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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 FORM 10-K þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended
December 31, 2004
Or o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-15040 PENNROCK FINANCIAL SERVICES CORP. 
  PENNSYLVANIA
    
    23-2400021(State of incorporation)
    
    (IRS Employer Identification Number)1060 Main StreetBlue Ball, Pennsylvania
    
    17506(Address of principal executive offices)
    
    (Zip code)
 Registrants telephone
number, including area code  (717) 354-4541 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $2.50 per share 
  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, and (2) has been subject to such filing
requirements for the past 90 days.
Yes þ  No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of the 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 þ Indicate by check mark whether the registrant is accelerated filer (as defined in Rule 12b-2 of the Exchange Act.
Yes þ  No o The aggregate market value of the shares of Common Stock of the Registrant held by non-affiliates of the
Registrant as of June 30, 2004 was $231 million. As of February 2, 2005, there were 7,679,343 shares of Common Stock, Par Value $2.50 Per Share, outstanding. DOCUMENTS INCORPORATED BY REFERENCE: None




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PennRock Financial Services Corp. TABLE OF CONTENTS PAGEPART IItem 1. Business
    
    
    3Item 2. Properties
    
    
    7Item 3. Legal Proceedings
    
    
    8Item 4. Submission of Matters to a Vote of Security Holders
    
    
    8PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    9Item 6. Selected Financial Data
    
    
    11Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 7A. Quantitative and Qualitative Disclosures about Market Risk
    
    
    30Item 8. Financial Statements and Supplementary Data
    
    
    33Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
    
    
    60Item 9A. Controls and Procedures
    
    
    60Item 9B. Other Information
    
    
    60PART IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    60Item 11. Executive Compensation
    
    
    63Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    71Item 13. Certain Relationships and Related Transactions
    
    
    71Item 14. Principal Accountant Fees and Services
    
    
    72PART IVItem 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    74SIGNATURES
    
    
    76SUBSIDIARIES OF REGISTRANTCONSENT OF CROWE CHIZEK AND COMPANY LLCCONSENT OF SIMON LEVER LLPRULE 13a-14(a) CERTIFICATION OF CEORULE 13a-14(a) CERTIFICATION OF CFOSECTION 1350 CERTIFICATIONS OF CEO & CFO
  FORWARD LOOKING STATEMENTS In addition to historical information, this Annual Report on Form 10-K includes certain
forward-looking statements, as defined in the Securities Act of 1933 and the Securities Exchange
Act of 1934, based on current management expectations. PennRocks actual results could differ
materially from those management expectations. Such forward-looking statements include statements
regarding our intentions, beliefs or current expectations as well as the assumptions on which such
statements are based. Also included in such forward-looking statements are statements regarding
PennRocks proposed merger with Community Banks, Inc. (Community). Stockholders and potential
stockholders are cautioned that any such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and that actual results may differ materially from
those contemplated by such forward-looking statements. Words such as expect, feel, believe,
will, may, anticipate, plan, estimate, intend, should, and similar expressions or the
negative thereof are intended to identify forward looking statements. Factors that could cause
future results to vary from current management expectations include, but are not limited to,
general economic conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulations of federal, state and local
tax authorities, changes in interest rates, deposit flows, cost of funds, demand for loan products,
demand for financial services, competition, changes in the quality or composition of PennRocks
loan and investment portfolios, changes in accounting principles, policies or guidelines and other
economic, competitive, governmental and technological factors affecting PennRocks operations,
markets, products services and fees. In addition, the benefits from the proposed merger with
Community may not be fully realized due to, among other things, the business of PennRock and
Community may not be combined successfully, or such combination may take longer to accomplish than
expected, the growth opportunities and cost savings from the merger of PennRock and Community may
not be fully realized or may take longer to realize than expected, operating cost and business
disruption following the completion of the merger, including adverse effects on relationships with
employees, may be greater than expected, governmental approvals of the merger may not be obtained,
or adverse regulatory conditions may be imposed in connection with governmental approvals of the
merger. PennRock undertakes no obligation to update or revise any forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated events or changes to future operating
results over time. 2




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PennRock Financial Services Corp. 
 PART I 
 ITEM 1. BUSINESS PennRock Financial Services Corp. PennRock Financial Services Corp. (PennRock or the Registrant) is a Pennsylvania business
corporation organized on March 5, 1986. It became a bank holding company when it acquired all of
the common stock of Blue Ball National Bank (the Bank) on August 1, 1986. Effective November 6,
2000, PennRock became a financial holding company as provided by the Gramm-Leach-Bliley Act of
1999. PennRocks common stock is listed for quotation on the National Market System of Nasdaq
under the symbol PRFS. PennRock is a financial holding company that operates through its subsidiaries to deliver financial
and related services to its customers. PennRock directly owns 100% of the stock of one community
bank and three non-bank entities. PennRocks primary function is to direct the policies and
coordinate the financial resources of its subsidiaries as well as provide various advisory
services. PennRock primarily obtains the cash necessary to pay dividends to stockholders from the
dividends paid to it by its subsidiaries. PennRock is a registered bank holding company under the Bank Holding Company Act of 1956, as
amended. It is also subject to regulation by the Federal Reserve Board and by the Pennsylvania
Department of Banking. On November 16, 2004, PennRock announced that it had signed a definitive agreement pursuant to
which PennRock will combine with Community Banks, Inc. (Community) under Communitys charter.
Under the terms of the agreement, each PennRock shareholder will receive 1.4 shares of Community in
exchange for each share of PennRock common stock. At the time of the announcement, the value of
the transaction was approximately $326 million. Following consummation, the joint franchise will
include 69 banking offices in central and south-central Pennsylvania and northern Maryland. The
merger is subject to regulatory approval and the separate approvals of the shareholders of both
PennRock and Community. 1906 Founders, Inc. 1906 Founders, Inc., a Delaware Corporation formed on November 26, 2003 as a wholly owned
subsidiary of PennRock, owns and manages certain investment securities. Blue Ball National Bank The Bank began operations in 1906. The Bank provides a full range of general commercial and retail
banking services to its customers, including several types of checking and savings accounts,
certificates of deposit, and commercial, consumer and mortgage loans through 19 full service
community offices in Lancaster, Berks and Chester Counties in southeastern and south-central
Pennsylvania. Commercial lending services provided by the Bank include short and medium term loans, revolving
credit loans, letters and lines of credit, real estate mortgage and construction loans and
agricultural loans. Consumer lending services include various types of secured and unsecured loans
including installment loans, home equity loans and overdraft protection lines of credit.
Residential mortgage loans are offered in a wide variety of types including fixed and
adjustable-rate loans. The Banks underwriting guidelines conform to Fannie Mae and Freddie Mac
guidelines. The Bank sells most of the conforming fixed-rate residential mortgage loans it
originates to either Fannie Mae or Freddie Mac in the secondary market but retains the servicing.
The Banks business is not considered seasonal. Following the merger with Community, the 19 offices of the Bank will operate as Blue Ball Bank, a
separate division of Community Banks. Community has agreed to operate the Blue Ball Bank Division
for a period of at least two years following consummation of the merger. PennRock Financial Advisors, N.A. PennRock Financial Advisors, N.A (PFA) is a limited purpose national bank formed as a subsidiary
of the Bank. PFA began operations on April 1, 2004 when the net assets of The National Advisory
Group, Inc. (National) and Pension Consulting Services, Inc. (PCS), two wholly-owned
subsidiaries of PennRock, as well as the operations of both companies were transferred to PFA. At
the same time, the operations of the Banks Financial Services Division, including trust
operations, were transferred to PFA. PFA provides consulting, actuarial and administrative
services to retirement and employee benefit plans as well as investment, advisory and asset
management services to 3




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PennRock Financial Services Corp. retirement plan sponsors and participants. PFA also provides personal and corporate trust and
agency services to individuals, corporations and others, including trust investment accounts,
investment advisory services, mutual funds, and estate planning. PennRock Insurance Group, Inc. PennRock Insurance Group, Inc. (PIGI), a Pennsylvania corporation, is a wholly owned subsidiary
of Blue Ball National Bank. PIGI is an insurance agency organized for the sale of annuities and
other types of insurance. Employees At year-end 2004, PennRock and its subsidiaries employed 353 full-time equivalent employees. Competition Blue Ball National Bank originates most of its loans to, and accepts most of its deposits from,
residents and businesses located in southeastern and south-central Pennsylvania, primarily
Lancaster, Berks and Chester Counties. The financial services industry in the Banks service area
continues to be extremely competitive, both among commercial banks and other financial service
providers such as consumer finance companies, thrifts, investment companies, mutual funds and
credit unions. Mortgage banking firms, insurance companies, brokerage companies, financial
affiliates of commercial companies, and government agencies also provide competition for loans and
other financial services. Some of these competitors are considerably larger and have more
resources than the Bank. However, the Bank has made a significant investment in technological
resources that allows us to offer a wide variety of products and services and enables us to be
competitive with any size financial institution. Among the most important factors influencing the Banks ability to compete successfully for new
loans and deposits are interest rates, convenience of office locations, and quality of service. We
have attempted to differentiate ourselves from other competitors by emphasizing the local decision
making and personalized nature of our services. In an effort to make our community offices more
convenient to our existing and potential customers, the Bank has, on average, added one new office
per year over the past ten years. We added one new community office in 2004 and opened another in
January 2005. We expect to open two more offices later in 2005. PFA has an office located in Dresher, Montgomery County, Pennsylvania, which offers asset
management and retirement plan administration services throughout southeastern Pennsylvania, New
Jersey and Delaware. Numerous financial institutions, accounting and law firms, as well as other
corporations offer similar services as those provided by PFA in the greater Philadelphia
metropolitan area. PennRock is not dependent upon a single customer or a small number of customers, the loss of which
would have a materially adverse effect upon PennRock or its subsidiaries. Supervision and Regulation General The Corporation is registered as a bank holding company and is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Company
Act of 1956, as amended. The Corporation has also made an effective election to be treated as a
financial holding company. Financial holding companies are bank holding companies that meet
certain minimum capital and other standards and are therefore entitled to engage in financially
related activities on an expedited basis; see further discussion below. As a financial holding
company, the Corporations activities and those of its bank subsidiary are limited to the business
of banking, activities closely related or incidental to banking, and activities that have been
determined by statute or the Federal Reserve Board to be financial in nature. Bank holding
companies are required to file periodic reports with and are subject to examination by the Federal
Reserve Board. The Federal Reserve Board has issued regulations under the Bank Holding Company Act
that require a bank holding company to serve as a source of financial and managerial strength to
its subsidiary banks. As a result, the Federal Reserve Board, pursuant to such regulations, may
require the Corporation to stand ready to use its resources to provide adequate capital funds to
its bank subsidiary during periods of financial stress or adversity. The Bank Holding Company Act prohibits the Corporation from acquiring direct or indirect control of
more than 5% of the outstanding shares of any class of voting stock, or substantially all of the
assets of, any bank, or from merging 4




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PennRock Financial Services Corp. or consolidating with another bank holding company, without prior approval of the Federal Reserve
Board. Additionally, the Bank Holding Company Act prohibits the Corporation from engaging in or
from acquiring ownership or control of more than 5% of the outstanding shares of any class of
voting stock of any company engaged in a non-banking business, unless such business has been
determined by the Federal Reserve Board to be so closely related to banking as to be a proper
incident thereto or, for financial holding companies, to be financial in nature or incidental
thereto. As a Pennsylvania bank holding company for purposes of the Pennsylvania Banking Code, the
Corporation is also subject to regulation and examination by the Pennsylvania Department of
Banking. The Bank is a national bank and a member of the Federal Reserve System, and its deposits are
insured (up to applicable limits) by the Federal Deposit Insurance Corporation (the FDIC). The
Bank is subject to regulation and examination by the Office of the Comptroller of the Currency, and
to a much lesser extent, the Federal Reserve Board and the FDIC. The Bank is also subject to
requirements and restrictions under federal and state law, including requirements to maintain
reserves against deposits, restrictions on the types and amounts of loans that may be granted and
the interest that may be charged thereon, and limitations on the types of investments that may be
made and the types of services that may be offered. The Community Reinvestment Act requires the
Bank to help meet the credit needs of the entire community where the Bank operates, including low
and moderate income neighborhoods. The Banks rating under the Community Reinvestment Act,
assigned by the Comptroller of the Currency pursuant to an examination of the Bank, is important in
determining whether the bank may receive approval for, or utilize certain streamlined procedures
in, applications to engage in new activities. Various consumer laws and regulations also affect
the operations of the Bank. In addition to the impact of regulation, commercial banks are affected
significantly by the actions of the Federal Reserve Board as it attempts to control the money
supply and credit availability in order to influence the economy. Capital Adequacy Guidelines Bank holding companies are required to comply with the Federal Reserve Boards risk-based capital
guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain
off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total
capital is required to be Tier 1 capital, consisting principally of common shareholders equity,
less certain intangible assets. The remainder (Tier 2 capital) may consist of certain preferred
stock, a limited amount of subordinated debt, certain hybrid capital instruments and other debt
securities, and a limited amount of the general loan loss allowance. The risk-based capital
guidelines are required to take adequate account of interest rate risk, concentration of credit
risk, and risks of nontraditional activities. In addition to the risk-based capital guidelines, the Federal Reserve Board requires a bank holding
company to maintain a leverage ratio of a minimum level of Tier 1 capital (as determined under the
risk-based capital guidelines) equal to 3% of average total consolidated assets for those bank
holding companies which have the highest regulatory examination ratings and are not contemplating
or experiencing significant growth or expansion. All other bank holding companies are required to
maintain a ratio of at least 1% to 2% above the stated minimum. The Bank is subject to almost
identical capital requirements adopted by the Comptrollers Office. Prompt Corrective Action Rules The federal banking agencies have regulations defining the levels at which an insured institution
would be considered well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. The applicable federal bank
regulator for a depository institution could, under certain circumstances, reclassify a
well-capitalized institution as adequately capitalized or require an adequately capitalized
or undercapitalized institution to comply with supervisory actions as if it were in the next
lower category. Such a reclassification could be made if the regulatory agency determines that the
institution is in an unsafe or unsound condition (which could include unsatisfactory examination
ratings). The Corporation and the Bank each satisfy the criteria to be classified as well
capitalized within the meaning of applicable regulations. 5




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PennRock Financial Services Corp. Regulatory Restrictions on Dividends The Bank may not, under the National Bank Act, declare a dividend without approval of the
Comptroller of the Currency, unless the dividend to be declared by the Banks Board of Directors
does not exceed the total of: (i) the Banks net profits for the current year to date, plus (ii)
its retained net profits for the preceding two current years, less any required transfers to
surplus. In addition, the Bank can only pay dividends to the extent that its retained net profits
(including the portion transferred to surplus) exceed its bad debts. The Federal Reserve Board,
the Comptroller and the FDIC have formal and informal policies which provide that insured banks and
bank holding companies should generally pay dividends only out of current operating earnings, with
some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of
banks to pay dividends, because banks which are not classified as well capitalized or adequately
capitalized may not pay dividends. Under these policies and subject to the restrictions applicable to the Bank, the Bank could
declare, during 2005, without prior regulatory approval, aggregate dividends of approximately $13.1
million, plus net profits earned to the date of such dividend declaration. FDIC Insurance Assessments The FDIC has implemented a risk-related premium schedule for all insured depository institutions
that results in the assessment of premiums based on capital and supervisory measures. Under the
risk-related premium schedule, the FDIC assigns, on a semiannual basis, each depository institution
to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and
further assigns such institution to one of three subgroups within a capital group. The
institutions subgroup assignment is based upon the FDICs judgment of the institutions strength
in light of supervisory evaluations, including examination reports, statistical analyses and other
information relevant to measuring the risk posed by the institution. Only institutions with a
total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-based
assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the
well-capitalized group. As of December 31, 2004, the Bank was well capitalized for purposes of
calculating insurance assessments. The Bank Insurance Fund is presently fully funded at more than the minimum amount required by law.
Accordingly, the 2005 Bank Insurance Fund assessment rates range from zero for those institutions
with the least risk, to $0.027 for every $100 of insured deposits for institutions deemed to have
the highest risk. The Bank is in the category of institutions that presently pay nothing for
deposit insurance. The FDIC adjusts the rates every six months. The FDIC has indicated that it
is possible that all banks will again be required to pay deposit insurance premiums in the future
if the current trend of the size of the insurance funds relative to all insured deposits continues. While the Bank presently pays no premiums for deposit insurance, it is subject to assessments to
pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress
to issue bonds to finance the resolution of failed thrift institutions. The FDIC sets the
Financing Corporation assessment rate every quarter. The Financing Corporation assessment for the
Bank (and all other banks and savings institutions) for the first quarter of 2005 is an annual rate
of $.0144 for each $100 of deposits. New Legislation No significant legislation in the financial services area was enacted in 2004. The
Gramm-Leach-Bliley Act, enacted in 1999, changed certain banking laws that had been in effect since
the early part of the 20th century. The most radical changes were that the separation
between banking and the securities businesses mandated by the Glass-Steagall Act was removed, and
the provisions of any state law that prohibits affiliation between banking and insurance entities
were preempted. The provisions of federal law that preclude banking entities from engaging in
non-financially related activities, such as manufacturing, were not changed. The
Gramm-Leach-Bliley Act also contained a number of additional provisions, including the Right to
Financial Privacy Act that directly affects banks and their customers. The USA PATRIOT Act, enacted in direct response to the terrorist attacks on September 11, 2001,
strengthens the anti-money laundering provisions of the Bank Secrecy Act. Most of the new
provisions added by the Act apply to accounts at or held by foreign banks, or accounts of or
transactions with foreign entities. The Bank does not have a significant foreign business and does
not expect this Act to materially affect its operations. The Act does, however, require the
banking regulators to consider a banks record of compliance under the Bank Secrecy Act in acting
on 6




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PennRock Financial Services Corp. any application filed by a bank. As the Bank is subject to the provisions of the Bank Secrecy Act
(i.e., reporting of cash transactions in excess of $10,000), the Banks record of compliance in
this area will be an additional factor in any applications filed by it in the future. To the
Banks knowledge, its record of compliance in this area is satisfactory. The Sarbanes-Oxley Act was enacted in 2002. This Act is not a banking law, but applies to all
public companies, including the Corporation. Sarbanes-Oxley is designed to restore investor
confidence. Sarbanes-Oxley adopts new standards of corporate governance and imposes new
requirements on the board and management of public companies. The chief executive officer and
chief financial officer of a public company must now certify the financial statements of the
company. New definitions of independent directors have been adopted, and new responsibilities
and duties have been established for the audit and other committees of the board. In addition, the
reporting requirements for insider stock transactions have been revised, requiring most
transactions to be reported within two business days. While complying with Sarbanes-Oxley will
result in increased costs to the Corporation, the additional costs are not expected to have a
material effect on the Corporation. The Fair and Accurate Credit Transactions Act was adopted in 2003. It extends and expands upon
provisions in the Fair Credit Reporting Act, affecting the reporting of delinquent payments by
customers and denials of credit applications. The revised act imposes additional record keeping,
reporting, and customer disclosure requirements on all financial institutions, including the Bank.
Also in late 2003, the Check 21 Act was adopted. This Act affects the way checks can be processed
in the banking system, allowing payments to be converted to electronic transfers rather than
processed as traditional paper checks. Congress is often considering some financial industry legislation, and the federal banking agencies
routinely propose new regulations. New legislation and regulation proposed in the future may
include dramatic changes to the federal deposit insurance system. The Corporation cannot predict
how any new legislation, or new rules adopted by the federal banking agencies, may affect its
business in the future. Foreign Operations PennRock does not depend on foreign sources for funds, nor does PennRock make foreign loans. Statistical Disclosure by Bank Holding Companies The required Statistical Information for Item 1 can be found in Item 6, Selected Financial Data,
Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations and
Item 8, Financial Statements and Supplementary Data, of this Annual Report. Available Information PennRocks internet address is www.pennrock.com. All Securities and Exchange Commission (SEC)
filings are available free of charge through our website including annual reports on form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and Section 16 filings. These are
posted on the web site as reasonably practicable after they are electronically filed with the SEC.
Also available on this web site are documents relating to corporate governance issues including
PennRocks Code of Ethics and Nominating Committee Charter. Financial Information about Segments Management measures the performance and allocates the resources of PennRock as a single segment,
community banking and none of our non-bank subsidiaries exceed 10% of PennRocks revenue, net
income or assets. Therefore, we do not have any operating segments that require additional
information. 
 ITEM 2. PROPERTIES PennRock Financial Services Corp. PennRocks headquarters are located at the main office of Blue Ball National Bank at 1060 Main
Street, Blue Ball, Pennsylvania. PennRock owns no real estate. 7




