UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K  

(X) 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
 
( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
 
Commission file number 0-23863


 
PEOPLES FINANCIAL SERVICES CORP.
 
(Exact Name of Registrant as Specified in its Charter)  
PENNSYLVANIA
 
23-2391852
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
     
50 MAIN STREET, HALLSTEAD, PA
 
18822
(Address of Principal Executive Offices)
 
(Zip Code)


Registrant's telephone number, including area code:
 
(570) 879-2175
 
Securities registered pursuant to Section 12(b) of the Act:
 
NONE
 
Securities registered pursuant to Section 12(g) of the Act:
 
COMMON STOCK ($2 Par Value)
   
(Title 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 X NO _____
 
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. [X]
 
Indicate by check mark whether the registrant is an accelerated filer. Yes X No_____
 
The aggregate market value of voting stock held by non-affiliates of the registrant is $ 98,133,789  
 
The aggregate dollar amount of the voting stock set forth equals the number of shares of the registrant’s Common Stock outstanding, reduced by the amount of Common stock held by executive officers, directors, and shareholders owning in excess of 10% of the registrant’s Common Stock, multiplied by the last sale price for the registrant’s Common Stock by June 30, 2004. The information provided shall in no way be construed as an admission that the officer, director, or 10% shareholder in the registrant may be deemed an affiliate of the registrant or that such person is the beneficial owner of the shares reported as being held by him, and any such inference is hereby disclaimed. The information provided herein is included solely for the record keeping purpose of the Securities and Exchange Commission.

     
Number of shares outstanding as of December 31, 2004
 
COMMON STOCK
($2 Par Value)
 
3,155,801
 
   
(Title Class)
 
(Outstanding Shares)
 
 
DOCUMENTS INCORPORATED BY REFERENCE  
 
Portions of the 2005 Proxy Statement for the Registrant are incorporated by reference into Part III of this report.
 

TABLE OF CONTENTS
         
           
Page
     
Part I
         
Number
     
   
Item 1
 
Business
 
3-14
     
   
Item 2
 
Properties
 
14
     
   
Item 3
 
Legal Proceedings
 
15
     
   
Item 4
 
Submission of Matters to a Vote of Security Holders
 
16
     
Part II
                 
   
Item 5
 
Market for Registrant's Common Equity and Related Stockholder Matters
 
16-17
     
   
Item 6
 
Selected Financial Data
 
17
     
   
Item 7
 
Management's Discussion and Analysis of Financial Condition and
 
18-36
     
       
Results of Operations
         
   
Item 7A
 
Quantitative and Qualitative Disclosures About Market Risk
 
37
     
   
Item 8
 
Financial Statements and Supplementary Data
 
38
     
       
Report of Independent Registered Public Accounting Firm
 
38
     
       
Consolidated Balance Sheets
 
39
     
       
Consolidated Statements of Income
 
40
     
       
Consolidated Statements of Stockholders' Equity
 
41
     
       
Consolidated Statements of Cash Flows
 
42-43
     
       
Notes to Consolidated Financial Statements
 
44-70
     
   
Item 9
 
Changes and Disagreements with Accountants on Accounting and
 
71
     
       
Financial Disclosure
         
   
Item 9A
 
Controls and Procedures
 
71
     
   
Item 9B
 
Other Information
 
71
     
Part III
                 
   
Item 10
 
Directors and Executive Officers of the Registrant
 
72
     
   
Item 11
 
Executive Compensation
 
72
     
   
Item 12
 
Security Ownership of Certain Beneficial Owners and Management
 
72
     
       
and Related Stockholder Matters
         
   
Item 13
 
Certain Relationships and Related Transactions
 
72
     
   
Item 14
 
Principal Accountant Fees and Services
 
72
     
Part IV
                 
   
Item 15
 
Exhibits and Financial Statements Schedules
 
73
     

 
 
 
 
 
 
 
 

 
2

ITEM 1 BUSINESS  

BRIEF HISTORY  
Peoples Financial Services Corp. was incorporated under the laws of the Commonwealth of Pennsylvania on February 6, 1986, and is a one-bank holding company headquartered in Hallstead, Pennsylvania.

The Company is engaged primarily in commercial and retail banking services and in businesses related to banking services through its sole subsidiary, Peoples National Bank (“PNB” or the “Bank”). PNB was chartered in Hallstead, Pennsylvania in 1905 under the name of The First National Bank of Hallstead. In 1965, the Hop Bottom National Bank (chartered in 1910) merged with and into the First National Bank of Hallstead to form Peoples National Bank of Susquehanna County. In 2001, the Bank changed its name to Peoples National Bank. PNB is currently in its 100th year of operation.

OPERATING SEGMENTS  
The Company has one reportable operating segment, Community Banking, which consists of commercial and retail banking, and other non-reportable operating segments, as described in Note 1 of the Notes to Consolidated Financial Statements included at page 51 of this Report. The Segment Reporting information in Note 1 is incorporated by reference into this Item 1.

SUPERVISION AND REGULATION  
The Company and PNB are extensively regulated under federal and state law. Generally, these laws and regulations are intended to protect depositors, not shareholders. The following is a summary description of certain provisions of law that affect the regulation of bank holding companies and banks. This discussion is qualified in its entirety by reference to applicable laws and regulations. Changes in law and regulation may have a material effect on the business and prospects of the Company and PNB.

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is subject to regulation, supervision, and examination by the Federal Reserve Bank (“FRB”). The Company is required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information as the FRB may require. The FRB also conducts examinations of the Company.

With certain limited exceptions, the Company is required to obtain prior approval from the FRB before acquiring direct or indirect ownership or control of more than 5% of any voting securities or substantially all of the assets of a bank or bank holding company, or before merging or consolidating with another bank holding company. Additionally, with certain exceptions, any person or entity proposing to acquire control through direct or indirect ownership of 25% or more of any voting securities of the Company is required to give 60 days written notice of the acquisition to the FRB, which may prohibit the transaction, and to publish notice to the public.

The Company’s banking subsidiary is a federally chartered national banking association regulated by the Office of the Comptroller of the Currency (“OCC”). The OCC may prohibit the institution over which it has supervisory authority from engaging in activities or investments that the agency believes constitute unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law; regulation or a regulatory agreement or which are deemed to constitute unsafe or unsound practices.
Enforcement actions may include:
 
  • the appointment of a conservator or receiver;
  • the issuance of a cease and desist order;
  • the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution affiliated parties;
 
  • the issuance of directives to increase capital;
 
  • the issuance of formal and informal agreements;
 
  • the removal of or restrictions on directors, officers, employees and institution-affiliated parties; and
 
  • the enforcement of any such mechanisms through restraining orders or any other court actions.


3

PNB is subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third persons dealing with PNB and not involving more than the normal risk of repayment. Other laws tie the maximum amount that may be loaned to any one customer and its related interests to capital levels of the Bank.

Limitations on Dividends and Other Payments  
The Company’s current ability to pay dividends is largely dependent upon the receipt of dividends from its banking subsidiary, PNB. Both federal and state laws impose restrictions on the ability of the Company to pay dividends. The FRB has issued a policy statement that provides that, as a general matter, insured banks and bank holding companies may pay dividends only out of prior operating earnings. Under the National Bank Act, a national bank, such as PNB, may pay dividends only out of the current year’s net profits and the net profits of the last two years. In addition to these specific restrictions, bank regulatory agencies, in general, also have the ability to prohibit proposed dividends by a financial institution that would otherwise be permitted under applicable regulations if the regulatory body determines that such distribution would constitute an unsafe or unsound practice.

Permitted Non-Banking Activities  
Generally, a bank holding company may not engage in any activities other than banking, managing, or controlling its bank and other authorized subsidiaries, and providing service to those subsidiaries. With prior approval of the FRB, the Company may acquire more than 5% of the assets or outstanding shares of a company engaging in non-bank activities determined by the FRB to be closely related to the business of banking or of managing or controlling banks. The FRB provides expedited procedures for expansion into approved categories of non-bank activities.

Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions:
 
  • on extensions of credit to the bank holding company or its subsidiaries;
 
  • on investments in their securities; and
 
  • on the use of their securities as collateral for loans to any borrower.

These regulations and restrictions may limit the Company’s ability to obtain funds from PNB for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, subject to certain exceptions, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, PNB may not generally require a customer to obtain other services from itself or the Company, and may not require that a customer promise not to obtain other services from a competitor as a condition to an extension of credit to the customer.

Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital injections into a troubled subsidiary bank, and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the holding company does not have the resources to provide it. In addition, depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with the default of or assistance provided to, a commonly controlled FDIC-insured depository institution. Accordingly, in the event that any insured subsidiary of the company causes a loss to the FDIC, other insured subsidiaries of the company could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Such cross guarantee liabilities generally are superior in priority to the obligation of the depository institutions to its stockholders due solely to their status as stockholders and obligations to other affiliates.

Pennsylvania Law  
As a Pennsylvania bank holding company, the Company is subject to various restrictions on its activities as set forth in Pennsylvania law. This is in addition to those restrictions set forth in federal law. Under Pennsylvania law, a bank holding company that desires to acquire a bank or bank holding company that has its principal place of business in Pennsylvania must obtain permission from the Pennsylvania Department of Banking.

Interstate Banking Legislation  
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 were enacted into law on September 29, 1994. The law provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies were eliminated effective September 29, 1995. The law also permits interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date.


                                                          4  
FIRREA (Financial Institution Reform, Recovery, and Enforcement Act)
FIRREA was enacted into law in order to address the financial condition of the Federal Savings and Loan Insurance Corporation, to restructure the regulation of the thrift industry, and to enhance the supervisory and enforcement powers of the federal bank and thrift regulatory agencies. As the primary federal regulator of the Bank, the OCC is responsible for the supervision of the Bank. When dealing with capital requirements, the OCC and FDIC have the flexibility to impose supervisory agreements on institutions that fail to comply with regulatory requirements. The imposition of a capital plan, termination of deposit insurance, and removal or temporary suspension of an officer, director or other institution-affiliated person may cause enforcement actions.

There are three levels of civil penalties under FIRREA.
 
  • The first tier provides for civil penalties of up to $5,000 per day for any violation of law or regulation.
 
  • The second tier provides for civil penalties of up to $25,000 per day if more than a minimal loss or a pattern is involved.
 
  • Finally, civil penalties of up to $1 million per day may be assessed for knowingly or recklessly causing a substantial loss to an institution or taking action that results in a substantial pecuniary gain or other benefit.

Criminal penalties are increased to $1 million per violation and may be up to $5 million for continuing violations or for the actual amount of gain or loss. These penalties may be combined with prison sentences of up to five years.

FDICIA (Federal Deposit Insurance Corporation Improvement Act of 1991)
In December 1991, Congress enacted FDICIA which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things:
 
  • publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants;
 
  • the establishment of uniform accounting standards by federal banking agencies;
 
  • the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital;
  • additional grounds for the appointment of a conservator or receiver; and
 
  • restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements.
FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums.

A central feature of FDICIA is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories:
 
  • "well capitalized";
 
  • "adequately capitalized";
 
  • "under capitalized";
 
  • "significantly undercapitalized"; and
 
  • "critically undercapitalized".
PNB is currently classified as “well capitalized.” An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity.

FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a cash dividend) or paying any management fees to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. If a depository fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized”. Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date such institution is determined to be critically under capitalized.
5
FDICIA provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions that fail to comply with capital or other standards. Such actions may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. FDICIA also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver.

Under FDICIA, each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies, including the OCC, have adopted standards covering:
 
  • internal controls;
 
  • information systems and internal audit systems;
 
  • loan documentation;
 
  • credit underwriting;
 
  • interest rate exposure;
 
  • asset growth; and
 
  • compensation fees and benefits.
Any institution that fails to meet these standards may be required by the agency to develop a plan acceptable to the agency, specifying the steps that the institutions will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Company, on behalf of PNB, believes that it meets substantially all the standards that have been adopted. FDICIA also imposed new capital standards on insured depository institutions. Before establishing new branch offices, PNB must meet certain minimum capital stock and surplus requirements and must obtain OCC approval.

Risk-Based Capital Requirements
The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, and recourse agreements, which are recorded as off-balance-sheet items. Under these guidelines, nominal dollar amounts of assets and credit-equivalent amounts of off-balance-sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain US Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which include off-balance-sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital.
 
  • "Tier 1", or core capital, includes common equity, perpetual preferred stock (excluding auction rate issues) and minority interest in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions.
 
  • "Tier 2", or supplementary capital, includes, among other things, limited life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations and less restricted deductions. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies.

Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total capital to risk-weighted assets of at least 8%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. As of December 31, 2004, PFSC’s ratio of Tier 1 capital to risk-weighted assets stood at 15.02% and its ratio of total capital to risk- weighted assets stood at 16.05%. In addition to risk-based capital, banks and bank holding companies are required to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage capital ratio, of at least 4%. As of December 31, 2004, the Company’s leverage-capital ratio was 10.57%.

Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions including:
 
  • limitations on its ability to pay dividends;
 
  • the issuance by the applicable regulatory authority of a capital directive to increase capital, and in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as to the measures described under FDICIA as applicable to under capitalized institutions.
 
6

In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of PNB to grow and could restrict the amount of profits, if any, available for the payment of dividends to the Company.

Interest Rate Risk  
In August 1995 and May 1996, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank’s capital adequacy, an assessment of the bank’s interest rate risk (“IRR”) exposure. The standards for measuring the adequacy and effectiveness of a banking organization’s IRR management includes a measurement of Board of Directors and senior management oversight, and a determination of whether a banking organization’s procedures for comprehensive risk management are appropriate to the circumstances of the specific banking organization. PNB has internal IRR models that are used to measure and monitor IRR. In addition, an outside source also assesses IRR using its model on a quarterly basis. Additionally, the regulatory agencies have been assessing IRR on an informal basis for several years. For these reasons, the Company does not expect the IRR evaluation in the agencies’ capital guidelines to result in significant changes in capital requirements for PNB.

FDIC Insurance Assessments  
As a FDIC member institution, PNB’s deposits are insured to a maximum of $100,000 per depositor through the Bank Insurance Fund (“BIF”) that is administered by the FDIC and each institution is required to pay semi-annual deposit insurance premium assessments to the FDIC. PNB’s assessment for 2004 was $40,474. These figures can be compared to FDIC assessments in 2003 of $40,765 and in 2002 of $41,810. Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the financing corporate bonds. On September 30, 1996, as part of the Omnibus Budget Act, Congress enacted the Deposit Insurance Funds Act of 1996, which recapitalized the Savings Association Insurance Fund (“SAIF”) and provided that BIF deposits would be subject to 1/5 of the assessment to which SAIF deposits are subject for FICO bond payments through 1999. Beginning in 2000, BIF deposits and SAIF deposits were subject to the same assessment for FICO bonds. The FICO assessment for PNB for 2004 was $ .0148 for each $100 of BIF deposits.

Community Reinvestment Act  
The Community Reinvestment Act of 1977, (“CRA”) is designed to create a system for bank regulatory agencies to evaluate a depository institution’s record in meeting the credit needs of its community. Until May 1995, a depository institution was evaluated for CRA compliance based on twelve assessment factors.

The CRA regulations were completely revised as of July 1, 1995, (the revised CRA regulation) to establish new performance-based standards for use in examining for compliance.

The Bank had its last CRA compliance examination in 2002 and received a “satisfactory” rating.

Concentration  
Payment risk is a function of the economic climate in which the Bank’s lending activities are conducted. Economic downturns in the economy generally or in a particular sector could cause cash flow problems for customers and make loan payments more difficult. The Bank attempts to minimize this risk by avoiding loan concentrations to a single customer or to a small group of customers whose loss would have a materially adverse effect on the financial condition of the Bank.

Monetary Policy  
The earnings of a bank holding company are affected by the policies of regulatory authorities, including the FRB, in connection with the FRB’s regulation of the money supply. Various methods employed by the FRB are:
 
  • open market operations in United States Government securities;
 
  • changes in the discount rate on member bank borrowings; and
 
  • changes in reserve requirements against member bank deposits.
These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to do so in the future.


7

RECENT LEGISLATION  
USA Patriot Act of 2001  
In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington D.C., which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Financial Services Modernization Legislation  
In November 1999, the Gramm-Leach-Bliley Act of 1999, or the GLB, was enacted. The GLB repeals provisions of the Glass-Steagall Act which restricted the affiliation of Federal Reserve member banks with firms “engaged principally” in specified securities activities, and which restricted officer, director or employee interlocks between a member bank and any company or person “primarily engaged” in specified securities activities.

In addition, the GLB also contains provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company to engage in a full range of financial activities through a new entity known as a “financial holding company.” “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

The GLB also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a financial holding company. Financial activities include all activities permitted under new sections of the Bank Holding Company Act or permitted by regulation.

To the extent that the GLB permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. The GLB is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis and which unitary savings and loan holding companies already possess. Nevertheless, the GLB may have the result of increasing the amount of competition that the Registrant faces from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Registrant has.

Sarbanes-Oxley Act of 2002  
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.

The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, or the Exchange Act. Given the extensive SEC role in implementing rules relating to many of the SOA’s new requirements, the final scope of these requirements remains to be determined.

The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
 
 
 

 8
 
The SOA addresses, among other matters:
 
  • audit committees for all reporting companies;
 
  • certification of financial statements by the chief executive officer and the chief financial officer;
 
  • the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
 
  • a prohibition on insider trading during pension plan black out periods;
 
  • disclosure of off-balance sheet transactions;
 
  • a prohibition on personal loans to directors and officers;
 
  • expedited filing requirements for Forms 4’s;
 
  • disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
 
  • "real time" filing of periodic reports;
 
  • the formulation of a public accounting oversight board;
 
  • auditor independence; and
 
  • various increased criminal penalties for violations of securities laws.
The SOA contains provisions, which became effective upon enactment on July 30, 2002 and provisions, which became effective over the following two years. The SEC has been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.

Regulation W  
Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which co-defies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. The company is considered to be an affiliate of the bank. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:
 
  • to an amount equal to 10% of the bank's capital and surplus, in the case of covered transactions with any one affiliate; and
 
  • to an amount equal to 20% of the bank's capital and surplus, in the case of covered transactions with all affiliates.
 
In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes:
 
  • a loan or extension of credit to an affiliate;
 
  • a purchase of, or an investment in, securities issued by an affiliate;
 
  • a purchase of assets from an affiliate, with some exceptions;
 
  • the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and
 
  • the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, under Regulation W:
 
  • a bank, and its subsidiaries may not purchase a low-quality asset from an affiliate;
 
  • covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and
 
  • with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.

Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.
9

Legislation and Regulatory Changes  

From time to time, legislation is enacted that affects the cost of doing business or limits the activities of a financial institution. We cannot predict the likelihood of any major changes or the impact those changes may have on the Company.

MARKET AREAS  
The PNB market areas are in the northeastern part of Pennsylvania with the primary focus being Susquehanna and Wyoming Counties. With the addition of an office in Conklin, Broome County, New York in 2003, Broome County is part of the Bank’s market area, particularly the Southern Tier that encompasses the towns of Conklin, Kirkwood, Windsor, and Deposit. In addition, parts of Lackawanna, Wayne, and Bradford Counties in Pennsylvania that border Susquehanna and Wyoming Counties are also considered part of the PNB market area.

A decision was made to apply for permission to establish a branch office in New York but closer to Hallstead. Property was purchased in Conklin, New York, approximately 10 miles from Hallstead. Permission to establish a branch was approved and the Conklin office was operational in March of 2003. PNB purchased property in Deposit, New York, on December 12, 2002. PNB has also signed a building lease agreement dated April 19, 2004, that will allow the Bank to establish a presence at Front Street in the Town of Chenango in Broome County, New York. With the addition of these offices, the Bank will be better able to serve its present customers as well as add new customers. However, the market areas will be substantially the same. The Conklin office opened on March 17, 2003. Regulatory approval has been received for the Deposit and Front Street locations with a second-quarter 2005 opening date expected for both offices.

The PNB market area is situated between:
 
  • the city of Binghamton, Broome County, New York, located to the north;
 
  • the city of Scranton, Lackawanna County, Pennsylvania, to the south; and
 
  • Wilkes-Barre, Luzerne County, Pennsylvania, to the southwest.

Susquehanna County could best be described as a bedroom county with a high percentage of its residents commuting to work in Broome County, New York, or to the Scranton, Pennsylvania, area. The southern part of Susquehanna County tends to gravitate south for both employment and shopping while the northern part of the county goes north to Broome County, New York. The western part of Susquehanna County gravitates south and west to and through Wyoming County. Wyoming County is home to a Proctor & Gamble manufacturing facility. This is an economic stimulus to Wyoming County and the surrounding areas.

Our offices are located in counties that would be considered sparsely populated as they are made up of many small towns and villages. The latest population figures show Susquehanna County at approximately 42,000 and Wyoming County at approximately 30,000 residents. Both counties are experiencing growth, but not robust growth. Broome County has approximately 208,000 residents and the Town of Conklin has approximately 7,000 residents. The economy of Broome County has overall been hit hard and has lost many manufacturing jobs in the past ten years. This trend continues. Fortunately, the new employment centers are in the Town of Conklin and the neighboring Town of Kirkwood. Both towns border Susquehanna County, Pennsylvania. Interstate 81 runs north and south through the eastern half of Susquehanna County and has brought an influx of people from New Jersey and the Philadelphia area. These people have purchased homes and land to build homes that are used as vacation/recreation retreats and, quite often, become retirement homes.

BUSINESS  
Lending Activities  
PNB provides a full range of retail and commercial banking services designed to meet the borrowing and depository needs of small and medium sized businesses and consumers in its market areas. A significant amount of PNB’s loans are to customers located within its service areas. PNB has no foreign loans or highly leveraged transaction loans, as defined by the FRB. A majority of the loans in PNB’s portfolio have been originated by PNB. Policies adopted by the Board of Directors are the basis by which PNB conducts its lending activities. These loan policies grant individual lending officers authority to make secured and unsecured loans in specific dollar amounts. Larger loans must be approved by senior officers or by the Board of Directors. PNB’s management information systems and loan review policies are designed to monitor lending to ensure adherence to PNB’s loan policies.
 
 
 
 

10
The commercial loans offered by PNB include:
 
  • commercial real estate loans;
 
  • working capital;
 
  • equipment and other commercial loans;
 
  • construction loans;
 
  • SBA guaranteed loans; and
 
  • agricultural loans.
PNB’s commercial real estate loans are used primarily to provide financing for retail operations, manufacturing operations, farming operations, multi-family housing units, and churches. Commercial real estate secured loans are generally written for a term of 15 years or less or amortized over a longer period with balloon payments at shorter intervals. Personal guarantees are obtained on nearly all commercial loans. Credit analysis, loan review, and an effective collections process are also used to minimize any potential losses. PNB employs three full-time commercial lending officers. These three people are augmented by branch managers who are authorized to make smaller, less complex, commercial loans.

Payment risk is a function of the economic climate in which PNB’s lending activities are conducted; economic downturns in the economy generally or in a particular sector could cause cash flow problems for customers and make loan payments more difficult. PNB attempts to minimize this risk by avoiding concentrations of credit to single borrowers or borrowers in a particular industry. Interest rate risk would occur if PNB were to make loans at fixed rates in
an environment in which rates were rising thereby preventing PNB from making loans at the higher prevailing rates. PNB attempts to mitigate this risk by making adjustable rate commercial loans and, when extending fixed rate commercial loans, fixing loan maturities at five years or less. Finally, collateral risk can occur if PNB’s position in collateral taken as security for loan repayment is not adequately secured. PNB attempts to minimize collateral risk by avoiding loan concentrations to particular borrowers, by perfecting liens on collateral and by obtaining appraisals on property prior to extending loans.

Consumer loans offered by PNB include:
 
  • residential real estate loans;
 
  • automobile loans;
 
  • manufactured housing loans;
 
  • personal installment loans secured and unsecured for almost any purpose;
 
  • student loans; and
 
  • home equity loans (fixed-rate term and open ended revolving lines of credit).
PNB offers credit cards as an agent bank through another correspondent bank.

Risks applicable to consumer lending are similar to those applicable to commercial lending. PNB attempts to mitigate payment risk in consumer lending by limiting consumer lending products to a term of five years or less. To the extent that PNB extends unsecured consumer loans, there is greater collateral risk; however, credit checks and borrower history are obtained in all consumer loan transactions.

Residential mortgage products include adjustable-rate as well as conventional fixed-rate loans. Terms vary from 1, 5, and 10-year adjustable rate loans to 5, 10, 15, 20, and 30-year fully amortized fixed rate loans. Bi-weekly payment plans are also available. Personal secured and unsecured revolving lines of credit with variable interest rates and principal amounts ranging from $1,000 to $10,000 are offered to credit-worthy customers. The largest segment of PNB’s installment loan portfolio is fixed-rate loans. Most are secured either by automobiles, motorcycles, snowmobiles, boats, other personal property, or by liens filed against real estate. These loans are generally available in terms of up to 15 years with automobile loans having maturities of up to 60 months and real estate loans having maturities up to 15 years. Loans secured by other collateral usually require a maturity of less than 60 months. Home equity products include both fixed-rate term products and also an open-end revolving line of credit with a maximum loan-to-value ratio of 80% of current appraisal. A special MGIC program now offered through the Bank, allows for loans of up to 100% of the appreciated value for qualified applicants. Credit checks, credit scoring, and debt-to-income ratios within preset parameters are used to qualify borrowers.

Mortgage loans have historically had a longer average life than commercial or consumer loans. Accordingly, payment and interest rate risks are greater in some respects with mortgage loans than with commercial or consumer lending. Deposits, which are used as the primary source to fund mortgage lending, tend to be of shorter duration than the average maturities on residential mortgage loans and are more susceptible to interest rate changes. Historical records indicate that our mortgage loans, no matter what maturity, have an average life of less than seven years. In 2003, the Bank started
 
11
selling mortgages in the secondary market. Mortgages are also written with adjustable rates. Mortgage lending is also subject to economic downturns, in that increases in unemployment could adversely affect the ability of borrowers to repay mortgage loans and decreases in property values could affect the value of the real estate serving as collateral for the loan.

Loan growth slowed in 2004 when compared to 2002 and 2003. Industry standard debt-to-income ratios and credit checks are used to qualify borrowers on all consumer loans. Managers, assistant managers, and customer service officers have retail lending authorities at each of the full-service branch office locations. PNB has centralized loan administration at its operations/administrative offices where mortgage underwriting and loan review and analysis take place.

Loan Approval  
Individual loan authorities are established by PNB’s Board of Directors upon recommendation by the senior credit officer. In establishing an individual’s loan authority, the experience of the lender is taken into consideration, as well as the type of lending in which the individual is involved. The President of PNB, along with members of senior management, have the authority to approve loans up to $500,000 following an analysis and review by loan administration and a written recommendation by the Chief Credit Officer. The full Board of Directors reviews on a monthly basis, all loans approved by individual lenders and the officers’ loan committee. All loan requests which are either complex in nature or exceed $500,000 must be analyzed and reviewed by loan administration and presented with a recommendation to the full Board of Directors for approval or denial.

PNB generally requires that loans secured by first mortgages or real estate have loan-to-value ratios within specified limits, ranging from 75% for loans secured by raw land to 80% for improved property. In addition, in some instances for qualified borrowers, private mortgage insurance is available for purchase that allows loan-to-value ratios to go as high as 100%. PNB also participates in a guaranteed mortgage insurance program. This allows PNB to make loans on real estate up to 100% of the value of the property. Adjustable rate mortgage products, as well as conventional fixed-rate products, are also available at PNB.

Deposit Activities  
PNB also offers a full range of deposit and personal banking services insured by the FDIC, including commercial checking and small business checking products, cash management services, retirement accounts such as Individual Retirement Accounts (“IRA”), retail deposit services such as certificates of deposit, money market accounts, savings accounts, a variety of checking account products, automated teller machines (“ATM’s”), point of sale and other electronic services such as automated clearing house (“ACH”) originations, and other personal miscellaneous services. These miscellaneous services would include:
 
  • safe deposit boxes;
 
  • night depository services;
 
  • traveler’s checks;
 
  • merchant credit cards;
 
  • direct deposit of payroll and other checks;
 
  • U.S. Savings Bonds;
 
  • official bank checks; and
 
  • money orders.

The principal sources of funds for PNB are core deposits that include demand deposits, interest bearing transaction accounts, money market accounts, savings deposits, and certificates of deposit. These deposits are solicited from individuals, businesses, non-profit entities, and government authorities. Substantially all of PNB’s deposits are from the local market areas surrounding each of its offices.

Investment Products
In 1999, PNB entered into an agreement with T.H.E. Financial Services to hire a joint employee to sell investment products. An agent was hired and has an office located in the Bank’s Hallstead Plaza building. In September of 2003, T.H.E. Financial Services was acquired by Financial Network Investment Corporation (FNIC) of Torrance, California. PNB signed a contract dated September 29, 2003 with FNIC.

Insurance Products  
In April of 2001, PNB purchased a 20% equity interest in Community Bankers Insurance Agency. This investment gives the Bank a referral avenue to provide insurance, broadening our available lines of financial services.

