SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from                                 to

 

Commission file number 0-17077

 

PENNS WOODS BANCORP, INC.

(exact name of registrant as specified in its charter)

 

Pennsylvania		23-2226454
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
300 Market Street, P.O. Box 967 Williamsport, Pennsylvania 17703-0967
(Address of principal executive offices)
Registrant’s telephone number, including area code (570) 322-1111

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Name of each exchange which registered
None		None

 

Securities to be registered pursuant to Section 12(g) of the Act:

 

Common Stock, par value $10 per share
(Title of Class)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.     Yes ý   No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.                                  ý

 

Indicate by check mark whether the registrant is an accelerated filer as of defined in Rule 12b-2 of the Act.     Yes ý  No o

 

State the aggregate market value of the voting stock held by non-affiliates of the registrant $135,611,421 at June 30, 2004.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding at March 7, 2005
Common Stock, $10 Par Value		3,321,637 Shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

 

INDEX

 

PART I
ITEM
Item 1.	Business
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
PART II
Item 5.		Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchase of Equity Securities
Item 6.		Selected Financial Data
Item 7.		Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations
Item 7A.		Quantitative and Qualitative Disclosure About Market Risk
Item 8.		Financial Statements and Supplementary Data
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A.		Controls and Procedures
Item 9B.		Other information
PART III
Item 10.		Directors and Executive Officers of the Registrant
Item 11.		Executive Compensation
Item 12.		Security Ownership and Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.		Certain Relationships and Related Transactions
Item 14.		Principal Accountant Fees and Services
PART IV
Item 15.		Exhibits and Financial Statement Schedules
Signatures and Certifications

 

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PART I

 

ITEM 1 BUSINESS

 

A. General Development of Business and History

 

On January 7, 1983, Penns Woods Bancorp, Inc. (the “Company”) was incorporated under the laws of the Commonwealth of Pennsylvania as a bank holding company. The Jersey Shore State Bank (the “Bank”) became a wholly owned subsidiary of the Company, and each outstanding share of Bank common stock was converted into one share of Company common stock. This transaction was approved by the shareholders of the Bank on April 11, 1983 and was officially effective on July 12, 1983. The Company’s business has consisted primarily of managing and supervising the Bank, and its principal source of income has been dividends paid by the Bank. The Company’s two other wholly-owned subsidiaries are Woods Real Estate Development Co, Inc. and Woods Investment Co., Inc.

 

The Bank is engaged in commercial and retail banking and the taking of time and regular savings and demand deposits, the making of commercial and consumer loans and mortgage loans, and safe deposit services. Auxiliary services, such as cash management, are provided to commercial customers. The Bank operates full banking services with eleven branch offices and a Mortgage/Loan Center in Northcentral Pennsylvania.

 

In October 2000, the Bank acquired The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”). The M Group, which operates as a subsidiary of the Bank, offers insurance and securities brokerage services. Securities are offered by The M Group through ING Financial Partners, Inc., a registered broker-dealer.

 

Neither the Company nor the Bank anticipates that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or on its competitive position. The Bank is not dependent on a single customer or a few customers, the loss of whom would have a material effect on the business of the Bank.

 

The Bank employed approximately 149 persons as of December 31, 2004. The Company does not have any employees. The principal officers of the Bank also serve as officers of the Company.

 

B. Regulation and Supervision

 

The Company is also subject to the provisions of the Bank Holding Company Act of 1956, as amended (the “BHCA”) and to supervision and examination by the Board of Governors of the Federal Reserve System (the “FRB”). The Bank is subject to the supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”), as its primary federal regulator and as the insurer of the Bank’s deposits. The Bank is also regulated and examined by the Pennsylvania Department of Banking (the “Department”).

 

The insurance activities of The M Group are subject to regulation by the insurance departments of the various states in which The M Group conducts business including principally the Pennsylvania Department of Insurance. The securities brokerage activities of The M Group are subject to regulation by federal and state securities commissions.

 

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The FRB has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the FRB, pursuant to such regulations, may require the Company to stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. The BHCA requires the Company to secure the prior approval of the FRB before it can acquire all or substantially all of the assets of any bank, or acquire ownership or control of 5% or more of any voting shares of any bank. Such a transaction would also require approval of the Department.

 

A bank holding company is prohibited under the BHCA from engaging in, or acquiring direct or indirect control of, more than 5% of the voting shares of any company engaged in non-banking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

 

Bank holding companies are required to comply with the FRB’s risk-based capital guidelines. The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets. Currently, the required minimum ratio of total capital to riskweighted 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, 45% of net unrealized gains on marketable equity 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 FRB requires each bank holding company to comply with the leverage ratio, under which the bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of 3% 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 expected to maintain a leverage ratio of at least 4% to 5%. The Bank is subject to similar capital requirements adopted by the FDIC.

 

C. Regulation of the Bank

 

From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions of, the business of the Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.

 

Prompt Corrective Action - The FDIC has specified the levels at which an insured institution will be considered “wellcapitalized,” “adequately capitalized,” “undercapitalized,” and “critically undercapitalized.” In the event an institution’s capital deteriorates to the “undercapitalized” category or below, the Federal Deposit Insurance Act (the “FDIA”) and FDIC regulations prescribe an increasing amount of regulatory intervention, including: (1) the institution of a capital restoration plan by a bank and a guarantee of the plan by a parent institution; and (2) the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver. For well-capitalized institutions, the FDIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity.