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PennRock Financial Services Corp. Blue Ball National Bank The principal executive office and main banking office is located in Blue Ball, Pennsylvania. An
operations center, also located in Blue Ball, Pennsylvania, accommodates the Banks data
processing, accounting, human resource, credit, and loan and deposit operations departments. These
and 15 of the Banks full service community offices are owned free and clear of any indebtedness.
The land on which seven of the branch offices are located is leased. The net book value of the
Banks premises and equipment as of December 31, 2004 is $17.0 million. PennRock Financial Advisors, N.A. PFA maintains offices in Dresher and Blue Ball, Pennsylvania. All real estate is leased. 
 ITEM 3. LEGAL PROCEEDINGS A PennRock non-bank subsidiary has been named as a defendant in a binding, nonappealable
arbitration proceeding in which the claimants seek to recover damages of approximately $4.6
million. The subsidiary is vigorously defending against these claims and is strongly contesting
the amount of recoverable damages, if any. Any award against the subsidiary would be subject to
offsets and insurance coverage aggregating approximately $1.0 million and PennRock believes that it
has valid claims for indemnity and contribution against various third parties. PennRock is unable
to determine at the present time whether a loss may be incurred relative to this matter, or, if a
loss is incurred, the extent thereof net of insurance, offsets and amounts recoverable from third
parties. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or
otherwise, during the 4th quarter of 2004. 8




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PennRock Financial Services Corp. 
 PART II 
  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES PennRocks common stock trades on the Nasdaq National Market under the symbol PRFS. The price of
PennRocks stock ranged from $26.16 to $41.77 in 2004 and closed the year at $39.65. The price of
PennRocks stock ranged from $21.47 to $33.49 in 2003 and closed the year at $31.08. The book
value per share was $13.47 as of December 31, 2004 and $12.85 as of December 31, 2003. All per
share data have been restated for 10% stock dividends paid in 2003. The prices listed below are
closing prices and represent the high, low and quarter ending prices for stock trades reported
during each quarter. Quarter
    
    
    Per ShareHigh
    
    
    Low
    
    
    End
    
    
    Dividend2004First quarter
    
    $
    33.54
    
    
    $
    27.48
    
    
    $
    28.40
    
    
    $
    0.20Second quarter
    
    
    30.40
    
    
    
    26.20
    
    
    
    30.20
    
    
    
    0.20Third quarter
    
    
    29.94
    
    
    
    26.16
    
    
    
    27.76
    
    
    
    0.20Fourth quarter
    
    
    41.77
    
    
    
    27.51
    
    
    
    39.65
    
    
    
    0.222003First quarter
    
    $
    25.90
    
    
    $
    21.47
    
    
    $
    25.55
    
    
    $
    0.18Second quarter
    
    
    27.94
    
    
    
    24.33
    
    
    
    24.33
    
    
    
    0.19Third quarter
    
    
    31.67
    
    
    
    25.35
    
    
    
    28.20
    
    
    
    0.19Fourth quarter
    
    
    33.49
    
    
    
    26.98
    
    
    
    31.08
    
    
    
    0.20
 As of February 2, 2005, there were approximately 3,937 shareholders of record and beneficial
shareholders of the Registrants common stock. On June 23, 2004, the Board of Directors authorized the repurchase of up to 300,000 shares of its
common stock to be used for future stock dividends and splits, employee benefit plans and other
appropriate corporate purposes. The following table shows the repurchases of common stock by
PennRock during the fourth quarter of 2004 under this plan. All purchases made in the fourth
quarter were part of this publicly announced plan. Maximum NumberTotal
    
    
    Average
    
    
    Total Number of
    
    
    of Shares ThatNumber of
    
    
    Price
    
    
    Shares Purchased
    
    
    May Yet BeShare
    
    
    Paid
    
    
    as Part of Publicly
    
    
    Purchased UnderPurchases
    
    
    Per Share
    
    
    Announced Plan
    
    
    the PlanOctober 1 to October 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    274,951November 1 to November 30, 2004
    
    
    41,928
    
    
    
    40.34
    
    
    
    41,928
    
    
    
    233,023December 1 to December 31, 2004
    
    
    2,945
    
    
    
    40.20
    
    
    
    2,945
    
    
    
    230,078Total
    
    
    44,873
    
    
    $
    40.33
    
    
    
    44,873
 Copies of PennRocks Annual Report on Form 10-K, as well as all other reports and forms filed with
the Securities and Exchange Commission by PennRock, are available without charge on the companys
web site at www.pennrock.com, or by writing to: Shannan B. Guthrie, Investor Relations Officer
PennRock Financial Services Corp.
1060 Main St.
P.O. Box 580
Blue Ball, PA 17506 9




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PennRock Financial Services Corp. Registrar/Transfer Agent:
          American Stock Transfer and Trust     (800) 937-5449
          59 Maiden Lane
           New York, NY 10038
Nasdaq Market Makers:
          As of December 31, 2004, the following firms made a market in PennRocks common stock:
                    Boenning
& Scattergood,
Inc.          (800) 842-8928
                    Ferris,
Baker, Watts, Inc.
                 (800) 638-7411
                    Janney
Montgomery LLC
                 (717) 293-4100
Independent Auditors:
           Crowe Chizek and Company LLC 10




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##### Table of Contents



PennRock Financial Services Corp. 
 ITEM 6. SELECTED FINANCIAL DATA In thousands, except share and per share data 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000FOR THE YEAR:Interest income
    
    $
    55,340
    
    
    $
    53,394
    
    
    $
    57,142
    
    
    $
    62,274
    
    
    $
    64,234Interest expense
    
    
    18,651
    
    
    
    17,825
    
    
    
    23,283
    
    
    
    32,366
    
    
    
    37,073Net interest income
    
    
    36,689
    
    
    
    35,569
    
    
    
    33,859
    
    
    
    29,908
    
    
    
    27,161Provision for loan losses
    
    
    565
    
    
    
    1,917
    
    
    
    1,750
    
    
    
    1,548
    
    
    
    3,076Non-interest income
    
    
    12,235
    
    
    
    13,750
    
    
    
    11,144
    
    
    
    11,030
    
    
    
    7,315Non-interest expense
    
    
    31,616
    
    
    
    29,678
    
    
    
    27,447
    
    
    
    25,282
    
    
    
    20,280Net income
    
    
    12,681
    
    
    
    14,000
    
    
    
    13,226
    
    
    
    12,067
    
    
    
    9,546Per share:Net income  Basic
    
    
    1.66
    
    
    
    1.84
    
    
    
    1.73
    
    
    
    1.59
    
    
    
    1.26Net income  Diluted
    
    
    1.63
    
    
    
    1.81
    
    
    
    1.71
    
    
    
    1.57
    
    
    
    1.25Cash dividends
    
    
    .82
    
    
    
    0.76
    
    
    
    0.68
    
    
    
    0.63
    
    
    
    0.55Book value as of year-end
    
    
    13.47
    
    
    
    12.85
    
    
    
    11.45
    
    
    
    10.27
    
    
    
    9.63Market value as of year-end
    
    
    39.65
    
    
    
    31.08
    
    
    
    25.23
    
    
    
    18.38
    
    
    
    11.02Number of shares outstanding:Basic
    
    
    7,679,343
    
    
    
    7,626,188
    
    
    
    7,599,326
    
    
    
    7,629,293
    
    
    
    7,541,240Diluted
    
    
    7,757,202
    
    
    
    7,741,287
    
    
    
    7,728,009
    
    
    
    7,662,865
    
    
    
    7,604,867AS OF YEAR-END:Securities available for sale
    
    
    302,623
    
    
    $
    309,189
    
    
    $
    304,814
    
    
    $
    303,334
    
    
    $
    323,556Loans
    
    
    773,324
    
    
    
    711,902
    
    
    
    602,840
    
    
    
    558,369
    
    
    
    501,140Allowance for loan losses
    
    
    (9,007
    )
    
    
    (8,643
    )
    
    
    (7,075
    )
    
    
    (7,262
    )
    
    
    (5,973
    )Earning assets
    
    
    1,074,779
    
    
    
    1,019,783
    
    
    
    915,748
    
    
    
    860,957
    
    
    
    841,940Total assets
    
    
    1,175,084
    
    
    
    1,108,740
    
    
    
    1,008,589
    
    
    
    948,938
    
    
    
    910,950Total deposits
    
    
    828,734
    
    
    
    784,042
    
    
    
    743,262
    
    
    
    663,694
    
    
    
    682,994Short-term borrowings
    
    
    125,459
    
    
    
    112,962
    
    
    
    40,363
    
    
    
    76,754
    
    
    
    54,175Long-term debt
    
    
    102,000
    
    
    
    102,000
    
    
    
    127,000
    
    
    
    121,000
    
    
    
    91,000Stockholders equity
    
    
    103,490
    
    
    
    98,007
    
    
    
    86,978
    
    
    
    78,404
    
    
    
    72,598Full-time equivalent employees
    
    
    353
    
    
    
    349
    
    
    
    335
    
    
    
    321
    
    
    
    276SELECTED RATIOS:Return on average assets
    
    
    1.11
    %
    
    
    1.34
    %
    
    
    1.34
    %
    
    
    1.34
    %
    
    
    1.09
    %Return on average equity
    
    
    12.44
    %
    
    
    15.24
    %
    
    
    15.86
    %
    
    
    15.80
    %
    
    
    14.93
    %Efficiency ratio
    
    
    59.34
    %
    
    
    56.51
    %
    
    
    56.91
    %
    
    
    59.28
    %
    
    
    55.90
    %Net interest margin (tax
equivalent)
    
    
    3.67
    %
    
    
    3.91
    %
    
    
    3.98
    %
    
    
    3.95
    %
    
    
    3.71
    %Total capital to average assets
    
    
    9.02
    %
    
    
    9.09
    %
    
    
    8.64
    %
    
    
    9.21
    %
    
    
    8.86
    %Total capital to risk-weighted
assets
    
    
    11.62
    %
    
    
    11.64
    %
    
    
    11.57
    %
    
    
    11.71
    %
    
    
    12.45
    %Price to earnings (x)
    
    
    23.89
    
    
    
    16.89
    
    
    
    14.58
    
    
    
    11.56
    
    
    
    8.75Market to book value (x)
    
    
    2.94
    
    
    
    2.42
    
    
    
    2.20
    
    
    
    1.79
    
    
    
    1.14Allowance for loan losses to loans
    
    
    1.16
    %
    
    
    1.21
    %
    
    
    1.17
    %
    
    
    1.30
    %
    
    
    1.19
    %Non-performing loans to loans
    
    
    0.06
    %
    
    
    0.22
    %
    
    
    0.41
    %
    
    
    0.21
    %
    
    
    0.85
    %Dividend payout ratio
    
    
    49.47
    %
    
    
    40.98
    %
    
    
    40.49
    %
    
    
    39.70
    %
    
    
    43.66
    %
 11




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##### Table of Contents



PennRock Financial Services Corp. 
  ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The following section presents managements discussion and analysis of the financial condition and
results of operations of PennRock Financial Services Corp., a bank holding company (PennRock),
its subsidiary, Blue Ball National Bank (the Bank), and the Banks subsidiaries, PennRock
Financial Advisors, N.A. (PFA) and PennRock Insurance Group, Inc. (PIGI). This discussion and
analysis is presented to assist the reader in understanding and evaluating the financial condition,
results of operations and future prospects of PennRock and should be read in conjunction with the
consolidated financial statements and other financial data presented elsewhere in this Annual
Report. PennRocks results of operations are dependent primarily on its net interest income, which is the
difference between the interest earned on its assets (primarily its loan and securities portfolios)
and its cost of funds, which consists of the interest paid on its deposits and borrowings.
PennRocks results of operations are also affected by its provision for loan losses as well as
non-interest income, non-interest expenses and income tax expense. Non-interest income consists of
service charges and fees for services relative to deposit accounts, investment management,
retirement plan administration, fiduciary activities and credit and debit card transactions, as
well as gains and losses from sales of investment securities, mortgage banking and income from bank
owned life insurance. Non-interest expenses consist of salaries and benefits, occupancy and
equipment expenses, advertising and marketing, data processing, insurance, professional fees,
telecommunications and other operating expenses. Results of operations are also dependent on the
dollar volume and asset quality of PennRocks loans and investments. The results of PennRocks operations, like those of other financial institutions, are affected by
our asset and liability management policies, as well as factors beyond our control, such as general
economic conditions and the monetary and fiscal policies of the federal government. Lending
activities are affected by the demand for commercial and mortgage financing and other types of
loans, and are thus influenced by interest rates and other economic factors. Deposit flows and
costs of funds are influenced by yields available on competing banking and non-banking investments
and by general market rates of interest. All per share data have been restated for a 10% stock
dividend paid in 2003. As previously discussed, on November 16, 2004, PennRock announced that it had signed a definitive
agreement pursuant to which PennRock will combine with Community Banks, Inc. (Community) under
Communitys charter. The merger is subject to regulatory approval and the separate approvals of
the shareholders of both PennRock and Community. Overview During 2004, PennRock recorded net income of $12.7 million, a decrease of $1.3 million or 9.4% from
2003. Basic and diluted earnings per share for the year were $1.66 and $1.63, respectively, as
compared to $1.84 and $1.81, respectively, for 2003. Net income was $13.2 million or $1.73 per
share in 2002. Return on average assets was 1.11% in 2004, and 1.34% in both 2003 and 2002.
Return on average equity was 12.44% in 2004, 15.24% in 2003 and 15.86% in 2002. Assets grew $66.3 million to $1.175 billion, an increase of 6.0 % from 2003. Earning assets
increased $55.0 million or 5.4% during 2004, while interest bearing liabilities grew $39.8 million
or 4.6%. The average yield on earning assets decreased 32 basis points from 5.77% in 2003 to 5.45%
in 2004. The average yield on paying liabilities decreased 5 basis points from 2.19% in 2003 to
2.14% in 2004. PennRocks net interest income on a fully taxable equivalent basis increased
$866,000 or 2.3% during 2004 and $1.8 million or 4.9% in 2003. The net interest margin was 3.67%
in 2004, 3.91% in 2003 and 3.98% in 2002. The provision for loan losses decreased from $1.9 million in 2003 to $565,000 in 2004. The
provision for loan losses was $1.8 million in 2002. Non-interest income from sources other than securities gains and losses decreased $800,000 or 6.0%
in 2004 compared with an increase of $2.6 million or 24.4% in 2003. Non-interest expenses increased $1.9 or 6.5% in 2004 and increased $2.2 million or 8.1% in 2003 12




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##### Table of Contents



PennRock Financial Services Corp. Critical Accounting Policies PennRocks financial position and results of operations are impacted by managements application of
accounting policies involving judgments made to arrive at the carrying value of certain assets.
Managements greatest challenge in implementing its policies is the need to make estimates about
the effect of matters that are inherently less than certain. For a detailed discussion of
PennRocks significant accounting policies, see Note 1: Summary of Significant Accounting Policies
in the Notes to Consolidated Financial Statements. A material estimate that is susceptible to
significant change is the determination of the allowance for loan losses. Both the estimates of
the amount of the allowance for loan losses and the placement of loans on non-accrual status affect
the carrying amount of the loan portfolio. The allowance for loan losses is a subjective judgment that management must make regarding the loan
portfolio, and is established and maintained at levels that management believes are adequate to
cover losses resulting from the inability of borrowers to make required payments on loans. To
estimate loan losses, we analyze:  i.
    historical loan losses;ii.
    current trends in delinquencies and charge-offs;iii.
    plans for problem loan administration and resolution;iv.
    the views of regulators;v.
    changes in the size and composition of the loan portfolio;vi.
    peer group information;vii.
    the economic climate and direction;viii.
    increases or decreases in overall lending rates;ix.
    political conditions;x.
    legislation directly or indirectly impacting the banking industry; andxi.
    economic conditions affecting specific geographical areas in which PennRock conducts
business. Where there is a question as to the impairment of a specific loan, management obtains valuations of
the property or collateral securing the loan, and current financial information of the borrower,
including financial statements, when available. Since the calculation of appropriate loan loss
allowances relies on managements estimates and judgments relating to inherently uncertain events,
actual results may differ from these estimates. For a more detailed discussion on the allowance
for loan losses, see Allowance For Loan Losses under the discussion of Financial Condition in this
Item 7 of this report and Allowance for Loan Losses in Note 1: Summary of Significant Accounting
Policies and Note 6: Allowance for Loan Losses in the Notes to Consolidated Financial Statements. Results of Operations Net Interest Income Net interest income is the amount by which interest income on loans, investments and other earning
assets exceeds interest paid on deposits, borrowings and other interest bearing liabilities. Net
interest income is the primary source of revenue for PennRock. The amount of net interest income
earned is affected by changes in interest rates and the balances of the various types of earning
assets and interest bearing liabilities. For comparative purposes, and throughout this discussion
unless otherwise noted, net interest income and corresponding yields are shown on a taxable
equivalent basis. This adjustment will give effect to the interest earned on tax-exempt loans and
investments by an amount equivalent to the federal income taxes, which would have been paid if the
income received on these assets were taxable at the statutory rate of 35% for 2004, 2003 and 2002. Net interest income is the product of the volume of average earning assets and the average rates
earned on them, less the volume of average interest bearing liabilities and the average rates paid
on them. All yield and rate information is calculated on an annualized basis by dividing the
income or expense item for the period by the average balance during the period. Net interest
margin is calculated by dividing net interest income by average earning assets. Interest rate
spread is the difference between yield earned on average interest earning assets and the rate paid
on average interest bearing liabilities. Table 1 presents average balances, taxable equivalent
interest income and expense and rates for PennRocks assets and liabilities for the years ended
December 31, 2004, 2003 and 2002. 13




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##### Table of Contents



PennRock Financial Services Corp. Table 1  Average Balances, Rates and Interest Income and Expense Summary
(Taxable equivalent basis) In thousands 2004
    
    
    2003
    
    
    2002Average
    
    
    
    
    
    
    Average
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    Average
    
    
    
    
    
    
    AverageBalance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    RateASSETSShort-term investments
    
    $
    5,371
    
    
    $
    36
    
    
    
    0.67
    %
    
    $
    3,982
    
    
    $
    33
    
    
    
    0.83
    %
    
    $
    5,375
    
    
    $
    100
    
    
    
    1.86
    %Mortgages held for sale
    
    
    1,712
    
    
    
    140
    
    
    
    8.18
    %
    
    
    7,783
    
    
    
    516
    
    
    
    6.63
    %
    
    
    2,720
    
    
    
    248
    
    
    
    9.12
    %Securities available for sale:U.S. Treasury and agency
    
    
    80,682
    
    
    