12

Investment Portfolio and Activities  
PNB’s investment portfolio has several objectives.
 
  • A key objective is to provide a balance in PNB's asset mix of loans and investments consistent with its liability structure, and to assist in management of interest rate risk. The investments augment PNB's capital position in the risk-based capital formula, providing the necessary liquidity to meet fluctuations in credit demands of the community and also fluctuations in deposit levels.
 
  • In addition, the portfolio provides collateral for pledging against public funds, and a reasonable allowance for control of tax liabilities.
 
  • Finally, the investment portfolio is designed to provide income for PNB.
In view of the above objectives, the portfolio is treated conservatively by management and only securities that pass those criteria are purchased.

Competition  
PNB operates in a fairly competitive environment, competing for deposits and loans with commercial banks, thrifts, credit unions, and finance and mortgage companies. Some of these competitors possess substantially greater financial resources than those available to PNB. Also, certain of these institutions have significantly higher lending limits than PNB and may provide various services for their customers, such as trust services, that are not presently available at PNB.

Financial institutions generally compete on the basis of rates and service. PNB is subject to increasing competition from credit unions, finance companies, and mortgage companies that may not be subject to the same regulatory restrictions and taxations as commercial banks.

PNB will seek to remain competitive with interest rates that it charges on its loans and offers on deposits. It also believes that its success has been, and will continue to be, due to its emphasis on community involvement, customer services, and relationships. With consolidation continuing in the financial industry, and particularly in PNB’s markets, smaller profitable banks are gaining opportunities where larger institutions exit markets that are only marginally profitable for them.

The financial services industry in the Company’s service area is extremely competitive. The Company’s competitors within its service area include banks and bank holding companies with substantially greater resources. Many competitors have substantially higher legal lending limits.

In addition, savings banks, savings and loan associations, credit unions, money market and other mutual funds, mortgage companies, leasing companies, finance companies, and other financial services companies offer products and services similar to those offered by the Company and PNB, on competitive terms.

Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act, which gives them a broader range of products with which we must compete. Although the long-range effects of this development cannot be predicted, most probably it will further narrow the differences and intensify competition among commercial banks, investment banks, insurance firms and other financial services companies.

SEASONALITY  
Management does not feel that the deposits or the business of PNB in general are seasonal in nature. The deposits may, however, vary with local and national economic conditions but should not have a material effect on planning and policy making.

SIGNIFICANT ACCOUNTING POLICIES  
Disclosure of the Company’s significant accounting policies is included in Note 1 to the Consolidated Financial Statements. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by management. Additional information is contained in Management’s Discussion and Analysis for the most sensitive of these issues, including the provision and allowance for loan losses, which are located in Note 4 to the Consolidated Financial Statements.

Significant estimates are made by management in determining the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan review, financial and managerial strengths of borrowers, adequacy of collateral, if collateral dependent, or present value of future cash flows and other relevant factors.

13
INTERNET ADDRESS DISCLOSURES  
PNB’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports can be found via a link to the SEC Web page through our Website located at www.peoplesnatbank.com. This website is available free of charge.

PNB has posted its Code of Ethics for the chief executive officer, chief operation and financial officer, and controller. This policy can be found at our Website located at www.peoplesnatbank.com.

STATISTICAL DISCLOSURES  
The following statistical disclosures are included in Management’s Discussion and Analysis, Item 8 hereof, and are incorporated by reference in this Item 1:
 
  • Interest Rate Sensitivity Analysis;
 
  • Interest Income and Expense, Volume and Rate Analysis;
 
  • Investment Portfolio;
 
  • Loan Maturity and Interest Rate Sensitivity;
 
  • Loan Portfolio;
 
  • Allocation of Allowance for Loan Losses;
 
  • Deposits; and
 
  • Short-term Borrowings.

ITEM 2 PROPERTIES

PNB has four full-service banking offices in Susquehanna County that are located in:
 
  • Borough of Susquehanna Depot;
 
  • Hallstead Plaza, Great Bend Township;
 
  • Borough of Hop Bottom; and
 
  • Montrose, Bridgewater Township.

PNB’s presence in Wyoming County, Pennsylvania had been limited to a de novo branch in Nicholson, which opened in 1992, until the purchase of the two Mellon bank offices in 1997. The Wyoming County locations are:
 
  • Borough of Nicholson;
 
  • Meshoppen Township; and
 
  • Tunkhannock Borough.

The administrative/operations office of the Company and PNB is located at 50 Main Street, Hallstead, Pennsylvania. The following departments are located at that office:
 
  • commercial, mortgage and consumer lending operations;
 
  • executive offices;
 
  • marketing department;
 
  • human resources department;
 
  • deposit account support services;
 
  • data processing services; and
 
  • corporate accounting.
 
14

PNB began expanding its branch locations into New York in 2002. The latest updates on these expansions are:
 
  • The Bank had an office located in the Price Chopper Super Market in Norwich, Chenango County, New York. This office was purchased from Mohawk Community Bank, Amsterdam, New York, in March of 2002. A decision was made to close this office effective March 31, 2003, because of distance from Hallstead, high lease payments, and lack of growth opportunity for our Bank.
 
  • Subsequently, real estate was purchased in Conklin, New York, approximately 10 miles from Hallstead. Regulators approved permission to establish an office at that site and the official opening date was March 17, 2003. The office is located at 1026 Conklin Road and is approximately ten miles from the Administrative Office of PNB.
 
  • Also, on December 12, 2002, property was purchased at 108 Second Street, Town of Sanford, Village of Deposit, Broome County, New York. Regulatory approval has been received to establish this second New York State office, and construction is nearing completion on this office which is located approximately 25 miles from the Administrative Office.
 
  • The application has been approved for a third New York State office to be located on Front Street in the Town of Chenango, Broome County. Construction is nearing completion. This office will be approximately 20 miles from the Administrative Office.

All offices are owned in fee title by PNB with the exception of the Hallstead Plaza office and the Meshoppen office. The Hallstead Plaza and Meshoppen offices are subject to ground leases; and the Front Street office will be subject to a building lease. Each lease is either long-term expiring in September 2028 or includes renewal options. Current lease payments range from $2,535 to $21,600 annually. The leases provide that the Bank pay property taxes, insurance, and maintenance costs. Seven of the eight offices provide drive-up banking services and six offices have 24-hour ATM services.

ITEM 3 LEGAL PROCEEDINGS

On October 23, 2001, the Securities and Exchange Commission filed suit against Robert L. Bentley, his d/b/a Entrust Group and Bentley Financial Services, Inc. , alleging fraud in the sales of securities to financial institutions. Specifically, the Commission alleged that the defendants were representing to investors that they were selling bank-issued, federally insured certificates of deposit when they were actually selling uninsured securities issued by the defendants. The Commission alleged that the defendants violated the broker-dealer registration and the antifraud provisions of the federal securities laws. The Commission’s action seeks permanent injunctions prohibiting future violations of these provisions and others, disgorgement of the defendants’ ill gotten gains plus prejudgment interest, and civil penalties against each defendant. Additionally, the Commission’s action sought emergency injunctive and equitable relief consisting principally of a temporary restraining order, an order freezing each defendant’s assets and an order appointing a receiver. The Court granted the Commission’s request on October 24, 2001 for a temporary restraining order and, on November 7, 2001, appointed a receiver for Robert L. Bentley, Entrust Group and Bentley Financial Services, Inc. (collectively the Bentley Receivership Entities). The receiver was required to take control of all investments and assets of the Bentley Receivership Entities.
 
The Bank regularly invested through Entrust Group and Bentley Financial Services, Inc. for certificates of deposit that the Bank had understood were bank issued, federally insured and the Entrust Group was holding in safekeeping for them. As of December 31, 2002 and 2001, the Bank had $1,980,000 of these investments outstanding with Entrust Group. Based on preliminary information, management estimates the loss to be approximately $297,000, which has been charged against operations in the amount of $158,000 and $139,000 for the years ended December 31, 2002 and 2001, respectively, and the asset had been written down to $1,683,000. Since January 1, 2003, the Bank has recovered $1,793,000. On October 8, 2004, the Bank received the fourth disbursement from the bankruptcy receivership, which recaptured the full asset value on the Bank’s balance sheet of $ 1,683,000. The fourth disbursement also included an additional $10,000 which was a partial recovery of the charges against operations in the amounts of $158,000 and $139,000 in 2001 and 2002 respectively. On December 28, 2004, the Bank received a fifth disbursement from the bankruptcy   receivership for $100,000. The full amount of the fifth disbursement was posted as a partial recovery of the charges against operations in the amounts of $158,000 and $139,000 in 2001 and 2002, respectively.
 
The Company is a defendant in various lawsuits wherein various amounts are claimed. In the opinion of the Company’s management, these suits are without merit and should not result in judgments which, in the aggregate, would have a material adverse effect on the Company’s consolidated financial statements.
 

15

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 

NONE

PART II  

ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS  

The Company’s Common Stock is not listed on an exchange or quoted on the National Association of Securities Dealers, Inc. Automated Quotation system (NASDAQ). The Company’s common stock is traded sporadically in the over-the-counter market and, accordingly, there is no established public trading market at this time. The Company’s stock is listed on the OTC Bulletin Board under the symbol PFIS. The cusip number is 711040-10-5. The investment firms of Ryan Beck from Livingston, New Jersey, and Ferris, Baker Watts, Incorporated from Baltimore, Maryland, make a limited market in the Company’s common stock. The Company, and previously the Bank, have continuously paid dividends for more than 90 years and it is the intention to pay dividends in the future. However, future dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions, and other factors at the time that the Board of Directors considers dividend payments. As of December 31, 2004, there were 64,035 outstanding options to purchase the company’s common stock. See Note 9 of the Consolidated Financial Statements for more information. Book value of common stock at December 31, 2004, was $13.42 and on December 31, 2003, it was $12.98. As of December 31, 2004, the Company had approximately 990 shareholders of record. At such date, 3,155,801 shares of Common Stock were outstanding.

The following table reflects high bid and low asked prices for shares of the Company’s Common Stock to the extent such information is available, and the dividends declared with respect thereto during the preceding two years. All amounts are adjusted for the three-for-two stock split in 2003.

COMPANY STOCK
   
2004  
     
2003  
 
   
Price Range
     
 Dividends
 
 
 
Price Range
 
 
 
Dividends
 
 
 
Low    
 
 
 
 
 
High
 
 
 
 
 
Declared
         
Low
         
High
         
Declared
 
First Quarter
 
$32.40
$33.55
$0.18
$20.00
$22.87
$0.16
     
Second Quarter
 
$33.00
$34.50
$0.18
$22.87
$29.25
$0.16
     
Third Quarter
 
$33.05
$35.50
$0.18
$29.25
$32.50
$0.16
     
Fourth Quarter
 
$34.10
$36.00
$0.19
$31.50
$32.40
$0.17
     


The following table discloses the number of outstanding options, warrants and rights granted by the Company to participants in equity compensation plans, as well as the number of securities remaining available for future issuance under these plans. The table provides this information separately for equity compensation plans that have and have not been approved by security holders.

   
(a)
Number of securities to be issued upon exercise of outstanding options, warrants and rights
 
(b)
Weighted-average exercise price of outstanding options, warrants and rights
 
(c)
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
Equity compensation plans approved by stockholders
   
64,035
 
$
18.83
   
*75,278
 
                     
Equity compensation plans not approved by stockholders
   
0
   
0
   
0
 
                     
Total
   
64,035
 
$
18.83
   
75,278
 
                     
* Securities for future issuance are reserved and issued at the discretion of the Board of Directors on an annual basis.

16
The following table discloses the purchases made by the Company of shares of its common stock in the fourth quarter of 2004.


 
 
 
MONTH
 
 
Total number
of shares
purchased
 
 
Average
price paid
per share
 
Total number
of shares purchased
as part of publicly
announced plans or programs
 
Maximum number of
shares that may yet be
purchased under the
plans or programs (1)
 
                           
October 1, 2004 - October 31, 2004
   
0
   
-
   
0
   
126,116
 
 
         
             
November 1, 2004 - November 31, 2004
   
3,242
 
$
34.10
   
0
   
122,874
 
 
         
             
December 1, 2004 - December 30, 2004
   
0
   
-
   
0
   
122,874
 
TOTAL
   
3,242
 
$
34.10
   
0
       
 
( 1) On December 27, 1995, the Board of Directors authorized the repurchase of 187,500 shares of the Company’s common stock from shareholders. On July 2, 2001, the Board of Directors authorized the repurchase of an additional 5%, or 158,931 shares of the Company’s common stock outstanding. Neither repurchase program stipulated an expiration date.

ITEM 6 SELECTED FINANCIAL DATA  

Consolidated Financial Highlights
 
December  
 
Unaudited  
      
  2004
 
  2003
 
  2002
 
  2001
 
  2000
 
Performance
 
(In Thousands, except Per Share Data)

Net Income
 
$
4,453
 
$
5,564
 
$
5,015
    $
4,836
 
$
3,905
 
Return of Average Assets
   
1.18
%
 
1.54
%
 
1.52
%
 
1.62
%
 
1.42
%
Return on Average Equity
   
10.84
%
 
14.18
%
 
14.30
%
 
15.15
%
 
14.28
%
Shareholders' Value  
   
   
   
   
   
 
Earnings per Share, Basic
 
$
1.41
 
$
1.76
 
$
1.59
 
$
1.52
 
$
1.20
 
Earnings per Share, Diluted
   
1.40
   
1.75
   
1.59
   
1.52
   
1.20
 
Dividends
   
0.73
   
0.65
   
0.59
   
0.48
   
0.41
 
Book Value
   
13.42
   
12.98
   
12.17
   
10.69
   
9.54
 
Market Value
   
36.00
   
32.40
   
20.00
   
17.33
   
16.00
 
Market Value/Book Value Ratio
   
268.26
%
 
249.61
%
 
164.38
%
 
162.20
%
 
167.71
%
Price Earnings Multiple
 
$
25.59
 
$
18.41
 
$
12.57
 
$
11.40
 
$
13.33
 
Dividend Payout Ratio
   
51.91
%
 
36.96
%
 
36.89
%
 
31.62
%
 
35.15
%
Dividend Yield
   
2.03
%
 
2.07
%
 
3.03
%
 
2.77
%
 
2.58
%
Safety and Soundness  
   
   
   
   
   
 
Stockholders' Equity/Asset Ratio
   
11.16
%
 
11.06
%
 
11.05
%
 
10.70
%
 
10.71
%
Allowance for Loan Loss as a Percent of Loans
   
1.12
%
 
0.89
%
 
0.87
%
 
0.94
%
 
1.11
%
Net Charge Offs/Total Loans
   
0.17
%
 
0.06
%
 
0.03
%
 
0.06
%
 
0.05
%
Allowance for Loan Loss/Nonaccrual Loans
   
132.77
%
 
212.70
%
 
567.45
%
 
383.67
%
 
464.44
%
Allowance for Loan Loss/Non-performing Loans
   
116.29
%
 
192.20
%
 
367.87
%
 
306.28
%
 
381.43
%
Balance Sheet Highlights  
   
   
   
   
   
 
Total Assets
 
$
379,375
 
$
371,289
 
$
346,842
 
$
315,347
 
$
287,625
 
Total Investments
   
113,598
   
116,126
   
105,972
   
100,783
   
99,678
 
Net Loans
   
242,075
   
234,274
   
219,437
   
191,913
   
170,262
 
Allowance for Loan Losses
   
2,739
   
2,093
   
1,935
   
1,816
   
1,918
 
Short-term Borrowings
   
14,614
   
7,085
   
13,113
   
21,338
   
7,245
 
Long-term Borrowings
   
46,034
   
41,952
   
34,744
   
20,000
   
17,500
 
Total Deposits
   
274,775
   
279,700
   
259,187
   
238,891
   
230,739
 
Stockholders' Equity
 
$
42,354
 
$
41,076
 
$
38,323
 
$
33,754
 
$
30,852
 
 
17

ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This consolidated review and analysis of Peoples Financial Services Corp. (the Company) is intended to assist the reader in evaluating the Company’s performance for the years-ending December 2004, 2003, and 2002. The information should be read in conjunction with the consolidated financial statements and the accompanying notes to those statements.

Peoples Financial Services Corp. (the Company) is the one-bank holding company of Peoples National Bank (the Bank), which is wholly owned by the Company. The Company and the Bank derive their primary income from the operation of a commercial bank, including earning interest on loans and investment securities. The Bank incurs interest expense in relation to deposits and other borrowings. The Bank operates eight full-service branches in the Hallstead Shopping Plaza, Hop Bottom, Montrose, Susquehanna, Nicholson, Tunkhannock, and Meshoppen, Pennsylvania and Conklin, Broome County, New York. The Bank has on-site automated teller machines at all offices except Hop Bottom and Meshoppen. The administrative offices and operations offices are located in Hallstead, Pennsylvania. Principal market areas are Susquehanna and Wyoming Counties in Pennsylvania and the Southern Tier of Broome County, New York and the bordering areas of those counties. As of December 31, 2004, the Bank employed 97 full-time employees and 16 part-time employees.

Forward Looking Statements
When used in this discussion, the words “believes”, “anticipates”, “contemplated”, “expects”, or similar expressions are intended to identify forward looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward looking statements that may be made to reflect events or circumstances after this date or to reflect the occurrence of unanticipated events.

Critical Accounting Policies
Note 1 to the Company’s consolidated financial statements lists significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Bank to make estimates and assumptions. The Bank believes that its determination of the allowance for loan losses involves a higher degree of judgment and complexity than the Bank’s other significant accounting policies. Further, these estimates can be materially impacted by changes in market conditions or the actual or perceived financial condition of the Bank’s borrowers, subjecting the Bank to significant volatility of earnings.

The allowance for loan losses is established through the provision for loan losses, which is a charge against earnings. Provisions for loan losses are made to reserve for estimated probable losses on loans. The allowance for loan losses is a significant estimate and is regularly evaluated by the Bank for adequacy by taking into consideration factors such as changes in the nature and volume of the loan portfolio, trends in actual and forecasted credit quality, including delinquency, charge-off and bankruptcy rates, and current economic conditions that may affect a borrower’s ability to pay. The use of different estimates of assumptions could produce a different provision for loan losses. For additional discussion concerning the bank’s allowance for loan losses and related matters, see “Provision for Loan Losses”.
 
 
 
 
 

 
18

As permitted by SFAS No. 123, the Company accounts for stock-based compensation in accordance with Accounting Principals Board Opinion (APB) No. 25. Under APB No. 25, no compensation expense is recognized in the income statement related to any option granted under the Company stock option plans. The pro forma impact to net income and earnings per share that would occur if compensation expense was recognized, based on the estimated fair value of the options on the date of the grant, is disclosed in the notes to the consolidated financial statements. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123(R), “Share-Based Payment.” Statement No. 123(R) replaces Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt the new standard using a modified prospective method and may elect to restate prior periods using the modified retrospective method. The Bank will not elect to use the modified retrospective method. Under the modified prospective method, companies are required to record compensation cost for new and modified awards over the related vesting period of such awards prospectively and record compensation cost prospectively for the unvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modified prospective method. Statement No. 123(R) is effective for periods beginning after June 15, 2005. Early application of Statement No. 123(R) is encouraged, but not required. Adopting Statement No. 123(R) on July 1, 2005 using the modified prospective method, the Company estimates that total stock-based compensation expense, net of related tax effects, will increase by $4,000 for the year-ending December 31, 2005.

RESULTS OF OPERATIONS  
Net Interest Income
Net interest income is the main source of the Company’s income. It is the difference between interest earned on assets and interest paid on liabilities. The discussion of net interest income should be read in conjunction with Table 2: “Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential”, and Table 3: “Rate/Volume Analysis of Changes in Net Interest Income.”

The following table shows the net interest income on a fully-tax-equivalent basis for each of the three years-ending December 2004, 2003, and 2002.

TABLE 1

 NET INTEREST INCOME                                      Year-Ended December 31,
 (In Thousands)                          
                                                   
 
 
     2004  
 
  2003     2002        
 Total Interest Income    $ 19,959    $ 19,900    $ 20,490        
 Tax Equivalent Adjustment                 1,175      906      892         
 Total Tax Equivalent Interest Income     21,134      20,806      21382         
 Total Interest Expense     7,084      7,574      8,329         
 
Net Interest Income (Fully Tax Equivalent Basis)
   $  13,232     $ 13,232     $ 13,053         


Table 2 includes the average balances, interest income and expense, and the average rates earned and paid for assets and liabilities. Yields on tax-exempt assets have not been calculated on a fully-tax-equivalent basis. For yield calculation purposes, nonaccruing loans are included in average loan balances. Table 3 analyzes the components contributing to the changes in net interest income and indicates the impact in either changes in rate or changes in volume.
 
 
 
 
 
19

TABLE 2
 
Distribution of Assets, Liabilities and Stockholders' Equity
Interest Rates and Interest Differential


 
Year-Ended
December 31, 2004
Year-Ended
December 31, 2003
Year-Ended
December 31, 2002
(In Thousands)
Average
Balance
 
Interest
  Yield/
  Rate
Average
Balance
 
Interest
Yield/
Rate
Average
Balance
 
Interest
 Yield/
     Rate    
ASSETS

Loans
 
 
 
 
 
   
 
 
 
 
   
 
 
 
 
 
Real Estate
$
107,956
$
7,045
6.53
%
$
108,030
$
7,654
7.09
%
$
106,390
$
8,103
7.62
%
Installment
 
17,561
 
1,178
6.71
%
 
17,862
 
1,252
7.01
%
 
18,383
 
1,447
7.87
%
Commercial
 
99,935
 
6,208
6.21
%
 
93,781
 
5,907
6.30
%
 
76,244
 
5,282
6.93
%
Tax Exempt
 
14,937
 
593
3.97
%
 
8,993
 
379
4.21
%
 
9,332
 
409
4.38
%
Other Loans
 
648
 
47
7.25
%
 
627
 
44
7.02
%
 
569
 
45
7.91
%
Total Loans
 
241,037
 
15,071
6.25
%
 
229,293
 
15,236
6.60
%
 
210,918
 
15,286
7.25
%
Investment Securities (AFS)
 
 
 
 
 
   
 
 
 
 
   
 
 
 
 
 
Taxable
 
72,816
 
3,152
4.33
%
 
78,890
 
3,250
4.12
%
 
72,492
 
3,902
5.38
%
Non-Taxable
 
41,257
 
1,687
4.09
%
 
30,515
 
1,380
4.52
%
 
25,591
 
1,323
5.17
%
Total Securities
 
114,073
 
4,839
4.24
%
 
109,405
 
4,630
4.23
%
 
98,083
 
5,225
5.33
%
Fed Funds Sold
 
3,796
 
49
1.29
%
 
2,922
 
34
1.16
%
 
1,320
 
25
1.89
%
Total Earning Assets
 
358,906
$
19,959
5.56
%
 
341,620
$
19,900
5.80
%
 
310,321
$
20,536
6.62
%
Less: Allowance for Loan Losses
 
(2,398)
 
 
 
   
(2,027)
 
 
 
   
(1,858)
 
 
 
 
Cash and Due from Banks
 
6,535
 
 
 
   
6,598
 
 
 
   
5,987
 
 
 
 
Premises and Equipment, Net
 
4,644
 
 
 
   
4,331
 
 
 
   
3,621
 
 
 
 
Other Assets
 
11,130
 
 
 
   
10,502
 
 
 
   
11,651
 
 
 
 
Total Assets
$
378,817
 
 
 
 
$
361,024
 
 
 
 
$
329,722
 
 
 
 
(In Thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
 
 
 
 
 
   
 
 
 
 
   
 
 
 
 
 
Interest Bearing Demand
$
26,282
$
190
0.72
%
$
24,568
$
217
0.88
%
$
23,307
$
272
1.17
%
Regular Savings
 
63,414
 
637
1.00
%
 
58,926
 
763
1.29
%
 
55,887
 
1,068
1.91
%
Money Market Savings
 
39,778
 
559
1.41
%
 
35,254
 
536
1.52
%
 
34,316
 
731
2.13
%
Time
 
111,431
 
3,392
3.04
%
 
114,956
 
3,907
3.40
%
 
107,742
 
4,467
4.15
%
Total Interest Bearing Deposits
 
240,905
 
4,778
1.98
%
 
233,704
 
5,423
2.32
%
 
221,252
 
6,538
2.96
%
Other Borrowings
 
53,957
 
2,306
4.27
%
 
49,903
 
2,151
4.31
%
 
37,857
 
1,792
4.73
%
Total Interest Bearing Liabilities
 
294,862
 
7,084
2.40
%
 
283,607
 
7,574
2.67
%
 
259,109
 
8,330
3.21
%
Net Interest Spread
 
 
$
12,875
3.16
%
 
 
$
12,326
3.13
%
 
 
$
12,206
3.40
%
Non-Interest Bearing
 
 
 
 
 
   
 
 
 
 
   
 
 
 
 
 
Demand Deposits
 
41,315
 
 
 
   
36,607
 
 
 
   
33,662
 
 
 
 
Accrued Expenses and
 
 
 
 
 
   
 
 
 
 
   
 
 
 
 
 
Other Liabilities
 
1,554
 
 
 
   
1,572
 
 
 
   
1,891
 
 
 
 
Stockholder's Equity
 
41,086
 
 
 
   
39,238
 
 
 
   
35,060
 
 
 
 
Total Liabilities and
 
 
 
 
 
   
 
 
 
 
   
 
 
 
 
 
Stockholder's Equity
$
378,817
 
 
 
 
$
361,024
 
 
 
 
$
329,722
 
 
 
 
Interest Income/Earning Assets
 
 
 
 
5.52
%
 
 
 
 
5.83 
 
%
 
 
 
 
6.62
%
Interest Expense/Earning Assets
 
 
 
 
1.97
%
 
 
 
 
2.22
 
%
 
 
 
 
2.68
%
Net Interest Margin
 
 
 
 
3.59
%
 
 
 
 
3.61
%
 
 
 
 
3.93
%

 
20

TABLE 3

Rate/Volume Analysis of Changes in Net Interest Income  
   
2004 to 2003
 
2003 to 2002
 
(In Thousands)
 
Increase
Decrease
 
Change Due to
Rate
 
Volume
 
Increase
Decrease
 
Change Due to
Rate
 
Volume
 
Interest Income
                     
Real Estate Loans
 
 
$            (609
) 
$             (604
) 
$                 (5)
 
$                      (449
 
 
)
$              (565
) 
$               116
 
Installment Loans
 
(74
) 
(54
) 
(20)
 
(195
) 
(158
) 
(37
) 
Commercial Loans
 
301
 
(73
) 
374
 
625
 
(462
) 
1,087
 
Tax Exempt Loans
 
214
 
(22
) 
236
 
(30
) 
(16
) 
(14
) 
Other Loans
   
3
   
2
   
1
   
(1
)
 
(5
)
 
4
 
Total Loans
   
(165
)
 
(751
)
 
586
   
(50
)
 
(1,206
)
 
1,156
 
Investment Securities (AFS)
                                     
Taxable
   
(98
)
 
165
   
(263
)
 
(652
)
 
(916
)
 
264
 
Non-Taxable
   
307
   
(133
)
 
440
   
57
   
(166
)
 
223
 
Total Securities (AFS)
   
209
   
32
   
177
   
(595
)
 
(1,082
)
 
487
 
Time Deposits with Other Banks
   
0
   
0
   
0
   
0
   
0
   
0
 
Fed Funds Sold
   
15
   
4
   
11
   
9
   
(10
)
 
19
 
Total Interest Income
   
59
   
(715
)
 
774
   
(636
)
 
(2,298
)
 
1,662
 
                                       
Interest Expense
                                     
Interest Bearing Demand Deposits
   
(27
)
 
(39
)
 
12
   
(55
)
 
(66
)
 
11
 
Regular Savings Deposits
   
(126
)
 
(171
)
 
45
   
(305
)
 
(344
)
 
39
 
Money Market Savings Deposits
   
23
   
(41
)
 
64
   
(195
)
 
(209
)
 
14
 
Time Deposits
   
(515
)
 
(408
)
 
(107
)
 
(560
)
 
(805
)
 
245
 
Other Borrowings
   
155
   
(18
)
 
173
   
359
   
(160
)
 
519
 
Total Interest Expense
   
(490
)
 
(677
)
 
187
   
(756
)
 
(1,584
)
 
828
 
 
                                     
Net Interest Spread
 
$
549
 
$
(38
)
$
587
 
$
120
 
$
(714
)
$
834
 
                                       

Interest income on total loans decreased in 2004. This decrease of $165,000 is shown in Table 3. Lower interest rates had a negative impact on the Bank’s earnings of $751,000 in our year-to-year comparisons of loan interest income as shown in Table 3. Although loan growth had a positive impact on the bottom line of $586,000, it was not enough to keep the earnings on loans even with the previous year. Table 2 shows the average balance in loans grew from $229,293,000 in 2003 to $241,037,000 in 2004. A similar analysis can be seen in the total securities portfolio, but ending with different results because of rate. Investments grew from $109,405,000 in 2003 to $114,073,000 in 2004, the interest income for the year shows an increase of $209,000 compared to 2003. The increase in rate caused a positive impact to earnings of $32,000 as did the growth in the investment portfolio which added $177,000 more to earnings.

