000.
NOTE 5: LOAN SERVICING
Mortgage loans serviced for Fannie Mae and Federal Home Loan Mortgage Corporation are not included in the accompanying Consolidated Balance Sheets. The unpaid principal balances of those loans were $167.5 million as of December 31, 2000 and $170.8 million as of December 31, 1999.
During 2000, $126,000 of originated mortgage servicing rights was capitalized and $185,000 of amortization and impairment of mortgage servicing rights was recorded. In 1999, $262,000 of originated mortgage servicing rights was capitalized and $89,000 of amortization and impairment of mortgage servicing rights was recorded. The estimated fair value of mortgage servicing rights was $593,000 as of December 31, 2000 and $652,000 as of December 31, 1999.
NOTE 6: ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses were as follows:
In thousands
2000 1999 1998 ------- ------- ------- Balance at beginning of year $ 5,514 $ 4,897 $ 4,247 Provision charged to expense 3,076 1,026 1,225 Recoveries of loans charged-off 223 84 104 ------- ------- ------- 8,813 6,007 5,576 Loans charged off (2,840) (493) (679) ------- ------- ------- Balance at end of year $ 5,973 $ 5,514 $ 4,897 ======= ======= =======
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7: PREMISES AND EQUIPMENT
Details of premises and equipment as of December 31 are as follows:
In thousands
2000 1999 -------- -------- Land $ 2,097 $ 2,097 Premises 11,728 11,114 Furniture and equipment 11,949 11,136 Construction in progress 116 193 -------- -------- Total cost 25,890 25,540 Less accumulated depreciation (12,444) (11,246) -------- -------- Net book value $ 13,446 $ 13,294 ======== ========
Depreciation and amortization expense was $1.2 million in 2000, 1999 and 1998.
Future minimum rental payments that are related to non-cancelable operating leases having initial terms in excess of one year are:
2001 $156,000 2002 166,000 2003 134,000 2004 134,000 2005 128,000 Thereafter 535,000
Total lease payments were $108,000, $95,000 and $117,000 in 2000, 1999 and 1998.
NOTE 8: SHORT-TERM BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase and the treasury tax and loan note generally mature within one to thirty days from the transaction date.
A summary of short-term borrowings is as follows for the years ended December 31, 2000, 1999 and 1998.
PennRock controls all securities that serve as collateral for the securities sold under agreements to repurchase.
The Bank has approved federal funds lines totaling $12.0 million and a borrowing capacity of $215.7 million at the Federal Home Loan Bank of Pittsburgh ("the FHLB").
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 9: LONG-TERM DEBT
Long-term debt consists of fixed rate advances from the FHLB with maturity schedules as follows:
Certain of the outstanding advances have options that allow the FHLB to convert the existing fixed-rate advance to a 3-month LIBOR variable-rate advance. If the FHLB exercises its option to convert the advance, the balance may be prepaid without penalty. During 2000, the FHLB exercised its option to convert two advances. One totaling $35 million we elected to prepay while the other advance totaling $15 was prepaid and replaced with another convertible advance of $15 million at an interest rate of 6.27%.
NOTE 10: CAPITAL TRANSACTIONS
On June 27, 2000, PennRock announced that the Board of Directors had authorized the purchase of up to 200,000 shares of PennRock's outstanding common stock. The shares are to be used for general corporate purposes including stock dividends and stock splits, executive compensation plans or for issuance under the dividend reinvestment plan. PennRock began open market repurchases of its outstanding common stock in 1995. In 2000, PennRock purchased 94,857 shares for $1.6 million and reissued 91,151 shares. In 1999, PennRock purchased 130,710 shares for $2.9 million and reissued 65,317 shares. PennRock purchased 112,665 shares for $2.7 million and reissued 52,850 shares in 1998. There were 139,553 shares with a cost of $2.8 million as of December 31, 2000 and 135,847 shares with a cost of $3.1 million as of December 31, 1999 held as treasury stock.