 

Deposit Insurance - There are two deposit insurance funds administered by the FDIC - the Savings Association Insurance Fund (“SAIF”) and the Bank Insurance Fund (“BIF”). The Bank’s deposits are

 

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insured under the BIF; however, the deposits assumed by the Bank in connection with the merger of Lock Haven Savings Bank are treated and assessed as SAIF-insured deposits. 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 measure. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each 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 gauging the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10.0% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6.0% or greater and a Tier 1 leverage ratio of 5.0% or greater, are assigned to the well-capitalized group. As of December 31, 2004, the Bank’s ratios were well above required minimum ratios.

 

Both the BIF and SAIF are presently fully funded at more than the minimum amount required by law. Accordingly, the BIF and SAIF 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. The FDIC indicated that all banks may again be required to pay deposit insurance premiums in the future if the current trend of the size of the deposit insurance funds relative to all insured deposits continues. While the Bank presently pays no premiums for deposit insurance, it is subject to assessments to pay the interest on Financing Corporation (“FICO”) bonds. FICO was created by Congress to issue bonds to finance the resolution of failed thrift institutions. The current annual FICO assessment for the Bank (and all banks) is $.0144 per $100 of BIF deposits.

 

Other Legislation

 

The Fair and Accurate Credit Transactions Act (“FACT”) was signed into law on December 4, 2003. This law extends the previously existing Fair Credit Reporting Act. New provisions added by FACT address the growing problem of identity theft. Consumers will be able to initiate a fraud alert when they are victims of identity theft, and credit reporting agencies will have additional duties. Consumers will also be entitled to obtain free credit reports, and will be granted certain additional privacy rights.

 

Regulators will be issuing rules to implement FACT over the next year, and some of these rules will likely impose additional duties on the Bank, although the Company does not believe that the application of these new rules will have a material effect on its operations. The Sarbanes-Oxley Act of 2002 was enacted to enhance penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures under the federal securities laws. The Sarbanes-Oxley Act generally applies to all companies, including the Company, that file or are required to file periodic reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934, or the Exchange Act. The legislation includes provisions, among other things, governing the services that can be provided by a public company’s independent auditors and the procedures for approving such services, requiring the chief executive officer and principal accounting officer to certify certain matters relating to the company’s periodic filings under the Exchange Act, requiring expedited filings of reports by insiders of their securities transactions and containing other provisions relating to insider conflicts of interest, increasing disclosure requirements relating to critical financial accounting policies and their application, increasing penalties for securities law violations, and creating a new public accounting oversight board, a regulatory body subject to SEC jurisdiction with broad powers to set auditing, quality control and ethics standards for accounting firms. In response to the legislation, the national securities exchanges and NASDAQ have adopted new rules relating to certain matters, including the independence of members of a company’s audit committee as a condition to listing or continued listing. The Company does not believe that the application of these new rules to the Company will have a material effect on its results of operations. In addition, Congress is often considering some financial industry legislation. The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future.

 

In addition to federal banking law, the Bank is subject to the Pennsylvania Banking Code. The Banking Code was amended in late 2000 to provide more complete “parity” in the powers of state-chartered institutions compared to national banks and federal savings banks doing business in Pennsylvania.

 

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Pennsylvania banks have the same ability to form financial subsidiaries authorized by the Gramm-Leach-Bliley Act, as do national banks.

 

Environmental Laws

 

Environmentally related hazards have become a source of high risk and potential liability for financial institutions relating to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. The Company is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse effect on the financial condition or results of operations of the Company.

 

Effect of Government Monetary Policies

 

The earnings of the Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States Government and its agencies. The monetary policies of the FRB have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The FRB has a major effect upon the levels of bank loans, investments and deposits through its open market operations in the United States Government securities and through its regulation of, among other things, the discount rate on borrowing of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.

 

DESCRIPTION OF BANK

 

a. History and Business

 

Jersey Shore State Bank (“Bank”) was incorporated under the laws of the Commonwealth of Pennsylvania as a state bank in 1934 and became a wholly owned subsidiary of the Company on July 12, 1983.

 

As of December 31, 2004, the Bank had total assets of $530,736,000; total shareholders’ equity of $56,743,000 and total deposits of $357,479,000. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation for the maximum amount provided under current law.

 

The Bank engages in business as a commercial bank, doing business at several locations in Lycoming, Clinton and Centre Counties, Pennsylvania. The Bank offers insurance and securities brokerage services through its wholly owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group.

 

Services offered by the Bank include accepting time, demand and savings deposits including Super NOW accounts, regular savings accounts, money market accounts, investment certificates, fixed rate certificates of deposit and club accounts. Its services also include making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and the renting of safe deposit facilities. Additional services include making residential mortgage loans, revolving credit loans with overdraft protection, small business loans, etc. Business loans include seasonal credit collateral loans and term loans.