Interest income on taxable investments decreased $98,000 from 2003 due to fewer investments in taxable. Average taxable investments, as shown in Table 2, were $72,816,000 in 2004 compared to $78,890,000 in 2003. Due to the higher rates however, interest income on taxable investments only dropped $98,000. Interest income on non-taxable investments increased $307,000 from 2003 due to more volume. Average non-taxable investments were $41,257,000 in 2004 compared to $30,515,000 in 2003. Interest income from federal funds sold increased $15,000 from 2003 to 2004 because of more volume and higher interest rates, as shown in Table 3. Average federal funds sold was $3,796,000 in 2004 compared to $2,922,000 in 2003. Again, as is the case with investments, interest income on federal funds increased in 2004 due to higher interest rates and more volume.
 
 

 
21

For comparison, interest income on total loans decreased in 2003 from 2002. Lower interest rates had a negative impact on the Bank’s earnings of $1,264,000 in our year-to-year comparisons of loan interest income as shown in Table 3. Although loan growth had a positive impact on the bottom line of $1,214,000, it was not enough to keep the earnings on loans even with the previous year. Table 2 shows the average balance in loans grew from $210,918,000 in 2002 to $229,293,000 in 2003. A similar analysis can be seen in the total securities portfolio. Although investments grew from $98,083,000 in 2002 to $109,405,000 in 2003, the interest income for the year shows a decrease of $595,000 compared to 2002. The decrease in rate caused a negative impact to earnings of $1,082,000 which was diminished somewhat by the growth in the investment portfolio which added $487,000 to earnings.

On the interest expense side, average deposits grew during 2004 by $7,201,000 as shown in the average balance comparisons in Table 2. This added more expense for 2004, as shown in Table 3, as $14,000 in the “Volume” column. The decrease in rates helped this side of the balance sheet with reducing interest expense by $659,000 on deposits. The rate effect also caused a decrease of $18,000 on borrowed funds. We did add more in other borrowings this year as shown in Table 2. The average borrowings in 2003 were $49,903,000 compared to an average of $53,957,000 in 2004. Borrowing these funds cost the Bank an additional $173,000 for the year as shown in Table 3.

For comparison, all the categories of deposits grew during 2003, when compared to 2002, as shown in the average balance comparisons in Table 2. This added more expense for 2003, as shown in Table 3, as $309,000 in the “Volume” column. The decrease in rates helped this side of the balance sheet with reducing interest expense by $1,424,000 on deposits and another $160,000 on borrowed funds. We did add more in other borrowings as shown in Table 2. The average borrowings in 2002 were $37,857,000 compared to an average of $49,903,000 in 2003. Borrowing these funds cost the Bank an additional $519,000 for the year.

On Table 3, you can see that the Bank increased its net interest income from $120,000 in 2003 to $549,000 in 2004. The negative effect of rate on total interest income in the change from 2003 to 2002 was significantly higher at $2,451,000 compared to the negative rate effect in 2004 to 2003 at $715,000. The total interest expense side also shows less impact by rate when comparing the year-to-year changes. In the 2003 to 2002 totals, total interest expense was affected by rate at $1,584,000 while 2004 to 2003 showed less of an effect at $677,000.

The net effect of the income and expense changes, comparing 2004 to 2003, is shown in the last row of Table 3. The Bank increased net interest income by $549,000 from 2003 to 2004. Net interest income was reduced by $38,000 in rate on its existing portfolio, and gained $587,000 in additional revenue from new business.


PROVISION FOR LOAN LOSS  
The provision and allowance for loan losses are based on management’s ongoing assessment of the Company’s credit exposure and consideration of other relevant factors. The allowance for loan losses is a valuation reserve that is available to absorb future loan charge-offs. The provision for loan losses is the amount charged to earnings on an annual basis. The factors considered in management’s assessment of the reasonableness of the allowance for loan losses include prevailing and anticipated economic conditions, assigned risk ratings on loan exposures, the results of examinations and appraisals of the loan portfolio conducted by federal regulatory authorities and an independent loan review firm, the diversification and size of the loan portfolio, the level of and inherent risk in non-performing assets, and any other factors deemed relevant by management.

The provision for loan losses was $1,050,000, $289,000 and $180,000 for the years 2004, 2003, and 2002, respectively. Net charge-offs for 2004 were $404,000 compared to $131,000 in 2003. As of December 31, 2004, the allowance for loan loss was 1.12% of loans and at December 31, 2003, the ratio was 0.89% of loans. After allocation of reserves to all non-accrual and special-mention loans, as well as applying a percentage of outstanding loans based on the loss history of such loans in each category, the opinion of management was that the provision for loan loss was proper and sufficient. The ratio of allowance for loan loss to non-performing loans was 116.29% at year-end 2004 compared to 192.20% at year-end 2003 and 367.87% at year-end 2002.
 
 

 
22

OTHER INCOME  
Non-Interest Income  
Non-interest income includes items that are not related to interest rates, but rather to services rendered and activities conducted in conjunction with the operation of a commercial bank. Service charges earned on deposit accounts is the largest single item in this category and represents fees related to deposit accounts including overdraft fees, minimum balance fees, and transaction fees. In 2004, service charges and fees increased $193,000 or 14.89% compared to an increase of $109,000 in 2003, when compared to 2002 or 9.18%.

There was an overall decrease in non-interest income of $859,000 in 2004. This decrease of 33.15% is due primarily to an other-than-temporary security impairment incurred in the fourth quarter of 2004. The Company owns four preferred equity securities issued by FNMA and FHLMC with aggregate market value depreciation of 20% or more from the Company’s amortized cost basis of $5,000,000. Management had been closely monitoring the market valuations of these preferred equity securities and recent adverse financial events regarding these agencies, and has concluded that these securities are other-than-temporarily impaired under guidance provided by the Financial Accounting Stands Board (FASB). Thus, an impairment charge of $1,144,000 was recorded in other income in the fourth quarter of 2004. Without the security impairment in the current year, non-interest income would show an increase of $285,000 or 11%. A major component of non-interest income, which reflects a significant increase, is income realized on overdrafts of $1,029,000 in 2004 compared to $845,000 in 2003. In addition to the overdraft fee being increased in the fourth quarter of 2003 to $30 from $25, the Company entered into an overdraft privilege program in June of 2004 which significantly increased the amount of overdraft fees recognized by the Company. Commissions earned by the Investment Division in 2004 were $426,000 compared to $182,000 in 2003, an increase of $244,000 or 134.07%. In 2004, the Bank added five Licensed Bank Employees to the Investment Division. These employees are licensed to sell life insurance and annuity products. Due to a high demand for these products within the Bank’s operating regions, sales and related commissions increased dramatically in 2004 when compared to 2003. Other income increased by $180,000 or 72.29% in 2004 to $429,000, compared to $249,000 in 2003. The two major components of other income, which contributed to this increase, were 2004 receipts which surpassed the net fraud claim involving certificates of deposit invested in through Entrust Group and Bentley Financial Services, Inc., in the amount of $110,000, and fees earned through the sale of mortgage loans to the Federal Home Loan Bank of Pittsburgh, which amounted to $61,000 in 2004. Both of these events were new in 2004. Realized gains on the sale of available-for-sale securities were a component of non-interest income which showed a decrease in 2004. Realized gains in 2004 were $296,000, a decrease of $366,000 or 55.29%. Non-interest income increased $1,307,000 from $1,284,000 in 2002, to $2,591,000 in 2003, an increase of 101.79%. Again, an $850,000 security impairment in 2002 was the cause of this increase. Without the security impairment in 2002, other income would have shown an increase of $457,000 or 21.42% when comparing 2003 to 2002. The remaining increase in 2003 was due primarily to realized gains on available-for-sale securities in the amount of $662,000 compared to $324,000 in 2002.

The following table analyzes the increase in total other income by comparing the years-ending 2004 and 2003:

TABLE 4

INCOME  
   
December 31,  
 
Variance 2004  
 
  Variance 2003  
 
   
2004  
 
2003  
 
2002  
 
Amount
Of Change  
 
  Percent
Of Change  
 
  Amount
Of Change  
 
Percent
Of Change  
 
Customer Service Fees
       
$
1,489
       
$
1,296
       
$
1,187
 
$
193
   
14.89
%
$
109
   
9.18
%
Investment Division Commission Income
         
426
         
182
         
153
   
244
   
134.07
%
 
29
   
18.95
%
Earnings on Investment on Life Insurance
         
236
         
202
         
211
   
34
   
16.83
%
 
(9
)
 
(4.27
%)
Other Income
         
429
         
249
         
259
   
180
   
72.29
%
 
(10
)
 
(3.86
%)
Gains on Security Sales
         
296
         
662
         
324
   
(366
)
 
(55.29
%)
 
338
   
104.32
%
Impairment of Securities
         
(1,144
)
       
0
         
(850
)
 
(1,144
)
 
100.00
%
 
850
   
(100.00
%)
TOTAL Other Income
       
$
1,732
       
$
2,591
       
$
1,284
 
$
(859
)
 
(33.15
%)  
$
1,307
   
101.79
%
 
 

 

23

OTHER EXPENSE  
Non-Interest Expense  
Total non-interest expense increased $856,000 from $7,234,000 in 2003 to $8,090,000 in 2004. This is an increase of 11.83%.

Non-interest expense includes all other expenses associated with the Company. Salaries and related benefits is the largest expense in this category and it increased $354,000 or 9.58% over year-end 2003. The full-time equivalent number of employees was 104 as of December 31, 2004 compared to 97 as of December 31, 2003 due to the addition of staff in 2004 when compared to 2003. A portion of the additional staff was hired in 2004 in preparation for 2005 branch expansion. In addition to the increased staff size, normal yearly pay increases and increased health insurance costs contributed to the overall increase in salary and benefit expense. In comparison, the increase in this category from 2002 to 2003 was 10.70% or $357,000. New employees and annual salary increases, along with an increase for health insurance were the reasons for the 2003 increase.

Occupancy expense increased 10.63% or $47,000 in 2004 as compared to 2003, when occupancy expense increased 10.78% or $43,000. The increase in 2004 can be attributed to increased heating costs experienced during the winter months of 2004.

Furniture and equipment expense increased in 2004 to $336,000 or 12.37% compared to 2003 at $299,000 which was down from 2002 expenses of $323,000. The increase in 2004 is associated with depreciation expense incurred on additional computer software and equipment placed in service in 2004.

Professional fees, which includes outside services, continues to increase as management and the Company find it efficient and cost effective to utilize outside services and consultants to facilitate management and operations. Professional fees and outside services were $297,000 in 2004 which compares to $240,000 in 2003 and $229,000 in 2002. The increase in 2004 is due to increased costs incurred by the Company in relation to testing and compliance with section 404 of the Sarbanes-Oxley Act of 2002 and consulting performed in connection with a new personal computer network and on-line teller system installed at the Bank’s branch offices.

Computer services and supplies is another component of other expenses and it is as its name implies. This category covers the expense of data processing for the Company. Each year, dependence grows as does the resultant expense. In 2004, the expense was $617,000 compared to $521,000 in 2003 and $477,000 in 2002. Technology has proven to be expensive, but necessary to provide excellent customer service and maintain efficiencies.

Taxes, other than payroll and income, are another component of non-interest expense and in 2004, this expense was $383,000 compared to $311,000 in 2003, an increase considered to be normal. In 2002 taxes were $320,000.

Every other non-interest expense is in the category of other. In 2004, this expense increased $188,000 or 11.81% and the total for 2004 is $1,780,000. The biggest components in this figure were: the amortization of premiums on the purchase of the Tunkhannock, Meshoppen, and Conklin branch offices at $262,000; directors’ and associate directors’ fees, and employee education costs of $293,000; stationary printing and supplies, $171,000; postage at $147,000; advertising at $123,000; expenses associated with other real estate owned in the amount of $166,000; and ATM expenses of $238,000. All were deemed to be in line with budget expectations, with the exception of expenses on other real estate owned which were dramatically increased due to the foreclosure of two large commercial loan accounts in 2003 and 2004.
 
 

 
24

TABLE 5

EXPENSE  
(In thousands)
 
 
December 31,
 
 
Variance 2004
 
 
Variance 2003
 
   
2004  
 
2003  
 
2002
 
Amount Of Change  
 
Percent Of Change  
 
Amount Of Change  
 
Percent Of Change  
 
Salaries and Benefits
 
$
4,048
 
$
3,694
 
$
3,337
 
$
354
   
9.58
%
$
357
   
10.70
%
Occupancy Expenses
   
489
   
442
   
399
   
47
   
10.63
%
 
43
   
10.78
%
Furniture and Equipment Expense
   
336
   
299
   
323
   
37
   
12.37
%
 
-24
   
-7.43
%
FDIC Insurance and Assessments
   
140
   
135
   
129
   
5
   
3.70
%
 
6
   
4.65
%
Professional Fees and Outside Services
   
297
   
240
   
229
   
57
   
23.75
%
 
11
   
4.80
%
Computer Services and Supplies
   
617
   
521
   
477
   
96
   
18.43
%
 
44
   
9.22
%
Taxes, Other Than Payroll and Income
   
383
   
311
   
320
   
72
   
23.15
%
 
-9
   
-2.81
%
Other Operating Expenses
   
1,780
   
1,592
   
1,574
   
188
   
11.81
%
 
18
   
1.14
%
Total Non-Interest Expense
 
$
8,090
 
$
7,234
 
$
6,788
 
$
856
   
11.83
%
$
446
   
6.57
%

FEDERAL INCOME TAXES  
The provision for income taxes was $1,014,000 in 2004 compared to $1,830,000 in 2003 and $1,553,000 in 2002. The effective tax rate, which is the ratio of income tax expense to income before taxes, was 19% in 2004, 25% in 2003, and 24% in 2002. The tax rate for all periods was substantially less than the federal statutory rate of 34% primarily due to tax-exempt securities and tax-exempt loan income. Please refer to Note 10 of the Notes to Consolidated Financial Statements included as part of this report for further analysis of federal income tax expense for 2004.

QUARTERLY RESULTS  
Table 6 shows the quarterly results of operation for the Company for 2004. Interest Income increased in the latter two quarters of 2004. This was due to the Federal Reserve Bank’s rate increases implemented in 25 basis point increments and the resulting 25 basis point increase to the Prime Rate. The first increase occurred on June 30, 2004, and continued at each meeting of the Federal Reserve’s Open Market Committee (FOMC) throughout the remainder of 2004. By December 31, 2004, the overnight funds rate had increased to 2.25% from 1.00% in the first half of 2004 and the Prime Rate had increased to 5.25% from 4.00% in the first half of 2004. Many of the Bank’s loans are tied directly to Prime and this accounts for the increase in interest income.

Interest expense has also increased slightly in the latter two quarters of 2004 due to the reasons outlined in the previous paragraph. Many deposit accounts are tied to indexes which reflect closely the short-end of the yield curve (Fed Funds) and therefore, as rates go up in 25 basis point increments, so does the resulting interest expense.

Table 6 also shows that less gains were taken in sales of available-for-sale securities in 2004 when compared to 2003. This was due in part to increasing yields in the bond markets which increased with Federal Reserve rate increases. When this happens, yields within the Bank’s portfolio become less attractive and the marketability or market value of bonds in that portfolio decrease. The result is that the Bank has fewer securities that can be sold at a gain.

Other income increased steadily throughout 2004. Two factors contributed to this increase. First, the Bank implemented an overdraft privilege program in June of 2004. With this program, the Bank saw its overdraft fees increase in the latter half of 2004. The Bank also recognized a dramatic increase in commission income from its Investment Division with the addition of five Licensed Bank Employees (LBE’s). The LBE’s are licensed to sell life insurance and annuity products on behalf of the Bank.

Other expenses are relatively steady throughout 2004. Slight increases were incurred for professional services contracted for by the Bank in relation to testing and compliance with Section 404 of the Sarbanes Oxley Act of 2002. Additionally, some increased occupancy expenses were experienced due to increased winter heating costs in 2004.
 

 
25

Earnings per common shares decreased in the second and fourth quarters of 2004. The decrease in the second quarter was due to the provision for an impaired loan relationship recorded in May 2004 in the amount of $741,000. In the fourth quarter, the Bank recorded an other-than-temporary loss impairment on $5,000,000 in FNMA and FHLMC Agency Preferred Equity securities. The after-tax effect to earnings was a negative $755,000. Refer to Note 1 in the Notes to Consolidated Financial Statements for an analysis of earnings per share.

TABLE 6

Quarterly Results of Operations  
(In thousands, except for per share data)
   
Quarter Ended 2004
 
   
31-Mar
 
30-Jun
 
30-Sep
 
31-Dec
 
Interest Income
 
$
4,973
 
$
4,926
 
$
5,017
 
$
5,043
 
Interest Expense
   
(1,762
)
 
(1,758
)
 
(1,785
)
 
(1,779
)
Net Interest Income
   
3,211
   
3,168
   
3,232
   
3,264
 
Provision for Loan Loss
   
(159
)
 
(741
)
 
(150
)
 
-
 
Securities Gains/Losses
   
55
   
21
   
105
   
115
 
Impairment of Security
   
-
   
-
   
-
   
(1,144
)
Other Income
   
562
   
603
   
668
   
747
 
Other Expense
   
(1,974
)
 
(2,037
)
 
(2,042
)
 
(2,037
)
Income Before taxes
   
1,695
   
1,014
   
1,813
   
945
 
Income Taxes
   
(398
)
 
(123
)
 
(394
)
 
(99
)
Net Income
 
$
1,297
 
$
891
 
$
1,419
 
$
846
 
Basic Earnings per share
 
$
0.41
 
$
0.28
 
$
0.45
 
$
0.27
 
Diluted Earnings per share
 
$
0.41
 
$
0.28
 
$
0.44
 
$
0.27
 
 
 
Quarter Ended 2003   
   
    31-Mar       
30-Jun
   
30-Sep
   
31-Dec
 
Interest Income
 
$
4,977
 
$
4,906
 
$
4,920
 
$
5,097
 
Interest Expense
   
(1,939
)
 
(1,943
)
 
(1,869
)
 
(1,823
)
Net Interest Income
   
3,038
   
2,963
   
3,051
   
3,274
 
Provision for Loan Loss
   
(60
)
 
(60
)
 
(60
)
 
(109
)
Securities Gains/Losses
   
57
   
139
   
456
   
10
 
Other Income
   
476
   
488
   
498
   
467
 
Other Expense
   
(1,763
)
 
(1,819
)
 
(1,751
)
 
(1,901
)
Income Before taxes
   
1,748
   
1,711
   
2,194
   
1,741
 
Income Taxes
   
(454
)
 
(433
)
 
(591
)
 
(352
)
Net Income
 
$
1,294
 
$
1,278
 
$
1,603
 
$
1,389
 
Basic Earnings per share
 
$
0.41
 
$
0.40
 
$
0.51
 
$
0.44
 
Diluted Earnings per share
 
$
0.41
 
$
0.40
 
$
0.50
 
$
0.44
 

RETURN ON AVERAGE ASSETS AND AVERAGE EQUITY  
Return on average assets (ROA) measures the Company’s net income in relation to its total average assets. The Company’s ROA for 2004 was 1.18%, compared to 1.54% in 2003.

Return on average equity (ROE) indicates how effectively the Company can generate net income on the capital invested by its stockholders. ROE is calculated by dividing net income by average stockholders’ equity. For purposes of calculating ROE, average stockholders’ equity includes the effect of unrealized gains (losses), net of income taxes, on securities available for sale, reflected as accumulated other comprehensive income. Reference should be made to Note 3 in the Notes to Consolidated Financial Statements for an analysis of securities available for sale. The Company’s ROE for 2004 was 10.84%, compared to 14.18% for 2003.

26

FINANCIAL CONDITION  
The Company’s financial condition can be evaluated in terms of trends in its sources and uses of funds. The following table illustrates how the Company has managed its sources and uses of funds that are directly affected by outside economic factors, such as interest rate fluctuations:

TABLE 7

Sources, Uses of Funds  
(In thousands)

   
2004
 
2003
 
2002
 
   
Average
 
Increase(Decrease)
 
Average
 
Increase(Decrease)
 
Average
 
Funding Uses
 
Balance
 
Amount
 
Percent
 
Balance
 
Amount
 
Percent
 
Balance
 
Real Estate Loans
 
$
107,956
 
$
(74
)
 
-0.07
%
$
108,030
 
$
1,640
   
1.54
%
$
106,390
 
Consumer Loans
   
17,561
   
(301
)
 
-1.69
%
 
17,862
   
(521
)
 
-2.83
%
 
18,383
 
Commercial Loans
   
99,935
   
6,154
   
6.56
%
 
93,781
   
17,537
   
23.00
%
 
76,244
 
Tax Exempt Loans
   
14,937
   
5,944
   
66.10
%
 
8,993
   
(339
)
 
-3.63
%
 
9,332
 
Other Loans
   
648
   
21
   
3.35
%
 
627
   
58
   
10.19
%
 
569
 
Total Loans
   
241,037
               
229,293
               
210,918
 
Less Allowance for Loan Loss
   
(2,398
)
             
(2,027
)
             
(1,858
)
Total Loans with Loan Loss
   
238,639
   
11,373
   
5.00
%
 
227,266
   
18,206
   
8.71
%
 
209,060
 
Taxable Securities (Include CDS)
   
72,816
   
(6,074
)
 
-7.70
%
 
78,890
   
6,398
   
8.83
%
 
72,492
 
Non-Taxable Securities
   
41,257
   
10,742
   
35.20
%
 
30,515
   
4,924
   
19.24
%
 
25,591
 
Total Securities
   
114,073
   
4,668
   
4.27
%
 
109,405
   
11,322
   
11.54
%
 
98,083
 
Fed Funds Sold
   
3,796
   
874
   
29.91
%
 
2,922
   
1,602
   
121.36
%
 
1,320
 
Total Uses
 
$
356,508
 
$
16,915
   
4.98
% 
$
339,593
 
$
31,130
   
10.09
% 
$
308,463
 
                                             
   
2004
2003
 
2002
 
 
    Average    
Increase(Decrease)
 
Average
 
Increase(Decrease)
 
Average
 
Funding Sources
   
Balance
   
Amount
   
Balance
   
Balance
   
Percent
   
Percent
   
Balance
 
Interest Bearing Demand Deposits
 
$
26,282
 
$
1,714
   
6.98
%
$
24,568
 
$
1,261
   
5.41
%
$
23,307
 
Regular Savings Deposits
   
63,414
   
4,488
   
7.62
%
 
58,926
   
3,039
   
5.44
%
 
55,887
 
Money Market Savings Deposits
   
39,778
   
4,524
   
12.83
%
 
35,254
   
938
   
2.73
%
 
34,316
 
Time Deposits
   
111,431
   
(3,525
)
 
-3.07
%
 
114,956
   
7,214
   
6.70
%
 
107,742
 
Total Interest Bearing Deposits
   
240,905
   
7,201
   
3.08
%
 
233,704
   
12,452
   
5.63
%
 
221,252
 
Other Borrowing
   
53,957
   
4,054
   
8.12
%
 
49,903
   
12,046
   
31.82
%
 
37,857
 
Short-Term Funds Borrowed
   
9,809
               
8,750
               
7,183
 
Long-Term Funds Borrowed
   
44,148
               
41,153
               
30,674
 
Total Funds Borrowed
   
53,957
               
49,903
               
37,857
 
Total Deposits and Funds Borrowed
   
294,862
               
283,607
               
259,109
 
Other Sources, net
   
61,646
               
55,986
               
49,354
 
Total Sources
 
$
356,508
             
$
339,593
             
$
308,463
 

 
 
 


27

Total assets increased 2.1% to $379,375,000 in the year-ending December 31, 2004. There were increases in both short-term and long-term borrowings on the liability side, which fueled this growth of assets. Loan portfolios on the asset side reflected growth also, with the most significant growth occurring in commercial loans. In 2003, total assets increased 7.05% to $371,289,000.

Investments at year-end 2004 totaled $113,598,000 compared to $116,126,000 on December 31, 2003.

The Bank’s long-term borrowings increased $4,082,000 or 9.73%, ending the year at $46,034,000 compared to $41,952,000 at December 31, 2003, while short-term borrowings increased to $14,614,000 at year-end 2004 compared to $7,085,000 the previous year. With rates remaining at or near historical lows, long-term borrowings have been attainable at attractive rates. Refer to the Consolidated Balance Sheet found in the financial statements for further information.

Loan Portfolio Types  
In 2004, loans to commercial borrowers helped fuel the growth in net loans. Mortgage loans decreased slightly, lower interest rates and mortgage finance companies made growth in this part of our loan portfolio tougher.

TABLE 8

Loan Portfolio
(In thousands)

                       
   
Dec 2004
 
Dec 2003
 
Dec 2002
 
Dec 2001
 
Dec 2000
 
     Commercial
 
$         119,641
 
$         112,617
 
$            95,113
 
$            73,422
 
$            58,204
 
     Real Estate Mortgage
 
106,454
 
105,949
 
107,756
 
101,934
 
94,429
 
     Installment
 
18,375
 
17,525
 
18,385
 
18,414
 
19,681
 
Total Loans
 
244,470
 
236,091
 
221,254
 
193,770
 
172,314
 
Deferred Loans
   
344
   
276
   
118
   
(41
)
 
(134
)
Total Loans, net of Deferred
   
244,814
   
236,367
   
221,372
   
193,729
   
172,180
 
Allowance for Loan Loss
   
(2,739
)
 
(2,093
)
 
(1,935
)
 
(1,816
)
 
(1,918
)
Net Loans
 
$
242,075
 
$
234,274
 
$
219,437
 
$
191,913
 
$
170,262
 

Loans continued to increase in 2004, ending the year with $242,075,000 in net loans compared to $234,274,000 at year-end 2003, an increase of 3.33%. Commercial loans were up 6.24% to close the year at $119,641,000 compared to $112,617,000 at year-end 2003.

Mortgages were up .50% to $106,454,000 compared to $105,949,000 on December 31, 2003, an increase of $505,000. Although our mortgage portfolio grew slightly in 2004, what is not reflected is the $3,392,000 in mortgages sold to the FHLB of Pittsburgh. We began selling mortgages in the fourth quarter of 2003 to attract and retain mortgage loans. We still believe that the mortgage portfolio will decrease going forward, due to continued sales to the FHLB of Pittsburgh.

The continued growth in commercial lending was due, in part, to a concerted effort on our part to continue to increase our exposure to this business segment.

Loan Maturities  
Table 9 shows the breakdown in maturity and type of our loan portfolio, net of non-accrual loans.

The Bank has 15.54% of its loans maturing within the next year. Of those maturing within one year, the majority are commercial loans with the remainder split between mortgages and consumer loans. In the one-to-five year maturity range, the Bank has 24.22% of its loan portfolio maturing. The over-five-year maturity group makes up 60.24% of the portfolio.

28

For comparison, at December 31, 2003, the Bank had 19.04% of its loans maturing within one year. Of those maturing within one year, the majority again were commercial loans with the remainder split between mortgages and consumer loans. In the one-to-five year maturity range, the Bank had 25.73% of its portfolio. The over-five-year maturity group made up 55.23% of the portfolio, which again reflected the Bank’s significant investment in mortgages. Mortgages were 45.06% of the total loan portfolio.

TABLE 9
(In thousands)
                   
 
 
 
 
Over One Year
 
 
 
 
 
 
 
One Year Or Less
 
Within Five Years
 
Over Five Years
 
Total Loans
 
Commercial
 
$
26,678
 
$
30,954
 
$
59,947
 
$
117,579
 
Real-Estate Construction
   
0
   
0
   
0
   
0
 
Real-Estate Mortgage
   
6,024
   
19,286
   
81,144
   
106,454
 
Installment
   
4,968
   
8,477
   
4,930
   
18,375
 
Total
 
$
37,670
 
$
58,717
 
$
146,021
 
$
242,408
 
                           
Total Loans with Predetermined Rates
 
$
15,719
 
$
29,269
 
$
33,518
 
$
78,506
 
Total Loans with Variable Rates
   
21,951
   
29,448
   
112,503
   
163,902
 
Total
 
$
37,670
 
$
58,717
 
$
146,021
 
$
242,408
 

Table 10 reflects the Company’s non-accrual and past due loans for each of the past five years. A commercial loan is generally placed on non-accrual when the contractual payment of principal or interest has become 90 days past due or when management has serious doubts about further collectibility of principal or interest even though the loan is currently performing. Consumer loans, including mortgages, are generally placed on non-accrual at 120 days. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured.