    2,832
    
    
    
    3.51
    %
    
    
    73,330
    
    
    
    1,938
    
    
    
    2.64
    %
    
    
    81,916
    
    
    
    5,842
    
    
    
    7.13
    %State and municipal
    
    
    10,657
    
    
    
    848
    
    
    
    7.96
    %
    
    
    15,954
    
    
    
    1,234
    
    
    
    7.73
    %
    
    
    34,955
    
    
    
    2,777
    
    
    
    7.94
    %Other
    
    
    219,253
    
    
    
    8,916
    
    
    
    4.07
    %
    
    
    213,340
    
    
    
    8,807
    
    
    
    4.13
    %
    
    
    200,914
    
    
    
    7,254
    
    
    
    3.61
    %Total securities available
for sale
    
    
    310,592
    
    
    
    12,596
    
    
    
    4.06
    %
    
    
    302,624
    
    
    
    11,979
    
    
    
    3.96
    %
    
    
    317,785
    
    
    
    15,873
    
    
    
    4.99
    %Loans: (1)Mortgage
    
    
    417,894
    
    
    
    25,956
    
    
    
    6.21
    %
    
    
    379,058
    
    
    
    26,521
    
    
    
    7.00
    %
    
    
    332,256
    
    
    
    25,687
    
    
    
    7.73
    %Commercial
    
    
    212,577
    
    
    
    12,663
    
    
    
    5.96
    %
    
    
    177,817
    
    
    
    10,759
    
    
    
    6.05
    %
    
    
    158,603
    
    
    
    10,858
    
    
    
    6.85
    %Consumer (2)
    
    
    98,721
    
    
    
    5,689
    
    
    
    5.76
    %
    
    
    88,690
    
    
    
    5,579
    
    
    
    6.29
    %
    
    
    81,930
    
    
    
    6,321
    
    
    
    7.72
    %Total loans
    
    
    729,192
    
    
    
    44,307
    
    
    
    6.08
    %
    
    
    645,565
    
    
    
    42,859
    
    
    
    6.64
    %
    
    
    572,789
    
    
    
    42,866
    
    
    
    7.48
    %Total earning assets
    
    
    1,046,867
    
    
    
    57,079
    
    
    
    5.45
    %
    
    
    959,954
    
    
    
    55,387
    
    
    
    5.77
    %
    
    
    898,669
    
    
    
    59,087
    
    
    
    6.57
    %Other assets
    
    
    91,630
    
    
    
    
    
    
    
    
    
    
    
    87,812
    
    
    
    
    
    
    
    
    
    
    
    85,931Total assets
    
    $
    1,138,497
    
    
    
    
    
    
    
    
    
    
    $
    1,047,766
    
    
    
    
    
    
    
    
    
    
    $
    984,600LIABILITIES AND
STOCKHOLDERS EQUITYInterest bearing deposits:Demand
    
    $
    222,682
    
    
    
    2,252
    
    
    
    1.01
    %
    
    $
    212,980
    
    
    
    2,260
    
    
    
    1.06
    %
    
    $
    211,869
    
    
    
    3,661
    
    
    
    1.73
    %Savings
    
    
    94,306
    
    
    
    707
    
    
    
    0.75
    %
    
    
    86,130
    
    
    
    714
    
    
    
    0.83
    %
    
    
    72,542
    
    
    
    991
    
    
    
    1.37
    %Time
    
    
    346,186
    
    
    
    9,138
    
    
    
    2.64
    %
    
    
    313,027
    
    
    
    7,944
    
    
    
    2.54
    %
    
    
    317,432
    
    
    
    10,505
    
    
    
    3.31
    %Total interest bearing
deposits
    
    
    663,174
    
    
    
    12,097
    
    
    
    1.82
    %
    
    
    612,137
    
    
    
    10,918
    
    
    
    1.78
    %
    
    
    601,843
    
    
    
    15,157
    
    
    
    2.52
    %Short-term borrowings
    
    
    108,298
    
    
    
    1,636
    
    
    
    1.51
    %
    
    
    90,245
    
    
    
    1,033
    
    
    
    1.14
    %
    
    
    53,710
    
    
    
    796
    
    
    
    1.48
    %Long-term debt
    
    
    102,000
    
    
    
    4,918
    
    
    
    4.82
    %
    
    
    112,411
    
    
    
    5,874
    
    
    
    5.23
    %
    
    
    123,663
    
    
    
    7,330
    
    
    
    5.93
    %Total interest bearing liabilities
    
    
    873,472
    
    
    
    18,651
    
    
    
    2.14
    %
    
    
    814,793
    
    
    
    17,825
    
    
    
    2.19
    %
    
    
    779,216
    
    
    
    23,283
    
    
    
    2.99
    %Non-interest bearing
demand deposits
    
    
    150,096
    
    
    
    
    
    
    
    
    
    
    
    129,284
    
    
    
    
    
    
    
    
    
    
    
    110,808Other liabilities
    
    
    12,983
    
    
    
    
    
    
    
    
    
    
    
    11,821
    
    
    
    
    
    
    
    
    
    
    
    11,210Stockholders equity
    
    
    101,946
    
    
    
    
    
    
    
    
    
    
    
    91,868
    
    
    
    
    
    
    
    
    
    
    
    83,366Total liabilities and
stockholders equity
    
    $
    1,138,497
    
    
    
    
    
    
    
    
    
    
    $
    1,047,766
    
    
    
    
    
    
    
    
    
    
    $
    984,600Excess of interest earning
assets over interest bearing
liabilities
    
    $
    173,395
    
    
    
    
    
    
    
    
    
    
    $
    145,161
    
    
    
    
    
    
    
    
    
    
    $
    119,453Net interest income
    
    
    
    
    
    $
    38,428
    
    
    
    
    
    
    
    
    
    
    $
    37,562
    
    
    
    
    
    
    
    
    
    
    $
    35,804Interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.32
    %
    
    
    
    
    
    
    
    
    
    
    3.58
    %
    
    
    
    
    
    
    
    
    
    
    3.58
    %Effect of non-interest
bearing funds
    
    
    
    
    
    
    
    
    
    
    0.35
    %
    
    
    
    
    
    
    
    
    
    
    0.33
    %
    
    
    
    
    
    
    
    
    
    
    0.40
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.67
    %
    
    
    
    
    
    
    
    
    
    
    3.91
    %
    
    
    
    
    
    
    
    
    
    
    3.98
    %
   (1)
    
    Interest income on loans includes fees of $1,779,000 in 2004, $2,143,000 in 2003 and
$1,619,000 in 2002. Average loan balances exclude non-accrual loans.(2)
    
    Average balances of consumer loans outstanding are net of unearned income. 14




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##### Table of Contents



PennRock Financial Services Corp. Table 2 presents the adjustment required to convert net interest income to net interest income on a
fully taxable equivalent basis for the years ended December 31, 2004, 2003 and 2002. Table 2  Net Interest Income In thousands 2004
    
    
    2003
    
    
    2002Total interest income
    
    $
    55,340
    
    
    $
    53,394
    
    
    $
    57,142Total interest expense
    
    
    18,651
    
    
    
    17,825
    
    
    
    23,283Net interest income
    
    
    36,689
    
    
    
    35,569
    
    
    
    33,859Tax equivalent adjustment
    
    
    1,739
    
    
    
    1,993
    
    
    
    1,945Net interest income (fully taxable equivalent)
    
    $
    38,428
    
    
    $
    37,562
    
    
    $
    35,804
 The amount of non-taxable interest earned determines the size of tax equivalent adjustment
necessary to convert net interest income into fully taxable equivalent net interest income. The
sources of non-taxable interest income for PennRock are from interest earned on municipal bonds,
dividends from Fannie Mae and Freddie Mac preferred stock and from loans which qualify for
tax-exempt status. The dividends earned on Fannie Mae and Freddie Mac preferred stock are 70%
tax-free. Changes in interest rates as well as changes in average balances (or volumes) of earning assets and
paying liabilities have an impact on the amount of net interest income earned and the net interest
margins realized by PennRock from year-to-year. By isolating the effect that changes in rates have
on net interest income from the effect of changes in volume, we can analyze the degree that each
influences the change in net interest income and net interest margins. Table 3 analyzes the
changes in the volume and rate components of net interest income. Table 3  Volume and Rate Analysis of Changes in Interest Income
(Taxable equivalent basis) In thousands
    
    Year Ended December 31,2004 over 2003
    
    
    2003 over 2002Change due to
    
    
    Total
    
    
    Change due to
    
    
    TotalVolume
    
    
    Rate
    
    
    Change
    
    
    Volume
    
    
    Rate
    
    
    ChangeInterest earned on:Short-term investments
    
    $
    12
    
    
    ($
    9
    )
    
    $
    3
    
    
    ($
    26
    )
    
    ($
    41
    )
    
    ($
    67
    )Mortgages held for sale
    
    
    (402
    )
    
    
    26
    
    
    
    (376
    )
    
    
    462
    
    
    
    (194
    )
    
    
    268Securities
    
    
    316
    
    
    
    301
    
    
    
    617
    
    
    
    (758
    )
    
    
    (3,136
    )
    
    
    (3,894
    )Loans
    
    
    5,552
    
    
    
    (4,104
    )
    
    
    1,448
    
    
    
    5,447
    
    
    
    (5,454
    )
    
    
    (7
    )Total interest income
    
    
    5,478
    
    
    
    (3,786
    )
    
    
    1,692
    
    
    
    5,125
    
    
    
    (8,825
    )
    
    
    (3,700
    )Interest paid on:Interest bearing demand deposits
    
    
    103
    
    
    
    (111
    )
    
    
    (8
    )
    
    
    19
    
    
    
    (1,420
    )
    
    
    (1,401
    )Savings deposits
    
    
    68
    
    
    
    (75
    )
    
    
    (7
    )
    
    
    186
    
    
    
    (463
    )
    
    
    (277
    )Time deposits
    
    
    842
    
    
    
    352
    
    
    
    1,194
    
    
    
    (146
    )
    
    
    (2,415
    )
    
    
    (2,561
    )Short-term borrowings
    
    
    207
    
    
    
    396
    
    
    
    603
    
    
    
    541
    
    
    
    (304
    )
    
    
    237Long-term debt
    
    
    (544
    )
    
    
    (412
    )
    
    
    (956
    )
    
    
    (667
    )
    
    
    (789
    )
    
    
    (1,456
    )Total interest expense
    
    
    676
    
    
    
    150
    
    
    
    826
    
    
    
    (67
    )
    
    
    (5,391
    )
    
    
    (5,458
    )Net interest income
    
    $
    4,802
    
    
    ($
    3,936
    )
    
    $
    866
    
    
    $
    5,192
    
    
    
    ($3,434
    )
    
    $
    1,758
 2004 over 2003: The average balance of interest-earning assets grew $86.9 million in 2004 over 2003 while the
average yield declined 32 basis points. The volume increase generated $5.5 million of additional
interest income which was offset by the rate decline which reduced interest income by $3.8 million.
Total interest income grew $1.7 million. The average balance of interest bearing liabilities increased $58.7 million in 2004 over 2003 while
the average cost of funds declined by 5 basis points. The change in interest expense relative to
the increase in interest bearing liabilities was $676,000. Even though the weighted average rate
on interest bearing liabilities declined by 5 basis points, interest expense relative to changes in
rates increased $150,000 due to a change in the mix of liabilities. 15




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##### Table of Contents



PennRock Financial Services Corp. Since overall interest expense increased less than interest income, net interest income increased
by $866,000 in 2004. 2003 over 2002: The average balance of interest-earning assets grew $61.3 million in 2003 over 2002 while the
average yield declined 80 basis points. The volume increase generated $5.1 million of additional
interest income which was more than offset by the rate decline which reduced interest income by
$8.8 million. Total interest income declined by $3.7 million. The average balance of interest bearing liabilities increased $35.6 million in 2003 over 2002 while
the average cost of funds declined by 80 basis points. The change in interest expense relative to
the increase in interest bearing liabilities actually declined by $67,000 due to the change in the
various components of the liabilities. Average balance increases of $51.2 million were realized in
demand and savings deposits and in short-term borrowings with a combined weighted-average interest
rate of 1.03% which caused interest expense to increase $746,000. Declines were realized in time
deposits and long-term debt of $15.7 million with a combined weighted-average interest rate of
3.25% which caused interest expense to decrease $813,000. So even though the average balance of
interest bearing liabilities increased in 2003, because the declining instruments had a
substantially higher weighted average rate, interest expense relative to volume increases
decreased. The 80 basis point decline in weighted average rates caused interest expense to
decrease by $5.4 million. Since overall interest expense declined by more than interest income, net interest income increased
by $1.8 million in 2003. Another method of analyzing the change in net interest income is to examine the changes between
interest rate spread and the net interest margin on earning assets. The interest rate spread as
shown in Table 4 is the difference between the average rate earned on earning assets and the
average rate paid on interest bearing liabilities. The net interest margin takes into account the
benefit derived from assets funded by interest free sources such as non-interest bearing demand
deposits and capital. Table 4 - Interest Rate Spread and Net Interest Margin on Earning Assets
(Taxable equivalent basis) In thousands 2004
    
    
    2003
    
    
    2002Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageBalances
    
    
    Rate
    
    
    Balances
    
    
    Rate
    
    
    Balances
    
    
    RateEarning assets
    
    $
    1,046,867
    
    
    
    5.46
    %
    
    $
    959,954
    
    
    
    5.77
    %
    
    $
    898,669
    
    
    
    6.57
    %Interest bearing
liabilities
    
    $
    873,472
    
    
    
    2.14
    %
    
    $
    814,793
    
    
    
    2.19
    %
    
    $
    779,216
    
    
    
    2.99
    %Interest rate spread
    
    
    
    
    
    
    3.32
    %
    
    
    
    
    
    
    3.58
    %
    
    
    
    
    
    
    3.58
    %Interest free sources used
to fund earning assets
    
    
    173,395
    
    
    
    0.35
    %
    
    
    145,161
    
    
    
    0.33
    %
    
    
    119,453
    
    
    
    0.40
    %Total sources of funds
    
    $
    1,046,867
    
    
    
    
    
    
    $
    959,954
    
    
    
    
    
    
    $
    898,669Net interest margin
    
    
    
    
    
    
    3.67
    %
    
    
    
    
    
    
    3.91
    %
    
    
    
    
    
    
    3.98
    %
 The interest rate spread decreased 26 basis points in 2004 while the net interest margin decreased
24 basis points. The yield on earning assets declined 32 basis points. The yield on securities
available for sale increased 10 basis points while loan yields declined 56 basis points. The rate
paid on interest bearing deposits increased 4 basis points. The average cost of borrowed funds
declined 29 basis points in 2004. The average rate paid on total interest bearing liabilities
declined 5 basis points. The interest rate spread was unchanged at 3.58% in 2003 while the net interest margin decreased 7
basis points. The yield on earning assets declined 80 basis points. The yield on securities
available for sale declined 103 basis points while loan yields declined 84 basis points. The rate
paid on interest bearing deposits declined 74 basis points not only due to lower deposit rates but
also because of a shift of balances from higher cost time deposits to lower cost
interest bearing demand and savings deposits. The average cost of borrowed funds declined 117
basis points in 2003. The average rate paid on total interest bearing liabilities declined 80
basis points. 16




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##### Table of Contents



PennRock Financial Services Corp. PennRock has realized net interest income increases over the past three years. In 2002 and 2003,
this was the result of interest expense declining more than interest income. However, by the
beginning of 2004, funding costs were no longer declining while yields on interest earning assets
continued to decline. This had a negative impact on PennRocks net interest income as evidenced by
the decrease in both the net interest spread and net interest margin in 2004. Fortunately, yields
on earning assets are now increasing. Prime increased 125 basis points in 2004 which had a
positive impact on loan yields while yields on securities are expected to improve due to slower
prepayment speeds on mortgage-backed securities and with cash flow from the portfolio being
reinvested into higher yielding securities. In the fourth quarter of 2004, the yield on earning
assets was 5.55% an increase of 20 basis points from the 5.35% earned in third quarter of 2004.
PennRocks cost of funds is also increasing but at a slower pace. The average cost of funds in the
fourth quarter of 2004 was 2.30% compared with 2.17% in the third quarter, an increase of 13 basis
points. As a result, the net interest spread increased 7 basis points while the net interest
margin increased 9 basis points in the fourth quarter of 2004. Provision for Loan Losses The amount of provision for loan losses that was charged against earnings was $565,000 in 2004
compared with $1.9 million in 2003 and $1.8 million in 2002. We review the adequacy of the
allowance in light of past loan loss experience, current economic conditions, size and
characteristics of the loan portfolio, volume of non-performing and delinquent loans and other
relevant information. Total non-performing loans decreased from $1.6 million at the end of 2003 to
$571,000 at the end of 2004. The ratio of non-performing loans to total loans decreased from 0.22%
at the end of last year to 0.06% at the end of 2004. Net charge-offs were $201,000 in 2004,
$349,000 in 2003 and $1.9 million in 2002. The decrease in the provision in 2004 reflects this
improvement in credit quality realized in the first and second quarters of 2004 and that we have
reduced our estimate of the amount of reserves required to cover probable losses and incurred
portfolio losses. We recorded no provision for loan losses in the third and fourth quarters of
2004. Non-Interest Income PennRock generates non-interest income in connection with fees charged on deposits and other
products, for financial services including asset management, trust services and retirement plan
administration fees, from gains and losses on securities available for sale, increases in the cash
surrender value of bank-owned life insurance, sale and servicing of mortgage loans, and merchant,
ATM and debit card fees. Table 5 - Non-Interest Income Table 5 indicates changes in the major categories of non-interest income for the three years ended
December 31, 2004, 2003 and 2002. In thousands 2004/2003
    
    2003/2002Increase
    
    
    
    
    
    
    Increase(Decrease)
    
    
    
    
    
    
    (Decrease)2004
    
    
    Amount
    
    
    %
    
    
    2003
    
    Amount
    
    
    %
    
    
    2002Service charges on deposit
accounts
    
    $
    3,403
    
    
    $
    83
    
    
    
    2.5
    %
    
    $
    3,320
    
    
    $
    469
    
    
    
    16.5
    %
    
    $
    2,851Other service charges and fees
    
    
    400
    
    
    
    46
    
    
    
    13.0
    %
    
    
    354
    
    
    
    46
    
    
    
    14.9
    %
    
    
    308Financial services
    
    
    4,695
    
    
    
    (309
    )
    
    
    (6.2
    %)
    
    
    5,004
    
    
    
    910
    
    
    
    22.2
    %
    
    
    4,094Net realized gains on sales of
available for sale securities
    
    
    855
    
    
    
    506
    
    
    
    145.0
    %
    
    
    349
    
    
    
    (20
    )
    
    
    (5.4
    %)
    
    
    369Impairment charge on available
for sale equity securities
    
    
    (1,221
    )
    
    
    (1,221
    )Mortgage banking
    
    
    753
    
    
    
    (466
    )
    
    
    (38.2
    %)
    
    
    1,219
    
    
    
    706
    
    
    
    137.6
    %
    
    
    513Increase in cash surrender value
of bank owned life insurance
    
    
    985
    
    
    
    (185
    )
    
    
    (15.8
    %)
    
    
    1,170
    
    
    
    (73
    )
    
    
    (5.9
    %)
    
    
    1,243Other
    
    
    2,365
    
    
    
    31
    
    
    
    1.3
    %
    
    
    2,334
    
    
    
    568
    
    
    
    32.2
    %
    
    
    1,766Total
    
    $
    12,235
    
    
    
    ($1,515
    )
    
    
    (11.0
    %)
    