 

The Bank’s loan portfolio mix can be classified into four principal categories of real estate, agricultural, commercial and consumer. Real estate loans can be further segmented into construction and land development, farmland, one-to-four family residential, multi-family and commercial or industrial. Qualified borrowers are defined by policy or by industry underwriting standards. Owner provided equity requirements range from 20% to 30% with a first lien status required. Terms are restricted to between 10 and 20 years with the exception of construction and land development, which is limited to one to five years.

 

Appraisals, verifications and visitations comply with industry standards.

 

Financial information that is required on all commercial mortgages includes the most current three years’ balance sheets and income statements and projections on income to be developed through the project. In the case of corporations and partnerships, the principals are often asked to indebt themselves personally as well. Residential mortgages, repayment ability is determined from information contained in the application and recent income tax returns. Emphasis is on credit, employment, income and residency verification. Broad hazard insurance is always required and flood insurance where applicable. In the case of construction mortgages, builders risk insurance is requested.

 

6

 

Agricultural loans for the purchase or improvement of real estate must meet the Bank’s real estate underwriting criteria. The only permissible exception is when a Farmers Home Loan Administration guaranty is obtained. Agricultural loans made for the purchase of equipment are usually payable in five years, but never more than seven, depending upon the useful life of the purchased asset. Minimum borrower equity ranges from 20% to 30%. Livestock financing criteria depends upon the nature of the operation. A dairy herd could be financed over three years, but a feeder operation would require cleanup in intervals of less than one year.

 

Agricultural loans are also made for crop production purposes. Such loans are structured to repay within the production cycle and not carried over into a subsequent year. General purpose working capital loans are also a possibility with repayment expected within one year. It is also a general policy to collateralize non-real estate loans with not only the asset purchased but also junior liens on all other available assets. Insurance and credit criteria is the same as mentioned previously. In addition, annual visits are made to our agricultural customers to determine the general condition of assets. Personal credit requirements are handled as consumer loans. Commercial loans are made for the acquisition and improvement of real estate, purchase of equipment and for working capital purposes on a seasonal or revolving basis. Criteria was discussed under real estate financing for such loans, but it is important to note that such loans may be made in conjunction with the Pennsylvania Industrial Development Authority. Caution is also exercised in taking industrial property for collateral by requiring, on a selective basis, environmental audits.

 

Equipment loans are generally amortized over three to seven years, with an owner equity contribution required of at least 20% of the purchase price. Unusually expensive pieces may be financed for a longer period depending upon the asset’s useful life. The increased cash flow resulting from the additional piece, through improved income or greater depreciation expense, serves in establishing the terms. Insurance coverage with the Bank as loss payee is required, especially in the case where the equipment is rolling stock. Seasonal and revolving lines of credit are offered for working capital purposes. Collateral for such a loan includes the pledge of inventory and/or receivables. Drawing availability is usually 50% of inventory and 75% of eligible receivables. Eligible receivables are defined as invoices less than 90 days delinquent. Exclusive reliance is very seldom placed on such collateral, therefore, other lienable assets are also taken into the collateral pool. Where reliance is placed on inventory and accounts receivable, the applicant must provide financial information including agings on a monthly basis. In addition, the guaranty of the principals is usually obtained.

 

It is unusual for the Bank to make unsecured commercial loans. But when such a loan is a necessity, credit information in the file must support that decision.

 

Letter of Credit availability is limited to standbys where the customer is well known to the Bank. Credit criteria is the same as that utilized in making a direct loan and collateral is obtained in most cases, and whenever the expiration date is for more than one year. Consumer loan products include second mortgages, automobile financing, small loan requests, overdraft check lines and PHEAA referral loans. Our policy includes standards used in the industry on debt service ratios and terms are consistent with prudent underwriting standards and the use of proceeds. Verifications are made of employment and residency, along with credit history. Second mortgages are confined to equity borrowing and home improvements. Terms are generally ten years or less and rates are fixed. Loan to collateral value criteria is 80% or less and verifications are made to determine values. Automobile financing is generally restricted to five years and done on a direct basis. The Bank, as a practice, does not floor plan and therefore does not discount dealer paper. Small loan requests are to accommodate personal needs such as the purchase of small appliances or for the payment of taxes. Overdraft check lines are limited to $5,000 or less.

 

The Bank’s investment portfolio is analyzed and priced on a monthly basis. Investments are made in U.S. Treasuries, U.S. Government Agency issues, bank qualified municipal bonds, corporate bonds and corporate stocks which consist of Pennsylvania bank stocks. Bonds with BAA or better ratings are used, unless a local issue is purchased that has a lesser or no rating. Factors taken into consideration when investments are made include liquidity, the Company’s tax position and the policies of the Asset/Liability Committee. Although the Bank has regular opportunities to bid on pools of funds of $100,000 or more in the hands of municipalities, hospitals and others, it does not rely on these monies to fund loans on intermediate or longer-term investments. Minor seasonal growth in deposits is experienced at or near the year-end.