TABLE 10

Non-performing Loans  
 
(In thousands)
 
December 31,
 
   
2004
 
2003
 
2002
 
2001
 
2000
 
Non-accrual and Restructured
 
$
2,063
 
$
984
 
$
341
 
$
473
 
$
413
 
Loans Past Due 90 or More Days, Accruing Interest
   
130
   
105
   
185
   
120
   
90
 
Total Nonperforming Loans
   
2,193
   
1,089
   
526
   
593
   
503
 
Foreclosed Assets
   
257
   
115
   
154
   
79
   
50
 
Total Nonperforming Assets
 
$
2,450
 
$
1,204
 
$
680
 
$
672
 
$
553
 
Nonperforming Loans to Total Loans at Period-end
   
.91
%
 
0.47
%
 
0.24
%
 
0.31
%
 
0.29
%
Nonperforming Assets to Period-end Loans and Foreclosed Assets
   
1.01
%
 
0.52
%
 
0.31
%
 
0.35
%
 
0.32
%
 
               
   
       
Interest Income That Would Have Been Recorded Under
 
$
94
 
$
62
 
$
66
 
$
70
 
$
52
 
Original Terms
                               
Interest Income Recorded During the Period
 
$
35
 
$
3
 
$
17
 
$
6
 
$
18
 
                                 
                                 
Commitments To Lend Additional funds
 
$
0
 
$
0
 
$
0
 
$
0
 
$
0
 
                                 

29

Allowance for Loan Losses  
The balance in the allowance for loan losses is based on management’s assessment of the risk in the loan portfolio. Allocations to specific commercial loans are made in adherence to SFAS 114, Accounting by Creditors for Impairments of a Loan. These allocations are based upon the present value of expected future cash flows or the fair value of the underlying collateral. In addition, management reviews the other components of the loan portfolio through the loan review function and assigns internal grades to loans based upon the perceived risks inherent in each loan. In that determination, management reviews a number of factors including historical analysis of similar credits, delinquency reports, ratio analysis as compared to peers, concentration of credit risks, local economic conditions, and regulatory evaluation of the allowance for loan losses. This evaluation is reviewed monthly by management and by the Board of Directors. Management believes that on December 31, 2004, the allowance for loan losses was adequate to absorb potential losses in the loan portfolio. However, this judgment is subjective and a significant degradation in loan quality could require a change in the estimates and therefore, a change in net income.

In 2004, asset quality remained high and past dues continued to remain level. Although trends continued to be positive, the Bank allotted $1,050,000 for provision for loan losses in 2004. The increase in the provision was due in part to a couple of factors; (1) the Bank down graded a large commercial loan to non-accrual and impaired status, and provided an allocation of the allowance of $741,000, and (2) increase in net charge-offs in 2004.

The following is a summary of loans charged off, recoveries and provisions to the allowance for loan losses for the periods presented.

TABLE 11

Summary of Loan Loss Experience  
(In thousands)

   
Years Ended
 
   
Dec 2004
 
Dec 2003
 
Dec 2002
 
Dec 2001
 
Dec 2000
 
Average Total Loans
 
$        241,037
 
$        229,293
 
$        210,919
 
$        180,833
 
$        162,928
 
Balance at Beginning of Period
 
$            2,093
 
$            1,935
 
$            1,816
 
$            1,918
 
$            1,756
 
Charge Offs
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
335
 
94
 
19
 
25
 
0
 
Residential Real Estate
 
0
 
10
 
5
 
35
 
4
 
Installment
   
108
   
81
   
92
   
125
   
115
 
Total charge Offs
   
443
   
185
   
116
   
185
   
119
 
Recoveries
   
   
   
   
   
 
Commercial
   
12
   
21
   
24
   
14
   
0
 
Real Estate
   
0
   
5
   
1
   
14
   
11
 
Installment
   
27
   
28
   
30
   
35
   
30
 
Total Recoveries
   
39
   
54
   
55
   
63
   
41
 
Net Charge-Offs
   
404
   
131
   
61
   
122
   
78
 
Provision for Loan Losses
   
1050
   
289
   
180
   
20
   
240
 
Balance at End of Period
 
$
2,739
 
$
2,093
 
$
1,935
 
$
1,816
 
$
1,918
 
Allowance for Credit Losses to Period-end Total Loans
   
1.12
%
 
0.89
%
 
0.87
%
 
0.94
%
 
1.11
%
Allowance for Credit Losses to Non-accrual Loans
   
132.77
%
 
212.70
%
 
567.45
%
 
383.67
%
 
464.44
%
Net Charge-Offs to Average Loans
   
0.17
%
 
0.06
%
 
0.03
%
 
0.07
%
 
0.05
%
 

30

The following table details the allocation of the allowance for loan losses to various categories:
 
Allocation of Allowances
(In thousands)
 
 
 
 
Dec 2004
 
 % of Loan Type t  Total Loans
 
 
Dec 2003
 
 % of Loan Type to Total Loans
 
 
Dec 2002
   % of Loan Type to Total Loans  
Commercial   $ 2,366     48.94 % $ 1,677     47.70 % $ 1,447     42.54 %
Real Estate Mortgage     272     43.54 %   283     44.88 %   296     48.77 %
Consumer      101     7.52 %   133     7.42 %   192     8.69 %
Unallocated         0     N/A     0     N/A     0     N/A  
Total Allowance for Loan Lossess    $ 2,739     100.00 %  $ 2,093     100.00 %  $ 1,935     100.00 %
                                       
 
TABLE 12
          
 (In Thousands)              
 
 Dec 2001            % of Loan Type to Total Loans    Dec 2000    % of Loan Type to Total Loans  
Commercial        $ 1,363     37.90 % $ 1,377     33.80 %
 Real Estate Mortgage     406     52.60 %   471     54.80 %
 Consumer     47     9.50 %   70     11.40 %
 Unallocated     0     N/A     0     N/A  
Total Allowance for Loan Losses   $ 1,816     100.00 % $ 1,918     100.00 %
                           

Management believes the allowance is adequate to cover the inherent risks associated with the loan portfolio. While allocations have been established for particular loan categories, management considers the entire allowance to be available to absorb losses in any category.

Highly leveraged transactions (HLT’s) that result in the borrower’s debt-to-total assets ratio exceeding 75% generally include loans and commitments made in connection with recapitalization, acquisitions, and leveraged buyouts. The Company had no loans at December 31, 2004 that qualified as HLT’s.

SECURITIES  
The Company’s securities portfolio is classified, in its entirety, as “available-for-sale” as shown in Table 13. Management believes that a portfolio classification of all available-for-sale allows complete flexibility in the investment portfolio. Using this classification, the Company intends to hold these securities for an indefinite amount of time but not necessarily to maturity. Such securities are carried at fair value with the unrealized holding gains or losses, net of taxes, reported as a component of the Company’s stockholders’ equity on the balance sheet. The portfolio is structured to provide maximum return on investments while providing a consistent source of liquidity and meeting strict risk standards.

Securities available-for-sale decreased by $2,528,000 in 2004. The securities available-for-sale portfolio is comprised of U.S. Government Agency securities, mortgage-backed securities, high-grade municipal securities, corporate-debt securities, and equity securities. At December 31, 2004, the unrealized gain on securities available-for-sale included in stockholders’ equity totaled $618,000, net of tax, compared to unrealized gains of $995,000, net of tax, at December 31, 2003. The weighted-average maturity of the securities available-for-sale portfolio was ten years at December 31, 2004, with a weighted-average yield of 4.21%.
 
 
 

 
31

Table 13 shows the amortized cost and average yield of securities by maturity or call date at December 31, 2004.

TABLE 13
Securities by Maturities
(Amortized Cost)  

 
 
1 Year or Less 
1-5 Years
5-10 Years
Over 10 Years
Total
(In thousands)
   
Book
 
 
Average
 
 
Book
 
 
Average
 
 
Book
 
 
Average
 
 
Book
 
 
Average
 
 
Book
 
 
Average
 
 
 
 
Value  
 
 
Yield
    
 
Value
 
 
Yield
    
 
Value
 
 
Yield
    
 
Value
 
 
Yield
     
 
Value
 
 
Yield
 
Available-for-Sale
   
   
   
   
   
   
   
   
   
   
 
US Government Agency
 
$
36
   
3.62
%
$
21,199
   
3.65
%
$
2,064
   
5.12
%
$
5
   
3.46
%
$
23,304
   
3.78
%
State/County/Municipal Obligation
   
0
   
0.00
%
 
15,604
   
3.39
%
 
16,258
   
3.97
%
 
8,393
   
5.04
%
 
40,255
   
3.97
%
Mortgage-Backed Securities
   
3,980
   
4.08
%
 
9,260
   
4.05
%
 
7,949
   
4.20
%
 
2,303
   
4.49
%
 
23,492
   
4.15
%
Corporate/Other Securities
   
6,537
   
6.77
%
 
10,069
   
5.41
%
 
1,755
   
4.21
%
 
0
   
0.00
%
 
18,361
   
5.78
%
Preferred Equity Securities
   
770
   
1.66
%
 
720
   
1.37
%
 
2,366
   
5.97
%
 
0
   
0.00
%
 
3,856
   
4.25
%
Common Equity Securities
   
0
   
0.00
%
 
0
   
0.00
%
 
0
   
0.00
%
 
3,391
   
1.88
%
 
3,391
   
1.88
%
TOTAL Available-for-Sale
 
$
11,323
   
5.47
%
$
56,852
   
3.93
%
$
30,392
   
4.28
%  
$
14,092
   
4.19
%
$
112,659
   
4.21
%

Table 14 shows the balance of securities for the past three years on December 31. More details on securities can be found in Note 3 of the Consolidated Financial Statement.

TABLE 14

Securities (Fair Value)
(In thousands)
               
               
   
2004
 
2003
 
2002
 
U. S. Government/Agency Obligations
 
$
23,207
 
$
20,417
 
$
9,400
 
State/Municipal Obligations
   
40,961
   
40,440
   
25,284
 
Mortgage-backed Securities
   
23,363
   
27,900
   
36,590
 
Other Securities
   
26,067
   
27,369
   
34,698
 
Total Securities Available-for-Sale
 
$
113,598
 
$
116,126
 
$
105,972
 

DEPOSITS  
Table 15 shows average deposit balances and rates for 2004, 2003 and 2002. Growth was experienced in average interest-bearing deposits in 2004. Overall average deposits on interest-bearing accounts increased $7,201,000 or 3.08% to $240,905,000 as of December 31, 2004, compared to average total deposits of $233,704,000 at year-end 2003. Average non-interest-bearing deposits grew $4,708,000 or 12.86% as shown in Table 15, ending 2004 with an average of $41,315,000 compared to $36,607,000 as of year-end 2003.

A significant portion of deposit growth in average deposits came in the form of savings accounts and money market accounts with the former gaining $4,488,000 from December 31, 2003 to December 31, 2004 and the latter growing $4,524,000. Average time deposits decreased $3,525,000 or 3.06% to end 2004 at $111,431,000 as compared to $114,956,000 as of year-end 2003.

32

TABLE 15

Average Deposits and Other Borrowings  
(In Thousands)

 

 
 
 
2004 
 
              2003                   2002          
 
 
 
Amount 
    Rate         Diff$       Amount       Rate       Diff$     Amount         Rate  
                                                           
Interest Bearing Demand Deposits
 
$
26,282
   
0.72
%
$
1,714
 
$
24,568
   
0.88
%
$
1,261
 
$
23,307
   
1.17
%
Savings Deposits
   
63,414
   
1.00
%
 
4,488
   
58,926
   
1.29
%
 
3,039
   
55,887
   
1.91
%
Money Market Savings
   
39,778
   
1.41
%
 
4,524
   
35,254
   
1.52
%
 
938
   
34,316
   
2.13
%
Time Deposits
   
111,431
   
3.04
%
 
(3,525
)
 
114,956
   
3.40
%
 
7,214
   
107,742
   
4.15
%
Total Interest Bearing Deposits
   
240,905
   
1.98
%
 
7,201
   
233,704
   
2.32
%
 
12,452
   
221,252
   
2.96
%
Other Borrowings
   
53,957
   
4.27
%
 
4,054
   
49,903
   
4.31
%
 
12,046
   
37,857
   
4.73
%
Total Interest Bearing Liabilities
   
294,862
   
2.40
%
 
11,255
   
283,607
   
2.67
%
 
24,498
   
259,109
   
3.21
%
Non-Interest Bearing Demand Deposits
   
41,315
         
4,708
   
36,607
   
   
2,945
   
33,662
       
Total
 
$
336,177
   
2.11
% 
$
15,963
 
$
320,214
   
2.36
% 
$
27,443
 
$
292,771
   
2.84
%

MATURITIES OF TIME DEPOSITS  
The maturities on the time deposits of $100,000 and over are spread fairly evenly throughout the first three of four categories in Table 16. The largest percentage, 51.34%, is in the last category of “Over Twelve Months”. Compare this to 2003 when the percentage of maturities on the “Over Six Months through Twelve Months” was 38.42% and the “Over Twelve Months” was 37.69%. This shows that in 2004, the maturities on large time deposits moved to longer maturities with the “Six to Twelve Months” at 20.46% and the “Over Twelve Months” at 51.34%. The “Three Months or Less” category remained fairly consistent when comparing 2003 at 12.06% to 2004 at 11.69%.

TABLE 16

Maturities
(In thousands)
 
2004
 
   
Amount
 
Percent
 
Three Months or Less
 
$                  2,219
 
11.69
% 
Over Three Month through Six Months
   
3,135
   
16.51
 
Over Six Months through Twelve Months
   
3,885
   
20.46
 
Over Twelve Months
   
9,751
   
51.34
 
Total
 
$
18,990
   
100.00
%

SHORT-AND LONG-TERM BORROWINGS  
Short-term borrowings, which are overnight or less than 30-day borrowings, consist of securities sold under agreements to repurchase, Federal Home Loan Bank advances, and U.S. Treasury tax and loan notes. Long-term borrowings consist of notes from the Federal Home Loan Bank. These notes are secured under terms of a blanket collateral agreement by a pledge of qualifying investment and mortgage-backed securities, certain mortgage loans and a lien on FHLB stock. For more details on short- and long-term borrowings see Note 7 and 8 of the Notes to Consolidated Financial Statements.

TABLE 17

BORROWED FUNDS
     
 
 
(In thousands)
         
     
2004
   
2003
 
Other Short-Term Borrowings
 
$
14,614
 
$
7,085
 
FHLB Long-Term Borrowings
   
46,034
   
41,952
 
Total
 
$
60,648
 
$
49,037
 
 
33

CAPITAL ACCOUNTS
Total stockholders’ equity increased 3.11% or $1,278,000 over year-end 2003 to finish at $42,354,000. Growth in stockholders’ equity came primarily from retained earnings. A common ratio used to determine the effective use of capital is the return on average equity. For the year-ended December 31, 2004, this ratio was 10.84%, compared to 14.18% at December 31, 2003. The Bank’s goal is to maintain a strong capital position as well as to make the best use of capital in the overall growth of the organization. At year-end 2004, the equity-to-assets ratio was 11.16%, compared to 11.06% at year-end 2003. It is the goal of management to implement ways to better leverage our capital with a capital-to-assets ratio closer to 8%.

Compare these results to 2003 when total stockholders’ equity increased 7.18% or $2,753,000 over year-end 2002. This growth was primarily attributable to two sources, retained earnings and accumulated other comprehensive income. The return on average equity for the year-ending December 31, 2003 ratio was 14.18% compared to 14.30% at December 31, 2002. At year-end 2003, the equity-to-assets ratio was 11.06% compared to 11.05% at year-end 2002.

Retained earnings increased capital by $4,453,000 in 2004 and dividends reduced that number by $2,311,000. The investment portfolio depreciated in value by $377,000, net of tax in 2004. Since all of our investments are available-for-sale, changes in market values adjusted for taxes are reflected in the equity portion of the balance sheet. A total of $487,000 in net treasury stock purchases reduced the capital account to equal the total net change. From time to time the Company has purchased PFSC stock in the open market or from individuals to leverage the capital account and to provide stock for our dividend reinvestment plan and stock compensation plan. During the year 2004, 23,742 shares were purchased in this manner. There were 13,920 shares issued from the treasury stock account by individuals exercising options and for the dividend reinvestment plan during 2004. The investment banking firms of Ferris, Baker Watts, Incorporated and Ryan Beck & Co. have been known to make markets in PFSC common stock.

Net Income increased capital by $5,564,000 in 2003 and dividends reduced that number by $2,057,000. The investment portfolio depreciated in value by $1,101,000 in 2003. Since all of our investments were available-for-sale, changes in market values adjusted for taxes are reflected in the equity portion of the balance sheet. A total of $347,000 in net treasury stock sales increased the capital account to equal the total net change.

The following table represents the Company’s capital position as it compares to the regulatory guidelines at December 31, 2004.

TABLE 18
Capital Ratios    
(In Thousands)
 
 
 
 
December 31, 2004 
   
December 31, 2003
   
Regulatory Requirment
                     
 Tier 1 capital to risk-weighted assets    
15.02
%
  14.93 %   4.00 %
 Total capital to risk-weighted assets     16.05 %   15.76 %   8.00 %
 Tier 1 capital to average-leveraged ratio     10.57 %   10.22 %   4.00 %
               
               
               
               

INTEREST RATE SENSITIVITY  
The operations of the Company do not subject it to foreign currency risk or commodity price risk. The Company does not utilize interest rate swaps, caps, or hedging transactions. In addition, the Company has no market risk sensitive instruments entered into for trading purposes. However, the Company is subject to interest rate risk and employs several different methods to manage and monitor the risk.
 
 
 
 

 
34

Interest rate sensitivity refers to the relationship between market interest rates and the earnings volatility of the Company due to the repricing characteristics of assets and liabilities. The responsibility for monitoring interest rate sensitivity and policy decisions has been given to the Asset/Liability Committee (ALCO) of the Bank. The tools used to monitor sensitivity are the Statement of Interest Sensitivity Gap and the Interest Rate Shock Analysis. The Bank uses a software model to measure and to keep track. In addition, an outside source does a quarterly analysis to make sure our internal analysis is current and correct. The Statement of Interest Sensitivity Gap is a good assessment of current position and is a very useful tool for the ALCO in performing its job. This report is monitored in an effort to “match” maturities or repricing opportunities of assets and liabilities in order to attain the maximum interest within risk tolerance policy guidelines. The statement does, although, have inherent limitations in that certain assets and liabilities may react to changes in interest rates in different ways with some categories reacting in advance of changes and some lagging behind the changes. In addition, there are estimates used in determining the actual propensity to change of certain items such as deposits without maturities.

The following sets forth the Company’s interest sensitivity analysis as of December 31, 2004:

TABLE 19

Statement of Interest Sensitivity Gap  
(In thousands)
   
Maturity or Repricing In:
 
 
 
3 Months
 
3-6 Months
 
6-12 Months
 
1-5 Years
 
Over 5 Years
 
RATE SENSITIVE ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans
 
$
43,233
 
$
15,906
 
$
25,792
 
$
121,755
 
$
38,128
 
Securities
   
12,639
   
5,960
   
10,285
   
50,129
   
34,585
 
Federal Funds Sold
   
0
   
0
   
0
   
0
   
0
 
Total Rate Sensitive Assets
   
55,872
   
21,866
   
36,077
   
171,884
   
72,713
 
Cumulative Rate Sensitive Assets
 
$
55,872
 
$
77,738
 
$
113,815
 
$
285,699
 
$
358,412
 
RATE SENSITIVE LIABILITIES
   
   
   
   
   
 
Interest Bearing Checking
 
$
702
 
$
702
 
$
1,403
 
$
11,226
 
$
9,356
 
Money Market Deposits
   
1,119
   
1,119
   
2,239
   
17,912
   
14,926
 
Regular Savings
   
2,229
   
1,950
   
3,900
   
31,202
   
26,002
 
CDs and IRAs
   
11,236
   
12,430
   
20,557
   
59,890
   
1,676
 
Short-term Borrowings
   
14,614
   
0
   
0
   
0
   
0
 
Long-term Borrowings
   
0
   
2,500
   
5,000
   
11,034
   
27,500
 
Total Rate Sensitive Liabilities
   
29,900
   
18,701
   
33,099
   
131,264
   
79,460
 
Cumulative Rate Sensitive Liabilities
 
$
29,900
 
$
48,601
 
$
81,700
 
$
212,964
 
$
292,424
 
 
   
   
   
   
   
 
Period Gap
 
$
25,972
 
$
3,165
 
$
2,978
 
$
40,620
 
$
(6,747
)
Cumulative Gap
 
$
25,972
 
$
29,137
 
$
32,115
 
$
72,735
 
$
65,988
 
Cumulative RSA to RSL
   
186.86
%
 
159.95
%
 
139.31
%
 
134.15
%
 
122.57
%
Cumulative Gap to Total Assets
   
6.85
% 
 
7.69
% 
 
8.47
% 
  
19.19
% 
 
17.41
%

For the first time since 2000, rates were increased by the Federal Reserve’s Open Market Committee starting on June 30, 2004. By year-end December 31, 2004, the overnight Fed Funds Rate had been increased in 25 basis point increments five times, ending the year at 2.25%. While the effects of the rate increases were somewhat muted in 2004 due to their late arrival and measured pace, it remains to be seen what effect they will have on the Company’s management of its net interest margin. The net interest margin in 2004 remained relatively stable at 3.55% when compared to the net interest margin of 3.61% for the year-ended December 31, 2003. Compare these results to 2003 when rates decreased slightly. The result was a net interest margin that decreased to 3.61% for the year-ended December 31, 2003 compared to 3.93% for the year 2002.

35

LIQUIDITY  
The liquidity of the Company is reflected in its capacity to have sufficient amounts of cash available to fund the needs of customer withdrawal requests, accommodate loan demand, and maintain regulatory reserve requirements; that is to conduct banking business. Additional liquidity is obtained by either increasing liabilities or by decreasing assets. The primary source for increasing liabilities is the generation of additional deposit accounts, which are managed through our system of branches. In addition, loan payments on existing loans or investments available-for-sale can generate additional liquidity. Other sources include income from operations, decreases in federal funds sold or interest-bearing deposits in other banks, securities sold under agreements to repurchase, and borrowings from the Federal Home Loan Bank. On December 31, 2004, the Bank had a borrowing capacity from the Federal Home Loan Bank of approximately $156,526,000. During the Year 2004, maturities and sales of investments, increases in deposits, and short-term and long-term borrowings provided the majority of additional cash with operating activities also contributing to liquidity. The funds were used primarily to grant loans to customers, purchase additional investment securities, and to pay dividends to our shareholders.

The following table represents the aggregate on-and-off balance sheet contractual obligations to make future payments.

Table 20
Contractual Obligations
             
(In thousands)
 
December 31
 
       
 
 
Less than 1 year
 
  1-3 Years
 
  4-5 Years
 
Over 5 years
 
  Total
 
 
 
 
 
 
 
 
 
 
 
 
 
Time Deposits
 
$
38,987
 
$
53,074
 
$
11,265
 
$
2,463
 
$
105,789
 
Long-term Debt
   
8,450
   
9,501
   
583
   
27,500
   
46,034
 
Operating Leases
   
54
   
138
   
99
   
510
   
801
 
 
 
$
47,491
 
$
62,713
 
$
11,947
 
$
30,473
 
$
152,624
 

The Company is not aware of any known trends or any known demands, commitments, events or uncertainties, which would result in any material increase or decrease in liquidity.

OFF-BALANCE-SHEET ARRANGEMENTS  
The financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance-sheet instruments. Unused commitments, at December 31, 2004, totaled $31,557,000. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk. Management believes that any amounts actually drawn upon can be funded in the normal course of operations.

The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources.

SUBSEQUENT EVENTS  
NONE

EFFECTS OF INFLATION  
The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from commercial and industrial companies that have significant investments in fixed assets or inventories. The precise impact of inflation upon the Company is difficult to measure. Inflation may affect the borrowing needs of consumers, thereby impacting the growth rate of the Company’s assets. Inflation may also affect the general level of interest rates, which can have a direct bearing on the Company.

Management believes that the most significant impact on financial results is the Company’s ability to react to changes in interest rates. As discussed previously, management is attempting to maintain a position that is within conservative parameters for interest sensitive assets and liabilities in order to be protected against wide interest rate fluctuation.


36

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

As previously stated in this document, the Federal Reserve Bank raised the Fed Funds Rate a total of five times in 2004, the first occurring on June 30, 2004 and all five being 25 basis point increases. While short-term rates have been increasing since June of 2004, longer rates have remained somewhat stationary. This has caused a flattening of the yield curve which in the long run can have an effect of slowing the Bank’s earnings growth. This is due to the payment of higher, short-term deposit interest while at the same time experiencing little or no additional interest income from longer maturity loans. With this being said, the Bank monitors this interest sensitivity on a monthly basis. The model used by the Bank shows interest rate sensitivity exceptions in the twelve-month period testing at the negative 100, 200 and 300 basis point scenario. In this model, both net interest income and net income fall outside of the Bank’s general guidelines. The likelihood of these decreases is deemed unlikely. Return on average equity and average assets also fall below their respective policy floor levels of 12% and 1.25%, respectively. The Bank will continue to monitor this rate sensitivity going forward. See previous discussion on Interest Rate Sensitivity.

Equity value at risk is monitored regularly and is within established policy limits.

The Company is not a party to any forward contract, interest rate swap, option interest, or similar derivations instruments. The Company does not deal in foreign currency.

 
 
 
 
 
 

 
37

ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA  



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders
 
Peoples Financial Services Corp.
 