    $
    13,750
    
    
    $
    2,606
    
    
    
    23.4
    %
    
    $
    11,144
 Total non-interest income decreased $1.5 million or 11.0% in 2004 and increased by $2.6 million or
23.4% in 2003. Excluding net security gains and losses, non-interest income decreased $800,000 or
6.0% in 2004 compared with a 17




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##### Table of Contents



PennRock Financial Services Corp. $2.6 million or 24.4% increase in 2003. Fees from financial services increased $910,000 or 22.2%
in 2003 (reflecting in part the acquisition of PCS in 2002) but declined by $309,000 or 6.2% in
2004. The increase in mortgage banking income in 2003 is due to a large increase in the volume of
residential mortgage refinancing as a result of historically low mortgage rates. Refinancing
volumes declined substantially in 2004. In 2003, the Bank originated $145.9 million in mortgage
loans held for sale and sold $151.3 million. In 2004, the Bank originated $50.6 million in
mortgage loans held for sale and sold $49.0 million. Net security losses of $366,000 in 2004 consist of a $773,000 gain on sale of debt securities, an
$82,000 gain on sale of equity securities and, as discussed below, an impairment charge of $1.2
million on equity securities. Net security gains totaled $349,000 in 2003 and $369,000 in 2002.
Securities gains and losses from sales of available for sale securities in all three years were
attributable to management of PennRocks equity portfolio and to the sale of other securities for
the purpose of adding liquidity, to control interest rate risk and to achieve other objectives
resulting from the active management of PennRocks balance sheet. At December 31, 2004, PennRock owns approximately $61 million face value of adjustable-rate
perpetual preferred stock issued by Freddie Mac and Fannie Mae, both government sponsored entities.
The preferred stock issues are investment grade securities (rated AA- by Standards & Poor and Aa3
by Moodys) that are held in PennRocks available-for-sale securities portfolio. Our evaluation of
the securities for other-than-temporary impairment included a review of the duration and amount of
unrealized loss, the financial condition of the issuers and the prospects for a recovery of market
value in a reasonable period of time. As a result, we concluded that approximately $5 million face
value of Freddie Mac preferred stock was other-than-temporarily impaired, resulting in an
impairment charge of $838,000 and an after-tax charge of $545,000. Prior to this
other-than-temporary charge, impairment was recorded as an unrealized mark-to-market loss on
securities available-for-sale and reflected as a reduction of equity, on an after tax basis,
through other comprehensive income. Accordingly, the reclassification of the unrealized after-tax
loss of $545,000 to an other-than-temporary non-cash charge will not affect shareholders equity or
related capital ratios. We recorded the impairment charge because the market value of the stock
declined significantly in the fourth quarter following several negative announcements by Fannie Mae
involving regulatory actions, earnings restatements and management turnover. We concluded that
these events made the likelihood of future price appreciation less certain in the near-term and
would extend the time period for a recovery of PennRocks investment cost beyond previous
estimates. However, once these issues are resolved and because these securities carry adjustable
rates, we believe the market values of these securities will improve. Therefore, we believe this
decision is based on a proper interpretation of accounting principles but does not reflect on the
long-term value of these investment grade securities. PennRock also has a portfolio of publicly traded common stock of approximately $1.5 million in its
available-for-sale portfolio. In addition to the impairment of the Freddie Mac preferred stock, we
determined that several of these securities were also other-than-temporarily impaired. As with the
Freddie Mac preferred stock, our evaluation included a review of the duration and amount of
unrealized loss, the financial condition of the issuers and the prospects for a recovery of market
value in a reasonable period of time. This resulted in an impairment charge of $383,000 and an
after-tax charge of $249,000. Because these securities had already been marked-to-market on an
after tax basis through other comprehensive income, this charge will have no impact on PennRocks
capital or capital ratios. The Banks total investment in Bank Owned Life Insurance (BOLI) as of December 31, 2004 was $28.5
million and $27.6 million as of December 31, 2003. The income from BOLI represents the increase in
the cash surrender value of life insurance contracts and is intended to partially offset the costs
of the Banks employee benefit plans including group life, disability and health insurance. Income
from BOLI totaled $985,000 in 2004 and $1.2 million in both 2003 and 2002. Other non-interest income includes fees from ATM and merchant card services, title insurance, and
letters or credit. Also included in other non-interest income for 2004 is a loss of $246,000 from
disposition of bank-owned real estate.  18




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##### Table of Contents



PennRock Financial Services Corp. Non-Interest Expense Table 6 provides a comparison for each category of non-interest expense for the years ending
December 31, 2004, 2003 and 2002. Table 6 - Non-Interest Expense In thousands 2004/2003
    
    2003/2002Increase
    
    
    
    
    
    
    Increase(Decrease)
    
    
    
    
    
    
    (Decrease)2004
    
    
    Amount
    
    
    %
    
    
    2003

    
    Amount
    
    
    %
    
    
    2002Salaries and employee benefits
    
    $
    20,297
    
    
    $
    2,201
    
    
    
    12.2
    %
    
    $
    18,096
    
    
    $
    1,949
    
    
    
    12.1
    %
    
    $
    16,147Occupancy, net
    
    
    2,114
    
    
    
    70
    
    
    
    3.4
    %
    
    
    2,044
    
    
    
    240
    
    
    
    13.3
    %
    
    
    1,804Equipment, depreciation and
service
    
    
    1,268
    
    
    
    (65
    )
    
    
    (4.9
    %)
    
    
    1,333
    
    
    
    (56
    )
    
    
    (4.0
    %)
    
    
    1,389Advertising and marketing
    
    
    1,083
    
    
    
    101
    
    
    
    10.3
    %
    
    
    982
    
    
    
    (16
    )
    
    
    (1.6
    %)
    
    
    998Computer program amortization
and maintenance
    
    
    939
    
    
    
    9
    
    
    
    1.0
    %
    
    
    930
    
    
    
    (134
    )
    
    
    (12.6
    %)
    
    
    1,064Other
    
    
    5,915
    
    
    
    (378
    )
    
    
    (6.0
    %)
    
    
    6,293
    
    
    
    248
    
    
    
    4.1
    %
    
    
    6,045Total
    
    $
    31,616
    
    
    $
    1,938
    
    
    
    6.5
    %
    
    $
    29,678
    
    
    $
    2,231
    
    
    
    8.1
    %
    
    $
    27,447
 Total non-interest expense for 2004 increased $1.9 million or 6.5%. Salaries and employee benefits
increased $2.2 million or 12.2% in 2004. The number of full-time equivalent employees increased
from 349 in 2003 to 353 by year-end 2004. Included in the salaries and benefits expense in 2004 is
a compensation charge of $1.1 million representing the difference between the exercise price and
market value of options on 41,928 shares of PennRock stock, in accordance with FASB Interpretation
No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensation, an
interpretation of APB Opinion No. 25. Also included in salaries and benefits for 2004 is a
$391,000 increase in health insurance premiums. Other non-interest expense decreased $378,000 or
6.0% in 2004. Included in other non-interest expense are costs of $292,000 that PennRock incurred
in 2004 to comply with Sarbanes-Oxley Section 404. Also included in this category are legal,
consulting and other professional fees, supplies, liability insurance, fees for outsourced services
and shares tax expense. Total non-interest expense for 2003 increased $2.2 million or 8.1%. Salaries and employee benefits
increased $1.9 million or 12.1% in 2003. The number of full-time equivalent employees increased
from 335 in 2002 to 349 by year-end 2003. The increase in salaries and benefits is also due in
part to larger than normal incentive bonuses paid to lenders and others on the sales team who
generated a net increase in loans of $109.0 million or 18.1%. All other non-interest expenses
increased a net $282,000 or 2.50% in 2003. The ratio of average assets (in millions) per employee was $2.94 in 2002, $3.00 in 2003 and $3.23
in 2004. The average salary and benefit expense per employee was $48,000 in 2002, $52,000 in 2003
and $57,000 in 2004. The efficiency ratio was 56.91% in 2002, 56.51% in 2003 and 59.34% in 2004. Provision for Income Taxes Income tax expense totaled $4.1 million in 2004, $3.7 million in 2003 and $2.6 million in 2002.
The statutory federal tax rate was 35% in 2004, 2003 and 2002. PennRocks effective tax rate was
24.3% in 2004 compared to 21.0% in 2003 and 16.3% in 2002. The primary reason for changes in the
effective tax rate is due to the change in the amount of tax-exempt income earned during the year
and to the amount of tax credits available from low-income housing and rehabilitation projects in
which the Bank becomes involved from time-to-time. For a more comprehensive analysis of income tax
expense, refer to Note 12: Income Taxes in the Notes to Consolidated Financial Statements. PennRock accounts for income taxes under the liability method as specified by Statement of
Financial Accounting Standards No. 109 (SFAS No. 109), Accounting for Income Taxes. Under the
liability method, a deferred tax

asset or liability is determined based on the enacted tax rates which will be in effect when the
differences between the financial statement carrying amounts and tax basis of existing assets and
liabilities are expected to be reported in PennRocks income tax returns. The deferred tax
provision for the year is equal to the net change in the deferred tax asset and liability accounts
from the beginning to the end of the year. The effect on deferred taxes of a change in tax rates
is recognized in income in the period that includes the enactment date. The principal types of
accounts that 19




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##### Table of Contents



PennRock Financial Services Corp. result in differences between assets and liabilities for financial statement and tax return
purposes are the allowance for loan losses, accumulated depreciation of fixed assets and discounts
on investment securities. Financial Condition Sources and Uses of Funds Table 7 examines PennRocks financial condition in terms of its sources and uses of funds. Average
funding uses increased $86.9 million or 9.1% in 2004 compared with an increase of $61.3 million or
6.8% in 2003. Table 7 - Sources and Uses of Funds In thousands 2004
    
    
    2003
    
    
    2002Average
    
    
    Increase (Decrease)
    
    
    Average
    
    
    Increase (Decrease)
    
    
    AverageBalance
    
    
    Amount
    
    
    %
    
    
    Balance
    
    
    Amount
    
    
    %
    
    
    BalanceFunding uses:Short-term
investments
    
    $
    5,371
    
    
    $
    1,389
    
    
    
    34.9
    %
    
    $
    3,982
    
    
    
    ($1,393
    )
    
    
    (25.9
    %)
    
    $
    5,375Mortgages held for
sale
    
    
    1,712
    
    
    
    (6,071
    )
    
    
    (78.0
    %)
    
    
    7,783
    
    
    
    5,063
    
    
    
    186.1
    %
    
    
    2,720Securities available
for sale
    
    
    310,592
    
    
    
    7,968
    
    
    
    2.6
    %
    
    
    302,624
    
    
    
    (15,161
    )
    
    
    (4.8
    %)
    
    
    317,785Loans
    
    
    729,192
    
    
    
    83,627
    
    
    
    13.0
    %
    
    
    645,565
    
    
    
    72,776
    
    
    
    12.7
    %
    
    
    572,789Total uses
    
    $
    1,046,867
    
    
    $
    86,913
    
    
    
    9.1
    %
    
    $
    959,954
    
    
    $
    61,285
    
    
    
    6.8
    %
    
    $
    898,669Funding sources:Interest-bearing
demand deposits
    
    $
    222,682
    
    
    $
    9,702
    
    
    
    4.6
    %
    
    $
    212,980
    
    
    $
    1,111
    
    
    
    0.5
    %
    
    $
    211,869Savings deposits
    
    
    94,306
    
    
    
    8,176
    
    
    
    9.5
    %
    
    
    86,130
    
    
    
    13,588
    
    
    
    18.7
    %
    
    
    72,542Time deposits
    
    
    346,186
    
    
    
    33,159
    
    
    
    10.6
    %
    
    
    313,027
    
    
    
    (4,405
    )
    
    
    (1.4
    %)
    
    
    317,432Short-term
borrowings
    
    
    108,298
    
    
    
    18,053
    
    
    
    20.0
    %
    
    
    90,245
    
    
    
    36,535
    
    
    
    68.0
    %
    
    
    53,710Long-term debt
    
    
    102,000
    
    
    
    (10,411
    )
    
    
    (9.3
    %)
    
    
    112,411
    
    
    
    (11,252
    )
    
    
    (9.1
    %)
    
    
    123,663Non-interest bearing
funds, net
    
    
    173,395
    
    
    
    28,234
    
    
    
    19.5
    %
    
    
    145,161
    
    
    
    25,708
    
    
    
    21.5
    %
    
    
    119,453Total sources
    
    $
    1,046,867
    
    
    $
    86,913
    
    
    
    9.1
    %
    
    $
    959,954
    
    
    $
    61,285
    
    
    
    6.8
    %
    
    $
    898,669
 Securities Available for Sale Table 8 indicates the composition and maturity of the securities available for sale (AFS)
portfolio as of December 31, 2004. The table is based on the expected maturities of securities
which may differ from contractual maturities. Included in the portfolio are callable agencies,
state and municipal securities, mortgage-backed securities (including adjustable rate
mortgage-backed securities) and CMOs that may be called, prepaid or reprice before final maturity.
For mortgage-backed securities, maturity is based on average lives rather than contractual
maturity. The weighted average duration of the portfolio decreased from 2.8 years at the end of
2003 to 2.3 years at the end of 2004. Duration is the weighted-average present value of future
cash flows from a financial instrument. Investment managers use it as an indication of the
potential price volatility of a financial instrument for various changes in market interest rates.
The higher the duration, the more the market value of a portfolio would be expected to fluctuate as
interest rates change. The decrease in the duration of the portfolio is attributable to purchases
of short-duration mortgage-backed securities during 2004 and the sale of $42.7 million of long-duration
fixed-rate Fannie Mae and Freddie Mac perpetual preferred stock.  20




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##### Table of Contents



PennRock Financial Services Corp. Table 8 - Analysis of Securities Available for Sale In thousands TaxableWithin
    
    
    1-5
    
    
    6-10
    
    
    Over 10
    
    
    
    
    
    
    
    
    
    
    EquivalentOne Year
    
    
    Years
    
    
    Years
    
    
    Years
    
    
    Equities
    
    
    Total
    
    
    YieldU.S. agency
    
    $
    7,026
    
    
    $
    4,106
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    11,132
    
    
    
    4.12
    %States and political subdivisions
    
    
    
    
    
    
    
    
    
    
    1,000
    
    
    
    8,935
    
    
    
    
    
    
    
    9,935
    
    
    
    7.52
    %Mortgage backed securities
    
    
    100
    
    
    
    89,469
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89,569
    
    
    
    4.70
    %Collateralized mortgage
obligations
    
    
    5,508
    
    
    
    50,809
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,317
    
    
    
    4.50
    %Corporate obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    71,083
    
    
    
    
    
    
    
    71,083
    
    
    
    3.52
    %Equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,216
    
    
    
    69,216
    
    
    
    5.15
    %Total (amortized cost)
    
    $
    12,634
    
    
    $
    144,384
    
    
    $
    1,000
    
    
    $
    80,018
    
    
    $
    69,216
    
    
    $
    307,252
    
    
    
    4.56
    %Total fair value
    
    $
    12,604
    
    
    $
    143,640
    
    
    $
    1,001
    
    
    $
    78,210
    
    
    $
    67,168
    
    
    $
    302,623Taxable equivalent yield
    
    
    4.09
    %
    
    
    4.63
    %
    
    
    5.50
    %
    
    
    3.75
    %
    
    
    5.15
    %
    
    
    4.56
    %Percent of portfolio
    
    
    4.11
    %
    
    
    46.99
    %
    
    
    0.33
    %
    
    
    26.03
    %
    
    
    22.53
    %Average maturity of debt
securities
    
    12.70 years
 Measured on an amortized cost basis, securities decreased $3.4 million or 1.1% in 2004 and
increased $761,000 or 0.2% during 2003. As of December 31, 2004, securities available for sale at
fair value totaled $302.6 million compared with $309.2 million at the end of 2003. During 2004,
PennRock sold $109.3 million and purchased $155.5 million in available for sale securities. During
2003, PennRock sold $93.4 million in securities and purchased $206.4 million. In addition,
principal payments of $44.0 million in 2004 and $109.7 million in 2003 were received from
securities that matured or were called and from principal repayments of mortgage-backed securities. As of December 31, 2004, the AFS portfolio had a net unrealized loss of $4.6 million consisting of
gross unrealized gains of $1.3 million and gross unrealized losses of $5.9 million. Substantially
all of the unrealized losses are related to adjustable rate securities whose coupons had been
adjusted downward over the past two years in response to the historically low level of market
interest rates. We expect these coupon rates to rise in the near-term as market interest rates
rise. As of December 31, 2003, the AFS portfolio had a net unrealized loss of $1.5 million
consisting of gross unrealized gains of $4.0 million and gross unrealized losses of $5.5 million. As indicated above, under the discussion of non-interest income, PennRock recorded an
other-than-temporary impairment charge on approximately $5 million face value Freddie Mac perpetual
preferred variable rate stock as well as several issues of publicly traded common stock maintained
in its available-for-sale portfolio. The impairment charge totaled $1.2 million and was recorded
as of year-end 2004. All other declines in market value have been determined to be temporary in
nature. Measured at fair value, as of December 31, 2004, PennRock had $145.9 million invested in
mortgage-backed securities and CMOs compared with $98.5 million as of December 31, 2003. A
mortgage-backed security depends on an underlying pool of mortgage loans to provide a cash flow
pass-through of principal and interest. A CMO is a mortgage-backed security that is comprised of
classes of bonds created by prioritizing the cash flows from the underlying mortgage pool in order
to meet different objectives of investors. PennRock had $89.4 million in mortgage-backed
securities and $55.8 million in CMO securities at the end of 2004 all of which were fixed rate.
None of the CMOs in the portfolio was considered high risk as defined by banking regulations. The proportion of assets invested in securities on PennRocks balance sheet has declined
significantly over the past several years. In 1999, securities comprised 37% of PennRocks assets.
By the end of 2004, that percentage had dropped to less than 26%. Securities at fair-value
totaled $309.5 million as of December 31, 1999 and totaled $302.6 million at the end of 2004. Had
management elected to maintain the same proportion of securities relative to total assets from
year-end 1999, the securities portfolio would be approximately $132 million larger by the end of
2004 than it currently is. Instead, we have elected to maintain the same level of securities
measured in terms of total value from year-to-year to provide an adequate source of secondary liquidity and cash-flow and for
pledging purposes, and to concentrate our efforts in growing the loan portfolio in proportion to
total assets. See the discussion of the loan portfolio below. 21




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##### Table of Contents



PennRock Financial Services Corp. During 2004 and 2003, there were no investments in securities of any single, non-federal issues in
excess of 10% of stockholders equity. Loans Table 9 presents loans outstanding, by type of loan, for the five years ended December 31, 2004. Table 9  Loans Outstanding, Net of Unearned Income In thousands December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Commercial, financial and
agricultural:Commercial, secured by real estate
    
    $
    419,114
    
    
    $
    371,105
    
    
    $
    327,592
    
    
    $
    276,667
    
    
    $
    223,722Agricultural
    
    
    8,654
    
    
    
    7,387
    
    
    
    6,838
    
    
    
    6,368
    
    
    
    6,589Other
    
    
    91,133
    
    
    
    91,934
    
    
    
    83,801
    
    
    
    77,849
    
    
    
    80,497Real estate  construction
    
    
    47,681
    
    
    
    45,319
    
    
    
    32,140
    
    
    
    46,558
    
    
    
    22,745Real estate
 mortgage
    
    
    198,217
    
    
    
    187,033
    
    
    
    141,983
    
    
    
    137,929
    
    
    
    151,709Consumer loans
    
    
    8,525
    
    
    
    9,124
    
    
    
    10,486
    
    
    