 

It is the policy of the Bank to generally maintain a rate sensitive asset (RSA) to rate sensitive liability (RSL) ratio of 150% of equity for a 6-month time horizon, 150% of equity for a 2-year time horizon and 150% of equity for a 5-year time horizon. The Bank operates eleven full service offices in Lycoming,

 

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Clinton, and Centre Counties, Pennsylvania, and a Mortgage/Loan Center in Centre County, Pennsylvania. The economic base of the region is developed around service, light manufacturing industries and agriculture. The banking environment in Lycoming, Clinton and Centre Counties, Pennsylvania is highly competitive. The Bank competes for loans and deposits with commercial banks, savings and loan associations and other financial institutions. The Bank has a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors (including federal, state and local governments). The Bank has not experienced any significant seasonal fluctuations in the amount of its deposits.

 

b. Supervision and Regulation

 

The earnings of the Bank are affected by the policies of regulatory authorities including the FDIC and the FRB. An important function of the FRB is to regulate the money supply and interest rates. Among the instruments used to implement these objectives are open market operations in U.S. Government Securities, changes in reserve requirements against member bank deposits and limitations on interest rates that member banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments on deposits, and their use may also affect interest rates charged on loans or paid for deposits.

 

The policies and regulations of the FRB have had and will probably continue to have a significant effect on the Bank’s deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Bank’s operation in the future. The effect of such policies and regulations upon the future business and earnings of the Bank cannot accurately be predicted.

 

EXECUTIVE OFFICERS OF THE REGISTRANT:

 

NAME		AGE		FIVE-YEAR ANALYSIS OF DUTIES
Ronald A. Walko		58		President and Chief Executive Officer of the Company; the Bank; The M Group; and Woods Investment Company, Inc.; President of Woods Real Estate Development Co, Inc.; and Federal Bank examiner prior to 1986 for an eighteen-year period.
Hubert A. Valencik		63		Senior Vice President of the Company; Senior Vice President and Operations Officer of the Bank; Assistant Secretary of Woods Investment Company, Inc.Vice President of Woods Real Estate Development Co, Inc.; Vice President - Operations of The M Group; Vice President with another bank prior to 1985 for a fourteen-year period.

 

ITEM 2 PROPERTIES

 

The Company owns and leases its properties. Listed herewith are the locations of properties owned or leased, in which the banking offices and Financial Center are located; all properties are in good condition and adequate for the Bank’s purposes:

 

Office		Address
Main		115 South Main Street P.O. Box 5098 Jersey Shore, Pennsylvania 17740		Owned
Bridge Street		112 Bridge Street Jersey Shore, Pennsylvania 17740		Owned
DuBoistown		2675 Euclid Avenue DuBoistown, Pennsylvania 17702		Owned
Williamsport		300 Market Street P.O. Box 967 Williamsport, Pennsylvania 17703-0967		Owned
Montgomery		9094 Rt 405 Highway Montgomery, Pennsylvania 17752		Under Lease
Lock Haven		4 West Main Street Lock Haven, Pennsylvania 17745		Owned

 

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Mill Hall		(Inside Wal-Mart), 167 Hogan Boulevard Mill Hall, Pennsylvania 17751		Under Lease
Spring Mills		Ross Hill Road, P.O. Box 66 Spring Mills, Pennsylvania 16875		Owned
Centre Hall		2842 Earlystown Road Centre Hall, Pennsylvania 16828		Land Under Lease
Zion		100 Cobblestone Road Bellefonte, Pennsylvania 16823		Under Lease
Jersey Shore State Bank Financial Center State College		1952 Waddle Road, Suite 106 State College, Pennsylvania 16803		Under Lease
The M Group, Inc. D/B/A The Comprehensive Financial Group		705 Washington Boulevard Williamsport, Pennsylvania 17701		Under Lease
State College		(Inside Wal-Mart), 1665 North Atherton Place State College, Pennsylvania 16803		Under Lease
State College		2050 North Atherton Street State College, Pennsylvania 16803		Land Under Lease

 

ITEM 3 LEGAL PROCEEDINGS

 

In the normal course of business, various lawsuits and claims arise against the Company and its subsidiary. There are no such legal proceedings or claims currently pending or threatened.

 

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of security holders during the fourth quarter of 2004.

 

PART II

 

ITEM 5 MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASE OF EQUITY SECURITIES

 

The Common Stock is listed on The NASDAQ National Market under the symbol “PWOD”. The following table sets forth (1) the quarterly high and low bid information for a share of the Company’s Common Stock during the periods indicated, and (2) quarterly dividends on a share of the Common Stock with respect to each quarter since January 1, 2003. The following quotations reflect inter-dealer prices and do not include retail markup, markdown or commission. They may not necessarily represent actual transactions.

 

		High			Low			Dividends Declared
2003:
First Quarter		$	41.27		$	32.86		$	0.27
Second Quarter		47.43			37.71			0.27
Third Quarter		42,32			38.64			0.27
Fourth Quarter		47.91			40.85			0.68
2004:
First Quarter		$	48.39		$	43.10		$	0.35
Second Quarter		46.91			42.47			0.35
Third Quarter		50.75			44.16			0.35
Fourth Quarter		50.12			45.26			0.71

 

The Bank has paid cash dividends since 1941. The Company has paid dividends since the effective date of its formation as a bank holding company. It is the present intention of the Company Board of Directors to

 

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continue the dividend payment policy; however, further dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Company considers dividend policy. Cash available for dividend distributions to shareholders of the Company must initially come from dividends paid by the Bank to the Company. Therefore, the restrictions on the Bank’s dividend payments are directly applicable to the Company.