Hallstead, Pennsylvania
 
We have audited the accompanying consolidated balance sheets of Peoples Financial Services Corp. and its subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Peoples Financial Services Corp. and its subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
 

 
/s/ Beard Miller Company LLP
 

 

 

 
Allentown, Pennsylvania
 
February 25, 2005
 

 
 
 
 

 

38
 
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
 
   
December 31,
 
   
  2004
 
  2003
 
 
 
(In Thousands, Except Per Share Data)  
Assets
 
Cash and due from banks
 
$
5,903
 
$
5,882
 
Interest bearing deposits in other banks
   
102
   
174
 

Cash and Cash Equivalents
   
6,005
   
6,056
 
Securities available for sale
   
113,598
   
116,126
 
Loans receivable, net of allowance for loan losses 2004 $2,739;
2003 $2,093
   
242,075
   
234,274
 
Premises and equipment, net
   
4,904
   
4,436
 
Accrued interest receivable
   
1,987
   
2,047
 
Intangible assets
   
1,892
   
2,154
 
Other assets
   
8,914
   
6,196
 

Total Assets
 
$
379,375
 
$
371,289
 

Liabilities and Stockholders’ Equity
 
Liabilities
 
Deposits:
         
Non-interest bearing
 
$
42,999
 
$
37,441
 
Interest-bearing
   
231,776
   
242,259
 

Total Deposits
   
274,775
   
279,700
 
               
Short-term borrowings
   
14,614
   
7,085
 
Long-term borrowings
   
46,034
   
41,952
 
Accrued interest payable
   
550
   
604
 
Other liabilities
   
1,048
   
872
 

Total Liabilities
   
337,021
   
330,213
 

Stockholders’ Equity
 
Common stock, par value $2 per share; authorized 12,500,000 shares;
issued 2004 3,341,251shares; 2003 3,341,251 shares; outstanding 2004 3,155,801 
                shares; 2003 3,165,623 shares
   
6,683
   
6,683
 
Surplus
   
2,821
   
2,618
 
Retained earnings
   
35,665
   
33,523
 
Accumulated other comprehensive income
   
618
   
995
 
Treasury stock, at cost, 2004 185,450 shares; 2003 175,628 shares
   
(3,433
)
 
(2,743
)

Total Stockholders’ Equity
   
42,354
   
41,076
 

Total Liabilities and Stockholders’ Equity
 
$
379,375
 
$
371,289
 
 
See notes to consolidated financial statements.  
39
 
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
 
   
Years Ended December 31,
 
     
2004
   
2003
   
2002
 
                                       
 
(In Thousands, Except Per Share Data)  

Interest Income
Loans receivable, including fees
 
$
15,071
 
$
15,236
 
$
15,332
 
Securities:
                   
Taxable
   
3,152
   
3,250
   
3,902
 
Tax-exempt
   
1,687
   
1,380
   
1,323
 
Other
   
49
   
34
   
25
 

Total Interest Income
   
19,959
   
19,900
   
20,582
 

Interest Expense
Deposits
   
4,778
   
5,423
   
6,538
 
Short-term borrowings
   
133
   
114
   
124
 
Long-term borrowings
   
2,173
   
2,037
   
1,668
 

Total Interest Expense
   
7,084
   
7,574
   
8,330
 

Net Interest Income
   
12,875
   
12,326
   
12,252
 

Provision for Loan Losses
   
1,050
   
289
   
180
 

Net Interest Income after Provision for Loan Losses
   
11,825
   
12,037
   
12,072
 

Other Income
Customer service fees
   
1,489
   
1,296
   
1,187
 
Investment division commission income
   
426
   
182
   
153
 
Earnings on investment in life insurance
   
236
   
202
   
211
 
Other income
   
429
   
249
   
259
 
Net realized gains on sales of securities available for sale
   
296
   
662
   
324
 
Impairment of security
   
(1,144
)
 
-
   
(850
)

Total Other Income
   
1,732
   
2,591
   
1,284
 

Other Expenses
Salaries and employee benefits
   
4,048
   
3,694
   
3,337
 
Occupancy
   
489
   
442
   
399
 
Equipment
   
336
   
299
   
323
 
FDIC insurance and assessments
   
140
   
135
   
129
 
Professional fees and outside services
   
297
   
240
   
229
 
Computer service and supplies
   
617
   
521
   
477
 
Taxes, other than payroll and income
   
383
   
311
   
320
 
Other
   
1,780
   
1,592
   
1,574
 

Total Other Expenses
   
8,090
   
7,234
   
6,788
 

Income before Income Taxes
   
5,467
   
7,394
   
6,568
 

Federal Income Taxes
   
1,014
   
1,830
   
1,553
 

Net Income
 
$
4,453
 
$
5,564
 
$
5,015
 

Earnings per Share
Basic
 
$
1.41
 
$
1.76
 
$
1.59
 

Diluted
 
$
1.40
 
$
1.75
 
$
1.59
 

See notes to c onsolidated financial statements.    
40
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2004, 2003 and 2002

 
      Common Stock       Surplus       Retained Earnings       Accumulated Other Comprehensive Income       Treasury Stock       Total    
                                                                    (In Thousands, Except Per Share Data)
                                       
                                       
Balance - December 31, 2001
 
$
4,455
 
$
4,611
 
$
26,851
 
$
536
 
$
(2,699
)
$
33,754
 
Comprehensive income:
                                     
Net income
   
-
   
-
   
5,015
   
-
   
-
   
5,015
 
Net change in unrealized gains (losses) on
          securities available for sale, net of
          reclassification adjustment and taxes
   
-
   
-
   
-
   
1,560
   
-
   
1,560
 
                                       
Total Comprehensive Income
                                 
6,575
 
Cash dividends declared, $.59 per share
   
-
   
-
   
(1,850
)
 
-
   
-
   
(1,850
)
Shares issued from treasury related to stock
option plan (675 shares)
   
-
   
6
   
-
   
-
   
5
   
11
 
Purchase of treasury stock (9,429 shares)
   
-
   
-
   
-
   
-
   
(167
)
 
(167
)

Balance - December 31, 2002
 
4,455
 
4,617
 
30,016
 
2,096
 
(2,861)
 
38,323
 
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
   
-
   
-
   
5,564
   
-
   
-
   
5,564
 
Net change in unrealized gains (losses) on  
          securities available for sale, net of  
          reclassification adjustment and taxes
   
-
   
-
   
-
   
(1,101
)
 
-
   
(1,101
)
                                       
Total Comprehensive Income
                                 
4,463
 
Cash dividends declared, $.65 per share
   
-
   
-
   
(2,057
)
 
-
   
-
   
(2,057
)
Shares issued from treasury related to dividend
reinvestment plan and stock option plan
(17,293 shares)
   
-
   
229
   
-
   
-
   
152
   
381
 
Purchase of treasury stock (1,671 shares)
   
-
   
-
   
-
   
-
   
(34
)
 
(34
)
Three-for-two stock split
   
2,228
   
(2,228
)
 
-
   
-
   
-
   
-
 
                                       
Balance - December 31, 2003
   
6,683
   
2,618
   
33,523
   
995
   
(2,743
)
 
41,076
 
Comprehensive income:
                                     
Net income
   
-
   
-
   
4,453
   
-
   
-
   
4,453
 
Net change in unrealized gains
          (losses) on securities available for sale, net of
          reclassification adjustment and taxes
   
-
   
-
   
-
   
(377
)
 
-
   
(377
)
                                       
Total Comprehensive Income
                                 
4,076
 
Cash dividends declared, $.73 per share
   
-
   
-
   
(2,311
)
 
-
   
-
   
(2,311
)
Shares issued from treasury related to stock option plan (13,920 shares)
   
-
   
203
   
-
   
-
   
123
   
326
 
Purchase of treasury stock (23,742 shares)
   
-
   
-
   
-
   
-
   
(813
)
 
(813
)

Balance - December 31, 2004
 
$
6,683
 
$
2,821
 
$
35,665
 
$
618
 
$
(3,433
)
$
42,354
 
 
See notes to c onsolidated financial statements.    
41
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
   
Years Ended December 31,
 
     
2004
   
2003
   
2002
 
 
(In Thousands)
 
Cash Flows from Operating Activities
Net income
 
$
4,453
 
$
5,564
 
$
5,015
 
Adjustments to reconcile net income to net cash provided by
operating activities:
                   
Depreciation and amortization
   
654
   
593
   
608
 
Provision for loan losses
   
1,050
   
289
   
180
 
Loss on sale of equipment
   
-
   
18
   
-
 
Loss on sale of other real estate
   
-
   
6
   
24
 
Net amortization of securities premiums and discounts
   
565
   
752
   
343
 
Net realized gains on sales of securities
   
(296
)
 
(662
)
 
(324
)
Deferred income taxes (benefit)
   
(300
)
 
(111
)
 
(79
)
Net increase in cash surrender value of life insurance
   
(236
)
 
(202
)
 
(211
)
                                       Impairment of security
   
1,144
   
-
   
850
 
                                       Proceeds from the sale of loans
   
3,429
   
-
   
-
 
                       Net gain on sale of loans
   
(50
)
 
-
   
-
 
                       Loans originated for sale
   
(3,379
)
 
-
   
-
 
          (Increase) decrease in assets:
                   
Accrued interest receivable
   
60
   
119
   
116
 
Other assets
   
154
   
1,176
   
(257
)
Increase (decrease) in liabilities:
                   
Accrued interest payable
   
(54
)
 
(52
)
 
(47
)
Other liabilities
   
176
   
53
   
158
 

Net Cash Provided by Operating Activities
   
7,370
   
7,543
   
6,376
 

Cash Flows from Investing Activities
Proceeds from sale of available for sale securities
   
28,121
   
27,049
   
22,708
 
Proceeds from maturities of and principal repayments on
available for sale securities
   
13,209
   
30,588
   
29,532
 
Purchase of available for sale securities
   
(40,786
)
 
(69,399
)
 
(55,934
)
Net increase in loans
   
(9,407
)
 
(15,240
)
 
(27,728
)
Purchase of investment in life insurance
   
(2,000
)
 
-
   
-
 
Proceeds from sale of equipment
   
-
   
7
   
-
 
Purchase of premises and equipment
   
(860
)
 
(962
)
 
(806
)
Proceeds from sale of other real estate
   
414
   
147
   
104
 

Net Cash Used in Investing Activities
   
(11,309
)
 
(27,810
)
 
(32,124
)

Cash Flows from Financing Activities
Increase (decrease) in deposits
   
(4,925
)
 
20,513
   
20,296
 
Proceeds from long-term borrowings
   
5,000
   
8,000
   
15,000
 
Repayment of long-term borrowings
   
(918
)
 
(792
)
 
(256
)
Net increase (decrease) in short-term borrowings
   
7,529
   
(6,028
)
 
(8,225
)
Proceeds from sale of treasury stock
   
326
   
381
   
11
 
Purchase of treasury stock
   
(813
)
 
(34
)
 
(167
)
Cash dividends paid
   
(2,311
)
 
(2,057
)
 
(1,850
)

Net Cash Provided by Financing Activities
   
3,888
   
19,983
   
24,809
 

Decrease in Cash and Cash Equivalents
   
(51
)
 
(284
)
 
(939
)

Cash and Cash Equivalents - Beginning
   
6,056
   
6,340
   
7,279
 

Cash and Cash Equivalents - Ending
 
$
6,005
 
$
6,056
 
$
6,340
 
See notes to c onsolidated financial statements  
42
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

 
 
 
Years Ended December 31,  
     
2004
   
2003
   
2002
 
 
 
(In Thousands)
 

Supplementary Cash Flows Information
Interest paid
 
$
7,138
 
$
7,626
 
$
8,377
 

Income taxes paid
 
$
1,200
 
$
2,162
 
$
1,466
 

Supplementary Disclosures of Noncash Investing and
Financing Activities         
       Foreclosed real estate acquired in settlement of loans  
$
556
 
$
114
 
$
203
 


 
 
 
 
 
 
 
 

 
See notes to c onsolidated financial statements.    
43
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Significant Accounting Policies
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of Peoples Financial Services Corp. and its wholly-owned subsidiary, Peoples National Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
Nature of Operations
 
The Company provides a variety of financial services, through the Bank, to individuals, small businesses and municipalities through its seven Pennsylvania offices located in Hallstead, Hop Bottom, Susquehanna, Montrose, Nicholson, Meshoppen and Tunkhannock, which are small communities in a rural setting. In 2002, the Company started operating in New York with an office located in Norwich. The Company opened an office in Conklin, New York, in March 2003 at which time the Norwich office was closed and its deposits transferred to the Conklin office. The Bank’s primary deposits are checking accounts, savings accounts and certificates of deposit. Its primary lending products are single-family residential loans and loans to small businesses. As a national bank, the Bank is subject to regulation of the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. The Company is subject to regulation of the Federal Reserve Bank.
 
Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.
 
Significant Group Concentrations of Credit Risk
 
Most of the Company’s activities are with customers located primarily in Susquehanna and Wyoming Counties of Pennsylvania, and Broome County of New York. Note 3 discusses the types of securities in which the Company invests. The concentrations of credit by type of loan are set forth in Note 4. The Company does not have any significant concentrations to any one industry or customer. Although the Company has a diversified loan portfolio, its debtors’ ability to honor their contracts is influenced by the region’s economy.
 
Presentation of Cash Flows
 
For purposes of cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and federal funds sold.
 

 

 

                                             44                                                                                  
 
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1 - Significant Accounting Policies (Continued)
 
 
Securities
 
Securities classified as available-for-sale are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available-for-sale are carried at fair value. Unrealized gains or losses are reported as increases or decreases in other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.
 
Common equity securities include restricted investments, primarily Federal Home Loan Bank and Federal Reserve Bank stock which are carried at cost. Federal law requires a member institution of the Federal Home Loan Bank and the Federal Reserve Bank to hold stock according to a predetermined formula.
 
Declines in the fair value of available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
 
Loans Receivable
 
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the contractual life of the related loan as an adjustment to the yield.
 
The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on non-accrual loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.
 
Loans Held for Sale
 
Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by aggregate outstanding commitments from investors or current investor yield requirements. Net unrealized losses are recognized through a valuation allowance by charges to income. The Company had no loans held for sale at December 31, 2004 and 2003.
 
 
 
 

45
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1 - Significant Accounting Policies (Continued)
 
Allowance for Loan Losses
 
The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
 
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on the Bank’s past loan loss experience, known or inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
 
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value for that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.
 
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
 
 
 
 
 
 

46
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
Premises and Equipment
 
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line and various accelerated methods over the following estimated useful lives of the related assets:
 
     
Years

 
Building and improvements
 
7 - 40
 
Furniture, fixtures and equipment
 
3 - 10

Maintenance, repairs and minor replacements are expensed when incurred. Gains and losses on routine dispositions are reflected in current operations.
 
Transfers of Financial Assets
 
Transfers of financial assets, which includes loan participation sales, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
 
Intangible Assets
 
The Bank has core deposit acquisition premiums which are being amortized over an estimated life of fifteen years using the straight-line method. These intangible assets were $1,892,000 and $2,154,000, net of accumulated amortization of $1,995,000 and $1,733,000 at December 31, 2004 and 2003, respectively. Amortization expense was $262,000, $262,000, and $261,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Amortization expense is estimated to be $262,000 per year for the next five years.
 
Foreclosed Assets
 
Foreclosed assets are comprised of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure and loans classified as in-substance foreclosure. The Company includes such properties in other assets. A loan is classified as in-substance foreclosure when the Company has taken possession of the collateral regardless of whether formal foreclosure proceedings take place. Foreclosed assets initially are recorded at fair value, net of estimated selling costs, at the date of foreclosure establishing a new cost basis. Subsequent declines in the recorded value of the property prior to its disposal and costs to maintain the assets are included in other expense. In addition, any gain or loss realized upon disposal is included in other income or expense.
 
Bank Owned Life Insurance
 
The Company invests in bank owned life insurance (“BOLI”) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a chosen group of employees. The Company is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies and is included in other assets in the amount of $6,773,000 and $4,537,000 at December 31, 2004 and 2003, respectively.
 

47
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
Income Taxes
 
Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Peoples Financial Services Corp. and its subsidiary file a consolidated federal income tax return.
 
Advertising
 
The Company follows the policy of charging marketing and advertising costs to expense as incurred. Advertising expense for the years-ended December 31, 2004, 2003 and 2002 was $123,000, $77,000, and $74,000, respectively.
 
Earnings per Common Share
 
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. All per share data has been adjusted for the effects of the three-for-two stock split declared April 1, 2003.
 
 
 
 
 
 
 
 
 
 
 
 

48
 
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
Earnings per Common Share (Continued)
 
The following table shows the amounts used in computing earnings per share for the years-ended December 31, 2004, 2003 and 2002:
 
 

 
 
 
Income Numerator  
 
 
Common Shares Denominator  
   
            EPS  
 
                                                                                                                   (In Thousands, Except Per Share Data)
                     
2004:
                   
Basic EPS
 
$
4,453
   
3,166
   
1.41
 
Dilutive effect of potential common stock,
stock options
   
-
   
21
   
.01
 

Diluted EPS
 
$
4,453
   
3,187
   
1.40
 

2003:
                   
Basic EPS
 
$
5,564
   
3,161
 
$
1.76
 
Dilutive effect of potential common stock,
stock options
   
-
   
18
   
0.01
 

Diluted EPS
 
$
5,564
   
3,179
 
$
1.75
 

2002:
                   
Basic EPS
 
$
5,015
   
3,152
 
$
1.59
 
Dilutive effect of potential common stock,
stock options
   
-
   
6
   
-
 

Diluted EPS
 
$
5,015
   
3,158
 
$
1.59
 

Comprehensive Income
 
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
 

49
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
Comprehensive Income (Continued)
 
The components of other comprehensive income and related tax effects for the years-ended December 31, 2004, 2003 and 2002 are as follows:
 
     
2004
   
2003
   
2002
 
 
 
(In Thousands) 

Unrealized holding gains (losses) on available for sale securities
 
$
(1,420
)
$
(1,006
)
$
1,838
 
Reclassification adjustment for (gains) losses realized in net income
   
848
   
(662
)
 
526
 

Net Unrealized Gains (Losses)
   
(572
)
 
(1,668
)
 
2,364
 
                     
Tax effect
   
195
   
567
   
(804
)

Net of Tax Amount
 
$
(377
)
$
(1,101
)
$
1,560
 

Stock-Based Compensation
 
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.” Accordingly, no compensation costs have been recognized for options granted in 2004, 2003 and 2002. Had compensation costs for stock options granted in 2004, 2003 and 2002 been determined based on the fair value at the grant dates for awards under the plan consistent with the provisions of SFAS No. 123, the Company’s net income and earnings per share for the years-ended December 31, 2004, 2003 and 2002 would have been reduced to the pro forma amounts indicated below:
 
     
2004
   
2003
   
2002
 
 
 
(In Thousands, except Per Share Amounts)
 
 
Net income as reported
 
$
4,453
 
$
5,564
 
$
5,015
 
Total stock-based compensation cost, net of tax, that would have been
      included in the determination of net income if the fair value based
      method had been applied to all awards.
   
(31
)
 
(2
)
 
(23
)
                     
Pro forma net income
 
$
4,422
 
$
5,562
 
$
4,992
 
                     
Basic earnings per share:
                   
As reported
 
$
1.41
 
$
1.76
 
$
1.59
 
Pro forma
 
$
1.40
 
$
1.75
 
$
1.59
 
                     
Diluted earnings per share:
                   
As reported
 
$
1.40
 
$
1.75
 
$
1.59
 
Pro forma
 
$
1.39
 
$
1.75
 
$
1.58
 

50
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
Stock-Based Compensation (Continued)
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for 2004, 2003 and 2002, respectively: risk-free interest rate of 3.89%, 3.23%, and 4.77%; volatility of .20, 0.11, and 0.11; dividend yield of 2.14%, 2.15%, and 3.14%; and an expected life of six years. The weighted-average fair value of options granted was $6.99 per share in 2004, $3.39 per share in 2003; and $2.33 per share in 2002, as adjusted for the three-for-two stock split in 2003.
 
Segment Reporting
 
The Bank acts as an independent community financial services provider and offers traditional banking and related financial services to individual, business and government customers. Through its branch and automated teller machine network, the Bank offers a full array of commercial and retail financial services, including: the taking of time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of other financial services.
 
Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial and retail operations of the Bank. As such, discrete information is not available and segment reporting would not be meaningful.
 
Off-Balance Sheet Financial Instruments
 
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded.
 
New Accounting Standards
 
In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 was revised in December 2003. This Interpretation provides new guidance for the consolidation of variable interest entities (VIEs) and requires such entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among parties involved. The Interpretation also adds disclosure requirements for investors that are involved with unconsolidated VIEs. The disclosure requirements apply to all financial statements issued after December 31, 2003. The consolidation requirements apply to companies that have interests in special-purpose entities for periods ending after December 15, 2003. Consolidation of other types of VIEs is required in financial statements for periods ending after March 15, 2004. The adoption of this Interpretation did not have an impact on the Company’s financial condition or results of operations.
 
In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3(SOP 03-3), “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality. SOP 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004. The Company intends to adopt the provisions of SOP 03-3 effective January 1, 2005, and does not expect the initial implementation to have a material effect on the Company’s consolidated financial statements.
 
 
 
 
 
 

 
51
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Note 1 - Significant Accounting Policies (Continued)
 
New Accounting Standards (Continued)
 
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105, “Application of Accounting Principles to Loan Commitments.” SAB 105 provides guidance about the measurements of loan commitments recognized at fair value under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SAB 105 also requires companies to disclose their accounting policy for those loan commitments including methods and assumptions used to estimate fair value and associated hedging strategies. SAB 105 is effective for all loan commitments accounted for as derivatives that are entered into after March 31, 2004. The adoption of SAB 105 did not have a material effect on our consolidated financial statements.
 
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123(R), “Share-Based Payment.” Statement No. 123(R) replaces Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt the new standard using a modified prospective method and may elect to restate prior periods using the modified retrospective method. The Bank will not elect to use the modified retrospective method. Under the modified prospective method, companies are required to record compensation cost for new and modified awards over the related vesting period of such awards prospectively and record compensation cost prospectively for the unvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modified prospective method. Statement No. 123(R) is effective for periods beginning after June 15, 2005. Early application of Statement No. 123(R) is encouraged, but not required. Adopting Statement No. 123(R) on July 1, 2005 using the modified prospective method, the Company estimates that total stock-based compensation expense, net of related tax effects, will increase by $4,000 for the year-ending December 31, 2005.
 

Note 2 - Branch Acquisition
 
On March 6, 2002, the Bank acquired certain assets, including furniture and equipment and assumed certain liabilities, including approximately $4,264,000 of deposits and a premises lease, of a branch located in Norwich, New York. The purchase price equals $50,000 for a deposit premium plus the book value cost of the personal property. In March 2003, the Norwich office was closed and its deposits transferred to the new Conklin, New York branch.
 
 
 
 
 
 

52
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 3 - Securities
 
At December 31, 2004 and 2003, the amortized cost and fair values of securities available-for-sale are as follows:
 
 
                           
      Amortized Cost       Gross Unrealized Gains       Gross Unrealized Losses       Fair Value    
                                                                                         (In Thousands)  
                           
December 31, 2004:
                         
U.S. Government agencies and
corporations
 
$
23,304
 
$
114
 
$
(211
)
$
23,207
 
Obligations of state and political
subdivisions
   
40,255
   
1,042
   
(336
)
 
40,961
 
Corporate debt securities
   
18,361
   
507
   
(48
)
 
18,820
 
Mortgage-backed securities
   
23,492
   
147
   
(276
)
 
23,363
 
Preferred equity securities
   
3,856
   
-
   
-
   
3,856
 
Common equity securities
   
3,391
   
-
   
-
   
3,391
 

Total
 
$
112,659
 
$
1,810
 
$
(871
)
$
113,598
 

December 31, 2003:
                 
U.S. Government agencies and
corporations
 
$
20,358
 
$
236
 
$
(177
)
$
20,417
 
Obligations of state and political
subdivisions
   
39,490
   
1,354
   
(404
)
 
40,440
 
Corporate debt securities
   
18,630
   
1,208
   
(25
)
 
19,813
 
Mortgage-backed securities
   
28,050
   
183
   
(333
)
 
27,900
 
Preferred equity securities
   
5,041
   
-
   
(534
)
 
4,507
 
Common equity securities
   
3,049
   
-
   
-
   
3,049
 

Total
 
$
114,618
 
$
2,981
 
$
(1,473
)
$
116,126
 

The amortized cost and fair value of securities as of December 31, 2004, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without any penalties.
 
   
Amortized
Cost
 
Fair
Value
   
(In Thousands)

Due in one year or less
 
$
6,537
 
$
6,656
 
Due after one year through five years
   
28,281
   
28,425
 
Due after five years through ten years
   
11,472
   
11,778
 
Due after ten years
   
35,630
   
36,129
 
     
81,920
   
82,988
 
Mortgage-backed securities
   
23,492
   
23,363
 
Equity securities
   
7,247
   
7,247
 
        
              
$               112,659
$
113,598
 
53
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Note 3 - Securities (Continued)
 
Proceeds from sale of available-for-sale securities during 2004, 2003 and 2002 were $28,121,000, $27,049,000, and $22,708,000, respectively. Gross gains realized on these sales were $312,000, $671,000, and $439,000, respectively. Gross losses on these sales were $16,000, $9,000, and $115,000, respectively.
 
Securities with a carrying value of $35,685,000 and $34,575,000 at December 31, 2004 and 2003, respectively, were pledged to secure public deposits and repurchase agreements as required or permitted by law.
 
The following table shows our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2004:
 
   
Less Than 12 Months
 
12 Months or More
 
Total
 
 
    Fair Value      
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
 
 
(In Thousands) 

U.S. Government agencies and corporations
 
$
11,970
 
$
(82
)
$
5,957
 
$
(129
)
$
17,927
 
$
(211
)
Obligations of state and political subdivisions
   
12,089
   
(136
)
 
7,366
   
(200
)
 
19,455
   
(336
)
Corporate debt securities
   
2,439
   
(48
)
 
-
   
-
   
2,439
   
(48
)
Mortgage-backed securities
   
11,344
   
(136
)
 
5,204
   
(140
)
 
16,548
   
(276
)

Total Temporarily Impaired Securities
 
$
37,842
 
$
(402
)
$
18,527
 
$
(469
)
$
56,369
 
$
(871
)

In management’s opinion, the unrealized losses primarily reflect changes in interest rates subsequent to the acquisition of specific securities. At December 31, 2004, the Company had 83 securities in an unrealized loss position. The Company has the intent and the ability to hold such securities until maturity or market price recovery. Management believes that the unrealized losses represent temporary impairment of the securities.
 
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
 
 
 
 
 
 

54
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Note 3 - Securities (Continued)
 
At December 31, 2004, the Company held four preferred equity securities issued by FNMA and FHLMC with aggregate market value depreciation of 20% or more from the Company’s amortized cost basis of $5,000,000. Management had been closely monitoring the market valuations of these preferred equity securities and recent adverse financial events regarding these agencies, and has concluded that these equity securities are other-than-temporarily impaired under guidance provided by the Financial Accounting Standards Board (FASB). An impairment charge of $1,144,000 pre-tax ($755,000 after tax) was recorded in the fourth quarter of 2004. These securities were classified as available-for-sale, therefore the unrealized losses had been recorded as a reduction of stockholders’ equity through charges to accumulated other comprehensive income. Therefore, the impairment charge had no significant impact on total capital as previously reported.
 

Note 4 - Loans Receivable
 
The composition of loans receivable at December 31, 2004 and 2003 is as follows:
 
   
December 31,
 
     
2004
   
2003
 
 
 
(In Thousands)  

Commercial
 
$
52,705
 
$
49,329
 
Real estate:
             
Commercial
   
66,936
   
63,288
 
Residential
   
106,454
   
105,949
 
Consumer
   
18,375
   
17,525
 

     
244,470
   
236,091
 
Unearned net loan origination fees and costs
   
344
   
276
 
Allowance for loan losses
   
(2,739
)
 
(2,093
)
               
     $ 242,075     $ 234,274   

 

A summary of the transactions in the allowance for loan losses is as follows:
 
 
 
Years Ended December 31  
     
2004
   
2003
   
2002
 
 
 
(In Thousands)  

Balance, beginning
 
$
2,093
 
$
1,935
 
$
1,816
 
Provision for loan losses
   
1,050
   
289
   
180
 
Recoveries
   
39
   
54
   
55
 
Loans charged off
   
(443
)
 
(185
)
 
(116
)

Balance, ending
 
$
2,739
 
$
2,093
 
$
1,935
 

 

55
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 4 - Loans Receivable (Continued)
 
The total recorded investment in impaired loans was $1,418,000 and $814,000 at December 31, 2004 and 2003, respectively. Impaired loans, not requiring an allowance for loan losses, were $87,000 and $38,000 at December 31, 2004 and 2003, respectively. Impaired loans requiring an allowance for loan losses were $1,331,000 and $776,000 at December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, the related allowance for loan losses associated with these loans was $668,000 and $367,000, respectively. For the years-ended December 31, 2004, 2003 and 2002, the average balance of these impaired loans was $1,598,000, $796,000, and $882,000, respectively. The Company recognizes income on impaired loans under the cash basis when the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company will record all payments as a reduction of principal on such loans. Interest income recognized for the time that the loans were impaired was $29,000, $3,000, and $-0- in 2004, 2003 and 2002, respectively.
 
Loans on which the accrual of interest has been discontinued amounted to $2,063,000 and $984,000 at December 31, 2004 and 2003, respectively. Loan balances past due 90 days or more and still accruing interest, but which management expects will eventually be paid in full, amounted to $130,000 and $105,000 at December 31, 2004 and 2003, respectively.
 
Loans outstanding to directors, executive officers, principal stockholders or to their affiliates totaled $462,000 and $719,000 at December 31, 2004 and 2003, respectively. Advances and repayments during 2004 totaled $591,000 and $848,000, respectively. These loans are made during the ordinary course of business at the Company’s normal credit terms. There were no related party loans that were classified as non-accrual, past due, restructured or considered a potential credit risk at December 31, 2004 and 2003.
 
Note 5 - Premises and Equipment
 
Premises and equipment at December 31, 2004 and 2003 are comprised of the following:
 
     
2004
   
2003
 
 
 
(In Thousands)  

Land
 
$
398
 
$
398
 
Building and improvements
   
5,148
   
4,818
 
Furniture, fixtures and equipment
   
4,627
   
4,097
 

     
10,173
   
9,313
 
Accumulated depreciation
   
(5,269
)
 
(4,877
)
               
    $  4,904   $  4,436  

 
Depreciation expense was $392,000, $331,000, and $347,000 for the years-ended December 31, 2004, 2003 and 2002, respectively.
 

56
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 6 - Deposits
 
The composition of deposits at December 31, 2004 and 2003 were as follows:
 
     
2004
   
2003
 
 
 
  (In Thousands)

Demand:
             
Non-interest bearing
 
$
42,999
 
$
37,441
 
Interest bearing
   
60,704
   
66,807
 
Savings
   
65,283
   
60,255
 
Time:
             
$100,000 and over
   
18,990
   
21,375
 
Less than $100,000
   
86,799
   
93,822
 
    $ 274,775   $  279,700  
               

 
At December 31, 2004, the scheduled maturities of time deposits are as follows (in thousands):
 
 
       2005       $ 38,987  
       2006     41,896  
       2007     11,178  
       2008     6,561  
       2009     4,704  
       Thereafter     2,463  
         
    $ 105,789  

 

Note 7 - Short-Term Borrowings
 
Securities sold under agreements to repurchase and Federal Home Loan Bank advances generally represent overnight or less than 30-day borrowings. U.S. Treasury tax and loan notes for collections made by the Bank are payable on demand. Short-term borrowings consisted of the following at December 31, 2004 and 2003:
                                                                              
 
 
                                                                             December 31, 2004
     
Ending Balance  
 
 
Average Balance 
 
 
Maximum Month-End Balance  
 
 
Average Rate  
 
Securities sold under agreements to repurchase
 
$
7,860
 
$
8,513
 
$
10,521
   
1.32
%
Federal Home Loan Bank
   
6,080
   
861
   
6,080
   
1.82
 
U.S. Treasury tax and loan notes
   
674
   
418
   
808
   
1.07
 
    $ 14,614    $ 9,792    $ 17,409      1.35   %
                           


 

57
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 7 - Short-Term Borrowings (CONTINUED)
                                                                                         December 31, 2003
 
 
  Ending Balance
 
  Average Balance
 
 Maximum Month-End Balance
 
   Average Rate
 
 
       
    (In Thousands)             
         
 Securities sold under agreements to repurchase   $ 6,640   $ 5,717   $ 7,325     1.30 %
 Federal Home Loan Bank  
 
0     2,585     13,455     1.41  
 U.S. Treasury tax and loan notes  
 
445     448     1,020     0.85  
    $ 7,085   $ 8,750   $ 21,800     1.31 %
                           
 
The Bank has an agreement with the Federal Home Loan Bank (FHLB) which allows for borrowings up to a percentage of qualifying assets. At December 31, 2004, the Bank had a maximum borrowing capacity for short-term and long-term advances of approximately $156,526,000, of which $46,034,000 was outstanding in long-term borrowings. All advances from FHLB are secured by qualifying assets of the Bank.
 