    12,998
    
    
    
    15,878Total loans
    
    $
    773,324
    
    
    $
    711,902
    
    
    $
    602,840
    
    
    $
    558,369
    
    
    $
    501,140
 As indicated in the discussion on securities above, management has made a concerted effort through
its sales staff, especially its commercial banking officers, to increase the proportion of assets
invested in loans outstanding while maintaining asset quality and our internal underwriting
standards. Loans as a percent of total assets increased from 54.7% at the end of 1999 to 65.8% by
the end of 2004. This decision was made for several reasons. First, in pure economic terms, loan
yields have exceeded security yields by 240 basis points on average over the past three years.
Second, although loans carry more credit risk and higher operational costs than securities,
investments provide no opportunity to develop any additional relationships or to cross-sell any
additional products or services to our customers. The third reason is to better fulfill our
commitment to serve the credit needs of customers in our market area. Loans increased in 2004 by $61.4 million or 8.6%, compared with a $109.1 million or 18.1% increase
during 2003. The fastest growing category in the loan portfolio for the past several years has
been commercial real estate loans which have more than doubled in the past five years. In 2004,
commercial real estate loans grew $48.0 million or 12.9% and in 2003 they grew $43.5 million or
13.3%. Consumer loans, on the other hand, have declined in each of the past five years as
consumers have shown a preference for home equity loans over traditional installment loans. Home
equity loans are included under the category real estate  mortgage loans. PennRock originated
$50.6 million and sold $49.0 million in conforming residential mortgage loans in 2004 and
originated $145.9 million and sold $151.3 million in 2003. We retained the servicing on all loans
sold. The Banks mortgage servicing portfolio grew from $222.9 million at the end of 2003 to
$224.0 million at the end of 2004. As of December 31, 2004, PennRock did not have any loan concentrations exceeding 10% of total loans
to any particular economic group or industry. The loan portfolio is well diversified as to
industry and companies within each industry which helps minimize risk. Loan quality is maintained
through diversification of risk, strict credit control practices and continued monitoring of the
loan portfolio. As of December 31, 2004, PennRock did not have any loans outstanding to any
foreign entity or government.  22




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##### Table of Contents



PennRock Financial Services Corp. Table 10  Loan Maturities and Interest Sensitivity(1) In thousands December 31, 2004One year
    
    
    One through
    
    
    Overor less
    
    
    Five years
    
    
    Five years
    
    
    TotalCommercial, financial and agricultural
    
    $
    15,032
    
    
    $
    103,601
    
    
    $
    400,268
    
    
    $
    518,901Real estate
  construction
    
    
    47,681
    
    
    
    
    
    
    
    
    
    
    
    47,681Total
    
    $
    62,713
    
    
    $
    103,601
    
    
    $
    400,268
    
    
    $
    566,582Loans with predetermined interest rate
    
    $
    11,229
    
    
    $
    45,854
    
    
    $
    34,626
    
    
    $
    91,709Loans with variable interest rate
    
    
    51,484
    
    
    
    57,747
    
    
    
    365,642
    
    
    
    474,873Total
    
    $
    62,713
    
    
    $
    103,601
    
    
    $
    400,268
    
    
    $
    566,582
   (1)Excludes residential mortgages and consumer loans. Non-Performing Assets Table 11 shows PennRocks non-performing loans for the five years ended December 31, 2004. Table 11  Non-performing Assets In thousands December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Non-accrual loans
    
    $
    277
    
    
    $
    951
    
    
    $
    1,203
    
    
    $
    692
    
    
    $
    3,675Loans accruing but 90 days past due as to
principal or interest
    
    
    225
    
    
    
    617
    
    
    
    1,276
    
    
    
    476
    
    
    
    569Total non-performing loans
    
    
    502
    
    
    
    1,568
    
    
    
    2,479
    
    
    
    1,168
    
    
    
    4,244Other real estate owned
    
    
    69
    
    
    
    66
    
    
    
    188
    
    
    
    208
    
    
    
    188Total non-performing assets
    
    $
    571
    
    
    $
    1,634
    
    
    $
    2,667
    
    
    $
    1,376
    
    
    $
    4,432Ratios:Non-performing loans to total loans
    
    
    0.06
    %
    
    
    0.22
    %
    
    
    0.41
    %
    
    
    0.21
    %
    
    
    0.85
    %Non-performing assets to total loans
and other real estate owned
    
    
    0.07
    %
    
    
    0.23
    %
    
    
    0.44
    %
    
    
    0.25
    %
    
    
    0.88
    %Allowance for loan losses to
non-performing loans
    
    
    1794.22
    %
    
    
    551.21
    %
    
    
    285.40
    %
    
    
    621.75
    %
    
    
    140.74
    %
 A loan is generally classified as non-accrual when principal or interest has consistently been in
default for a period of 90 days or more or when full payment of principal and interest is not
expected because of deterioration in the financial condition of the borrower. When a loan is
placed on non-accrual status, any unpaid interest is charged against income. If a loan is past due
90 days or more but still accruing, the loan is generally well secured and in the process of being
collected or is expected to be restored to current status in the near future. Non-performing loans decreased by $911,000 or 36.7% from 2002 to 2003 and decreased by $1.1 million
or 65.1% in 2004. The proportion of non-performing loans relative to total loans decreased from
0.22% to 0.06% during 2004. The coverage ratio of the allowance for loan losses to non-performing
loans increased from 551.21% at the end of 2003 to 1794.22% at the end of 2004. Impaired loans include all non-accrual loans plus all loans whose original terms have been
restructured as to the payment of principal, interest or both. Impaired loans totaled $3.0 million
as of December 31, 2004 of which $277,000 was in non-accrual status and $958,000 as of December 31,
2003 of which $951,000 was in non-accrual. Table 14 below presents the balance of impaired loans
at year-end 2004 and 2003. As of December 31, 2004, real estate acquired in foreclosure known as other real estate owned
(OREO) totaled $69,000 and was included in other assets on the Consolidated Balance Sheets. As
of December 31, 2003, OREO totaled $66,000. During 2004, sales of OREO property totaled $91,000 and $148,000 in 2003.
Valuation reserves are established for OREO properties whenever estimated current realizable values
fall below the original fair value recorded.  23




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##### Table of Contents



PennRock Financial Services Corp. Allowance for Loan Losses The allowance for loan losses (Table 12) is established and maintained at a level that we believe
is adequate to absorb probable losses in the Banks loan portfolio based upon a periodic evaluation
of current information of the risks inherent in the portfolio and is monitored with continuous
internal as well as semiannual independent loan reviews. There are many elements that we evaluate
to determine the adequacy of the allowance for loan losses. The Bank has an internal rating system that assigns grades for all loans except residential
mortgage loans, consumer loans and commercial and commercial real estate loans under $100,000.
Loans are initially assigned to one of seven risk grades. The loan officer assigns the loan rating
at the time the loan is made. These ratings may be changed over time to reflect changes in the
financial condition of the borrowing entity. If warranted, the risk rating may be lowered to
eight (substandard), nine (doubtful) or ten (loss). Loans rated ten are charged-off. All
loans rated seven through nine, which are considered watch loans, are assigned either a specific
allowance allocation or a general allowance allocation percentage. The specific allowance
allocation is based on an analysis of each loan for which a specific allowance allocation is
assigned. General allowance allocation percentages assigned to watch loans are based upon a
three-year average historical loss experience for that particular risk rating. General allowance
allocation percentages are also assigned to commercial and commercial mortgage loans not on the
watch loan list, for consumer loans and residential mortgage loans. The general allowance
allocation percentage assigned to categories of non-watch loans are based on the three-year average
historical loss experience for each category of loan. The sum of all allowance amounts determined
by this methodology is utilized as the primary indicator of the appropriate level of the allowance
for loan losses. We may increase the allowance for loan losses to an amount higher than that computed above in
response to factors and conditions that may not be fully reflected in the determination of the
allowance allocation percentages. These factors and conditions may not be adequately captured in
the historical loss component and is an assessment of information delay and its impact on the
timeliness of the risk rating process. These factors and conditions include:  i.
    general economic and business conditions affecting our key lending areas;ii.
    credit quality trends (including trends in non-performing loans expected to result from
existing economic conditions);iii.
    trends that could affect collateral values;iv.
    loan volumes and concentrations;v.
    seasoning of the loan portfolio;vi.
    specific industry conditions affecting portfolio segments;vii.
    duration of the current business cycle;viii.
    bank regulatory examination results; andix.
    the results of our internal loan review process. When we assign loan ratings to individual loans, we consider the risk elements attributable to
particular loan types or categories. These risk elements may include:  i.
    for non-farm and non-residential loans, multifamily residential loans and agricultural
real estate loans, the debt service coverage ratio (income from the property in excess of
operating expenses compared to loan payment requirements);ii.
    for construction and land development loans, the perceived feasibility of the project
including the ability to sell developed lots or improvements constructed for resale or
ability to lease property constructed for lease, experience and ability of the developer
and loan-to-value ratios;iii.
    for commercial and commercial real estate loans, the operating results of the
commercial, industrial or professional enterprise, the specific risks and volatility of
income and operating results typical for similar businesses and the value, nature and
marketability of collateral; andiv.
    for non-real estate agricultural loans, the operating results, experience and ability
of the borrower, historical and expected market conditions and the value, nature and
marketability of the collateral. In addition, for each category, we consider secondary sources of income and the financial strength
of the borrower and any guarantors. The Board of Directors reviews the allowance on a quarterly basis to determine whether the amount
of monthly provision is adequate or whether additional provisions should be increased or decreased. The internally classified watch list, along with the list of non-accrual and non-performing
loans, helps the Board and management assess the overall quality of the loan portfolio and the
adequacy of the allowance. Loans classified as an eight (substandard) are loans with clear and
defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain
repayment sources or poor financial condition which may jeopardize recoverability of the loan.
Loans 24




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##### Table of Contents



PennRock Financial Services Corp. classified as a nine (doubtful) are those loans that have characteristics similar to substandard
loans, but also have an increased risk that a loss may occur or at least a portion of the loan may
require a charge-off if liquidated. Both eight and nine rated loans categories may include
loans that are past due at least 90 days, are on non-accrual status or have been restructured. As
of December 31, 2004, there were no loans rated nine or ten. The total allowance amount is
available for losses across the Banks entire portfolio. The following table shows the changes in the allowance for loan losses for the five years ended
December 31, 2004. Table 12 - Allowance for Loan Losses In thousands Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Balance, beginning of year
    
    $
    8,643
    
    
    $
    7,075
    
    
    $
    7,262
    
    
    $
    5,973
    
    
    $
    5,514Provision charged to expense
    
    
    565
    
    
    
    1,917
    
    
    
    1,750
    
    
    
    1,548
    
    
    
    3,076Loans charged off:Commercial, financial and agricultural
    
    
    281
    
    
    
    545
    
    
    
    2,104
    
    
    
    393
    
    
    
    1,258Consumer
    
    
    90
    
    
    
    172
    
    
    
    93
    
    
    
    195
    
    
    
    1,582Total loans charged off
    
    
    371
    
    
    
    717
    
    
    
    2,197
    
    
    
    588
    
    
    
    2,840Recoveries:Commercial, financial and agricultural
    
    
    97
    
    
    
    330
    
    
    
    215
    
    
    
    290
    
    
    
    106Consumer
    
    
    73
    
    
    
    38
    
    
    
    45
    
    
    
    39
    
    
    
    117Total recoveries
    
    
    170
    
    
    
    368
    
    
    
    260
    
    
    
    329
    
    
    
    223Net charge-offs
    
    
    201
    
    
    
    349
    
    
    
    1,937
    
    
    
    259
    
    
    
    2,617Balance, end of year
    
    $
    9,007
    
    
    $
    8,643
    
    
    $
    7,075
    
    
    $
    7,262
    
    
    $
    5,973Total loansAverage
    
    $
    729,728
    
    
    $
    646,391
    
    
    $
    576,305
    
    
    $
    518,202
    
    
    $
    485,999Year-end
    
    
    773,324
    
    
    
    711,902
    
    
    
    602,840
    
    
    
    558,369
    
    
    
    501,140Ratios:Net charge-offs to:Average loans
    
    
    0.03
    %
    
    
    0.05
    %
    
    
    0.34
    %
    
    
    0.05
    %
    
    
    0.54
    %Total loans
    
    
    0.03
    %
    
    
    0.05
    %
    
    
    0.32
    %
    
    
    0.05
    %
    
    
    0.52
    %Allowance for loan losses
    
    
    2.23
    %
    
    
    4.04
    %
    
    
    27.38
    %
    
    
    3.57
    %
    
    
    43.81
    %Provision for loan losses
    
    
    35.58
    %
    
    
    18.21
    %
    
    
    110.69
    %
    
    
    16.73
    %
    
    
    85.08
    %Allowance for loan losses to:Average loans
    
    
    1.23
    %
    
    
    1.34
    %
    
    
    1.23
    %
    
    
    1.40
    %
    
    
    1.23
    %Loans as of year-end
    
    
    1.16
    %
    
    
    1.21
    %
    
    
    1.17
    %
    
    
    1.30
    %
    
    
    1.19
    %
 The allowance for loan losses totaled $9.0 million as of December 31, 2004, an increase of 4.2%
from 2003. The allowance for loan losses as a percentage of year-end loans declined from 1.21% at
the end of December 31, 2003 to 1.16% as of December 31, 2004. The provision for loan losses
exceeded net-charge-offs by $364,000 million in 2004 and by $1.6 million in 2003. Total loans charged-off decreased from $717,000 in 2003 to $371,000 in 2004. Loans charged-off in
2002 totaled $2.2 million. Recoveries of loans previously charged-off increased from $260,000 in
2002 to $368,000 in 2003 and decreased to $170,000 in 2004. The ratio of net charge-offs to
average loans was 0.03% in 2004, 0.05% in 2003 and 0.34% in 2002. Based on our analysis of the loan portfolio as well as other factors and conditions, we believe the
current allowance is adequate. However, changing economic and other conditions may require future
adjustments to the allowance for loan losses. Table 13 presents the allocation of the allowance for loan losses by major loan category for the
five years ended December 31, 2004. The specific allocations in any particular category may prove
to be excessive or inadequate to absorb actual future charge-offs so balances may be reallocated in
the future to reflect changing conditions. Accordingly, the entire allowance is considered
available to absorb losses in any category. 25




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##### Table of Contents



PennRock Financial Services Corp. Table 13  Allocation of Allowance for Loan Losses In thousands December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % ofAmount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    LoansCommercial,
financial
and agricultural
    
    $
    7,983
    
    
    
    67.1
    %
    
    $
    7,647
    
    
    
    66.1
    %
    
    $
    5,693
    
    
    
    69.4
    %
    
    $
    6,216
    
    
    
    64.6
    %
    
    $
    4,232
    
    
    
    61.7
    %Real estate:construction
    
    
    
    
    
    
    6.2
    %
    
    
    38
    
    
    
    6.4
    %
    
    
    578
    
    
    
    5.3
    %
    
    
    
    
    
    
    8.4
    %
    
    
    
    
    
    
    4.6
    %mortgage
    
    
    114
    
    
    
    25.6
    %
    
    
    201
    
    
    
    26.3
    %
    
    
    111
    
    
    
    23.6
    %
    
    
    71
    
    
    
    24.7
    %
    
    
    185
    
    
    
    30.5
    %Consumer
    
    
    735
    
    
    
    1.1
    %
    
    
    757
    
    
    
    1.2
    %
    
    
    693
    
    
    
    1.7
    %
    
    
    975
    
    
    
    2.3
    %
    
    
    484
    
    
    
    3.2
    %Unallocated
    
    
    175
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,072Total
    
    $
    9,007
    
    
    
    100.0
    %
    
    $
    8,643
    
    
    
    100.0
    %
    
    $
    7,075
    
    
    
    100.0
    %
    
    $
    7,262
    
    
    
    100.0
    %
    
    $
    5,973
    
    
    
    100.0
    %
 The identification of impaired loans is conducted in conjunction with the review of the adequacy of
the allowance for loan losses. Loss allowances are established for specifically identified
impaired loans based on the fair value of the underlying collateral in accordance with SFAS No.
114. Impairment losses are included in the allowance for loan losses through a charge to the provision
for loan losses. Adjustments to impairment losses resulting from changes in the fair value of an
impaired loans collateral are included in the provision for loan losses. Upon disposition of an
impaired loan, any related valuation allowance is removed from the allowance for loan losses. The following table presents the status of impaired loans. Table 14  Impaired Loans In thousands 2004
    
    
    2003Impaired loans with a reserve
    
    $
    2,802
    
    
    $
    187Impaired loans with no reserve
    
    
    227
    
    
    
    771Total impaired loans
    
    $
    3,029
    
    
    $
    958Reserve for impaired loans(1)
    
    $
    598
    
    
    $
    88Average balance of impaired loans during the year
    
    $
    1,994
    
    
    $
    959
   (1)The reserve for impaired loans is part of the overall allowance for loan losses. Liquidity The purpose of liquidity management is to ensure that there are sufficient cash flows available to
meet a variety of needs while minimizing the cost of funds and maximizing yields on liquid assets.
These needs include financial commitments such as satisfying the credit needs of our borrowers and withdrawals by our depositors,
the ability to capitalize on investment and business opportunities as they occur, and the funding
of PennRocks own operations. Liquidity is measured by PennRocks ability to convert assets to
cash at a reasonable cost or a minimum loss. We achieve these objectives through the
implementation of our asset/liability policy. Maturities and sales of investment securities (Table
8), loan payments and maturities (Table 10), and liquidating money market investments such as
federal funds sold all provide liquidity. In addition, PennRock is a member of the Federal Home
Loan Bank of Pittsburgh (the FHLB) which provides a reliable source of long and short-term funds.
As of December 31, 2004, PennRock had unused lines of credit with the FHLB of $145.3 million,
unused federal funds line of credit of $15 million and unpledged securities available for sale of
$243.7 million. However, PennRocks primary source of liquidity lies in our ability to renew,
replace and expand its base of core deposits (consisting of demand, NOW, money market and cash
management accounts, savings accounts and time deposits less than $100,000.) Total deposits increased $44.7 million or 5.7% in 2004 compared with an increase of $40.8 million
or 5.5% in 2003. Core deposits increased $22.0 million in 2004 compared with an increase of $35.3
million in 2003. Deposits grew in every category in 2004 except time deposit under $100,000 which
declined by $15.0 million. Non-interest 26




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##### Table of Contents



PennRock Financial Services Corp. bearing demand deposits increased $17.4 million while time deposits of $100,000 or more grew $22.7
million. The average rate paid on interest bearing deposits in 2004 increased 4 basis points from
1.78% in 2003 to 1.82%. The average rate paid in 2003 declined 74 basis points from 2002. Table
15 reflects the changes in the major classifications of deposits by comparing the year-end balances
for the five years ended December 31, 2004. Table 16 reflects the maturity of time deposits of
$100,000 or more for the five years ended December 31, 2004. Table 15  Deposits by Major Classification In thousands December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Non-interest bearing deposits
    
    $
    158,104
    
    
    $
    140,753
    
    
    $
    121,598
    
    
    $
    108,529
    
    
    $
    94,001NOW accounts
    
    
    48,593
    
    
    
    48,408
    
    
    
    44,429
    
    
    
    40,936
    
    
    
    37,390Money market deposit accounts
    
    
    178,539
    
    
    
    168,130
    
    
    
    176,967
    
    
    
    160,590
    
    
    
    98,130Savings accounts
    
    
    97,488
    
    
    
    88,438
    
    
    
    79,884
    
    
    
    63,966
    
    
    
    55,526Time deposits under $100,000
    
    
    275,773
    
    
    