 

Under the Pennsylvania Business Corporation Law of 1988, a corporation may not pay a dividend, if after giving effect thereto, the corporation would be unable to pay its debts as they become due in the usual course of business and after giving effect thereto the total assets of the corporation would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of the shareholders whose preferential rights are superior to those receiving the dividend.

 

As of March 7, 2005, the Company had approximately 1,234 shareholders of record.

 

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ITEM 6 SELECTED FINANCIAL DATA

 

The following table sets forth certain financial data as of and for each of the years in the five-year period ended December 31, 2004.

 

(In Thousands, Except Per Share Data)		2004			2003			2002			2001			2000
Consolidated Statement of Income Data:
Interest income		$	30,947		$	29,232		$	29,302		$	28,736		$	28,454
Interest expense		8,768			9,265			10,846			12,481			12,778
Net interest income		22,179			19,967			18,456			16,255			15,676
Provision for loan losses		465			255			365			372			286
Net interest income after provision for loan losses		21,714			19,712			18,091			15,883			15,390
Noninterest income		7,949			8,454			5,255			5,109			2,615
Noninterest expense		14,317			13,289			12,213			11,272			9,820
Income before income taxes		15,346			14,877			11,133			9,720			8,185
Applicable income taxes		4,263			3,703			2,247			1,978			1,619
Net Income		$	11,083		$	11,174		$	8,886		$	7,742		$	6,566
Consolidated Balance Sheet at End of Period:
Total assets		$	546,703		$	527,381		$	472,206		$	424,810		$	394,913
Loans		324,505			275,828			257,845			251,623			244,798
Allowance for loan losses		(3,338		)	(3,069		)	(2,953		)	(2,927		)	(2,879		)
Deposits		356,836			334,318			339,848			305,150			278,134
Long-term debt – other		75,878			70,878			51,778			41,778			31,778
Shareholders’ equity		73,165			69,769			63,142			55,252			50,514
Per Share Data:
Earnings per share - Basic		$	3.33		$	3.35		$	2.66		$	2.30		$	1.91
Earnings per share - Diluted		3.33			3.35			2.66			2.30			1.91
Cash dividends declared		1.76			1.49			1.24			1.11			1.00
Book value		22.03			21.00			18.94			16.53			14.83
Number of shares outstanding, at end of period		3,321,527			3,321,560			3,031,329			3,039,590			3,097,293
Average number of shares outstanding-basic		3,325,007			3,330,585			3,336,312			3,371,845			3,431,494
Selected financial ratios:
Return on average shareholders’ equity		15.49		%	16.60		%	15.00		%	14.38		%	13.77		%
Return on average total assets		2.06		%	2.24		%	2.01		%	1.95		%	1.74		%
Net interest income to average interest earning assets		4.41		%	4.28		%	4.45		%	4.39		%	4.35		%
Dividend payout ratio		52.72		%	44.76		%	46.40		%	48.17		%	52.18		%
Average shareholders’ equity to average total assets		13.30		%	13.51		%	13.39		%	13.54		%	12.62		%
Loans to deposits, at end of period		90.94		%	82.50		%	75.87		%	82.46		%	88.01		%

 

Per share data and number of shares outstanding have been adjusted in each reporting period to give retroactive effect to a stock split effected in the form of a 100% stock dividend issued January 15, 1998, a 10% stock dividend issued June 9, 1999 and a 10% stock dividend issued November 13, 2003.

 

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ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

RESULTS OF OPERATIONS

 

NET INTEREST INCOME

 

Net interest income is determined by calculating the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to taxable equivalents based on the marginal corporate federal tax rate of 34%. The tax equivalent adjustments to net interest income for 2004, 2003, and 2002 were $907,000, $1,367,000, and $1,738,000, respectively.

 

2004 vs 2003

 

Reported net interest income increased $2,212,000 or 11.1% from fiscal 2003 to 2004. Total interest income increased $1,715,000 and is attributed to the increase of $41,067,000 in the average balance of the loan portfolio, offset partially by a decrease of the return on investment securities of 4 basis points, the decrease in the average balance of the investment securities of $1,270,000, and a decrease in the return on loans of 57 basis points.

 

On a tax equivalent basis, net interest income increased 8.2% or $1,752,000, to $23,086,000 in a period when both average interest earning assets and average interest-bearing liabilities increased. The increase of taxable security income of $1,216,000 is due to the purchases of U.S. Government Agency securities over the past year, with the average of these securities increasing $13,585,000, while the decrease in the average of tax-exempt State & Political securities decreased tax equivalent interest income $1,366,000. The investment portfolio has been repositioned from longer term assets to shorter term assets to take advantage of the cash flow opportunities for reinvestment in anticipation of rising rates. The net growth in the volume of the loan portfolio has generated additional interest income that has offset the 57 basis point decline in the overall portfolios weighted average interest rate.