NOTE 11: INCOME TAXES
An analysis of the provision for income taxes included in the Consolidated Statements of Income is as follows:
In thousands
2000 1999 1998 ------ ------ ------ Current expense $1,699 $2,594 $2,245 Deferred taxes (125) (91) (264) ------ ------ ------ Total income tax expense $1,574 $2,503 $1,981 ====== ====== ======
A reconciliation between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to income before provision for income taxes is as follows:
2000 1999 1998 ------ ------ ------ Statutory federal income tax rate 34.0% 34.0% 34.0% Tax exempt income (20.2) (14.4) (17.0) Other, net .4 (.7) .1 ------ ------ ------ Effective income tax rate 14.2% 18.9% 17.1% ====== ====== ======
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of PennRock's deferred tax liabilities and assets as of December 31, 2000 and 1999 are as follows:
In thousands
2000 1999 ------ ------ Deferred tax assets: Allowance for loan losses $1,929 $1,773 Net unrealized loss on securities available for sale 1,328 5,469 Other 69 131 ------ ------ Total deferred tax assets 3,326 7,373 ------ ------ Deferred tax liabilities: Depreciation 244 284 Investment security discount 164 165 Net expense from limited partnership 68 58 ------ ------ Total deferred tax liabilities 476 507 ------ ------ Net deferred tax asset $2,850 $6,866 ====== ======
Included in the table above is the recognition of unrealized gains and losses on certain investments in debt and equity securities accounted for under SFAS 115 for which no deferred tax expense or benefit was recognized in the Consolidated Statements of Income.
Management believes that it is more likely than not that the net deferred tax asset of $2.9 million will be realized since PennRock has a long history of earnings and has a carry-back potential greater than the deferred tax asset and is unaware of any reason that PennRock would not ultimately realize this asset.
NOTE 12: EMPLOYEE BENEFIT PLAN
The Bank has a non-contributory profit sharing plan covering substantially all full time employees of the Bank. Contributions made to the plan by PennRock were $825,000 in 2000, $906,000 in 1999 and $802,000 in 1998.
NOTE 13: STOCK OPTION PLAN
PennRock has an Omnibus Stock Option Plan ("the Plan"), the terms of which permit the granting of non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and restricted stock to senior executives of PennRock. The Board of Directors has granted the following incentive stock options under this plan at an exercise price equal to the market price at the date of the grant. Each of the incentive stock options vests and becomes exercisable, one-half after three years and the balance after five years of date granted.
There were 3,750 shares exercisable as of December 31, 2000. No options were exercised in 2000.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of PennRock's options outstanding as of December 31 is as follows:
PennRock has elected to account for its stock options and stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Based Compensation." Under this method, no compensation expense is recognized for stock options when the exercise price equals fair value at the date of grant. Since the Plan stipulates that the exercise price of the options is always equal to the market price at the date of the grant, we have recognized no compensation costs under the Plan. Had compensation costs for the Plan been determined based on the fair value of the options at the grant dates in accordance with SFAS 123, "Accounting for Stock-Based Compensation," PennRock's net income and earnings per share would have been as follows:
The fair value of each option is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2000, 1999 and 1998: dividend yield of 2.5% and expected volatility of 30% for all years; risk free interest rates of 6.67%, 4.65% and 5.51%; and expected average life of five years.
NOTE 14: COMMITMENTS AND CONTINGENT LIABILITIES AND CONCENTRATIONS OF CREDIT RISK
PennRock's financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest rate risk and liquidity risk. These financial instruments include commitments to extend credit, standby letters of credit, guarantees, and liability for assets held in trust, which arise in the normal course of business. PennRock uses the same credit policies in commitments and conditional obligations as it does for on-balance sheet instruments.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of PennRock's commitments and contingent liabilities as of December 31, 2000 and 1999 are as follows:
In thousands
2000 1999 -------- -------- Commitments to extend credit $118,640 $114,262 Financial and performance standby letters of credit 37,606 23,290 Commercial letters of credit 452 Commitments to purchase securities 871
Commitments to extend credit are agreements to lend to a customer to the extent that there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not represent future cash requirements. Management evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by management upon extension of credit is based on a credit evaluation of the customer.