Securities sold under repurchase agreements are retained under the Bank’s control at its safekeeping agent. The Bank may be required to provide additional collateral based on the fair value of the underlying securities.
 
The Bank has a $7,000,000 line of credit for the sale of federal funds with Atlantic Central Bankers Bank of which $-0- was outstanding at December 31, 2004 and 2003. These borrowings are unsecured.
 
Note 8 - Long-Term Borrowings
 
Long-term debt consisted of advances from the Federal Home Loan Bank under various notes.
 
Detail of long-term debt at December 31, 2004 and 2003 is as follows:
 
Due
 
 
Convertible
 
 
Strike
Rate
 
 
Current
Interest
Rate
 
 
2004
 
 
2003
 
 
   
 
              (In Thousands)       
May 2005
 
 
February 2005
 
 
8.5
%
 
7.02
%  
$
2,500
 
$
2,500
 
November 2005
 
 
February 2005
 
 
N/A
 
 
5.93
 
 
5,000
 
 
5,000
 
May 2010
 
 
February 2005
 
 
7.5
 
 
6.37
 
 
5,000
 
 
5,000
 
September 2010
 
 
March 2005
 
 
N/A
 
 
6.10
 
 
5,000
 
 
5,000
 
October 2011
 
 
January 2005
 
 
8.0
 
 
4.47
 
 
2,500
 
 
2,500
 
January 2007
 
 
January 2005
 
 
7.5
 
 
4.06
 
 
7,500
 
 
7,500
 
September 2012
 
 
March 2005
 
 
8.0
 
 
3.69
 
 
5,000
 
 
5,000
 
February 2009
 
 
N/A
 
 
N/A
 
 
4.80
 
 
1,588
 
 
1,924
 
February 2013
 
 
February 2005
 
 
8.0
 
 
3.59
 
 
5,000
 
 
5,000
 
February 2008
 
 
N/A
 
 
N/A
 
 
2.69
 
 
1,946
 
 
2,528
 
June 2014
   
June 2005
   
8.0
   
4.47
   
5,000
   
-
 
                                 
                       $ 46,034     $ 41,952   

 

58
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 

NOTE 8 - LONG-TERM BORROWINGS (CONTINUED)
 
On convertible rate notes, the Federal Home Loan Bank has the option to convert the notes at rates ranging from the three-month LIBOR (2.50% at December 31, 2004) plus .10% to plus .26% on a quarterly basis, if greater than the applicable strike rate, commencing on the conversion date. If converted, the Bank has the option to repay these advances at each of the option dates without penalty.
 
Maturities of long-term debt, by contractual maturity, in years subsequent to December 31, 2004 are as follows (in thousands):
 
      2005  
$
8,450
 
       2006    
983
 
       2007    
8,518
 
       2008    
513
 
       2009    
70
 
  Thereafter
   
27,500
 
    $ 46,034  
         

 

The notes are secured under terms of a blanket collateral agreement by a pledge of qualifying investment and mortgage-backed securities, certain mortgage loans and a lien on FHLB stock.
 

Note 9 - Stock Purchase Plans
 
The Company has a stock option plan covering non-employee directors and a stock incentive plan for all officers and key employees. The Plan is administered by a committee of the Board of Directors. Under the Plan, 187,500 shares of common stock are reserved for possible issuance, as adjusted for the three-for-two stock split issued in 2003. The number of shares available is subject to future adjustment in the event of specified changes in the Company’s capital structure. Under the Plan, the exercise price cannot be less than 100% of the fair market value on the date of grant. The vesting period of options granted is at the discretion of the Board of Directors. Options granted during 2004, 2003 and 2002 expire in ten years.
 
A summary of transactions under this Plan were as follows as adjusted for the stock split declared April 1, 2003:
 
   
2004
 
2003
 
2002
 
 
   
 
Options   		   
Weighted
Average
Price
   
Options
   
Weighted
Average
Price
   
Options
   
Weighted
Average
Price
 

Outstanding, beginning of year
   
74,127
 
$
17.38
   
79,155
 
$
16.66
   
65,698
 
$
16.35
 
Granted
   
5,050
   
34.10
   
4,850
   
27.50
   
14,700
   
18.00
 
Exercised
   
(13,920
)
 
16.68
   
(9,878
)
 
16.55
   
(1,148
)
 
16.19
 
Forfeited
   
(1,222
)
 
18.63
   
-
   
-
   
(95
)
 
14.80
 

Outstanding, end of year
   
64,035
 
$
18.83
   
74,127
 
$
17.38
   
79,155
 
$
16.66
 

Exercisable, end of year
   
59,435
 
$
18.16
   
69,277
 
$
16.67
   
79,100
 
$
16.66
 

59
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 9 - Stock Purchase Plans (continued)
 
The weighted-average remaining contractual life of the above options is approximately six years at December 31, 2004. Stock options outstanding at December 31, 2004 are exercisable at prices ranging from $14.80 to $34.10 a share.
 
During 1999, the Company implemented a Dividend Reinvestment and Stock Purchase Plan. Under the Plan, the Company registered with the Securities and Exchange Commission 100,000 shares of the common stock to be sold pursuant to the Plan. Participation is available to all common stockholders. The Plan provides each participant with a simple and convenient method of purchasing additional common shares without payment of any brokerage commission or other service fees. The Plan may purchase shares on the open market if available or they may be issued from treasury shares. A participant in the Plan may elect to reinvest dividends on all or part of their shares to acquire additional common stock. A participant may withdraw from the Plan at any time. Effective in 2002, the Plan was amended to permit stockholders participating in the Plan to purchase additional shares of common stock with voluntary cash payments of a minimum of $100 and a maximum of $2,500 each calendar quarter.
 

Note 10 - Income Taxes
 
The provision for federal income taxes consists of the following:
 
   
Years Ended December 31,
 
     
2004
   
2003
   
2002
 
 
 
  (In Thousands)

Current
 
$
1,314
 
$
1,941
 
$
1,632
 
Deferred
   
(300
)
 
(111
)
 
(79
)
                     
     $  1,014    $  1,830    $ 1,553   

 
 
 
 
 
 
 
 

 
 

60
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 10 INCOME TAXES (CONTINUED)
 
The components of the net deferred tax asset (liability) at December 31, 2004 and 2003 are as follows:
 
   
2004
 
2003
 
 
 
(In Thousands)  

            Deferred tax asset:          
                  Allowance for loan losses  
$
803
 
$
583
 
     Deferred loan fees
   
8
   
11
 
     Deferred compensation
   
273
   
217
 
     Other
   
86
   
122
 
     Impairment on security
   
389
   
-
 

 
 
1,559
   
933
 

     Deferred tax liabilities:
             
     Unrealized gain on available for sale securities
   
(318
)
 
(513
)
     Depreciation
   
(138
)
 
(42
)
                Section 481 Adjustment-Prepaid Expenses
   
(42
)
 
-
 
               Section 481 Adjustment-Deferred Loan Costs
   
(188
)
 
-
 

 
(686
)   
(555
)

          Net Deferred Tax Asset
 
$
873
 
$
378
 

 
A reconciliation of the provision for income taxes and the amount that would have been provided at statutory rates for the years-ended December 31 is as follows:
 
   
2004
 
2003
 
2002
 
 
    Amount      
% of
Pretax
Income
   
Amount
   
% of
Pretax
Income
   
Amount
   
% of
Pretax
Income
 
 
 
(In Thousands)  

Federal income tax at statutory rate
 
$
1,859
   
34
%
$
2,514
   
34
%
$
2,233
   
34
%
Tax exempt interest
   
(802
)
 
(14
)
 
(644
)
 
(9
)
 
(642
)
 
(10
)
Non-deductible interest
   
74
   
2
   
56
   
1
   
60
   
1
 
Officers’ life insurance income
   
(83
)
 
(2
)
 
(68
)
 
(1
)
 
(74
)
 
(1
)
Other, net
   
(34
)
 
(1
)
 
(28
)
 
-
   
(24
)
 
-
 
                                       
    $ 1,014     19 %    $ 1,830     25 %  $         1,553     24 %

 

The income tax provision includes ($288,000), $225,000, and ($179,000) in 2004, 2003 and 2002, respectively, of income tax (benefit) expense on net realized securities gains and losses.
 
61
  PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11 - Employee Benefit Plans
 
The Company has an employee stock ownership and profit-sharing plan with 401(k) provisions. The Plan is for the benefit of all employees who meet the eligibility requirements set forth in the Plan. The amount of employer contributions to the plan, including 401(k) matching contributions, is at the discretion of the Board of Directors. Employer ESOP contributions are allocated to participant accounts based on their percentage of total compensation for the Plan year. Shares of Company stock owned by the Plan are included in the earnings per share calculation and dividends on these shares are deducted from undivided profits. During 2004, 2003 and 2002, ESOP contributions to the Plan charged to operations were $126,000, $128,000, and $126,000, respectively. During 2004, 2003 and 2002, employer 401(k) matching contributions to the Plan charged to operations were $69,000, $65,000, and $58,000, respectively. At December 31, 2004, 139,101 shares of the Company’s common stock were held in the Plan. In the event a terminated Plan participant desires to sell his or her shares of the Company’s stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair market value.
 
The Bank has deferred compensation agreements with its chief executive officer, chief operating officer and certain directors that provide fixed retirement benefits. The Bank’s deferred compensation liability as of December 31, 2004 and 2003 was $803,000 and $639,000, respectively. The cost charged to operations for these deferred compensation plans was $164,000, $163,000, and $149,000 for the years-ended December 31, 2004, 2003 and 2002, respectively.
 
Note 12 - Contingencies
 
On October 23, 2001, the Securities and Exchange Commission filed suit against Robert L. Bentley, his d/b/a Entrust Group and Bentley Financial Services, Inc. alleging fraud in the sales of securities to financial institutions. Specifically, the Commission alleged that the defendants were representing to investors that they were selling bank-issued, federally insured certificates of deposit when they were actually selling uninsured securities issued by the defendants. The court granted the Commission’s request on October 24, 2001 for a temporary restraining order and, on November 7, 2001, appointed a receiver for Robert L. Bentley, Entrust Group and Bentley Financial Services, Inc. (collectively the Bentley Receivership Entities). The receiver obtained control of all investments and assets of the Bentley Receivership Entities.
 
The Bank regularly invested through Entrust Group and Bentley Financial Services, Inc. for certificates of deposit that the Bank had understood were bank issued, federally insured and the Entrust Group was holding in safekeeping for them. Based on preliminary information, management estimated the fraud loss to be approximately $297,000, which has been charged against operations in the amount of $158,000 and $139,000 for the years-ended December 31, 2002 and 2001, respectively. As of December 31, 2003 and 2002, the net claim with the receiver was $173,000 and $1,683,000 respectively and was included in other assets on the balance sheet. In 2003 and 2004, the Bank received $1,510,000 and $283,000, respectively, from the receiver. The 2004 receipt surpassed the net claim with the receiver recorded in the balance sheet by $110,000. This amount is included in other income for 2004 in the statement of income.
 
The Company is a defendant in various lawsuits wherein various amounts are claimed. In the opinion of the Company’s management, these suits are without merit and should not result in judgments which, in the aggregate, would have a material adverse effect on the Company’s consolidated financial statements.
 
 
 
 

 
62
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 13 - Financial Instruments with Off-Balance Sheet Risk and Concentration of Credit Risk
 
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets.
 
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
 
The contract or notional amounts at December 31, 2004 and 2003 were as follows:
 
   
2004
 
2003
 
 
 
(In Thousands)  

Commitments to extend credit
 
$
29,854
 
$
27,701
 
    Standby letters of credit
   
1,703
   
1,808
 
               
    $  31,557   $   29,509  

 


 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment.
 
Outstanding letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.
 
The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Company requires collateral supporting these letters of credit as deemed necessary. The maximum undiscounted exposure related to these commitments at December 31, 2004 and 2003 was $1,703,000 and $1,808,000, respectively and the approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $960,000 and $950,000, respectively. The current amount of the liability as of December 31, 2004 and 2003 for guarantees under standby letters of credit issued is not material.
 
 
 
 
 

63
 
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 14 - Regulatory Matters
 
The Bank is required to maintain average cash reserve balances in vault cash and with the Federal Reserve Bank based on a percentage of deposits. The required reserve balance at December 31, 2004 and 2003 was $503,000 and $3,190,000, respectively. The reduction in the required reserve balance at the Federal Reserve Bank is due to the implementation by the Company of a deposit account reclassification system which more accurately quantifies the portion of deposits that are transactional and non-transactional. The result of this process is that fewer transactional deposits are reported to the Federal Reserve Bank, thus reducing the amount of required reserves.
 
Dividends are paid by the Company from its assets, which are mainly provided by dividends from the Bank. However, certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. Under such restrictions, the Bank may not, without the prior approval of the Comptroller of the Currency, declare dividends in excess of the sum of the current year’s earnings (as defined) plus the retained earnings (as defined) from the prior two years. Under this restriction, the Bank, without prior regulatory approval, can declare dividends to the Company totaling $6,450,000, plus an additional amount equal to the net profit for 2005, up to the date any such dividend is declared.
 
The Company 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 the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
 
Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2004, that the Company and Bank meet all capital adequacy requirements to which they are subject.
 
As of December 31, 2004, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.
 
 
 
 

 
64
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 14 - Regulatory Matters (CONTINUED)
 
 
The Company and Bank’s actual capital ratios as of December 31, 2004 and 2003, and the minimum ratios required for capital adequacy purposes and to be well capitalized under the prompt corrective action provisions are as follows:
 
 
 
 
 
Actual 
 
For Capital Adequacy Purposes
To be Well Capitalized under Prompt Corrective Action
For Capital Adequacy Purposes on Provisions
 
 
 
      Amount  
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
 
 
(Dollars in Thousands)  
     As of December 31, 2004:
                                     
Total capital (to risk-weighted assets):
                                     
     Consolidated
 
$
42,583
   
16.05
%
$
³ 21,255
   
³ 8.00
%
 
N/A
   
N/A
 
     Peoples National Bank
   
42,053
   
15.85
   
³ 21,226
   
³ 8.00
 
$
³ 26,532
   
³ 10.00
%
Tier 1 capital (to risk-weighted assets):
                                     
     Consolidated
   
39,844
   
15.02
   
³ 10,611
   
³ 4.00
   
N/A
   
N/A
 
     Peoples National Bank
   
39,314
   
14.82
   
³ 10,611
   
³ 4.00
   
³ 15,917
   
³ 6.00
 
Tier 1 capital (to average assets):
                                     
     Consolidated
   
39,844
   
10.57
   
³ 15,078
   
³ 4.00
   
N/A
   
N/A
 
     Peoples National Bank
   
39,314
   
10.43
   
³ 15,077
   
³ 4.00
   
³ 18,847
   
³ 5.00
 
                                       
As of December 31, 2003:
                                     
Total capital (to risk-weighted assets):
                                     
     Consolidated
 
$
39,668
   
15.76
%
$
³ 20,134
   
³ 8.00
%
 
N/A
   
N/A
 
     Peoples National Bank
   
38,919
   
15.46
   
³ 20,141
   
³ 8.00
 
$
³ 25,176
   
³ 10.00
%
Tier 1 capital (to risk-weighted assets):
                                     
     Consolidated
   
37,575
   
14.93
   
³ 10,067
   
³ 4.00
   
N/A
   
N/A
 
     Peoples National Bank
   
36,826
   
14.63
   
³ 10,070
   
³ 4.00
   
³ 15,105
   
³ 6.00
 
Tier 1 capital (to average assets):
                                     
     Consolidated
   
37,575
   
10.22
   
³ 14,711
   
³ 4.00
   
N/A
   
N/A
 
     Peoples National Bank
   
36,826
   
10.01
   
³ 14,711
   
³ 4.00
   
³ 18,389
   
³ 5.00
 

 
 
 

 
65
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 15 - Fair Value of Financial Instruments
 
Management uses its best judgment in estimating the fair value of the Company’s financial instruments, however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends, and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end.
 
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2004 and 2003:
 
Cash and Cash Equivalents
 
The carrying amounts of cash and cash equivalents approximate their fair value.
 
Securities
 
Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
 
Loans Receivable
 
For variable-rate loans that reprice frequently and which entail no significant changes in credit risk, fair values are based on carrying amounts. The fair values of fixed rate loans are estimated using discounted cash flow analyses, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
 
Accrued Interest Receivable
 
The carrying amount of accrued interest receivable approximates its fair value.
 
Deposits
 
The fair values for demand deposits, savings accounts and certain money market accounts are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.
 
Accrued Interest Payable
 
The carrying amount of accrued interest payable approximates fair value.
 

 

66
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 15 - Fair Value of Financial Instruments (Continued)
 
Short-Term Borrowings
 
The carrying amounts of short-term borrowings approximate their fair values.
 
Long-Term Borrowings
 
The fair values of the Bank’s long-term debt are estimated using discounted cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements.
 
Commitments to Extend Credit and Standby Letters of Credit
 
These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented in Note 13.
 
The estimated fair values of the Company’s financial instruments are as follows:
 
   
December 31, 2004
 
December 31, 2003
 
 
    Carrying Amount      
Fair
Value
   
Carrying
Amount
   
Fair
Value
 
 
 
 (In Thousands)

Financial assets:
                         
Cash and cash equivalents
 
$
6,005
 
$
6,005
 
$
6,056
 
$
6,056
 
Securities available-for-sale
   
113,598
   
113,598
   
116,126
   
116,126
 
Loans receivable, net of
allowance
   
242,075
   
237,714
   
234,274
   
232,034
 
Accrued interest receivable
   
1,987
   
1,987
   
2,047
   
2,047
 
                           
Financial liabilities:
                         
Deposits
   
274,775
   
274,131
   
279,700
   
280,902
 
Short-term borrowings
   
14,614
   
14,614
   
7,085
   
7,085
 
Long-term borrowings
   
46,034
   
49,473
   
41,952
   
49,557
 
Accrued interest payable
   
550
   
550
   
604
   
604
 



67
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 16 - Parent Company Only Financial Information
 
Balance Sheets
 
 
 
December 31,  
     
2004
   
2003
 
 
 
(In Thousands)  

Assets
 
             
Cash
 
$
92
 
$
373
 
Investment in bank subsidiary
   
41,823
   
40,326
 
Due from subsidiary
   
440
   
378
 

Total Assets
 
$
42,355
 
$
41,077
 

       Liabilities and Stockholders' Equity
 
 
 
         
 Other liabilities
       
$
1
 
$
1
 


Stockholders’ equity:
             
Common stock
   
6,683
   
6,683
 
Surplus
   
2,821
   
2,618
 
Retained earnings
   
35,665
   
33,523
 
Accumulated other comprehensive income
   
618
   
995
 
     
45,787
   
43,819
 
                Treasury stock
   
(3,433
)
 
(2,743
)
 
 Total Stockholders’ Equity
   
42,354
   
41,076
 

 Total Liabilities and Stockholders’ Equity
 
$
42,355
 
$
41,077
 


68
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 16 - Parent Company Only Financial Information (Continued)
 
Statements of Income
 
     
Years Ended December 31,
     
2004
 
2003
 
2002
     
(In Thousands)

Dividends from bank subsidiary
 
$
2,611
 
$
2,056
 
$
1,950
 
Other income
   
-
   
28
   
46
 
Other expenses
   
48
   
78
   
83
 

Income before Income Taxes and Equity in
       Undistributed Net Income of Subsidiary
   
2,563
   
2,006
   
1,913
 

Income tax benefits
   
(16
)
 
(17
)
 
(13
)

Income before Equity in Undistributed Net
      Income of Subsidiary
   
2,579
   
2,023
   
1,926
 

Equity in undistributed net income of subsidiary
   
1,874
   
3,541
   
3,089
 

Net Income
 
$
4,453
 
$
5,564
 
$
5,015
 
 
 
 
 
 
 

 

69
PEOPLES FINANCIAL SERVICES CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 16 - Parent Company Only Financial Information (Continued)
 
Statements of Cash Flows
 
 
  Years Ended December 31,                  
     
2004
   
2003
   
2002
 
 
(In Thousands)  

Cash Flows from Operating Activities
 
                   
            Net income
 
$
4,453
 
$
5,564
 
$
5,015
 
     Adjustments to reconcile net income
     to net cash provided by operating 
     activities:
                   
     Undistributed net income of subsidiary
   
(1,874
)
 
(3,541
)
 
(3,089
)
            Increase (decrease) in due from/to subsidiary
   
(62
)
 
(514
)
 
25
 
            Decrease in accrued interest receivable
   
-
   
23
   
-
 
            Increase (decrease) in other liabilities
   
-
   
-
   
(1
)
            (Increase) decrease in other assets
   
-
   
25
   
-
 

Net Cash Provided by Operating Activities
   
2,517
   
1,557
   
1,950
 

Cash Flows Provided by Investing Activities
 
                   
Proceeds from maturities of and principal
repayments on available-for-sale securities
   
-
   
500
   
-
 

        Cash Flows from Financing Activities  
 
             
Cash dividends paid
         
(2,311
)
 
(2,057
)
 
(1,850
)
Proceeds from sale of treasury stock
         
326
   
381
   
11
 
Purchase of treasury stock
         
(813
)
 
(34
)
 
(167
)

           Net Cash Used in Financing Activities
   
(2,798
)
 
(1,710
)
 
(2,006
)

     Increase (Decrease) in Cash and Cash
                Equivalents
   
(281
)
 
347
   
(56
)

Cash and Cash Equivalents - Beginning
   
373
   
26
   
82
 

Cash and Cash Equivalents - Ending
 
$
92
 
$
373
 
$
26
 



70


ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

 
None.
ITEM 9A CONTROLS AND PROCEDURES  
 
(a) Evaluation of disclosure controls and procedures.

 
The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed as of December 31, 2004, the chief executive and principal financial officers of the Company concluded that the Company’s disclosure controls and procedures were adequate.

 
(b) Internal control over financial reporting.

 
The Company is not filing with this Form 10-K report management’s annual report on internal control over financial reporting or an attestation report of the Company’s independent auditing firm as to management’s assessment of the Company’s internal control over financial reporting in reliance upon SEC Exemptive Order, dated November 30, 2004, under Section 36 of the Securities Exchange Act of 1934, which permits both reports to be filed not later than 45 days after the end of the 75 day filing period specified in Form 10-K for accelerated filers.
   
 
The Company will complete its form 10-K by filing an amendment to include both reports described above no later than April 30, 2005.

 
(c) Changes in internal controls.

 
There were no changes in the Company’s internal controls over financial reporting that occurred during the fourth fiscal quarter ending December 31, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

ITEM 9B OTHER INFORMATION

On December 3, 2004, the Bank entered into a Supplemental Executive Retirement Agreement with each of Mr. Ord and Ms. Dissinger which provide for supplemental retirement payments to each executive officer. In the case of Mr. Ord, the annual benefit payable following normal retirement is $84,520 and, in the case of Ms. Dissinger, the annual benefit payable following normal retirement is $20,000, payable for 15 years. The agreements are unfunded, but the Bank purchased life insurance and annuities that are actuarially designed to offset the annual expenses associated with these agreements.

On December 3, 2004, the Bank also entered into a Supplemental Director Retirement Plan Agreement with each of the non-employee directors which provides the directors with supplemental retirement payments following normal retirement from the Board at age 70, provided the director had served as a director of the Bank for at least 10 years prior to the normal retirement date. Eligible directors would receive an annual benefit equal to $150 for each year of service as a director, payable for a period of 10 years.


71

PART III

ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT  
 
This item is incorporated by reference under Section “Governance of the Company” under the previously submitted document DEF 14A Proxy Statement filed with the SEC.

ITEM 11 EXECUTIVE COMPENSATION
 
This item is incorporated by reference under Section “Executive Compensation” under the previously submitted document DEF 14A Proxy Statement filed with the SEC.

ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT   AND RELATED STOCKHOLDER MATTERS
 
This item is incorporated by reference under Section “Share Ownership of Management and Directors” under the previously submitted document DEF 14A Proxy Statement filed with the SEC.

ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
This item is incorporated by reference under Section “Executive Compensation” under the previously submitted document DEF 14A Proxy Statement filed with the SEC.

ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES  
 
This item is incorporated by reference under Section “Report of the Audit Committee” under the previously submitted document DEF 14A Proxy Statement filed with the SEC.

 
 
 
 
 
 

 
72

PART IV  

ITEM 15 EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES  
(a)
Financial Statement Schedules can be found under Item 8 of this report.

Exhibits required by Item 601 of Regulation S-K:

(3.1)
 
Articles of Incorporation of Peoples Financial Services Corp. *;
 
(3.2)
 
Bylaws of Peoples Financial Service Corp. as amended **;
 
(10.1)
 
Agreement dated January 14, 1997, between John W. Ord and Peoples Financial Services Corp. *;
 
(10.2)
 
Excess Benefit Plan dated January 14, 1992, for John W. Ord *;
 
(10.4)
 
Termination Agreement dated January 1, 1997, between Debra E. Dissinger and Peoples Financial
 
   
Services Corp. *;
 
(10.5)
 
Supplemental Executive Retirement Plan Agreement, dated December 3, 2004, for John W. Ord, filed herewith;
 
(10.6)
 
Supplemental Executive Retirement Plan Agreement, dated December 3, 2004, for Debra E. Dissinger, filed herewith;
 
(10.7)
 
Supplemental Director Retirement Plan Agreement, dated December 3, 2004, for all Non-Employee Directors of the Company, filed herewith;
 
(11)
 
 
The statement regarding computation of per-share earnings required by this exhibit is contained in Note 1 to the consolidated financial statements captioned “Earnings Per Common Share” filed as part of Item 8 of this report;
 
(14)
 
Code of Ethics, filed herewith;
 
(21)
 
Subsidiaries of Peoples Financial Services Corp. *;
 
(23)
 
Consent of Independent Registered Public Accounting Firm - Beard Miller Company LLP, filed herewith;
 
(31.1)
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a), filed herewith;
 
(31.2)
 
Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a), filed herewith;
 
(32.1)
 
Certification of Chief Executive Officer pursuant to Section 1350 of Sarbanes-Oxley Act of 2002, filed herewith; and
 
(32.2)
 
Certification of Principal Financial Officer pursuant to Section 1350 of Sarbanes-Oxley Act of 2002, filed herewith.
 
       

   
*
 
Incorporated by reference to the Corporation’s Registration Statement on Form 10 as filed with the U.S. Securities and Exchange Commission on March 4, 1998.
 
       
**
 
 
Incorporated by reference to the Company’s Exhibit 3.2 on Form 10Q filed with the U.S. Securities and Exchange Commission on November 8, 2004.
 
 
 
 

 

73

SIGNATURES  

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

PEOPLES FINANCIAL SERVICES CORP
   
By
/s/
John W. Ord
John W. Ord, President and Chief Executive Officer
 
 
 
 
/s/
Debra E. Dissinger
Debra E. Dissinger, Executive Vice President
 
 
 
 
/s/
Frederick J. Malloy
Frederick J. Malloy, Principal Accounting Officer
 
 
 
 
/s/
Gerald R. Pennay
Gerald R. Pennay, Chairman, Board of Directors
 
 
 
 
/s/
George H. Stover, Jr.
George H. Stover, Jr., Member, Board of Directors
 
 
 
 
/s/
Thomas F. Chamberlain
Thomas F. Chamberlain, Member, Board of Directors
 
 
 
 
/s/
Russell D. Shurtleff, Esq.
Russell D. Shurtleff, Member, Board of Directors
 
       
 
/s/
Richard S. Lochen, Jr.
Richard S. Lochen, Jr., Member, Board of Directors
 
 
 
 
 
 

 

74

EXHIBIT INDEX
ITEM NUMBER
 
DESCRIPTION
 
PAGE
10.5
 
Supplemental Executive Retirement Plan Agreement, dated December 3, 2004, for John W. Ord
 
76-82
 
10.6
 
Supplemental Executive Retirement Plan Agreement, dated December 3, 2004, for Debra E. Dissinger
 
83-94
 
10.7
 
Supplemental Director Retirement Plan Agreement, dated December 3, 2004, for All Directors of the Company
 
95-99
 
14
 
Code of Ethics
 
100
 
23
 
Consent of Independent Registered Public Accounting Firm
 
101
 
31.1
 
Certification of Chief Executive Officer
 
102
 
31.2
 
Certification of Principal Financial Officer
 
103
 
32.1
 
Sarbanes-Oxley Act of 2002 Section 1350
 
104
 
   
Certification of Chief Executive Officer
     
32.2
 
Sarbanes-Oxley Act of 2002 Section 1350
 
105
 
   
Certification of Principal Financial Officer
     
 
 
 
 
 
 

 
75

PEOPLES NATIONAL BANK
SUPPLEMENTAL EXECUTIVE RETIREMENT AGREEMENT
FOR
JOHN W. ORD


THIS AGREEMENT is adopted this 3rd day of December, 2004, by and between PEOPLES NATIONAL BANK, a national association having a place of business at 50 Main Street, Hallstead, Pennsylvania 18822 (the "Bank"), and JOHN W. ORD (the "Executive"), an individual residing at R.R. #1, Box 1095, Hallstead, Pennsylvania 18822.