    290,773
    
    
    
    278,323
    
    
    
    253,757
    
    
    
    340,868Total core accounts
    
    
    758,497
    
    
    
    736,502
    
    
    
    701,201
    
    
    
    627,778
    
    
    
    625,915Time deposits of $100,000 or more
    
    
    70,237
    
    
    
    47,540
    
    
    
    42,061
    
    
    
    35,916
    
    
    
    57,079Total deposits
    
    $
    828,734
    
    
    $
    784,042
    
    
    $
    743,262
    
    
    $
    663,694
    
    
    $
    682,994
 Table 16  Maturity of Time Deposits of $100,000 or More In thousands December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Three months or less
    
    $
    6,601
    
    
    $
    5,490
    
    
    $
    8,996
    
    
    $
    10,182
    
    
    $
    28,208Over three months through six
months
    
    
    58,916
    
    
    
    35,319
    
    
    
    11,780
    
    
    
    5,660
    
    
    
    11,416Over six months through twelve
months
    
    
    2,201
    
    
    
    6,063
    
    
    
    11,884
    
    
    
    14,677
    
    
    
    13,809Over twelve months
    
    
    2,519
    
    
    
    668
    
    
    
    9,401
    
    
    
    5,397
    
    
    
    3,646Total
    
    $
    70,237
    
    
    $
    47,540
    
    
    $
    42,061
    
    
    $
    35,916
    
    
    $
    57,079
 Deposit levels may be affected by a number of factors, including rates paid by competitors, general
interest rate levels, returns available to customers on alternative investments and general
economic conditions. Loan repayments are a relatively stable source of funds, but such loans
generally are not readily convertible to cash and are subject to risks associated with borrowers
ability to pay that may be impacted by national and local economic conditions. Accordingly,
PennRock may be required from time to time to rely on secondary sources of liquidity to meet loan
and withdrawal demands or otherwise fund operations. Such sources include FHLB advances, federal
funds lines of credit from correspondent banks and Federal Reserve Bank borrowings. The Bank may borrow funds from the FHLB of Pittsburgh and from other sources. The FHLB system acts
as an additional source of funding for financial institutions. In addition, the Bank uses federal
funds lines and securities sold under agreements to repurchase as funding sources. In order to
utilize the services of the FHLB, the Bank is required to own stock in the FHLB. The amount of
stock held by the Bank varies with the total amount of advances the Bank has outstanding at any
point in time. As of December 31, 2004, the Bank held $11.5 million in stock of the FHLB. The
FHLB uses various factors to determine the amount of credit to extend to a financial institution.
These factors include:  i.
    total regulatory capital;ii.
    net income;iii.
    the quality and composition of assets;iv.
    lending policies and practices;v.
    the level of current borrowings from all sources; andvi.
    the amount of qualifying collateral. Securities sold under agreements to repurchase (repurchase agreements) are another source of
borrowed funds. Under this type of borrowing, securities are pledged against borrowed funds and
are released when the funds are repaid. The Bank uses this type of short-term borrowing
alternative on an overnight basis. The repurchase agreements with customers are part of a cash
management account arrangement the Bank maintains with certain of its larger corporate customers. 27




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##### Table of Contents



PennRock Financial Services Corp. Short-term borrowings increased $12.5 million, from $113.0 million as of December 31, 2003 to
$125.5 million as of December 31, 2004. Of the repurchase agreements outstanding at year-end 2004,
$14.8 million were with bank customers while $108.0 million were outstanding at the FHLB. The
level of short-term borrowings depends on loan growth, deposit growth, current market rates and
other factors. The increase in short-term borrowings in 2004 was required to fund the increase in
the loan portfolio since there was insufficient growth in deposits to do so. As previously
indicated, loans grew $61.4 million in 2004 while deposits grew $44.7 million. We chose to fund
the excess loan growth with short-term borrowing since they represented the least expensive source
of funds readily available. The average cost of short-term borrowings decreased from 1.48% in 2002
to 1.14% in 2003 and increased to 1.51% in 2004. The average balance of short-term borrowings
outstanding during the year was $53.7 million in 2002, $90.2 million in 2003 and $108.3 million on
2004. Table 17 shows PennRocks short-term borrowings for the five years ended December 31, 2004. Table 17  Short-Term Borrowings In thousands December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Securities sold under agreements to
repurchase:FHLB
    
    $
    108,000
    
    
    $
    97,000
    
    
    $
    12,000
    
    
    $
    45,000
    
    
    $
    30,000Customers
    
    
    14,825
    
    
    
    14,181
    
    
    
    23,363
    
    
    
    26,752
    
    
    
    21,567Federal funds purchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,330U.S. Treasury tax and loan note
    
    
    2,634
    
    
    
    1,781
    
    
    
    5,000
    
    
    
    672
    
    
    
    2,608Total short-term borrowings
    
    $
    125,459
    
    
    $
    112,962
    
    
    $
    40,363
    
    
    $
    76,754
    
    
    $
    54,175
 See Note 9: Short-Term Borrowings in the Notes to Consolidated Financial Statements for additional
disclosures about short-term borrowings. Long-Term Debt In addition to short-term borrowings from the FHLB, the Bank has $102.0 million of long-term fixed
rate advances from the FHLB of which $62.0 million are convertible advances that permit the FHLB to
convert the advance from a fixed-rate to a variable-rate at its discretion on a specified call date
following an initial lock-out period ranging from one year to five years. $17.0 million of these
convertible advances further restrict the FHLBs ability to call the advance unless the 3-month
LIBOR rate is at or above a specified rate. If the FHLB exercises its option to convert an advance to variable rate, the Bank has the option to repay the advance in full. During
2004 and 2003, the FHLB did not exercise its option to convert any advances. However, in 2003, one
fixed-rate advance bearing interest at 7.11% matured and was not replaced. Also during the second
quarter of 2003, two advances totaling $40 million were paid-off and replaced by new advances at
lower interest rates. The prepayment penalty assessed by the FHLB is being amortized over the life
of the new advances in accordance with EITF 96-19 (Debtors Accounting for a Modification or
Exchange of Debt Instruments) issued by the FASB in 1996. The maturities of long-term debt at the end of both 2004 and 2003 ranged from 2006 to 2012. The
average rate paid on these advances during 2004 was 4.74%. The average rate on these advances at
year-end 2004 was 4.74%. The average rate paid during 2003 was 5.23%. The average rate on these
advances at year-end 2003 was 4.74%. These long-term advances are part of the same line of credit
with the FHLB utilized by the Banks short-term advances. Capital Resources On June 23, 2004, the Board of Directors of PennRock authorized the repurchase of up to 300,000
shares of common stock. Any repurchased shares will be held as treasury shares available for
issuance in connection with future stock dividends and stock splits, employee benefit plans,
executive compensation plans, the Dividend Reinvestment Plan and other appropriate corporate
purposes. PennRock began open market repurchases of its outstanding common stock in 1995. In
2004, PennRock purchased 90,546 shares for $3.1 million and reissued 143,701 shares. In 2003,
PennRock purchased 65,424 shares for $1.7 million and reissued 92,286 shares. There were 39,200
shares with a cost of $1.0 million as of December 31, 2004 and 93,355 shares with a cost of $2.1
million as of December 31, 2003 held as treasury stock. Total stockholders equity increased $5.5 million or 5.6% in 2004 compared with an increase of
$11.0 million or 12.7% in 2003. In 2004, stockholders equity increased by net income of $12.7
million less dividends of $6.3 million. The change in net unrealized gains and losses on AFS
securities decreased equity by $2.0 million. In 2003, 28




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##### Table of Contents



PennRock Financial Services Corp. stockholders equity increased by net income of $14.0 million less dividends of $5.7 million.
The change in net unrealized gains and losses on AFS securities increased equity by $2.4 million.
The ratio of average equity to average assets was 9.0% in 2004, compared with 8.77% for 2003 and
8.47% in 2002. Internal capital generation is calculated by multiplying return on average equity
by the percentage of earnings retained. Internal capital generation amounted to 6.29% in 2004,
8.99% in 2003 and 9.44% in 2002. Regulatory risk based capital is segregated into two components, tier 1 capital and tier 2 capital.
Tier 1 capital includes stockholders equity reduced by certain intangibles and excludes net
unrealized holding gains and losses on AFS securities except for net unrealized losses on
marketable equity securities are deducted from Tier 1 capital. Tier 2 capital includes the
allowance for loan losses (subject to limitations) and qualifying debt obligations. Banking
organizations must adjust their assets and off-balance sheet exposures by assigning risk-weighted
percentages, ranging for 0% to 100%, depending on regulatory defined credit risks.
Off-balance-sheet assets must be converted to credit equivalents before being risk weighted. These
risk-weighted on and off-balance sheet balances are then added to determine total risk weighted
assets. As of December 31, 2004, the most recent notification from the Federal Reserve Bank categorized
PennRock as well capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, PennRock must maintain a minimum total risk-based capital ratio of
10%, a Tier 1 risk-based capital ratio of 6% and a Tier 1 leverage ratio of 5%. As of December 31,
2004, PennRocks total risk-based capital ratio was 11.62%, its Tier 1 risk-based capital ratio was
10.62% and its Tier 1 leverage ratio was 11.71%. There are no conditions or events since that
notification that management believes have changed this category. The Bank also exceeded all
minimum ratios at the end of 2004. Table 18 shows PennRocks and the Banks capital resources for
the past three years. Table 18  Capital Resources December 31,2004
    
    
    2003
    
    
    2002PennRock Financial Services Corp:Leverage ratios:Total capital to total average assets
    
    
    9.02
    %
    
    
    9.09
    %
    
    
    8.64
    %Tier 1 capital to total average assets
    
    
    8.24
    %
    
    
    8.23
    %
    
    
    7.92
    %Risk-based ratios:Common stockholders equity to risk
weighted assets
    
    
    11.71
    %
    
    
    11.53
    %
    
    
    11.45
    %Tier 1 capital to risk-weighted assets
    
    
    10.62
    %
    
    
    10.54
    %
    
    
    10.61
    %Total capital to risk-weighted assets
    
    
    11.62
    %
    
    
    11.64
    %
    
    
    11.57
    %Blue Ball National Bank:Leverage ratios:Total capital to total average assets
    
    
    8.62

    %
    
    
    8.87
    %
    
    
    8.56
    %Tier 1 capital to total average assets
    
    
    7.84
    %
    
    
    7.99
    %
    
    
    7.79
    %Risk-based ratios:Common stockholders equity to risk
weighted assets
    
    
    11.22
    %
    
    
    10.07
    %
    
    
    10.11
    %Tier 1 capital to risk-weighted assets
    
    
    10.11
    %
    
    
    10.25
    %
    
    
    10.51
    %Total capital to risk-weighted assets
    
    
    11.12
    %
    
    
    11.37
    %
    
    
    11.55
    %
 29




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##### Table of Contents



PennRock Financial Services Corp. Off-Balance Sheet Arrangements, Commitments and Contractual Obligations The following table summarizes PennRocks contractual obligations and other commitments to make
future payments as of December 31, 2004. Payments for borrowings do not include interest.
Payments related to leases are based on actual payments specified in the underlying contracts.
Loan commitments and standby letters of credit are presented at contractual amount. However, since
many commitments are expected to expire without being drawn upon, the total commitment amounts do
not represent future cash requirements. Table 19  Contractual Obligations and Other Commitments In thousands Payments Due by PeriodMore than
    
    
    Three yearsone year
    
    
    or moreOne year
    
    
    but less than
    
    
    but less than
    
    
    Five yearsor less
    
    
    three years
    
    
    five years
    
    
    or more
    
    
    TotalContractual obligations:Federal Home Loan advances
    
    $
    
    
    
    $
    51,000
    
    
    $
    
    
    
    $
    51,000
    
    
    $
    102,000Operating leases
    
    
    555
    
    
    
    976
    
    
    
    815
    
    
    
    1,205
    
    
    
    3,551Deposits with stated maturity
dates
    
    
    313,138
    
    
    
    21,711
    
    
    
    11,160
    
    
    
    1
    
    
    
    346,010Total contractual obligations
    
    
    313,693
    
    
    
    73,687
    
    
    
    11,975
    
    
    
    52,206
    
    
    
    451,561Other commitmentsLoan commitments
    
    
    179,921
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179,921Standby letters of credit
    
    
    40,131
    
    
    
    12,006
    
    
    
    61
    
    
    
    
    
    
    
    52,198Total other commitments
    
    
    220,052
    
    
    
    12,006
    
    
    
    61
    
    
    
    
    
    
    
    232,119Total contractual obligations
and other commitments
    
    $
    533,745
    
    
    $
    85,693
    
    
    $
    12,036
    
    
    $
    52,206
    
    
    $
    683,680
 In the normal course of business, PennRock enters into transactions which are not included in its
consolidated balance sheets. These transactions are designed to meet the financing needs of our
customers. These transactions involve commitments to extend credit and standby letters of credit
which involve elements of credit risk and interest rate risk in excess of the amounts recognized in
the consolidated balance sheets. PennRock also holds certain assets which are not included in its
consolidated balance sheets including assets held in a fiduciary or custodial capacity for its
trust customers. Interest Rate Risk Information regarding interest rate risk may be found in Item 7A of this Annual Report under the
caption Quantitative and Qualitative Disclosures about Market Risk. Recently Issued Accounting Standards For a discussion of recently issued accounting pronouncements, see Note 1: Summary of Significant
Accounting Policies in the Notes to Consolidated Financial Statements. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK PennRocks financial performance is impacted by, among other factors, interest rate risk and credit
risk. We manage credit risk by relying on strict credit standards, loan review and adequate loan
loss reserves. Interest rate risk refers to PennRocks degree of exposure to loss of earnings
resulting from changes in market interest rates. As a financial intermediary, PennRock invests in
various types of interest-earning assets (primarily loans and securities) that are funded largely
by interest-bearing liabilities (primarily deposits and borrowed funds). Such financial
instruments have varying levels of sensitivity to changes in market interest rates. The disparity
of sensitivity between financial assets and liabilities creates interest rate risk for PennRock. The magnitude of
this exposure depends on the severity and timing of the market rate changes and on our ability to
adjust the composition of the balance sheet in reaction to those changes. PennRocks Asset
Liability Management Committee (the ALCO) addresses this risk. PennRocks executive management
team comprises the ALCO. The ALCO monitors interest rate risk by modeling the estimated net
interest income and net income under various interest rate scenarios. The 30




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##### Table of Contents



PennRock Financial Services Corp. ALCO attempts to manage the various components of PennRocks balance sheet to minimize the impact
of sudden and sustained changes in interest rates on net interest income and net income. However,
the ALCO may sometimes structure the balance sheet to take advantage of expected interest rate
movements. PennRocks exposure to interest rate risk is reviewed on a monthly basis by the Board of Directors
and the ALCO. Interest rate risk exposure is measured using various types of interest rate
sensitivity analyses to determine PennRocks change in net interest income and net income in the
event of hypothetical changes in interest rates. If the potential changes to net interest income
and net income resulting from hypothetical interest rate swings are not within the exposure limits
established by the Board, the Board may direct management to adjust its asset and liability mix to
bring interest rate risk within Board-approved limits. PennRock utilizes financial modeling to forecast earnings under different interest rate
projections. The model quantifies the effects of various interest rate scenarios on projected net
interest income and net income when measured against a base case. PennRocks Board of Directors
has adopted an interest rate risk policy which establishes a maximum decrease in the net interest
income and net income in the event of a sudden and sustained increase or decrease in market
interest rates of 200 basis points. The following tables present the Banks projected change in
net interest income and net income for 100 and 200 basis point rate shocks as of December 31, 2004
and 2003 and the Boards established limit. The impact on net interest income and net income
relate to the Bank only. The assets and liabilities of the parent company only or for PFA are not
considered in this analysis and their corresponding earnings at risk do not have a significant
effect on this analysis. Table 20  Changes in Net Interest Income
In thousands December 31, 2004Net Interest
    
    
    Computed
    
    
    Percent
    
    
    BoardChange in Interest Rates
    
    Income
    
    
    Change
    
    
    Change
    
    
    Limit200 basis point rise
    
    $
    40,774
    
    
    $
    1,789
    
    
    
    4.59
    %
    
    
    (15.00
    %)100 basis point rise
    
    
    40,124
    
    
    
    1,139
    
    
    
    2.92
    %Base rate scenario
    
    
    38,985100 basis point decline
    
    
    36,907
    
    
    
    (2,078
    )
    
    
    (5.33
    %)200 basis point decline
    
    
    34,938
    
    
    
    (4,047
    )
    
    
    (10.38
    %)
    
    
    (15.00
    %)
 December 31, 2003Net Interest
    
    
    Computed
    
    
    Percent
    
    
    BoardChange in Interest Rates
    
    Income
    
    
    Change
    
    
    Change
    
    
    Limit200 basis point rise
    
    $
    40,374
    
    
    $
    2,676
    
    
    
    7.10
    %
    
    
    (15.00
    %)100 basis point rise
    
    
    40,326
    
    
    
    2,628
    
    
    
    6.97
    %Base rate scenario
    
    
    37,698100 basis point decline
    
    
    35,175
    
    
    
    (2,523
    )
    
    
    (6.69
    %)200 basis point decline
    
    
    31,894
    
    
    
    (5,804
    )
    
    
    (15.40
    %)
    
    
    (15.00
    %)
 31




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##### Table of Contents



PennRock Financial Services Corp. Table 21  Changes in Net Income In thousands December 31, 2004Computed
    
    
    Percent
    
    
    BoardChange in Interest Rates
    
    Income
    
    
    Change
    
    
    Change
    
    
    Limit200 basis point rise
    
    $
    15,583
    
    
    $
    1,312
    
    
    
    9.19
    %
    
    
    (20.00
    %)100 basis point rise
    
    
    15,079
    
    
    
    807
    
    
    
    5.66
    %Base rate scenario
    
    
    14,271100 basis point decline
    
    
    12,731
    
    
    
    (1,541
    )
    
    
    (10.79
    %)200 basis point decline
    
    
    11,268
    
    
    
    (3,004
    )
    
    
    (21.05
    %)
    
    
    (20.00
    %)
 December 31, 2003Computed
    
    
    Percent
    
    
    BoardChange in Interest Rates
    
    Income
    
    
    Change
    
    
    Change
    
    
    Limit200 basis point rise
    
    $
    16,122
    
    
    $
    1,932
    
    
    
    13.62
    %
    
    
    (20.00
    %)100 basis point rise
    
    
    16,016
    
    
    
    1,826
    
    
    
    12.87
    %Base rate scenario
    
    
    14,190100 basis point decline
    
    
    12,425
    
    
    
    (1,765
    )
    
    
    (12.44
    %)200 basis point decline
    
    
    10,214
    
    
    
    (3,976
    )
    
    
    (28.02
    %)
    
    
    (20.00
    %)
 The preceding tables indicate that as of December 31, 2004 and 2003 in the event of a sudden and
sustained decrease of 200 basis points in prevailing market interest rates, PennRocks net interest
income would be expected to decrease by $4.0 million and $5.8 million respectively while net income
would decrease by $3.0 million and $4.0 million respectively. However, if market rates increased
by 200 basis points, net interest income would be expected to increase by $1.8 million and $2.7
million respectively while net income would increase by $1.3 million and $1.9 million
respectively. This simulation analysis that indicates that PennRock is asset sensitive.
PennRocks interest income and net income increase if rates rise and decline if rates fall. At
December 31, 2004 and 2003, PennRocks estimated changes in net interest income and net income
given a 200 basis point increase in interest rates are well within policy limits. However,
PennRocks estimated change in net income given a 200 basis point decrease in interest rates is
outside of policy limits for both years. With ALCOs expectation that rates are more likely to
rise than fall (consider that federal funds rates have risen 150 basis points since June 30, 2004)
the Board of Directors has indicated that they were satisfied with this exception to policy. Computation of forecasted effects of hypothetical interest rate changes are based on numerous
assumptions. These include loan and mortgage-backed security prepayment rates, calls of callable
securities, conversions of fixed-rate FHLB advances to adjustable advances, and rates of deposit
decay, and should not be relied upon as indicative of actual future results. Even minor changes in
these assumptions may significantly alter the results of the model. Further, the computations do
not contemplate any actions the ALCO could take to mitigate any negative effects of changes in
interest rates as discussed above. 32