Stand-by letters of credit are conditional commitments issued by PennRock to guarantee the performance of a customer to a third party. The term of the letters of credit varies from one month to 24 months and may have renewal features. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. PennRock holds collateral supporting those commitments for which collateral is deemed necessary.
PennRock's exposure to possible loss in the event of non-performance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of the instruments.
Most of PennRock's business activity is with customers located within PennRock's defined market area. Investments in state and municipal securities may also involve government entities within PennRock's market area. The concentrations by loan type are set forth in Note 4. The distribution of commitments to extend credit approximates the distribution of loans outstanding. The Bank, as a matter of policy, does not extend credit to any single borrower or group of related borrowers in excess of 65% of its legal lending limit. As of December 31, 2000, this limit was $7,011,000.
NOTE 15: RESTRICTIONS ON RETAINED EARNINGS
Certain restrictions exist regarding the ability of the bank subsidiary to transfer funds to PennRock in the form of cash dividends. The approval of the Comptroller of the Currency is required if the total dividends declared by a national bank in any calendar year exceeds the Bank's net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, the Bank can declare dividends in 2000 without approval of the Comptroller of the Currency of approximately $9.8 million plus an additional amount equal to the Bank's net profit (as defined) for 2001 up to the date of any such dividend declaration.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 16: COMPREHENSIVE INCOME
PennRock has elected to report its comprehensive income in the Consolidated Statements of Stockholders' Equity. The only element of "other comprehensive income" applicable to PennRock is the net unrealized gain or loss on available for sale securities.
The components of the change in unrealized gains (losses) on securities available for sale are as follows:
NOTE 17: REGULATORY MATTERS
PennRock and the Bank are 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 PennRock's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, PennRock and the Bank must meet specific capital guidelines that involve quantitative measures of PennRock's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. PennRock's and the Bank's capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require PennRock and the Bank to maintain 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 (as defined) to average assets (as defined). Management believes, as of December 31, 2000, that PennRock and the Bank meet all capital adequacy requirements to which it is subject.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 2000, the most recent notification from the Federal Reserve Bank categorized PennRock as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, PennRock must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth below. There are no conditions or events since that notification that management believes have changed this category. PennRock's and the Bank's actual capital amounts and ratios are also presented in the table.
NOTE 18: FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 ("SFAS 107"), "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions would significantly affect the estimates. SFAS 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of future business. The value of significant sources of income such as trust or mortgage banking operations has not been estimated. In addition, the tax effect relative to the recognition of unrealized gains and losses can have a significant impact on fair value estimates and have not been considered in any of the estimates. Accordingly, the aggregate fair value amounts do not represent the underlying value of PennRock.
We used the following methods and assumptions in estimating the fair value of PennRock's financial instruments:
Cash and cash equivalents: The carrying amounts reported in the Consolidated Balance Sheets for cash and short-term investments approximate their fair values.
Mortgages held for sale: The fair value of mortgages held for sale is estimated using current secondary market rates.
Securities: Fair values for securities are based on quoted prices, where available. If quoted prices are not available, fair values are based on quoted 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 values. The fair values of other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying amount of accrued interest receivable approximates its fair value.
Off-balance sheet instruments: For PennRock's off-balance sheet instruments consisting of commitments to extend credit and financial and performance standby letters of credit, the estimated fair value is the same as the instrument's contract or notional values since they are priced at market at the time of funding.
Deposit liabilities: The fair values of deposits with no stated maturities, such as demand deposits, savings accounts, NOW and money market deposits are calculated using estimated future cash flows, discounted at the FHLB overnight advance rate less the Bank's operating costs to service the account. We also assume that 1% or the outstanding balance of the accounts will be withdrawn each month for 100 months. Fair values for fixed-rate 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 expected monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of federal funds purchased and securities sold under agreements to repurchase, advances from the Federal Home Loan Bank and other short-term borrowings approximate their fair values.