INTRODUCTION


To encourage the Executive to remain an employee of the Bank, the Bank is willing to provide supplemental retirement income benefits to the Executive. The Bank will pay the benefits from its general assets.

AGREEMENT

The Bank and the Executive agree as follows:

Article 1
Definitions

Whenever used in this Agreement, the following words and phrases shall have the meanings specified:

1.1.    “Affiliate” means any company that controls, is controlled by, or is under common control with the Bank. For this Agreement, company includes any bank, corporation, general or limited partnership, limited liability company, associations or similar organization, business trust or any other trust.
 
1.2.    "Bank” or “Corporation" means Peoples National Bank.
 
1.3.    "Code" means the Internal Revenue Code of 1986, as amended.
 
1.4.    “Death Benefit” means the annual benefit paid to the Executive’s spouse pursuant to Article 3.1 hereto.
 
1.5.    "Disability" means Executive suffering a physical or mental impairment, which, in the judgment of a physician satisfactory to Bank, prevents Executive from performing all of the essential job functions of Executive’s position on a full time basis with or without reasonable accommodation and without posing a direct threat to himself or others, for a period of one hundred eighty days. As a condition to any benefits, Bank may require Executive to submit to such physical or mental evaluations and tests as Bank’s Board of Directors deems appropriate.
 
1.6.    “Employment Agreement” means the Employment Agreement entered into between Bank and Executive, dated January 1, 1997.
 
1.7.    "Normal Retirement Age" means December 31, 2006.
 

 
Article 2
 
Life Time Retirement Benefits
 
2.1   Normal Retirement Benefit . If Executive terminates employment on or after the Normal Retirement Age for reasons other than death, Bank shall pay to Executive the benefit described in this Article 2.1 hereof.
 
76
2.1.1   Amount of Benefit . The benefit under this Article 2.1 hereof is $84,520.00 per year.
 
2.1.2   Payment of Benefit . The Bank shall pay 1/12 of $84,520.00 to Executive on the first day of each month beginning the month following the month in which Executive terminates employment after reaching Normal Retirement Age.
 
2.1.3   Spousal Benefit. In the event of the death of the Executive whether before or after the Executive is eligible to receive benefits pursuant to this Article 2.1, the Bank shall pay the Executive’s spouse a benefit equal to fifty (50%) percent of the Executive’s benefits each month, such benefit to commence on the first day of the month following the month of Executive’s death and continue until the death of Executive’s spouse.
 
2.1.4   Acceleration of Deferred Payments . In the discretion of the Bank, but only with the Executive’s or his spouse’s consent, the payment of any remaining benefits to Executive or his spouse as a deferred payment may be accelerated, or the unpaid balance of such benefits may be distributed to the Executive or his spouse in a lump sum.
 
2.2   Early Termination Benefit . If Executive’s employment is terminated before the Normal Retirement Age and for reasons of Executive’s voluntary termination of employment, non-renewal of the Employment Agreement, Disability, or if Bank terminates Executive’s employment for reasons other than for Cause, Bank shall pay to Executive the benefit described in Article 2.1 hereof.
 
2.3   Purchase of Annuity. The parties agree that the Bank may, at any time, purchase an annuity to pay to Executive the benefit described in Article 2, which shall be a substitute for the Bank’s obligations under this Agreement.
 
Article 3
 
Death Benefits
 
3.1   Death Before Retirement . If Executive dies while actively employed by Bank, Executive’s spouse shall receive from the Bank the benefit described in this Article 3.1.
 
3.1.1   Amount of Benefit . The death benefit under this Article 3.1 shall be equal to 50% of the amount Executive would have been entitled to receive under Article 2.1.1 had Executive terminated employment on or after Normal Retirement Age.
 
3.1.2   Payment of Benefit . After the Bank receives notice of the death of the Executive, the Bank shall pay the surviving spouse 1/12 of the death benefit amount calculated under the Article 3.1.1 on the first day of each month beginning the month following the month of Executive’s death.
 
3.2   Purchase of Annuity. The parties agree that the Bank may, at any time, purchase an annuity to pay to the surviving spouse the benefit described in Article 3, which shall be a substitute for the Bank’s obligations under this Agreement.
 

 
Article 4
 
Assignment
 
Executive may assign without consideration all interests in this Agreement to any person, entity or trust. In the event Executive transfers all of Executive’s interest in this Agreement, then all of Executive’s interest in the Agreement shall be vested in Executives’ transferee, who shall be substituted as a party hereunder and Executive shall have no further interest in this Agreement.
 

Article 5
 
General Limitations
 
5.1   Termination for Cause. Notwithstanding any provision of this Agreement to the contrary, the benefit provided under this Agreement shall be forfeited if Bank terminates Executive’s employment for:
 
77
5.1.1   The willful failure by the Executive to substantially perform his duties, other than any such failure resulting from Disability.
 
5.1.2   The willful engaging by the Executive in gross misconduct materially injurious to the Bank or Affiliate.
 
5.1.3   Executive’s conviction of or plea of guilty or nolo contendere to a felony, a crime of falsehood or a crime involving moral turpitude, or the actual incarceration of Executive for a period of twenty (20) consecutive days or more.
 
5.1.4   Executive’s failure to follow the good faith lawful instructions of the Boards of Directors of Bank or Affiliate with respect to its operations, after written notice from Bank or Affiliate and a failure to cure such violation within thirty (30) days of said written notice.
 
5.1.5   Conduct on the part of the Executive, which brings public discredit to Bank, Affiliate or their subsidiaries, as determined by an affirmative vote of one hundred (100%) percent of the disinterested members of the Boards of Directors of Bank.
 
5.1.6   Executive’s breach of fiduciary duty involving personal profit.
 
5.1.7   Unlawful discrimination by the Executive, including harassment against employees, customers, business associates, contractors, or vendors of Bank, Affiliate or their subsidiaries, which could result in liability to Bank, Affiliate or their subsidiaries, as determined by an affirmative vote of one hundred (100%) percent of the disinterested members of the Boards of Directors of Bank or Affiliate following an investigation of the claims by a third party.
 
5.1.8   Theft or material abuse by Executive of property of Bank, Affiliate or their subsidiaries, or the property of customers, employees, contractors, vendors or business associates of Bank, Affiliate or their subsidiaries.
 
5.2   Removal. Notwithstanding any provision of this Agreement to the contrary, Bank shall not pay any benefit under this Agreement if Executive is subject to a final removal or prohibition order issued by an Appropriate Federal Banking Agency pursuant to Section 8(e) or (g) of the Federal Deposit Insurance Act.
 
5.3   Competition After Termination of Employment. Executive shall forfeit his right to any further benefits if Executive, without the prior written consent of Bank, violates the following described restrictive covenants.
 
5.3.1   Covenant Not to Compete. Executive hereby acknowledges and recognizes the highly competitive nature of the business of Bank and accordingly agrees that, during the period the Executive has the right to receive payment pursuant to this Agreement, Executive shall not, except as otherwise permitted in writing by Bank:
 
(a)   be engaged, directly or indirectly, either for his own account or as agent, consultant, employee, partner, officer, director, proprietor, investor (except as an investor owning less than 5% of the stock of a publicly owned company) or otherwise of any person, firm, corporation or enterprise engaged in (i) the banking (including bank or financial institution holding company), insurance or financial services industry, or (ii) any other activity in which Bank is engaged during the Employment Period, and remain so engaged at the end of the Employment Period in any area in which, at any time during the Employment Period or at the date of termination of Executive’s employment, is within twenty (20) miles of any branch location, office or other facility of Bank, unless Executive exclusively performs all such activity outside of said twenty (20) mile area (the “Non-Competition Area”); or
 
(b)   provide financial or other assistance to any person, firm, corporation, or enterprise engaged in (i) the banking (including bank or financial institution holding company), insurance or financial services industry, or (ii) any other activity in which Bank is engaged during the Employment Period, in the Non-Competition Area; or
 
 
 
 
78
(c)   if employed in a capacity provided in 5.3.1(a) and 5.3.1(b), solicit current customers, during the term of this Agreement, of Bank in the Non-Competition Area; or
 
(d)   solicit employees of Bank who are employed during the term of this Agreement.
 
5.3.2   Judicial Remedies. In the event of a breach or threatened breach by Executive of any provision of these restrictions, Executive recognizes the substantial and immediate harm that a breach or threatened breach will impose upon Bank or any of its subsidiaries or Affiliates, and further recognizes that in such event monetary damages may be inadequate to fully protect Bank or any of its subsidiaries or Affiliates. Accordingly, in the event of a breach or threatened breach of this Agreement, Executive consents to Bank’s or any of its subsidiaries or Affiliates’ entitlement to such preliminary, interlocutory, temporary or permanent injunctive, or any other equitable relief, protecting and fully enforcing Bank’s or any of its subsidiaries or Affiliates’ rights hereunder and preventing Executive from further breaching any of his obligations set forth herein. Executive expressly waives any requirement, based on any statute, rule of procedure, or other source, that Bank or any of its subsidiaries or Affiliates post a bond as a condition of obtaining any of the above-described remedies. Nothing herein shall be construed as prohibiting Bank or any of its subsidiaries or Affiliates from pursuing any other remedies available to Bank or any of its subsidiaries or Affiliates at law or in equity for such breach or threatened breach, including the recovery of damages from Executive. Executive expressly acknowledges and agrees that: (i) the restrictions set forth in Article 5.3.1 hereof are reasonable, in terms of scope, duration, geographic area, and otherwise, (ii) the protections afforded Bank or any of its subsidiaries or Affiliates in Article 5.3.1 hereof are necessary to protect its legitimate business interest, (iii) the restrictions set forth in Article 5.3.1 hereof will not be materially adverse to Executive’s employment with Bank, and (iv) his agreement to observe such restrictions form a material part of the consideration for this Agreement.
 
5.3.3   Overbreadth of Restrictive Covenant. It is expressly understood and agreed that, although Executive and Bank consider the restrictions contained in Article 5.3.1 hereof reasonable for the purpose of preserving for Bank its good will and other proprietary rights, if a final judicial determination is made by a court having jurisdiction that the time or territory or any other restriction contained in Article 5.3.1 hereof is an unreasonable or otherwise unenforceable restriction against Executive, the provisions of Article 5.3.1 hereof shall not be rendered void but shall be deemed amended to apply as to such maximum time and territory and to such other extent as such court may judicially determine or indicate to be reasonable.
 
 
Article 6
 
Claims and Review Procedures
 
6.1    Claims Procedure . An Executive or spouse (“claimant”) who has not received benefits under the Agreement that he or she believes should be paid shall make a claim for such benefits as follows:
 
                   6.1.1    Initiation - Written Claim. The claimant initiates a claim by submitting to the Bank a written claim for the benefits.
 
6.1.2    Timing of Bank Response. The Bank shall respond to such claimant within 90 days after receiving the claim. If the Bank determines that special circumstances require additional time for processing the claim, the Bank can extend the response period by an additional 90 days by notifying the claimant in writing, prior to the end of the initial 90-day period, that an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Bank expects to render its decision.
 
6.1.3    Notice of Decision. If the Bank denies part or all of the claim, the Bank shall notify the claimant in writing of such denial. The Bank shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth:
 
 
 
 
 
79
6.1.3.1    The specific reasons for the denial,
 
6.1.3.2    A reference to the specific provisions of the Agreement on which the denial is based,
 
6.1.3.3    A description of any additional information or material necessary for the claimant to perfect the claim and an explanation of why it is needed,
 
6.1.3.4    An explanation of the Agreement’s review procedures and the time limits applicable to such procedures, and
 
6.1.3.5    A statement of the claimant’s right to bring a civil action under ERISA Section 502(a) following an adverse benefit determination on review.
 
6.2   Review Procedure . If the Bank denies part or all of the claim, the claimant shall have the opportunity for a full and fair review by the Bank of the denial, as follows:
 
6.2.1   Initiation - Written Request . To initiate the review, the claimant, within 60 days after receiving the Bank’s notice of denial, must file with the Bank a written request for review.
 
6.2.2   Additional Submissions - Information Access . The claimant shall then have the opportunity to submit written comments, documents, records and other information relating to the claim. The Bank shall also provide the claimant, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits.
 
6.2.3   Considerations on Review . In considering the review, the Bank shall take into account all materials and information the claimant submits relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.
 
6.2.4   Timing of Bank Response . The Bank shall respond in writing to such claimant within 60 days after receiving the request for review. If the Bank determines that special circumstances require additional time for processing the claim, the Bank can extend the response period by an additional 60 days by notifying the claimant in writing, prior to the end of the initial 60-day period, that an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Bank expects to render its decision.
 
6.2.5   Notice of Decision . The Bank shall notify the claimant in writing of its decision on review. The Bank shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth:
 
6.2.5.1     The specific reasons for the denial,
 
6.2.5.2     A reference to the specific provisions of the Agreement on which the denial is based,
 
6.2.5.3   A statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits, and
 
6.2.5.4   A statement of the claimant’s right to bring a civil action under ERISA Section 502(a).
 

Article 7
 
Amendments and Termination
 
 
 
80
This Agreement may be amended or terminated only by a written agreement signed by the Bank and the Executive. Notwithstanding the previous sentence, the Bank may amend or terminate this Agreement at any time if, pursuant to legislative, judicial or regulatory action, continuation of the Agreement would (i) cause benefits to be taxable to the Executive prior to actual receipt, or (ii) result in significant financial penalties or other significantly detrimental ramifications to the Bank (other than the financial impact of paying the benefits). If either (i) or (ii) above should occur, the Executive shall be entitled to the benefit which he has accrued up through the date of such action.
 

Article 8
 
Miscellaneous
 
8.1   Binding Effect . This Agreement shall bind the Executive and the Bank, and their beneficiaries, survivors, executors, successors, administrators and transferees.
 
8.2   No Guarantee of Employment . This Agreement is not an employment policy or contract and does not affect nor is affected by the Employment Agreement or any other employment agreement that Executive and Bank have executed or may execute in the future, except as specifically stated in this Agreement. It does not give Executive the right to remain an employee of Bank, nor does it interfere with Bank’s right to discharge Executive. It also does not require Executive to remain an employee nor interfere with Executives’ right to terminate employment at any time.
 
8.3   Tax Withholding . The Bank shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement.
 
8.4   Applicable Law . The Agreement and all rights hereunder shall be governed by the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America.
 
8.5   Unfunded Arrangement . The Executive and beneficiary are general unsecured creditors of the Bank for the payment of benefits under this Agreement. The benefits represent the mere promise by the Bank to pay such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. The Bank has absolute and sole discretion to informally fund or not informally fund is obligations under this Agreement.
 
8.6   Successors. Bank shall not merge or consolidate into or with another company, or reorganize, or sell substantially all of its assets to another company, firm or person unless such succeeding or continuing company, firm or person agrees to assume and discharge the obligations of Bank under this Agreement.
 
8.7   Notice. Any notice, consent or demand required or permitted to be given under the provisions of this Supplemental Executive Retirement Agreement by one party to another shall be in writing, shall be signed by the party giving or making the same, and may be given either by delivering the same to such other party personally, or by mailing the same, by United States certified mail, postage, prepaid, to such party, addressed to his or her last known address as shown on the records of Bank. The date of such mailing shall be deemed the date of such mailed notice, consent or demand.
 
8.8   Recovery of Estate Taxes. If Executive’s gross estate for federal estate tax purposes includes any amount determined by reference to and on account of this Agreement, and if the beneficiary is other than Executive’s estate, then Executive’s estate shall be entitled to recover from the beneficiary receiving such benefit under the terms of the agreement, an amount by which the total estate tax due by Executive’s estate, exceeds the total estate tax which would have been payable if the value of such benefit had not been included in Executive’s gross estate. If there is more than one person receiving such benefit, the right of recovery shall be against each such person. In the event the beneficiary has a liability hereunder, the beneficiary may petition Bank for a lump sum payment in an amount not to exceed the beneficiary’s liability hereunder.
 
8.9   Entire Agreement. This Agreement constitutes the entire agreement between the Bank and the Executive as to the subject matter hereof. No rights are granted to the Executive by virtue of this Agreement other than those specifically set forth herein.
 
81
8.10   Administration. The Bank shall have powers which are necessary to administer this Agreement, including but not limited to:
 
(a)   Establishing and revising the method of accounting for the Agreement;
 
(b)   Maintaining a record of benefit payments;
 
(c)   Establishing rules and prescribing any forms necessary or desirable to administer the Agreement; and
 
(d)   Interpreting the provisions of the Agreement.
 
8.11   Named Fiduciary. The Bank shall be the named fiduciary and plan administrator under this Agreement. It may delegate to others certain aspects of the management and operational responsibilities and the delegation of ministerial duties to qualified individuals.
 
8.12   Headings. Headings are included in this Agreement for the convenience of the parties and shall not be taken into consideration in construing the provisions of this Agreement.
 
IN WITNESS WHEREOF, the Executive and the Bank have executed this Agreement as of the day and year first above written.
 

 
ATTEST:             BANK:
 
PEOPLES NATIONAL BANK
 
_____________________________            By:______________________________          
(Asst.) Secretary             (Vice) President
 

 
WITNESS:             EXECUTIVE:
 
__________________________         _________________________________
                                            John W. Ord
 
 
 
 
 
 
 
 
 
82

EXHIBIT 10.6
PEOPLES NATIONAL BANK
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN AGREEMENT
FOR
DEBRA E. DISSINGER
 
THIS AGREEMENT is made and entered into this 3 RD day of December, 2004, by and between PEOPLES NATIONAL BANK, a national association having a place of business at 50 Main Street, Halstead, Pennsylvania 18822 ("Bank"), and   DEBRA E. DISSINGER ("Executive"), an individual residing at R.R. #2, Box 190C, Susquehanna, Pennsylvania 18847. This Agreement shall append the Split Dollar Endorsement entered into in April 2003, or as subsequently amended, by and between the aforementioned parties.

INTRODUCTION

To encourage Executive to remain an employee of Bank, Bank is willing to provide Executive with supplemental retirement benefits or to divide the death proceeds of two life insurance policies on Executive's life. Bank will pay the benefits and the life insurance premiums from its general assets.

Article 1
General Definitions

The following terms shall have the meanings specified:

1.1   "Affiliate" means any company that controls, is controlled by, or is under common control with Bank. For this Agreement, company includes any bank, corporation, general or limited partnership, limited liability companies, association or similar organization, business trust, or any other trust.

1.2   "Change in Control" means any of the following:

(A)  
(A) a merger, consolidation or division involving Peoples Financial Services Corp. (“Peoples”) or Bank, (B) a sale, exchange, transfer or other disposition of substantially all of the assets of Peoples or Bank, or (C) a purchase by Peoples or Bank of substantially all of the assets of another entity, unless (y) such merger, consolidation, division, sale, exchange, transfer, purchase or disposition is approved in advance by seventy-five percent (75%) or more   of the members of the Board of Directors of Peoples or Bank (as the case may be) who are not interested in   the transaction and (z) a majority of the members of the Board of Directors   of the legal entity resulting from or existing after any such transaction and of   the Board of Directors of such entity's parent corporation, if any, are former members of the Board of Directors of Bank; or

(B)  
any " person " (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act")), other than Bank or any "person" who on the date hereof is a director or officer of Peoples or Bank, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of Peoples or Bank representing twenty-five (25%) percent or more of the combined voting power of Peoples or Bank's then outstanding securities, or

(C)  
during any period of two (2) consecutive years during the term of this Agreement, individuals who at the beginning of such period constitute the Board of Directors of Peoples or Bank cease for   any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds of the directors then in office who were directors at the beginning of the period; or
83
(D)  
any other change in control of Peoples or Bank similar in effect to any of the foregoing.

  
 

Notwithstanding anything else to the contrary set forth in this Agreement, if (i) an agreement   is executed by Peoples or Bank providing for any of the transactions or events constituting a Change in Control   as defined herein, and the agreement subsequently expires or is terminated without the transaction   or event being consummated, and (ii) Executive's employment did not terminate during the period after the agreement and prior to such expiration or termination, for purposes of this Agreement it shall be as though such agreement was never executed and no Change in Control event shall be deemed to have occurred as a result of the execution of such agreement.

1.3 "Disability" means Executive suffering a physical or mental impairment, which, in the judgment of a physician satisfactory to Bank, prevents Executive from performing all of the essential job functions of Executive's position on a full time basis with or without reasonable accommodation and without posing a direct threat to herself or others, for a period of one hundred   eighty days. As a condition to any benefits, Bank may require Executive to submit to such physical or mental evaluations and tests as Bank's Board of Directors deems appropriate.

1.4   "Bank" means Peoples National Bank

1.5   "Insured" means Executive.

1.6   "Insurer" means The MONY Group and Clarcia Life Insurance Company.
   
               1.7   "Policy " means The MONY Group insurance policy no. B25016399 and Clarcia Life Insurance Company insurance policy
                       no. 631408.
                1.8   "Net Death Proceeds" means the death proceeds of the Policy, in the aggregate amount as provided in the attached
         endorsements.
 
              1.9   "Normal Retirement Age" means 65 years old.
 
              1.10   "Code" means the Internal Revenue Code of 1986, as amended.
 
              1.11   "Termination Agreement" means the Termination Agreement entered into between Bank and Insured, dated January 1, 1997.
 
              1.12   “Peoples” means Peoples Financial Services Corp.

Article 2
Lifetime Benefits

2.1   Normal Retirement Benefit.   If Executive terminates employment on or after the Normal Retirement Age for reasons other than death, Bank shall pay to Executive the benefit described in this Section 2.1

2.1.1   Amount of Benefit.   The benefit under this Section 2.1 is $20,000.00 per year.

2.1.2   Payment of Benefit.   Bank shall pay 1/12 pf $20,000.00 to Executive on the first day of the month commencing with the month following the month in which Executive terminates employment after reaching Normal Retirement Age and continuing for 15 years.

2.2   Early Termination Benefit.   If Executive's employment is terminated before the Normal Retirement Age absent a change of control and for reasons of Executive's voluntary termination of employment, non-renewal of an employment agreement, Disability, or if Bank terminates Executive's employment for reasons other than for Cause, Bank shall pay to Executive the benefit described in this Section 2.2.

84        


2.2.1   Amount of Benefit.   The Executive's benefit under this Section 2.2 is the amount accrued for the benefit set forth in Section 2.1, as calculated in accordance with GAAP and reflected in the accounting records of Bank, on the date of termination of Executive's employment.

2.2.2   Payment of Benefit.   Bank shall pay 1/12 of $20,000.00 to Executive on the first day of the month following Executive's birthday, commencing with the month following the month in which Executive reaches Normal Retirement Age and continuing for 15 years.

2.3   Change of Control Benefit.   If Executive is actively employed by Bank at the time of a Change of Control, Section 10.4 shall not apply and Bank shall pay to Executive the benefit described in Section 2.1.

2.3.1   Payment of Benefit.   Bank shall pay 1/12 of $20,000.00 to Executive on the first day of the month following Executive's birthday, commencing with the month following the month in which Executive reaches Normal Retirement Age and continuing for 15 years.
 
2.4   Exclusive Benefits. Any Lifetime Benefits paid under this Agreement are exclusive; if Lifetime Benefits are paid, no Death Benefits will be paid under this Agreement or the appended Endorsements.

Article 3
Death Benefits

3.1   Death Before Normal Retirement Age. If Executive dies while actively employed by Bank before reaching the Normal Retirement Age, Executive's beneficiary shall receive from the Insurer the benefit described in this Section 3.1.

3.1.1   Amount of Benefit. The benefit under Section 3.1 is a death benefit in the amount as reflected in Schedule 3.1.1. The benefit paid is determined by the Plan Year in which Executive dies.   For example, if Executive dies in Plan Year 1, the benefit is $82,082. Plan year 1 commences on the   date this Agreement is executed and ends one year later. Plan Year 2 commences at the end of Plan   Year 1 and ends one year later. Each subsequent Plan Year runs similarly. If such death benefit is paid, no Lifetime Benefits under this Agreement will be paid.
 
 
 
 
 
 

85
 
Year One
82,082
Year Two
87,007
Year Three
92,227
Year Four
97,761
Year Five
103,626
Year Six
109,844
Year Seven
116,434
Year Eight
123,421
Year Nine
130,826
Year Ten
138,675
Year Eleven
146,996
Year Twelve
155,816
Year Thirteen
165,165
Year Fourteen
175,074
Year Fifteen
185,579
Year Sixteen
196,714
Year Seventeen
208,516
Year Eighteen
221,027
Year Nineteen
234,289
 
 
 
 
 
 
 
 
 
 

 
86       

3.1.2   Payment of Benefit.   The benefit shall be paid to the beneficiary by Insurer, as provided in the Policy.

3. 2   Death After Normal Retirement Age, But Before Receipt of Lifetime Benefits. If Executive dies after reaching the Normal Retirement Age, but before receiving any Lifetime Benefit   payments under this Agreement, the death benefit identified in Section 3.1 shall be paid in accordance   with Section 3.1.2.   If such death benefit is paid, no Lifetime Benefits under this Agreement will be paid.

3.3   Death Following Normal Retirement Age, But After Receipt of Lifetime Benefits.   In the event Executive dies after Normal Retirement Age and after the Executive has begun to receive   any Lifetime Benefits from the Bank, the Bank shall continue to pay those Lifetime Benefits, as provided in   Article 2, and the Executive, Executive's estate or beneficiaries shall have no right to receive a death benefit and the rights under the endorsements will be terminated.

3. 4   Death After Change of Control. If Executive dies following a Change of   Control, but prior to the commencement of the Lifetime Benefit payments, provided Executive was actively employed at the time   of the Change   of   Control, Executive's beneficiary shall be paid the death benefit   described in Section 3.1 in accordance with Section 3.1.2.   If such death benefit is paid, no Lifetime Benefits under this Agreement will be paid.

3.4.1   Payment of Benefit.   The benefit shall be paid to the beneficiary by Insurer in accordance with Section 3.1.2.

3.5   Endorsement.   All death benefits paid under this Agreement shall be in accordance with and as designated by the appended endorsements.

Article 4
Policy Ownership/Interests

4.1   Bank Ownership.   Bank is the sole owner of   the Policy and shall have the right to exercise all incidents   of ownership. Bank shall be the beneficiary   of the death proceeds   of the Policy remaining after Executive's interest is determined according to Section 4.2 below.

4.2   Executive's Interest.   Subject to the provisions of Article 10, Executive shall have the right to designate the beneficiary   of the Net Death Proceeds. Executive shall also have the right to elect and change settlement options that may be permitted.

4.3   Comparable Coverage.   Upon execution of   this Agreement, Bank shall maintain the Policy in full force and effect and in no event shall Bank amend, terminate or otherwise abrogate Executive's interest in the Policy, unless Bank replaces the Policy with a comparable insurance policy to cover the benefit provided under this Agreement. The Policy or any comparable policy shall be subject to the claims of   Bank's creditors.
 
4.4   Option to Purchase.   Bank shall not sell, surrender or transfer ownership of the Policy while this Agreement is in effect without first giving Executive or Executive's transferee the option to purchase the Policy for a period of 60 days from written notice of such intention. The purchase price shall be an amount equal to the cash surrender value of the Policy. This provision shall not apply if the Agreement has terminated pursuant to Article 9.

Article 5
Premiums

5.1   Premium Payment . Bank shall pay any premiums due on the Policy.

5.2   Imputed Income.   Bank shall impute income to Executive in an amount equal to the current term rate for Executive's age multiplied by the aggregate death benefit payable to Executive's beneficiary. The "current term rate" is the minimum amount required to be imputed under Revenue Rulings 64-328 and 66-110, or any subsequent applicable authority.

87       


Article 6
Assignment

Executive may assign without consideration all interests in the Policy and in this Agreement   to any person, entity or trust. In the event Executive transfers all of Executive's interest in the Policy, then all of Executive's interest in the Policy and in the Agreement shall be vested in Executive's transferee, who shall be substituted as a party hereunder and Executive shall have no further interest in the Policy or in this Agreement.

Article 7  
Insurer

The Insurer shall be bound only by the terms of the Policy. Any payments the Insurer makes or actions it takes in accordance with the Policy shall fully discharge it from all claims, suits and demands of all entities or persons. The Insurer shall not be bound by or be deemed to have notice of the provisions of this Agreement.

Article 8
Claims Procedure

8.1   Claims Procedure.   Bank shall notify any person or entity that makes a claim under this Agreement (the "Claimant') in writing, within 90 days of Claimant's written application for benefits, of his or her eligibility or ineligibility for benefits under this Agreement. If Bank determines that the Claimant is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for such denial, (2) a specific reference to the provisions of this Agreement on which the denial is based, (3) a description of any additional information or material necessary for the Claimant to perfect his or her claim, and a description of why it is needed, and (4) an explanation of this Agreement's claims review procedure and other appropriate information as to the steps to be taken if the Claimant wishes to have the claim reviewed. If Bank determines that there are special circumstances requiring additional time to make a decision, Bank shall notify the Claimant of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional 90 days.
 