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##### Table of Contents



PennRock Financial Services Corp. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following audited consolidated financial statements are set forth in this Annual Report of Form
10-K on the following pages: PennRock Financial Services Corp. and SubsidiariesReport of Independent Registered Public Accounting Firm on Financial Statements
    
    
    33Consolidated Balance Sheets
    
    
    34Consolidated Statements of Income
    
    
    35Consolidated Statements of Stockholders Equity
    
    
    36Consolidated Statements of Cash Flows
    
    
    37Notes to Consolidated Financial Statements
    
    
    38
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders
PennRock Financial Services Corp.
Blue Ball, Pennsylvania We have audited the accompanying consolidated balance sheet of PennRock Financial Services Corp.
and Subsidiaries (the Company) as of December 31, 2004 and the related consolidated statements of
income, stockholders equity and cash flows for the year then ended.. 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 audit. The consolidated financial
statements of the Company as of December 31, 2003 and 2002 and for the years ended December 31,
2003 were audited by other auditors whose report dated January 30, 2004, expressed an unqualified
opinion on those statements We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the 2004 consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company as of December 31, 2004, and
the consolidated results of its operations and its cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States of America. /s/CROWE CHIZEK AND COMPANY LLCMarch 4, 2005Columbus, Ohio
 33




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##### Table of Contents



PennRock Financial Services Corp. 
 CONSOLIDATED BALANCE SHEETS In thousands, except share and per share data December 31,2004
    
    
    2003ASSETSCash and due from banks
    
    $
    17,994
    
    
    $
    17,858Short-term investments
    
    
    4,358
    
    
    
    6,283Total cash and cash equivalents
    
    
    22,352
    
    
    
    24,141Mortgages held for sale
    
    
    3,758
    
    
    
    2,004Securities available for sale (at fair value)
    
    
    302,623
    
    
    
    309,189Loans
    
    
    773,324
    
    
    
    711,902Allowance for loan losses
    
    
    (9,007
    )
    
    
    (8,643
    )Net loans
    
    
    764,317
    
    
    
    703,259Premises and equipment, net
    
    
    17,032
    
    
    
    16,283Accrued interest receivable
    
    
    3,463
    
    
    
    3,100Bank owned life insurance
    
    
    28,539
    
    
    
    27,609Goodwill
    
    
    10,051
    
    
    
    10,051Other intangible assets, net
    
    
    1,083
    
    
    
    1,021Other assets
    
    
    21,866
    
    
    
    12,083Total assets
    
    $
    1,175,084
    
    
    $
    1,108,740LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Deposits:Non-interest bearing
    
    $
    158,104
    
    
    $
    140,753Interest bearing
    
    
    670,630
    
    
    
    643,289Total deposits
    
    
    828,734
    
    
    
    784,042Short-term borrowings
    
    
    125,459
    
    
    
    112,962Long-term debt
    
    
    102,000
    
    
    
    102,000Accrued interest payable
    
    
    2,926
    
    
    
    2,353Other liabilities
    
    
    12,475
    
    
    
    9,376Total liabilities
    
    
    1,071,594
    
    
    
    1,010,733Stockholders Equity:Common stock, par value $2.50 per share; authorized
20,000,000 shares; issued - 7,718,543 shares
    
    
    19,296
    
    
    
    19,296Surplus
    
    
    54,798
    
    
    
    53,677Accumulated other comprehensive loss, net of tax
    
    
    (3,008
    )
    
    
    (991
    )Retained earnings
    
    
    33,416
    
    
    
    28,134Treasury stock at cost (39,200 and 92,355 shares)
    
    
    (1,012
    )
    
    
    (2,109
    )Total stockholders equity
    
    
    103,490
    
    
    
    98,007Total liabilities and stockholders equity
    
    $
    1,175,084
    
    
    $
    1,108,740
 The accompanying notes are an integral part of these consolidated financial statements. 34




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##### Table of Contents



PennRock Financial Services Corp. 
 CONSOLIDATED STATEMENTS OF INCOME In thousands, except share and per share data Year Ended December 31,2004
    
    
    2003
    
    
    2002Interest income:Interest and fees on loans
    
    $
    44,038
    
    
    $
    42,665
    
    
    $
    42,733Securities available for sale:Taxable
    
    
    10,545
    
    
    
    9,335
    
    
    
    12,159Tax-exempt
    
    
    581
    
    
    
    845
    
    
    
    1,902Mortgages held for sale
    
    
    140
    
    
    
    516
    
    
    
    248Other
    
    
    36
    
    
    
    33
    
    
    
    100Total interest income
    
    
    55,340
    
    
    
    53,394
    
    
    
    57,142Interest expense:Deposits
    
    
    12,097
    
    
    
    10,918
    
    
    
    15,157Short-term borrowings
    
    
    1,636
    
    
    
    1,033
    
    
    
    796Long-term debt
    
    
    4,918
    
    
    
    5,874
    
    
    
    7,330Total interest expense
    
    
    18,651
    
    
    
    17,825
    
    
    
    23,283Net interest income
    
    
    36,689
    
    
    
    35,569
    
    
    
    33,859Provision for loan losses
    
    
    565
    
    
    
    1,917
    
    
    
    1,750Net interest income after provision for loan losses
    
    
    36,124
    
    
    
    33,652
    
    
    
    32,109Non-interest income:Service charges on deposit accounts
    
    
    3,403
    
    
    
    3,320
    
    
    
    2,851Other service charges and fees
    
    
    400
    
    
    
    354
    
    
    
    308Financial services
    
    
    4,695
    
    
    
    5,004
    
    
    
    4,094Net realized gains on sales of available for sale
securities
    
    
    855
    
    
    
    349
    
    
    
    369Impairment charge on available for sale equity
securities
    
    
    (1,221
    )Mortgage banking
    
    
    753
    
    
    
    1,219
    
    
    
    513Increase in cash surrender value of bank owned life
insurance
    
    
    985
    
    
    
    1,170
    
    
    
    1,243Other
    
    
    2,365
    
    
    
    2,334
    
    
    
    1,766Total non-interest income
    
    
    12,235
    
    
    
    13,750
    
    
    
    11,144Non-interest expenses:Salaries and benefits
    
    
    20,297
    
    
    
    18,096
    
    
    
    16,147Occupancy, net
    
    
    2,114
    
    
    
    2,044
    
    
    
    1,804Equipment depreciation and service
    
    
    1,268
    
    
    
    1,333
    
    
    
    1,389Advertising and marketing
    
    
    1,083
    
    
    
    982
    
    
    
    998Computer program amortization and maintenance
    
    
    939
    
    
    
    930
    
    
    
    1,064Other
    
    
    5,915
    
    
    
    6,293
    
    
    
    6,045Total non-interest expense
    
    
    31,616
    
    
    
    29,678
    
    
    
    27,447Income before income taxes
    
    
    16,743
    
    
    
    17,724
    
    
    
    15,806Income taxes
    
    
    4,062
    
    
    
    3,724
    
    
    
    2,580Net income
    
    $
    12,681
    
    
    $
    14,000
    
    
    $
    13,226Per share information:Basic earnings
    
    $
    1.66
    
    
    $
    1.84
    
    
    $
    1.73Diluted earnings
    
    
    1.63
    
    
    
    1.81
    
    
    
    1.71Cash dividends
    
    
    0.82
    
    
    
    0.76
    
    
    
    0.68Weighted average number of shares outstanding:Basic
    
    
    7,650,913
    
    
    
    7,626,208
    
    
    
    7,641,520Diluted
    
    
    7,757,202
    
    
    
    7,741,287
    
    
    
    7,728,009
 The accompanying notes are an integral part of these consolidated financial statements. 35




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##### Table of Contents



PennRock Financial Services Corp. 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY In thousands, except share and per share data AccumulatedOtherComprehensiveCommon
    
    
    
    
    
    
    Retained
    
    
    Treasury
    
    
    Income (Loss)Stock
    
    
    Surplus
    
    
    Earnings
    
    
    Stock
    
    
    Net of Tax
    
    
    TotalBalance as of January 1, 2002
    
    $
    15,952
    
    
    $
    16,446
    
    
    $
    52,780
    
    
    
    ($1,609
    )
    
    
    ($5,165
    )
    
    $
    78,404Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    13,226
    
    
    
    
    
    
    
    
    
    
    
    13,226Change in net unrealized gains and
losses on securities available for
sale, net of reclassification
adjustment and tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,788
    
    
    
    1,788Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,014Purchase of treasury stock (129,680
shares)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,139
    )
    
    
    
    
    
    
    (3,139
    )Treasury stock reissued (84,178 shares)
    
    
    
    
    
    
    (29
    )
    
    
    347
    
    
    
    1,580
    
    
    
    
    
    
    
    1,898Stock options exercised (15,535 shares)
    
    
    
    
    
    
    
    
    
    
    (122
    )
    
    
    308
    
    
    
    
    
    
    
    18610% stock dividend
    
    
    1,592
    
    
    
    17,328
    
    
    
    (18,950
    )
    
    
    
    
    
    
    
    
    
    
    (30
    )Cash dividend ($0.68 per share)
    
    
    
    
    
    
    
    
    
    
    (5,355
    )
    
    
    
    
    
    
    
    
    
    
    (5,355
    )Balance as of December 31, 2002
    
    
    17,544
    
    
    
    33,745
    
    
    
    41,926
    
    
    
    (2,860
    )
    
    
    (3,377
    )
    
    
    86,978Comprehensive income:Net income
    
    
    
    
    
    

    
    
    



    
    14,000
    
    
    
    
    
    
    

    
    
    
    
    14,000Change in net unrealized gains and
losses on securities available for
sale, net of reclassification
adjustment and tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,386
    
    
    
    2,386Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,386Purchase of treasury stock (66,424 shares)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,744
    )
    
    
    
    
    
    
    (1,744
    )Treasury stock reissued (71,295 shares)
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    1,906
    
    
    
    
    
    
    
    1,904Stock options exercised (20,991 shares)
    
    
    
    
    
    
    
    
    
    
    (340
    )
    
    
    589
    
    
    
    
    
    
    
    24910% stock dividend
    
    
    1,752
    
    
    
    19,932
    
    
    
    (21,713
    )
    
    
    
    
    
    
    
    
    
    
    (29
    )Cash dividend ($0.76 per share)
    
    
    
    
    
    
    
    
    
    
    (5,737
    )
    
    
    
    
    
    
    
    
    
    
    (5,737
    )Balance as of December 31, 2003
    
    
    19,296
    
    
    
    53,677
    
    
    
    28,134
    
    
    
    (2,109
    )
    
    
    (991
    )
    
    
    98,007Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    12,681
    
    
    
    
    
    
    
    
    
    
    
    12,681Change in net unrealized gains and
losses on securities available for
sale, net of reclassification
adjustment and tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,017
    )
    
    
    (2,017
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,664Purchase of treasury stock (90,546 shares)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,113
    )
    
    
    
    
    
    
    (3,113
    )Treasury stock reissued (65,685 shares)
    
    
    
    
    
    
    74
    
    
    
    45
    
    
    
    1,823
    
    
    
    
    
    
    
    1,942Stock options exercised (78,016 shares)
    
    
    
    
    
    
    1,047
    
    
    
    (1,171
    )
    
    
    2,387
    
    
    
    
    
    
    
    2,263Cash dividend ($0.82 per share)
    
    
    
    
    
    
    
    
    
    
    (6,273
    )
    
    
    
    
    
    
    
    
    
    
    (6,273
    )Balance as of December 31, 2004
    
    $
    19,296
    
    
    $
    54,798
    
    
    $
    33,416
    
    
    
    ($1,012
    )
    
    
    ($3,008
    )
    
    $
    103,490
 The accompanying notes are an integral part of these consolidated financial statements. 36




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##### Table of Contents



PennRock Financial Services Corp. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS In thousands Year Ended December 31,2004
    
    
    2003
    
    
    2002OPERATING ACTIVITIES:Net income
    
    $
    12,681
    
    
    $
    14,000
    
    
    $
    13,226Adjustments to reconcile net income to net cash provided by
operating activities:Provision for loan losses
    
    
    565
    
    
    
    1,917
    
    
    
    1,750Depreciation and amortization
    
    
    1,299
    
    
    
    1,310
    
    
    
    1,331Loss on bank owned real estate
    
    
    246Accretion and amortization of securities
    
    
    1,503
    
    
    
    1,962
    
    
    
    1,708Deferred income taxes
    
    
    (406
    )
    
    
    (340
    )
    
    
    (290
    )Net realized gains on sale of available for sale securities
    
    
    (855
    )
    
    
    (349
    )
    
    
    (369
    )Impairment charge on available for sale equity securities
    
    
    1,221Proceeds from sales of mortgage loans
    
    
    48,954
    
    
    
    151,286
    
    
    
    66,382Originations of mortgages held for sale
    
    
    (50,582
    )
    
    
    (145,912
    )
    
    
    (71,019
    )Gain on sale of mortgage loans, net
    
    
    (126
    )
    
    
    (231
    )
    
    
    (90
    )(Increase) decrease in interest receivable
    
    
    (363
    )
    
    
    182
    
    
    
    608Increase in prepaid expenses
    
    
    (1,734
    )
    
    
    (643
    )
    
    
    (677
    )Increase (decrease) in interest payable
    
    
    573
    
    
    
    (112
    )
    
    
    (495
    )Increase in cash surrender value of bank owned life insurance
    
    
    (930
    )
    
    
    (1,118
    )
    
    
    (1,243
    )Other changes, net
    
    
    (1,328
    )
    
    
    745
    
    
    
    (1,064
    )Net cash provided by operations
    
    
    10,718
    
    
    
    22,697
    
    
    
    9,758INVESTING ACTIVITIES:Proceeds from sales of securities available for sale
    
    
    109,267
    
    
    
    93,375
    
    
    
    119,799Purchases of securities available for sale
    
    
    (155,454
    )
    
    
    (206,442
    )
    
    
    (231,116
    )Maturities of securities available for sale
    
    
    47,758
    
    
    
    109,694
    
    
    
    111,994Proceeds from sale of other real estate
    
    
    91
    
    
    
    148
    
    
    
    479Net increase in loans
    
    
    (62,971
    )
    
    
    (109,062
    )
    
    
    (44,471
    )Net cash paid for business acquisition
    
    
    
    
    
    
    
    
    
    
    (1,665
    )Purchases of premises and equipment
    
    
    (2,293
    )
    
    
    (1,609
    )
    
    
    (3,226
    )Net cash used in investing activities
    
    
    (63,602
    )
    
    
    (113,896
    )
    
    
    (48,206
    )FINANCING ACTIVITIES:Net increase in non-interest bearing deposits
    
    
    17,351
    
    
    
    19,155
    
    
    
    13,068Net increase in interest bearing deposits
    
    
    27,341
    
    
    
    21,625
    
    
    
    66,499Net increase (decrease) in short-term borrowings
    
    
    12,497
    
    
    
    72,599
    
    
    
    (36,391
    )Proceeds from issuance of long-term debt
    
    
    
    
    
    
    40,000
    
    
    
    21,000Maturities and repayments of long-term debt
    
    
    
    
    
    
    (65,000
    )
    
    
    (15,000
    )Issuance of treasury stock
    
    
    3,129
    
    
    
    2,153
    
    
    
    2,085Purchase of treasury stock
    
    
    (3,113
    )
    
    
    (1,744
    )
    
    
    (3,139
    )Cash dividends
    
    
    (6,110
    )
    
    
    (5,737
    )
    
    
    (5,355
    )Cash paid with stock dividend
    
    
    
    
    
    
    (29
    )
    
    
    (30
    )Net cash provided by financing activities
    
    
    51,095
    
    
    
    83,022
    
    
    
    42,737Increase (decrease) in cash and cash equivalents
    
    
    (1,789
    )
    
    
    (8,177
    )
    
    
    4,289Cash and cash equivalents at beginning of year
    
    
    24,141
    
    
    
    32,318
    
    
    
    28,029Cash and cash equivalents at end of year
    
    $
    22,352
    
    
    $
    24,141
    
    
    $
    32,318Supplemental schedule of interest and income taxes paid:Total interest paid
    
    $
    19,224
    
    
    $
    17,937
    
    
    $
    23,778Total income taxes paid
    
    
    6,250
    
    
    
    3,550
    
    
    
    3,189Transfers of loans to other real estate owned
    
    
    88
    
    
    
    12
    
    
    
    642
 The accompanying notes are an integral part of these consolidated financial statements. 37




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##### Table of Contents



PennRock Financial Services Corp. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of PennRock Financial Services Corp. (PennRock) and
subsidiaries conform to accounting principles generally accepted in the United States of America
and to general practices within the banking industry. The following is a description of PennRocks
more significant accounting policies. Business: PennRock is a bank holding company incorporated in 1986 under the laws of Pennsylvania. Blue Ball
National Bank (the Bank) is a wholly owned subsidiary of PennRock. The Bank provides a broad
range of banking, trust and other financial services to consumers, small businesses and
corporations in south-central and southeastern Pennsylvania. PennRock Financial Advisors, N.A.
(PFA) is a limited purpose national bank formed as a subsidiary of the Bank. PFA began
operations on April 1, 2004 when the net assets of The National Advisory Group, Inc. and Pension
Consulting Services, Inc., two wholly-owned subsidiaries of PennRock, as well as the operations of
both companies were transferred to PFA. At the same time, the operations of the Banks Financial
Services Division, including trust operations, were transferred to PFA. PFA provides consulting,
actuarial and administrative services to retirement and employee benefit plans as well as
investment, advisory and asset management services to retirement plan sponsors and participants.
PFA also provides personal and corporate trust and agency services to individuals, corporations and
others, including trust investment accounts, investment advisory services, mutual funds, and estate
planning. PennRock Insurance Group, Inc., a wholly owned subsidiary of the Bank sells annuity and
other insurance products. 1906 Founders, Inc., a Delaware Corporation formed on November 26, 2003
as a wholly owned subsidiary of PennRock, owns and manages certain investment securities. Basis of Presentation: The consolidated financial statements of PennRock include the accounts of PennRock and its
subsidiaries. All significant intercompany balances and transactions have been eliminated.
Certain prior year amounts may have been reclassified to conform to current year presentation. All
share and per-share data have been restated to reflect the impact of a 10% stock dividend paid in
both 2003 and 2002. Use of Estimates: In preparing the consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as of the date of the consolidated balance sheets and operations for the
reporting periods. Actual results could differ from those estimates. The allowance for loan
losses and the fair value of financial instruments are particularly subject to change. Cash and Cash Equivalents: For purposes of the Consolidated Statements of Cash Flows, PennRock defines cash and cash
equivalents to include cash, amounts due from banks, federal funds sold and other short-term
investments all of which have maturities of less than 90 days. Net cash flows are reported for
loans, deposit transactions and short-term borrowings. Mortgages Held for Sale: Mortgages originated and intended for sale in the secondary market are carried at the lower of
aggregate cost or fair value with market determined on the basis of open commitments for committed
loans. For uncommitted loans, market is determined on the basis of current delivery prices in the
secondary mortgage market. Any resulting unrealized losses are included in other income under the
category Mortgage Banking. Mortgages are sold with mortgage servicing rights retained by PennRock.
Gains or losses on sales of mortgage loans are based on the difference between the selling price
and the carrying value of the related mortgage loan sold. Securities Available for Sale: Debt securities are classified as available for sale if management intends to hold these securities
for an indefinite period of time but not necessarily to maturity. All equity securities with
readily determinable fair values are classified as available for sale. All securities purchased by
PennRock are classified as available for sale (AFS). 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 PennRocks assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors. AFS securities are carried at fair
value. Unrealized gains or losses, net of the related deferred tax effect, are reported in other
comprehensive income. Securities with limited marketability, such as stock in the Federal Reserve
Bank and the Federal Home Loan Bank, are carried at cost. 38