Long-term debt: The fair values of long-term debt are estimated using discounted cash flow analyses, based on PennRock's incremental borrowing rates for similar types of borrowing arrangements.
Accrued interest payable: The fair value of accrued interest payable is estimated to be the current book value.
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 2000 and 1999, the estimated fair values of financial instruments based on disclosed assumptions are as follows:
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 19: PARENT COMPANY ONLY FINANCIAL INFORMATION
The following represents parent only financial information:
PENNROCK FINANCIAL SERVICES CORP. (PARENT COMPANY ONLY) BALANCE SHEETS
PENNROCK FINANCIAL SERVICES CORP. (PARENT COMPANY ONLY) STATEMENTS OF INCOME
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PENNROCK FINANCIAL SERVICES CORP. (PARENT COMPANY ONLY) STATEMENTS OF CASH FLOWS
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 20: CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)
PENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 21: SUBSEQUENT EVENT
On January 11, 2001, PennRock signed a definitive agreement to acquire The National Advisory Group ("National") located in Dresher, Pennsylvania, for $6.6 million. National is the parent company of the following:
The Dresher Family of Funds is an open-end diversified management investment company, which consists of two portfolios: The Dresher Comprehensive Growth Fund and The Dresher Retirement Fund. National has $150 million in assets under management.
The transaction will be accounted for as a purchase and is expected to close during the first quarter of 2001 subject to regulatory approvals and other conditions.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PENNROCK FINANCIAL SERVICES CORP.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and nominees for election to the Board of Directors is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 24, 2001 under the caption "Information about Nominees and Continuing Directors", and information concerning executive officers is included under Part I, Item 4A, "Executive Officers of the Registrant" of this report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning director compensation is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 24, 2001 under the caption "Compensation of Directors" and concerning executive compensation under the caption "Executive Compensation and Related Matters," except that information appearing under the caption "Board Report on Executive Compensation" and information appearing under the caption "Stock Performance Graph" is not incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 24, 2001, under the caption "Voting of Shares and Principal Holders Thereof" and concerning security ownership of management under the caption "Information about Nominees and Continuing Directors."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information under the caption "Transactions with Directors and Executive Officers" is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 24, 2001.
PENNROCK FINANCIAL SERVICES CORP.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The consolidated financial statements listed on the index to Item 8 of this Annual Report on Form 10-K are filed as a part of this Annual Report.
(a) 2. Financial Statement Schedules
All schedules applicable to the Registrant are shown in the respective financial statements or in the notes thereto included in this Annual Report.
(a) 3. Exhibits
(3)(a) Articles of Incorporation of PennRock.
(3)(b) Bylaws of PennRock.
(10)(a) Omnibus Stock Plan is incorporated by reference to Exhibit 4.1 to Registration Statement Number 33-53022 of Form S-8 dated October 8, 1992.
(10)(b) Executive Incentive Compensation Plan.
(10)(c) Melvin Pankuch Deferred Compensation Agreement Plan.
(10)(d) Melvin Pankuch Employment Agreement.
(10)(e) Employment Agreement with Certain Executive Officers as set forth below:
Executive Officer Date of Agreement Base Salary ----------------- ----------------- -----------
George B. Crisp April 11, 2000 $130,268 Joseph C. Spada April 13, 2000 132,798 Michael H. Peuler April 17, 2000 130,308
(21) Subsidiaries of the Registrant
(23) Consent of Simon Lever & Company, Independent Auditors
(b) Reports on Form 8-K There were no reports on Form 8-K filed in the fourth quarter of 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PENNROCK FINANCIAL SERVICES CORP. --------------------------------- (Registrant)
Dated: March 13, 2001 By /s/ Glenn H. Weaver -------------------------------- Glenn H. Weaver, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on the 13th of March 2001.