 

Within the loan portfolio, a 27 basis point decrease of the tax equivalent return on loans was offset by an increase of $41,067,000 in the average balance of loans when comparing the year 2004 to the year 2003. For the year ended December 31, 2004, reported interest expense decreased $497,000 or 5.4% over the same period of 2003. Lower rates on deposit accounts contributed the most substantial decrease in interest expense. The weighted average rate on deposits declined 38 basis points for 2004 as compared to 2003. The overall average balance of savings deposits increased $12,481,000, offset by a decrease in the weighted average rate for a net decrease in interest expense of $343,000. Interest expense on time deposits decreased $538,000 due to both the 39 basis point decline in the weighted average rate and the decrease in the average balance of $1,020,000.

 

During 2004, the Company borrowed an additional $5 million in long term advances through the FHLB to minimize future borrowing costs and to enhance liability positioning. These additional borrowings were utilized by management to fund the substantial loan growth of 2004. The $273,000 increase in expense on long-term borrowings is the result of average balances of long term FHLB borrowings increasing $8,442,000 partially offset by the 17 basis point decline in the resulting weighted average interest rate for the year ending December 31, 2004 compared to the same period in 2003. Interest paid on short-term borrowings increased $111,000 as a result of an increase of the average balances outstanding during the year of $6,866,000 offset partially by a decline in the weighted average interest rate of 3 basis points. The opportunity to borrow from the Federal Home Loan Bank at historically low interest rates was utilized to assist the funding of the loan portfolio growth and is attributed to the increase of interest expense paid on borrowings.

 

2003 vs 2002

 

Reported net interest income increased $1,511,000 or 8.2% from year end 2002 to year end 2003. The decrease in total interest income of $70,000 is the result of an increase of $44,185,000 in the average balance of investment securities held for the current period relative to the same period a year ago offset by

 

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a decrease in the return on loans of approximately 62 basis points. Overall, interest income generated from the net increase in volume of interest earning assets was offset by a decline in rates of approximately 95 basis points.

 

On a tax equivalent basis, net interest income increased 5.6% or $1,140,000, to $21,334,000 in a period when both average interest earning assets and average interest-bearing liabilities increased. The increase of taxable security income of $1,522,000 is due to the significant purchase of U.S. Government securities over the past year, with the average of these securities increasing $70,159,000, while the decrease in the average of tax-exempt State & Political securities decreased tax equivalent interest income $975,000. The investment portfolio has been repositioned from longer term assets to shorter term assets to take advantage of the cash flow opportunities for reinvestment in anticipation of rising rates. The net growth in the volume of investment holdings has generated additional interest income that has offset the 115 basis point decline in the overall portfolios weighted average interest rates.

 

Within the loan portfolio, a 62 basis point decrease in the tax equivalent return on loans was partially offset by an increase of $7,612,000 in the average balance of loans when comparing the year 2003 to the year 2002. Variable rate loans within the portfolio and other new loan originations at lower effective rates aided in the reduction of new income compared to a year ago because of the historically low rates.

 

For the year ended December 31, 2003, reported interest expense decreased $1,581,000 or 14.6% over the same period of 2002. Lower rates for all deposit accounts contribute the most substantial decrease in interest expense. The weighted average rate on interest paid on deposits declined 92 basis points for the year 2003 as compared to 2002. The overall average balance of savings deposits increased $17,925,000, offset by a decrease in the weighted average rate for a net decrease in the related interest expense of $997,000. Interest expense on time deposits decreased $1,204,000 due to both the 76 basis point decline in the weighted average rate and the decrease in the average balance of $5,453,000.

 

Favorable long-term borrowing rates offer opportunities to reduce interest expenses over the coming years. Throughout 2003, the Company borrowed an additional $19.1 million in long term advances through the FHLB to minimize future borrowing costs and to enhance liability positioning. These additional borrowings were utilized by management to take advantage of current investment opportunities while minimizing interest rate risk. The $693,000 increase in expense on long-term borrowings is the result of these additional advances with average balances of $20,986,000 partially offset by the 64 basis point decline in the resulting weighted average interest rate for the year ending December 31, 2003 compared to the same period in 2002. Interest paid on short-term borrowings decreased $73,000 as a result of an overall decline in the weighted average interest rate of 131 basis points while the average balances outstanding during the year increased $8,322,000. The increase in short-term borrowings is the result of taking advantage of the opportunity to borrow from Federal Home Loan Bank at historically low rates.

 

AVERAGE BALANCERS AND INTEREST RATES

 

The following tables set forth certain information relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

 

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		2004
(In Thousands)		AVERAGE BALANCE(2)			INTEREST			AVERAGE RATE
ASSETS:
Interest-earning assets:
Securities:
U.S. Treasury and federal agency		$	138,434		$	6,555		4.74	%
State and political subdivisions(4)		34,665			2,586			7.46	%
Other		26,174			1,322			5.05	%
Total securities		199,273			10,463			5.25	%
LOANS:
Tax-exempt loans(4)		1,359			82			6.03	%
All other loans, net of discount where applicable		301,248			21,309			7.07	%
Total loans(1),(3)		302,607			21,391			7.07	%
Total interest-earning assets		501,880			$	31,854		6.35	%
Other assets		35,766
TOTAL ASSETS		$	537,646
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Interest-bearing liabilities:
Deposits:
Savings		$	159,650		$	1,361		0.85	%
Other time		130,340			3,414			2.62	%
Total interest-bearing deposits		289,990			4,775			1.65	%
Short-term borrowings		31,653			539			1.70	%
Other borrowings		75,727			3,454			4.56	%
Total interest-bearing liabilities		397,370			$	8,768		2.21	%
Demand deposits		64,434
Other liabilities		4,295
Shareholders’ equity		71,547
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	537,646
Interest rate spread								4.14	%
Net interest income/margin					$	23,086		4.60	%