 
8.2   Review Procedure.   If the Claimant is determined by Bank not to be eligible for benefits, or if the Claimant believes that he or she is entitled to greater or different benefits, the Claimant shall have the opportunity to have such claim reviewed by Bank by filing a petition for review with Bank within 60 days after receipt of the notice issued by Bank. Said petition shall state the specific reasons which the Claimant believes entitle him or her to benefits or to greater or different benefits. Within 60 days after receipt by Bank of the petition, Bank shall afford the Claimant (and counsel, if any) an opportunity to present his or her position to Bank verbally or in writing, and the Claimant (or counsel) shall have the right to review the pertinent documents. Bank shall notify the Claimant of its decision in writing within the sixty-day period, stating specifically the basis of its decision, referencing the specific provisions of this Agreement on which the decision is based. If, because of the need for a hearing, the 60-day period is not sufficient, the decision may be deferred for up to another 60-day period at the election of Bank, but notice of this deferral shall be given to the Claimant.

Article 9
Amendments and Termination

This Agreement may be amended or terminated only by a written agreement signed by Bank and Executive, except as provided in Article 10.

88       


Article 10
General Limitations

10.1   Excess Parachute or Golden Parachute Payment.   Notwithstanding any provision of this Agreement to the contrary, if any benefit provided under this Agreement, when added to all other amounts or benefits provided to or on behalf of Executive in connection with her termination of employment, including but not limited to the Termination Agreement, would result in the imposition   of an excise tax under Code Section 4999, such payments shall be retroactively (if necessary) reduced to the extent necessary to avoid such excise tax imposition or shall be forfeited to the extent the benefit would be a prohibited golden parachute payment pursuant to 12 C.F.R. §359.2 and for which the appropriate federal banking agency has not given written consent to pay pursuant to 12 C.F.R. § 359.4. Upon written notice to Executive, together with calculations of Bank' s independent auditors,   Executive shall remit to Bank the amount of the reduction plus such interest as may be necessary to   avoid the imposition of such excise tax. Notwithstanding the foregoing or any other provision of this contract to the contrary, if any portion of the amount herein payable to the Executive is determined to be non-deductible pursuant to the regulations promulgated under Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), the Corporation shall be required only to pay to Executive the amount determined to be deductible under Section 280G.
 
10.2   Termination for Cause   Notwithstanding any provision of this Agreement to the contrary, the benefit provided under this Agreement shall be forfeited if Bank terminates Executive's employment for:
 
(A)  
The willful failure by the Executive to substantially perform her duties, other than any such failure resulting from Disability.
 
(B)  
The willful engaging by the Executive in gross misconduct materially injurious to Peoples or Bank.
 
(C)  
Executive's conviction of or plea of guilty or nolo contendere to a felony, a crime of falsehood or a crime involving moral turpitude, or the actual incarceration of Executive for a period of twenty (20) consecutive days or more.
 
(D)  
Executive's failure to follow the good faith lawful instructions of the Boards of Directors of Peoples or Bank with respect to its operations, after written notice from Peoples or Bank and a failure to cure such violation within thirty (30) days of said written notice.
 
(E)  
Conduct on the part of the Executive, which brings public discredit to Peoples or Bank or their subsidiaries, as determined by an affirmative vote   of one hundred percent (100%) of the disinterested members of the Boards of Directors of Peoples or Bank.
 
(F)  
Executive's breach of fiduciary duty involving personal profit.
 
(G)  
Unlawful discrimination by the Executive, including harassment against employees, customers, business associates, contractors, or vendors of Peoples, Bank or their subsidiaries, which could result in liability to Peoples, Bank or their subsidiaries, as determined by an affirmative vote   of one hundred percent (100%) of the disinterested members of the Boards of   Directors of Peoples or Bank, following an investigation of the claims by a third party.
 
(H)  
Theft or material abuse by Executive of property of Peoples, Bank or their subsidiaries, or the property of customers, employees, contractors, vendors or business associates of Peoples, Bank or their subsidiaries.

89       

 

 
10.3   Removal.   Notwithstanding any provision of this Agreement to the contrary, Bank shall not pay any benefit under this Agreement if Executive is subject to a final removal or prohibition order issued by an Appropriate Federal Banking Agency pursuant to Section 8(e) or (g) of the Federal Deposit Insurance Act.
 
10.4   Competition After Termination of Employment.   Executive shall forfeit her right to any further benefits if Executive, without the prior written consent of Bank, violates the following described restrictive covenants.
 
              10.4.1   Covenant Not to Compete.   Executive hereby acknowledges and recognizes the highly competitive nature of the business of the Bank and accordingly agrees that, during for and after term of her employment with Bank and until Executive reaches the age of six-five (65), Executive shall not, except as otherwise permitted in writing by Bank:
 
 
(i)
be engaged, directly or indirectly, either for her own account or as agent, consultant, employee, partner, officer, director, proprietor, investor (except as an investor owning less than 5% of the stock of a publicly owned company) or otherwise of any person, firm, corporation or enterprise engaged in (1) the banking (including bank or financial institution holding company), insurance or financial services industry, or (2) any other activity in which Bank is engaged   during the employment period, and remain so engaged at the end of   the employment period, in any area in which, at any time during the employment period or at the date of termination of Executive's employment, is within twenty (20) miles of any branch location, office or other facility of Bank, unless Executive exclusively performs all such activity outside of said twenty (20) mile area (the "Non-Competition Area"); or

 
(ii)
provide financial or other assistance to any person, firm, corporation, or enterprise engaged in (1) the banking (including bank or financial   institution holding company), insurance or financial services industry, or (2) any other activity in which Bank is engaged during the employment period, in the Non-Competition Area; or

 
(iii)
if employed in a capacity provided in (i) and (ii), solicit current customers, during the term of this Agreement, of Bank in the Non-Competition Area; or

 
(iv)
solicit employees of Bank who are employed during the term of this Agreement.
 
 
10.4.2   Judicial Remedies     In the event of a breach or threatened breach by Executive   of any provision of these restrictions, Executive recognizes the substantial and   immediate harm that a breach or threatened breach will impose upon Bank or   any of its subsidiaries or Affiliates, and further recognizes that in such event monetary damages may be inadequate to fully protect Bank or any of its subsidiaries or Affiliates. Accordingly, in the event of a breach or threatened breach of this Agreement, Executive consents to Bank's or any of its subsidiaries or Affiliates' entitlement to such preliminary, interlocutory, temporary or permanent injunctive, or any other equitable relief, protecting and fully enforcing Bank's or any of its subsidiaries or Affiliates' rights hereunder and preventing Executive from further breaching any of her obligations set forth herein. Executive expressly waives any requirement, based on any statute, rule of procedure, or other source, that Bank or any of   its subsidiaries or Affiliates post a bond as a condition of obtaining any of the   above-described remedies. Nothing herein shall be construed as prohibiting   Bank or any of its subsidiaries or Affiliates from pursuing any other remedies   available to Bank or any of its subsidiaries or

90       

 
Affiliates at law or in equity for such breach or threatened breach, including the recovery of damages from Executive. Executive expressly acknowledges and agrees that: (i) the restrictions set forth in Section 10.4.1 are reasonable, in terms of scope, duration, geographic area, and otherwise, (ii) the protections afforded Bank   or any of its subsidiaries or Affiliates in Section 10.4.1 are necessary to protect   its legitimate business interest, (iii) the restrictions set forth in Section 10.4.1   will not be materially adverse to Executive's employment with Bank, and (iv) his agreement to observe such restrictions forms a material part of the consideration for this Agreement.

10.4.3   Overbreadth of Restrictive Covenant. It is expressly understood and agreed that, although Executive and Bank consider the restrictions contained in Section 10.4.1 hereof reasonable for the purpose of preserving for Bank its good will and other proprietary rights, if a final judicial determination is made   by a court having jurisdiction that the time or territory or any other restriction contained in Section 10.4.1 hereof is an unreasonable or otherwise unenforceable restriction against Executive, the provisions of Section 10.4.1   hereof shall not be rendered void but shall be deemed amended to apply as to   such maximum time and territory and to such other extent as such court may judicially determine or indicate to be reasonable.

10.4.4   Change of Control. This Section 10.4 shall not apply if there is a Change of Control.

10.5   Suicide or Misstatement. If Insurer denies coverage because Executive commits suicide within two (2) years after the date of this Agreement, or if the Insurer denies coverage for material misstatements of fact made by Executive on any application for life insurance purchased by Bank, or if Insurer denies coverage for any other reason, Bank shall evaluate the reason for the denial, and upon advice of Counsel and in its sole discretion, may judicially challenge any denial.
 
 
Article 11
Miscellaneous

11.1   Binding Effect.   This Agreement shall bind Executive and Bank and their beneficiaries, survivors, executors, administrators and transferees, and any Policy beneficiary.

11.2   No Guarantee of Employment.   This Agreement is not an employment policy or contract and does not affect nor is affected by the Termination Agreement or any other employment   agreement that Executive and Bank have executed or may execute in the future, except as specifically stated in this Agreement. It does not give Executive the right to remain an employee of Bank, nor does it interfere with Bank's right to discharge Executive. It also does not require Executive to remain an employee nor interfere with Executive's right to terminate employment at any time.

11.3   Applicable Law.   The Agreement and all rights hereunder shall be governed by and construed according to the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America.

11.4   Successors.   Bank shall not merge or consolidate into or with another company, or reorganize, or sell substantially all of its assets to another company, firm or person unless such succeeding or continuing company, firm or person agrees to assume and discharge the obligations of Bank under this Agreement.

11.5   Notice.   Any notice, consent or demand required or permitted to be given under the provisions of this Supplemental Executive Retirement Plan Agreement by one party to another shall be in writing, shall be signed by the party giving or making the same, and may be given either by delivering the same to such other party personally, or by mailing the same, by United States certified mail, postage prepaid, to such party, addressed to his or her last known address as shown on the records of Bank. The date of such mailing shall be deemed the date of such mailed notice, consent or demand.

91       


11.6   Recovery of Estate Taxes.   If Executive's gross estate for federal estate tax purposes includes any amount determined by reference to and on account of this Agreement, and if the beneficiary is other than Executive's estate, then Executive's estate shall be entitled to recover from the beneficiary receiving such benefit under the terms of the Agreement, an amount by which the total estate tax due by Executive's estate, exceeds the total estate tax which would have been payable if the value of such benefit had not been included in Executive's gross estate. If there is more   than one person receiving such benefit, the right of recovery shall be against each such person.

11.7   Entire Agreement.   This Agreement constitutes the entire agreement between Bank and Executive as to the subject matter hereof. No rights are granted to Executive by virtue of this Agreement other than those specifically set forth herein.
 
11.8   Administration.   Bank shall have powers which are necessary to administer this Agreement, including but not limited to:

(a)    Interpreting the provisions of the Agreement;

(b)    Establishing and revising the method of accounting for the Agreement;

(c)    Maintaining a record of benefit payments; and

(d)  
Establishing rules and prescribing any forms necessary or desirable to administer the Agreement.

11.9   Named Fiduciary.   Bank shall be the named fiduciary and plan administrator under the Agreement. The named fiduciary may delegate to others certain aspects of the management and operation responsibilities of the plan including the employment of advisors and the delegation of ministerial duties to qualified individuals.

IN WITNESS WHEREOF, Executive and a duly authorized Bank officer have signed this Agreement.
 
ATTEST:           PEOPLES NATIONAL BANK ("BANK")
 
___________________            By:_________________________
          Secretary                 Gerald R. Pennay, Chairman of the Board



WITNESS:
 
______________________              _______________________________
                                       Debra E. Dissinger ("Executive " )

 
 
 
 
 

 


92       


SPLIT DOLLAR POLICY FOR
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN AGREEMENT
 
Policy No. B25016399                           Insured:   Debra E. Dissinger
Policy No. 631408         
 
 
Supplementing and amending the application for insurance to The MONY Group, Clarica Life Insurance Company ("Insurer") on June 1, 2001, the applicant requests and directs that:

BENEFICIARIES

1.  
PEOPLES NATIONAL BANK, a national association, located in Halstead, Pennsylvania ("Bank") shall be the direct beneficiary of death proceeds of the Policy remaining after the Insured's interest is determined according to paragraph (2) below.
 
2.  
The Insured shall have the right to designate the beneficiary of DEBRA E. DISSINGER the death proceeds in the amounts for representative years enumerated on Schedule 3.1.1 attached hereto and incorporated by reference.
 
OWNERSHIP

3.  
The Owner of the policy shall be Bank. The Owner shall have all ownership rights in the Policy except as may be specifically granted to the Insured or the Insured's transferee in paragraph (4) of this endorsement.

4.  
The Insured or the Insured's transferee shall have the right to assign his or her rights and interests in the Policy with respect to that portion of the death proceeds designated in paragraph (2) of this endorsement, and to exercise all settlement options with respect to such death proceeds.

5.  
Notwithstanding the provisions of paragraph (4) above, the Insured or the Insured's transferee shall have no rights or interests in the Policy with respect to that portion of   the death proceeds designated in paragraph (2) of this endorsement if the Insured does not comply with the General Limitations specified in Article 10 of the Peoples National Bank Supplemental Executive Retirement Plan Agreement for Debra E. Dissinger, unless agreed to in writing by Bank and the Insured.

MODIFICATION OF ASSIGNMENT PROVISIONS OF THE POLICY

Upon the death of the Insured, the interest of any collateral assignee of the Owner of the Policy designated in (3) above shall be limited to the portion of the proceeds described in paragraph (1) above.
 

 

 

93


 
OWNER'S AUTHORITY

The Insurer is hereby authorized to recognize the Owner's claim to rights hereunder without investigating the reason for any action taken by the Owner, including its statement of the amount of   premiums it has paid on the Policy. The signature of the Owner shall be sufficient for the exercise   of any rights under this Endorsement and the receipt of the Owner for any sums received by it shall be a full discharge and release therefore to the Insurer.

Any transferee's rights shall be subject to this Endorsement.

The Owner accepts and agrees to this split dollar endorsement.
 
Signed at ________________________________, Pennsylvania, this ________ day of ____________, 2004.  
 
PEOPLES NATIONAL BANK

Gerald R. Pennay, Chairman of the Board
 
The Insured accepts and agrees to the foregoing and, subject to the rights of the Owner as stated above, designates ____________ as primary beneficiary and __________________________   as secondary beneficiary of the portion of the proceeds described in (1) above.

Signed at ________________   , Pennsylvania, this ____ day of __________, 2004.  

THE INSURED:
 
__________________________________
Debra E. Dissinger
 
 
 
 
 
 
 
 
 

 
94       

EXHIBIT 10.7
SUPPLEMENTAL DIRECTOR RETIREMENT PLAN AGREEMENT
FOR

DIRECTORS

THIS AGREEMENT is made and entered into this 3 RD day of December, 2004, by and between PEOPLES NATIONAL BANK, a national association having a place of business at 50 Main Street, Hallstead, Pennsylvania 18822 (“Bank”), and __________________ (“Director”), an individual residing at ________________________________.


INTRODUCTION

To encourage Director to remain as a Director of Bank, Bank is willing to provide Director with supplemental retirement benefits. Bank will pay the benefits from its general assets.

Article 1
General Definitions

The following terms shall have the meanings specified:

1.1   “Affiliate” means any company that controls, is controlled by, or is under common control with Bank. For this Agreement, company includes any bank, corporation, general or limited partnership, limited liability companies, association or similar organization, business trust, or any other trust.

1.2   “Change in Control” means any of the following:

1.2.1   (a) A merger, consolidation or division involving Peoples Financial Services Corp. (“Peoples”) or Bank, (b) a sale exchange, transfer or other disposition of substantially all of the assets of Peoples or Bank, or (c) a purchase by Peoples or Bank of substantially all of the assets of another entity, unless (i) such merger, consolidation, division, sale, exchange, transfer, purchase or disposition is approved in advance by seventy-five percent (75%) or more of the members of the Board of Directors of Peoples or Bank (as the case may be) who are not interested in the transaction, and (ii) a majority of the members of the Board of Directors of the legal entity resulting from or existing after any such transaction and of the Board of Directors of such entity’s parent corporation, if any, are former members of the Board of Directors of Bank; or

1.2.2   Any " person " (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act")), other than Bank or any "person" who on the date hereof is a director or officer of Peoples or Bank, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of Peoples or Bank representing twenty-five (25%) percent or more of the combined voting power of Peoples’ or Bank's then outstanding securities, or

1.2.3.   During any period of two (2) consecutive years during the term of this Agreement, individuals who at the beginning of such period constitute the Board of Directors of Peoples or Bank cease for   any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds of the directors then in office who were directors at the beginning of the period; or
 
 
 
 
 
 
 

 
95       


1.2.4   Any other change in control of Peoples or Bank similar in effect to any of the foregoing.

Notwithstanding anything else to the contrary set forth in this Agreement, if (a) an agreement   is executed by Peoples or Bank providing for any of the transactions or events constituting a Change in Control   as defined herein, and the agreement subsequently expires or is terminated without the transaction   or event being consummated, and (b) Director’s tenure as a director did not terminate during the period after the agreement and prior to such expiration or termination, for purposes of this Agreement it shall be as though such agreement was never executed and no Change in Control event shall be deemed to have occurred as a result of the execution of such agreement.

1.3   “Disability” means Director suffering a physical or mental impairment, which, in the judgment of a physician satisfactory to Bank, prevents Director from performing all of the essential functions of Director’s position with or without reasonable accommodation and without posing a direct threat to himself or others, for a period of one hundred   eighty days. As a condition to any benefits, Bank may require Director to submit to such physical or mental evaluations and tests as Bank's Board of Directors deems appropriate.

1.4   “Bank” means Peoples National Bank

1.5   “Normal Retirement Date” means the date of the Peoples annual meeting of shareholders following the Director’s 70 th birthday.
 
               1.6   “Code” means the Internal Revenue Code of 1986, as amended.
 
                1.7   “GAAP” means Generally Accepted Accounting Principles.
 
               1.8   "Peoples" means Peoples Financial Services Corp.

Article 2
Life Time Retirement Benefits

2.1   Normal Retirement Benefit.   If Director ceases to be a director on or after the Normal Retirement Date for reasons other than death, Bank shall pay to Director the benefit described in this Section 2.1

2.1.1   Amount of Benefit.   The benefit to be provided under this Section 2.1 shall not be payable unless the Director has served as a Director of the Bank for at least 10 years prior to the Normal Retirement Date. If Director has served for at least 10 years prior to the Normal Retirement Date, upon reaching the Normal Retirement Date, Director shall be entitled to an annual benefit equal to $150 for each year of service, payable for a period of 10 years. For example, if Director serves for 25 years, he will receive an annual benefit of $3,750 for 10 years.

2.1.2   Payment of Benefit.   Bank shall pay the annual benefit to Director on a monthly basis on the first day of the month commencing with the month following the month in which Director reaches the Normal Retirement Date and continuing for 10 years.

2.2   Early Termination Benefit.   If Director’s term is terminated before the Normal Retirement Date absent a Change of Control and for reasons of Director’s voluntary resignation, Disability, or if Bank removes Director for reasons other than for Cause, Bank shall pay to Director the benefit described in this Section 2.2.

2.2.1   Amount of Benefit.   The Director’s benefit under this Section 2.2 is the amount accrued for the benefit set forth in Section 2.1, as calculated in accordance with GAAP and reflected in the accounting records of Bank, on the date of Director’s resignation or removal.

96      


2.2.2   Payment of Benefit.   Bank shall pay, pro rata, the benefit to Director on the first day of the month commencing with the month following the month in which the Normal Retirement Date would have occurred and continuing for 10 years.

2.3   Change of Control Benefit.   If Director is serving as such at the time of a Change of Control, Bank shall pay to Director the benefit described in Section 2.1.

2.3.1   Payment of Benefit.   Bank shall pay the annual benefit to Director on a monthly basis on the first day of the month commencing with the month following the month in which Director reaches the age of 70 and continuing for 10 years.

2.4   Exclusive Benefits. Any benefits paid under this Agreement are exclusive.

3.1   Death Before Retirement. If Director dies while actively serving as a Director of Bank before reaching the Normal Retirement Date, Director’s beneficiary shall receive from the Bank the benefit described in this Section 3.1.

3.1.1   Amount of Benefit. The benefit under Section 3.1 is a death benefit in an amount accrued for the benefit set forth in Section 2.1, as calculated in accordance with GAAP and reflected in the accounting records of the Bank on the death of the Director. If such death benefit is paid, no other benefits under this Agreement will be paid.

3.1.2   Payment of Benefit . After the Bank receives notice of the death of the Director, the Bank shall promptly calculate the amount of benefit described in Article 3.1.1 and shall promptly pay the entire amount of the benefit to Director’s spouse or Director’s estate, in the event Director is unmarried at the time of Director’s death.

3.2   Death After Change of Control. If Director dies following a Change of Control, but prior to the commencement of benefit payments as set forth in Article 2, provided Director was actively serving as a Director of Bank at the time   of the Change   of   Control, Director’s beneficiary shall be paid the death benefit   described in Section 3.1. If such death benefit is paid, no benefits under this Agreement will be paid.

3.3   Death After Disability . If the Director dies while Disabled, as defined in Section 1.3 hereof, but prior to the commencement of benefit payments as set forth in Article 2., Director’s beneficiary shall be paid the death benefit described in Section 3.1. If such death benefit is paid, no benefits under this Agreement will be paid

Article 4
Assignment

Director may assign without consideration all interests in this Agreement   to any person, entity or trust. In the event Director transfers all of Director’s interest in this Agreement, then all of Director’s interest in the Agreement shall be vested in Director’s transferee, who shall be substituted as a party hereunder and Director shall have no further interest in this Agreement or in any insurance policies related hereto.
Article 5
Amendments and Termination

This Agreement may be amended or terminated only by a written agreement signed by Bank and Director, except as provided in Article 6.

97       


Article 6
General Limitations

6.1   Termination for Cause . Notwithstanding any provision of this Agreement to the contrary, the benefits provided under this Agreement shall be forfeited if the Bank’s Directors or the Bank’s shareholders remove the Director from office for:

6.1.1   Director’s conviction of or plea of guilty or nolo contendere to a felony, a crime of falsehood or crime involving moral turpitude, or the actual incarceration of Director for a period of thirty (30) consecutive days or more;

6.1.2   Director’s failure to follow the good faith lawful instructions of the Board of Directors of Bank with respect to its operations, after written notice from Bank and a failure to cure such violation within sixty (60) days of said written notice;

6.1.3   Director’s willful failure to substantially perform Director’s duties for Bank, other than a failure resulting from Director’s incapacity because of Disability as defined in Section 1.3 hereof;

6.1.4   Gross misconduct on the part of Director as determined by an affirmative vote of eighty percent (80%) of the disinterested members of the Board of Directors which brings public discredit to Bank;

6.1.5   Director’s breach of fiduciary duty involving personal profit; or

6.1.6   Director’s willful violation of any law, rule or regulation governing banks or bank officers or any final cease and desist order issued by a bank regulatory authority, unless Director’s conduct that led to the violation was authorized by or occurred at the instruction of Bank’s Board of Directors.

6.2   Removal.   Notwithstanding any provision of this Agreement to the contrary, Bank shall not pay any benefit under this Agreement if Director is subject to a final removal or prohibition order issued by an appropriate federal banking agency pursuant to Section 8(e) of the Federal Deposit Insurance Act.
 
Article 7
Miscellaneous

7.1   Binding Effect.   This Agreement shall bind Director and Bank and their respective successors, assigns, beneficiaries, survivors, executors, administrators and transferees.

7.2   Applicable Law.   The Agreement and all rights hereunder shall be governed by and construed according to the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America.

7.3   Successors.   Bank shall not merge or consolidate into or with another company, or reorganize, or sell substantially all of its assets to another company, firm or person unless such succeeding or continuing company, firm or person agrees to assume and discharge the obligations of Bank hereunder.

7.4   Notice.   Any notice, consent or demand required or permitted to be given under the provisions of this Supplemental Director Retirement Plan Agreement by one party to another shall be in writing, shall be signed by the party giving or making the same, and may be given either by delivering the same to such other party personally, or by mailing the same, by United States certified mail, postage prepaid, to such party, addressed to his or her last known address as shown on the records of Bank. The date of such mailing shall be deemed the date of such mailed notice, consent or demand.

98        


7.5   Recovery of Estate Taxes.   If Director’s gross estate for federal estate tax purposes includes any amount determined by reference to and on account of this Agreement, and if the beneficiary is other than Director’s estate, then Director’s estate shall be entitled to recover from the beneficiary receiving such benefit under the terms of the Agreement, an amount by which the total estate tax due by Director’s estate, exceeds the total estate tax which would have been payable if the value of such benefit had not been included in Director’s gross estate. If there is more   than one person receiving such benefit, the right of recovery shall be against each such person.

7.6   Entire Agreement.   This Agreement constitutes the entire agreement between Bank and Director as to the subject matter hereof. No rights are granted to Director by virtue of this Agreement other than those specifically set forth herein.

7.7   Administration.   Bank shall have powers which are necessary to administer this Agreement, including but not limited to:

         7.7.1   Interpreting the provisions of the Agreement;

7.7.2   Establishing and revising the method of accounting, as required by GAAP, for the Agreement;

7.7.3   Maintaining a record of benefit payments; and

7.7.4   Establishing rules and prescribing any forms necessary or desirable to administer the Agreement.

7.8   Named Fiduciary.   Bank shall be the named fiduciary and plan administrator under the Agreement. The named fiduciary may delegate to others certain aspects of the management and operational responsibilities of the plan including the employment of advisors and the delegation of ministerial duties to qualified individuals.


IN WITNESS WHEREOF, Director and a duly authorized Bank officer have assigned this Agreement.


ATTEST:      PEOPLES NATIONAL BANK
 
__________________________                        By:________________________________
Secretary                                                  _______________,Chairman of the Board
WITNESS:
 
 _________________________                    _________________________________(“Director”)
 
 
 
 
 
 

 
99       

EXHIBIT 14
 
Code of Ethics
 
 
For Senior Financial Officers
 
 
Peoples National Bank
 
 
Peoples Financial Services Corp
 
Our officers adhere to the ethical principles of business and believe that these standards of conduct emphasize the importance of our responsibilities to build a profitable ongoing enterprise that maintains the public’s trust and confidence. The Chief Executive Officer, Chief Operations & Financial Officer, and the Controller adhere to and advocate the following principles governing their professional and ethical conduct in the fulfillment of their responsibilities.
1.
All officers' actions will be carried out with honesty and integrity, avoiding any conflicts of interest.

2.
All officers will foster fair, ethical and responsible practices in the use of corporate assets and resources. Each officer must refuse any commissions, special discounts, or other forms of compensation from agencies, attorneys, insurance and real estate agents, sales people, firms or others who offer such a gratuity for giving or referring business to them. Cash gifts in any amount are prohibited.

3.
Each officer must comply and cooperate promptly, honestly, and professionally with all regulatory agencies.

4.
Each officer is responsible to promptly and accurately complete and review all periodic reports filed with the SEC.

5.
Each officer's actions are to be carried out in good faith with diligence and care.

6.
Each officer is entrusted with important confidential information about our business and the business of others. It is essential that all officers safeguard this information. Officers must never inappropriately discuss confidential information.

7.
By example, each officer is to foster honesty and integrity as core values to the Company at large.
 
 
 
 
 

 

100       

EXHIBIT 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statement, No. 333-84169, of our report dated February 25, 2005, with respect to the consolidated financial statements of Peoples Financial Services Corp. included in this Annual Report (Form 10-K) for the year ended December 31, 2004.

/s/ BEARD MILLER COMPANY LLP

Allentown, Pennsylvania
March 11, 2005
 
 
 
 
 
 
 
 

 

101       

Exhibit 31.1
CERTIFICATION
I, John W. Ord, certify that:
1.
I have reviewed this annual report on Form 10-K of Peoples Financial Services Corp.;

2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have:

   
a)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

   
b)
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

   
c)
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s Board of Directors (or persons performing the equivalent functions):

   
a)
all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

   
b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.




   
By/s/
John W. Ord
Chief Executive Officer and President
   
Date: March 9, 2005

102        

Exhibit 31.2
CERTIFICATION
I, Debra E. Dissinger, certify that:
1.
I have reviewed this annual report on Form l0-K of Peoples Financial Services Corp.;

2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have:

   
a)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

   
b)
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

   
c)
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

   
a)
all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

   
b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.




   
By/s/
Debra E. Dissinger
Executive Vice President
   
Date: March 9, 2005

103      

Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADDED BY
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Peoples Financial Services Corp. (the “Company”) for the period ended December 31, 2004, as filed with the Securities and Exchange Commission (the “Report”), I, John W. Ord, Chief Executive Officer and President, of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. To my knowledge, the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report.

   
By/s/
John W. Ord
Chief Executive Officer & President
   
Date: March 9, 2005
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
104       

Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADDED BY
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Peoples Financial Services Corp. (the “Company”) for the period ended December 31, 2004, as filed with the Securities and Exchange Commission (the “Report”), I, Debra E. Dissinger, Executive Vice President, of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. To my knowledge, the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the
Report.

   
By/s/
Debra E. Dissinger
Executive Vice President
   
Date: March 9, 2005
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

105