 

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		2003								2002
(In Thousands)		AVERAGE BALANCE(2)			INTEREST			AVERAGE RATE		AVERAGE BALANCE(2)			INTEREST			AVERAGE RATE
ASSETS:
Interest-earning assets:
Securities:
U.S. Treasury and federal agency		$	124,849		$	5,584		4.47	%	$	54,690		$	2,923		5.34	%
State and political subdivisions(4)		50,822			3,952			7.78	%	77,216			4,927			6.38	%
Other		24,872			1,077			4.33	%	24,452			2,216			9.06	%
Total securities		200,543			10,613			5.29	%	156,358			10,066			6.44	%
LOANS:
Tax-exempt loans(4)		1,008			68			6.75	%	2,309			185			8.01	%
All other loans, net of discount where applicable		260,532			19,918			7.65	%	251,619			20,789			8.26	%
Total loans(1),(3)		261,540			19,986			7.64	%	253,928			20,974			8.26	%
Total interest-earning assets		462,083			$	30,599		6.62	%	410,286			$	31,040		7.57	%
Other assets		36,297								31,977
TOTAL ASSETS		$	498,380							$	442,263
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Interest-bearing liabilities:
Deposits:
Savings		$	147,169		$	1,704		1.16	%	$	129,244		$	2,701		2.09	%
Other time		131,360			3,952			3.01	%	136,813			5,156			3.77	%
Total interest-bearing deposits		278,529			5,656			2.03	%	266,057			7,857			2.95	%
Short-term borrowings		24,787			428			1.73	%	16,465			501			3.04	%
Other borrowings		67,285			3,181			4.73	%	46,299			2,488			5.37	%
Total interest-bearing liabilities		370,601			$	9,265		2.50	%	328,821			$	10,846		3.30	%
Demand deposits		56,672								50,877
Other liabilities		3,780								3,334
Shareholders’ equity		67,327								59,231
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	498,380							$	442,263
Interest rate spread								4.12	%							4.27	%
Net interest income/margin					$	21,334		4.62	%				$	20,194		4.92	%

 

1. Fees on loans are included with interest on loans. Loan fees are included in interest income as follows: 2004 $889,000, 2003 $1,032,000, 2002, $803,000.

2. Information on this table has been calculated using average daily balance sheets to obtain average balances.

3. Non-accrual loans have been included with loans for the purpose of analyzing net interest earnings.

4. Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate.

 

15

 

Rate/Volume Analysis

 

The table below sets forth certain information regarding changes in our interest income and interest expense for the periods indicated. For interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate); (ii) changes in rates (changes in rate multiplied by old average volume). Increases and decreases due to both rate and volume, which cannot be separated, have been allocated proportionally to the change due to volume and the change due to rate. Income and rates are on a taxable equivalent basis.

 

		Year Ended December 31,
		2004 vs 2003 Increase (Decrease) Due to									2003 vs 2002 Increase (Decrease) Due to
(In Thousands)		Volume			Rate			Net			Volume			Rate			Net
Interest income:
Taxable investment securities		$	737		$	479		$	1,216		$	3,223		$	(577	)	$	2,646
Tax-exempt investment securities		(1,197		)	(169		)	(1,366		)	(2,054		)	(28		)	(2,082		)
Loans		2,979			(1,574		)	1,405			616			(1,604		)	(988		)
Total interest-earning assets		$	2,519		$	(1,264	)	$	1,255		$	1,785		$	(2,209	)	$	(424	)
Interest expenses:
Savings deposits		$	136		$	(479	)	$	(343	)	$	335		$	(1,332	)	$	(997	)
Other time deposits		(31		)	(507		)	(538		)	(216		)	(988		)	(1,204		)
Short-term borrowings		116			(5		)	111			194			(267		)	(73		)
Long-term borrowings		388			(115		)	273			1,021			(328		)	693
Total interest-bearing liabilities		$	609		$	(1,106	)	$	(497	)	$	1,334		$	(2,915	)	$	(1,581	)
Change in net interest income		$	1,910		$	(158	)	$	1,752		$	451		$	706		$	1,157

 

PROVISION FOR LOAN LOSSES

 

2004 vs 2003

 

The provision for loan losses is based upon management’s quarterly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served. An external independent loan review is also performed annually for the Bank. Management remains committed to an aggressive program of problem loan identification and resolution.

 

The allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management’s consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience. In addition, management considers industry standards and trends with respect to nonperforming loans and its knowledge and experience with specific lending segments.

 

Although management believes that it uses the best information available to make such determinations and that the allowance for loan losses is adequate at December 31, 2004, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy, employment and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets and chargeoffs, increased loan loss provisions and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Bank’s loan loss allowance. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

 

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The allowance for loan losses increased from $3,069,000 at December 31, 2003 to $3,338,000 at December 31, 2004. At December 31, 2004, allowance for loan losses was 1.01% of total loans compared to 1.10% of total loans at December 31, 2003. Management’s conclusion is that the allowance for loan losses is adequate to provide for probable losses inherent in its loan portfolio as of the balance sheet date.

 

The provision for loan losses totaled $465,000 for the year ended December 31, 2004. The provision for the same period in 2003 was $255,000. Management concluded that the increase of the provision is adequate with the loan growth experienced during 2004 and economic changes during the year. Based upon this analysis, as well as the others noted above, senior management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in the loan portfolio.

 

2003 vs 2002

 

The allowance for loan losses increased 3.9% or $116,000 from fiscal 2002 after net charge-offs of $139,000 contributing to a year-end allowance for loan losses of $3,069,000 or 1.10% of total loans. Based upon this analysis, as well as the others noted above, senior management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in the loan portfolio.

 

		YEAR ENDED DECEMBER 31,
		(IN THOUSANDS)
		2004			2003			2002			2001			2000
Balance at beginning of period		$	3,069		$	2,953		$	2,927		$	2,879		$	2,823
Charge-offs:
Real estate		121			63			262			154			165
Commercial and industrial		50			37			80			122			38
Installment loans to individuals		111			116			60			82			66
Total charge-offs		282			216			402			358			269
Recoveries:
Real estate		50			42			25			9			8
Commercial and industrial		4			16			21			8			20
Installment loans to individuals		32			19			17			17			11
Total recoveries		86			77			63			34			39
Net charge-offs		196			139			339			324			230
Additions charged to operations		465			255			365			372			286
Balance at end of period		$	3,338		$	3,069		$	2,953		$	2,927		$	2,879
Ratio of net charge-offs during the period to average loans outstanding during the period		0.06		%	0.05		%	0.13		%	0.13		%	0.10		%

 

NON-INTEREST INCOME

 

2004 vs 2003

 

Total non-interest income decreased $505,000 from fiscal 2003 to 2004. Security gains realized decreased $1,303,000. Excluding the security gains, non-interest income increased $798,000. Service charges increased $66,000 due to an increased fee structure. Earnings on bank-owned life insurance decreased $110,000 due to the decrease of the average crediting rate paid on the policies as a result of the low rate environment. Commissions earned on the sales of insurance increased $684,000 due to the expanded staff and market area of the sales. The majority of the increase in other income of $158,000 was attributed to commissions generated from the new addition of title insurance to the bank’s product line.

 

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(In Thousands)		2004		2003		% Change
Service charges		1,983		1,917		3.4	%
Securities gains, net		2,176		3,479		(37.5	)
Bank-owned life insurance		294		404		(27.2	)
Insurance commissions		2,282		1,598		42.8
Other income		1,214		1,056		15.0
Total non-interest income		7,949		8,454		(6.0	)%

 

2003 vs 2002

 

Total non-interest income for 2003 was $8,454,000, an increase of $3,199,000 from the prior year. Excluding security gains of $3,479,000 in 2003 and $35,000 in 2002, other income decreased $245,000. Service charges increased 4.6% or $84,000 to $1,917,000 in 2003.

 

Decreases in commission income from the sale of financial products sold by the Bank’s subsidiary, The M Group, accounted for $209,000 of the total decrease of other operating income. Other operating income decreased $108,000 primarily due to a nonrecurring life insurance income item included in 2002, resulting in a $116,000 decrease.

 

(In Thousands)		2004		2002		% Change
Service charges		1,917		1,833		4.6	%
Securities gains, net		3,479		35		9,840.0
Bank-owned life insurance		404		416		(2.9	)
Insurance commissions		1,598		1,807		(11.6	)
Other income		1,056		1,164		(9.3	)
Total non-interest income		8,454		5,255		60.9	%

 

NON-INTEREST EXPENSES

 

2004 vs 2003

 

Total non-interest expenses increased $1,028,000 or 7.7% from the year ended December 31, 2003 to December 31, 2004. Salaries and employee benefits increase of $675,000 was the result of the increase in commission earned by the M Group and standard cost of living increases. Expenses related to the new State College Atherton Street branch caused the majority of the $82,000 increase in occupancy expense. Increased maintenance and repairs contributed the $17,000 increase to furniture and equipment expense. Advertising expense decreased $44,000 as the result of a purchase of brochures in 2003 for $22,000 and a decrease in normal advertising expenses. Pennsylvania shares taxes increased $53,000 from 2003 to 2004. Other expenses increased $245,000. This increase was primarily the increase of computer software amortization due to the implementation of teller machines, the increase of legal, audit, and consultant fees in relation to Sarbanes-Oxley compliance, and expenses on the new title insurance product.

 

(In Thousands)		2004		2003		% Change
Salaries and employee benefits		7,937		7,262		9.3	%
Occupancy expense, net		959		877		9.4
Furniture and equipment expense		1,016		999		1.7
Advertising Expense		344		388		(11.3	)
Pennsylvania shares tax expense		508		455		11.6
Other expenses		3,553		3,308		7.4
Total non-interest expenses		14,317		13,289		7.7	%

 

18