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) Purchase premiums and discounts on securities are amortized and accreted to interest income using a
method which approximates a level yield over the period to maturity of the related securities.
Purchase premiums and discounts on mortgage-backed securities are amortized and accreted to
interest income using a method which approximates a level yield over the remaining lives of the
securities, taking into consideration assumed prepayment patterns. Interest and dividend income
are recognized when earned. A decline in the market value of any debt or equity security below
cost that is deemed to be other than temporary is charged to income resulting in the establishment
of a new cost basis for the security. In estimating the other-than-temporary impairment losses,
management considers the financial condition and near-term prospects of the issuer and the intent
and ability of PennRock to retain its investment in the issuer for a period sufficient to allow for
any anticipated recovery in fair value. Realized gains and losses for securities are included in
other income and are determined using the specific identification method. Loans: A substantial percentage of PennRocks loans are made to individuals and businesses in the counties
in which PennRock has branch facilities: Lancaster, Berks and Chester Counties in Pennsylvania.
Accordingly, the ultimate collectibility of the loan portfolio is susceptible to changes in market
conditions in the above counties. Loans are carried at the principal amount outstanding, net of unearned income, if any, and are
reduced by any charge-offs or specific valuation accounts. Interest income is accounted for on an
accrual basis. Loan fees, net of certain origination costs are deferred and amortized over the
lives of the underlying loans using a method, which approximates a level yield. Interest income is
generally not accrued when, in the opinion of management, its full collectibility is doubtful or
when the loan becomes past due 90 days as to principal or interest unless the loan is well secured
and in the process of collection. When a loan is designated as non-accrual, any accrued interest
receivable is charged against current earnings. The interest on these loans is accounted for on a
cash basis or cost recovery method. Loans may be returned to accrual status when they become
current as to principal and interest or demonstrate a period of performance under the contractual
terms, and, in managements opinion, are fully collectible. A loan is considered to be impaired when it is probable that all amounts, including principal and
interest, will not be collected in accordance with the contractual terms of the loan agreement. In
such cases, the amount of impairment and any subsequent changes are recorded as an adjustment to
the allowance for loan losses. This analysis applies to all loans, both collateralized and
uncollateralized, except for large groups of smaller balance homogeneous loans that are
collectively evaluated for impairment, loans held for sale and debt securities. PennRock evaluates
a loan for impairment when the loan is internally classified as an 8 (substandard) or 9
(doubtful). All non-accrual loans not meeting the definition of smaller balance homogeneous loans
are considered impaired. PennRock generally measures impairment based upon the present value of
the loans expected future cash flows, except where foreclosure or liquidation is probable or when
the primary source of repayment is provided by real estate collateral. In these circumstances,
impairment is based upon the fair value of the collateral. Allowance for Loan Losses: PennRocks allowance for loan losses is established and maintained based upon managements
evaluation of the risks inherent in PennRocks loan portfolio including the economic trends and
other conditions in specific geographic areas as they relate to the nature of PennRocks portfolio.
PennRocks one-to four family residential loans and consumer loans are homogeneous in nature and
no single loan is individually significant in terms of its size or potential risk of loss.
Therefore, management evaluates these loans as a group of loans. Management utilizes historical
loan losses, current trends in delinquencies and charge-offs, plans for problem loan administration
and resolution, the views of its regulators, and other relevant factors, such as assumptions and
projections of current economic and market conditions in order to determine the adequacy of the
allowance for loan losses on these loans. For individually impaired commercial real estate loans,
an estimated value of the property or collateral securing the loan is determined through an
appraisal, where possible. If the unpaid balance of the loan is greater than the estimated fair
value of the property, an allowance is established for the difference between the carrying value and
the estimated fair value or liquidation value. Other impaired loans such as non-mortgage
commercial loans are evaluated individually as well. For these loans, a determination is made of
the value of the collateral, if any, through 39




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) examination of current financial information. If the unpaid balance of the loan is greater than
estimated fair value of the collateral, an allowance is established for the difference between the
carrying value and the estimated fair value or liquidation value. Allowances are also established on some classes of the performing portfolio and represent loss
allowances that have been established to recognize the probable losses incurred in that class of
the loan portfolio. In determining the adequacy of the loss allowance, management considers
changes in the size and composition of the loan portfolio, historical loan loss experience, current
economic and market conditions and PennRocks credit administration procedures. Management believes that the allowance for loan losses is adequate. While management uses
historical and currently available information to evaluate the adequacy of the allowance, this
evaluation is inherently subjective as it requires material estimates, including the amounts and
timing of expected future cash flows on impaired loans, which may be susceptible to significant
change. Future additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of their examination
process, periodically review the allowance for loan losses. Such agencies may require changes to
the allowance based on their judgments about information available to them at the time of their
examination. Loan losses are charged directly against the allowance for loan losses, and recoveries on
previously charged off loans are added to the allowance. Provisions for loan losses charged
against income increase the allowance. Other Real Estate Owned: Other real estate owned represents properties acquired through customers loan defaults. When
properties are acquired through foreclosure or deed in lieu of foreclosure, any excess of the loan
balance at the time of foreclosure over the fair value of the real estate held as collateral is
recognized as a loss and charged to the allowance for loan losses. After foreclosure, other real
estate is reported at the lower of fair value at acquisition date or current fair value less
estimated disposal costs. Fair value is determined on the basis of current appraisals obtained
from independent sources. Subsequent write-downs are charged to an allowance for other real estate
established through provisions for other real estate expenses. Costs of significant property
improvements which enhance the salability of the property are capitalized while costs associated
with holding or maintaining other real estate are charged to operations as incurred. Other real
estate owned which totaled $69,000, $66,000 and $188,000 as of December 31, 2004, 2003 and 2002
respectively is recorded as other assets in the Consolidated Balance Sheets. Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed
on straight line and accelerated methods based on the estimated service lives of the assets as
follows: banking premises, 10 to 40 years; furniture, fixtures and equipment, 3 to 5 years;
leasehold improvements over the lesser of the term of the respective lease or the estimated useful
lives of the improvements. When assets are retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected
in income for the period. Maintenance, repairs, and minor improvements are expensed as incurred.
Significant renewals and improvements are capitalized. Goodwill: Goodwill represents the excess of cost over the assigned value of net assets acquired in a business
combination. PennRock utilizes a two-step process for testing the impairment of goodwill on at
least an annual basis. As of December 31, 2004 and December 31, 2003, PennRock has goodwill of
$10.1 million. Originated Mortgage Servicing Rights: Originated mortgage loan servicing rights (OMSRs) are capitalized when realized through the
origination of mortgage loans that are subsequently sold with servicing rights retained. PennRock
recognizes OMSRs as an allocation of the carrying amount of the loans sold between the loans sold
and the servicing rights retained. PennRock receives fees for servicing mortgage loans it has
sold. Servicing fees, expressed as a percentage of the unpaid principal balance, are collected
from the borrowers payments. Late charges and other ancillary fees are also included in servicing
income. Servicing fee revenue is recognized as earned, unless collection is doubtful. OMSRs are periodically evaluated for impairment based on the fair value of these rights. The fair
value of OMSRs is determined by discounting the estimated future cash flows using a discount rate
commensurate with the risks involved. This method of valuation incorporates assumptions that
market participants would use in estimating 40




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) future servicing income and expense, including assumptions about prepayment, default, and interest
rates. For purposes of measuring impairment, the loans underlying the OMSRs are stratified by type
(conventional fixed-rate, conventional adjustable-rate, etc.). Impairment is measured by the
amount the book value of the OMSRs exceeds the fair value of the OMSRs. Impairment, if any, is
recognized through a valuation allowance and a charge to current operations. The recovery of any
previously established impairment reserve is recognized as income in current operations. OMSRs,
net of valuation allowances, are amortized in proportion to, and over the period of, the estimated
net servicing revenue of the underlying mortgages, which are secured by single-family properties.
The amortization expense is deducted from the related servicing fee revenue in the Consolidated
Statements of Income. The amortization of OMSRs is periodically evaluated and adjusted, if
necessary, to reflect changes in prepayment rates or other related factors. Fiduciary Assets and Assets Under Management: Assets held by PFA in a fiduciary or agency capacity are not included in the consolidated financial
statements since such assets are not assets of PFA. In accordance with banking industry practice,
income from fiduciary activities is generally recognized on a cash basis which is not significantly
different from amounts that would have been recognized on the accrual basis. Federal Income Taxes: PennRock and its subsidiaries file a consolidated federal income tax return. Deferred income taxes
have been provided for elements of income and expense that are recognized for financial reporting
purposes in periods different than when such items are recognized for income tax purposes.
PennRock accounts for income taxes under the liability method which applies the enacted statutory
tax rates in effect as of the balance sheet date to differences between the book and tax bases of
assets and liabilities. The resulting deferred tax assets or liabilities are adjusted to reflect
changes in tax rates or laws. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period the change is enacted. For further discussion on
federal income taxes and deferred tax assets and liabilities, see Note 12: Income Taxes in Notes to
Consolidated Financial Statements. Treasury Stock: The purchase of PennRocks treasury stock is recorded at cost. At the date of subsequent reissue,
the treasury stock account is reduced by the cost of such stock on a first-in, first-out method.
Any losses realized from the reissue of treasury stock are charged against retained earnings. Profit Sharing Plan: Profit sharing contributions are calculated by a formula approved by the Board of Directors and are
based on PennRocks return on equity. Costs are funded as accrued. Advertising, Marketing and Public Relations: PennRock expenses advertising, marketing and public relations costs as incurred. These expenses
for 2004, 2003 and 2002 totaled $1.1 million, $982,000 and $998,000, respectively. Stock-Based Compensation: PennRock accounts for its stock options and stock-based compensation plans using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25 (APB 25), Accounting
for Stock Based Compensation Under this method, no compensation expense is recognized for stock
options when the exercise price of the option equals fair value, or market price, of the underlying
stock at the date of grant. PennRock makes disclosures of pro forma net earnings and earnings per
share as if the fair-value-based method of accounting had been applied as required by SFAS No. 123,
Accounting for Stock-Based Compensation and as amended by SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure. Since the Plan stipulates that the exercise
price of the options is always equal to the market price at the date of the grant, we have
recognized no compensation costs under the Plan for stock options issued. We did recognize
compensation expense of $1.1 million related to options exercised in 2004 for which the Company
repurchased the shares issue. Had compensation costs for the Plan been determined based on the
fair value of the options at the grant dates in accordance with SFAS No. 123, Accounting for
Stock-Based Compensation, as amended, PennRocks net income and earnings per share would have been
as follows: 41




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) In thousands, except per share data 2004
    
    
    2003
    
    
    2002Net income  as reported
    
    $
    12,681
    
    
    $
    14,000
    
    
    $
    13,226Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
    
    
    (265
    )
    
    
    (243
    )
    
    
    (165
    )Pro-forma net income
    
    $
    13,115
    
    
    $
    13,757
    
    
    $
    13,061Earnings per share:Basic  as reported
    
    $
    1.66
    
    
    $
    1.84
    
    
    $
    1.73Basic  pro-forma
    
    
    1.63
    
    
    
    1.80
    
    
    
    1.71Diluted  as reported
    
    
    1.63
    
    
    
    1.81
    
    
    
    1.71Diluted  pro-forma
    
    
    1.60
    
    
    
    1.78
    
    
    
    1.69
 The fair value of each option is estimated on the date of the grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used for grants in 2004, 2003
and 2002. 2004
    
    
    2003
    
    
    2002Dividend yield
    
    
    2.86
    %
    
    
    2.62
    %
    
    
    3.33
    %Expected volatility
    
    
    81.00
    %
    
    
    40.00
    %
    
    
    36.00
    %Risk free interest rate
    
    
    5.53
    %
    
    
    4.89
    %
    
    
    5.58
    %Expected life
    
    8.0 years
    
    8.0 years
    
    7.12 years
 Net Income per Share: Basic earnings per share (EPS) is computed by dividing net income available to common
stockholders by the weighted-average number of common shares outstanding during the period.
Diluted EPS is computed by dividing net income available to common stockholders by the
weighted-average number of common shares outstanding during the period plus the maximum number of
potentially dilutive common shares related to PennRocks outstanding stock options. Potentially
dilutive common shares are computed using the treasury stock method. As of December 31, 2004, 2003
and 2002, all outstanding options were dilutive. Earnings per common share have been computed based on the following: Net income in thousands Years Ended December 312004
    
    
    2003
    
    
    2002Net income
    
    $
    12,681
    
    
    $
    14,000
    
    
    $
    13,226Average number of common shares outstanding
    
    
    7,650,913
    
    
    
    7,626,208
    
    
    
    7,641,520Basic earnings per share
    
    $
    1.66
    
    
    $
    1.84
    
    
    $
    1.73Add effect of dilutive options
    
    
    106,289
    
    
    
    115,079
    
    
    
    86,489Diluted average number of shares outstanding
    
    
    7,757,202
    
    
    
    7,741,287
    
    
    
    7,728,009Diluted earnings per share
    
    $
    1.63
    
    
    $
    1.81
    
    
    $
    1.71
 Segment Disclosure: Management measures the performance and allocates the resources of PennRock as a single segment,
community banking. Therefore, we do not have any material operating segments that require
additional disclosure. Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business
are recorded as liabilities when the likelihood of loss is probable and the amount of loss can be
reasonably estimated. 42




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other
assumptions. Fair value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments and other factors, especially in the absence of
broad markets for particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. Recent Accounting Pronouncements and Effect of Newly Issued but Not Yet Effective Accounting
Standards: SFAS No. 123 (Revised 2004): In December 2004, the FASB issued a revision to SFAS No. 123, Accounting for Stock-Based
Compensation, SFAS No. 123-R, Share-Based Payment. SFAS 123R establishes standards for the
accounting for transactions in which an entity (i) exchanges its equity instruments for goods or
services, or (ii) incurs liabilities in exchange for goods or services that are based on the fair
value of the entitys equity instruments or that may be settled by the issuance of the equity
instruments. SFAS 123R eliminates the ability to account for stock-based compensation using APB 25
and requires that such transactions be recognized as compensation cost in the income statement
based on their fair values on the date of the grant. SFAS 123R is effective for PennRock on July
1, 2005. PennRock will transition to fair value based accounting for stock-based compensation
using a modified version of prospective application. Under modified prospective application, SFAS
123R applies to new awards and to awards modified, repurchased, or cancelled after July 1, 2005 and
the unvested portion of previously issued options. Emerging Issues Task Force (EITF) Issue 03-1: The EITF reached consensus in March 2004 regarding guidance provided in EITF Issue No. 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1
provides guidance for determining when an investment is considered impaired, whether impairment is
other-than-temporary, and measurement of an impairment loss. An investment is considered impaired
if the fair value of the investment is less than its cost. Generally, an impairment is considered
other-than-temporary unless: (i) the investor has the ability and intent to hold an investment for
a reasonable period of time sufficient for an anticipated recovery of fair value up to (or beyond)
the cost of the investment; and (ii) evidence indicating that the cost of the investment is
recoverable within a reasonable period of time outweighs evidence to the contrary. If impairment
is determined to be other-than-temporary, then an impairment loss should be recognized equal to the
difference between the investments cost and its fair value. The recognition and measurement
provisions were initially effective for other-than-temporary impairment evaluations in reporting
periods beginning after June 15, 2004. However, in September 2004, the effective date of these
provisions was delayed (for debt securities) until the finalization of a FASB Staff Position to
provide additional implementation guidance. As of December 31, 2004, PennRock determined that
certain equity securities in its AFS portfolio met the criteria for other-than-temporary impairment
and recognized an impairment charge of $1.2 million which is recorded in Non-Interest Income. American Institute of Certified Public Accountants Statement of Position (SOP) No. 03-3: SOP No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer addresses
accounting for the differences between the contractual cash flows of certain loans and debt
securities and the cash flows expected to be collected when loans or debt securities are acquired
in a transfer and those cash flow differences are attributable, at least in part, to credit
quality. As such, SOP 03-3 applies to loans and debt securities acquired individually, in pools or
as part of a business combination and does not apply to originated loans. The application of SOP
03-3 limits the interest income, including accretion of purchase price discounts, that may be
recognized for certain loans and debt securities. Additionally, SOP 03-3 does not allow the excess
of contractual cash flows over cash flows expected to be collected to be recognized as an
adjustment of yield, loss accrual or valuation allowance, such as the allowance for possible loan
losses. SOP 03-3 requires that increases in expected cash flows subsequent to the initial
investment be recognized prospectively through adjustment of the yield on the loan or debt security
over its remaining life. Decreases in expected cash flows should be recognized as impairment. In
the case of loans acquired in a business combination where the loans show signs of credit
deterioration, SOP 03-3 represents a significant change from current purchase accounting practice
whereby the acquirees allowance for loan losses is typically added to the acquirers allowance for
loan losses. SOP 03-3 is effective for loans and debt securities acquired beginning January 1,
2005. The adoption of this new standard is not expected to have a material impact on PennRocks
financial statements. 43




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) Financial Statement Reclassifications: Certain prior period amounts have been reclassified to conform with the December 31, 2004
consolidated financial statements. NOTE 2: RESTRICTIONS ON CASH AND DUE FROM BANKS The Bank is required to maintain average balances of reserves on deposit with the Federal Reserve
Bank based on deposits outstanding. The amount of those required reserves as of December 31, 2004
was approximately $11.6 million. Balances maintained at the Federal Reserve Bank are included in
cash and due from banks. NOTE 3: SECURITIES AVAILABLE FOR SALE The amortized cost and estimated fair value of securities available for sale, with gross unrealized
gains and losses, are as follows: In thousands December 31, 2004Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueU.S. government agencies
    
    $
    11,132
    
    
    $
    1
    
    
    
    ($107
    )
    
    $
    11,026Obligations of states and political
subdivisions
    
    
    9,935
    
    
    
    172
    
    
    
    (230
    )
    
    
    9,877U.S. agency mortgage-backed securities
    
    
    89,569
    
    
    
    121
    
    
    
    (295
    )
    
    
    89,395Collateralized mortgage obligations
    
    
    56,317
    
    
    
    44
    
    
    
    (538
    )
    
    
    55,823Corporate notes
    
    
    71,083
    
    
    
    365
    
    
    
    (2,114
    )
    
    
    69,334Total debt securities available for sale
    
    
    238,036
    
    
    
    703
    
    
    
    (3,284
    )
    
    
    235,455Equity securities
    
    
    69,216
    
    
    
    576
    
    
    
    (2,624
    )
    
    
    67,168Total securities available for sale
    
    $
    307,252
    
    
    $
    1,279
    
    
    
    ($5,908
    )
    
    $
    302,623
 December 31, 2003Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueU.S. government agencies
    
    $
    10,909
    
    
    $
    74
    
    
    $
    (114
    )
    
    $
    10,869Obligations of states and political
subdivisions
    
    
    13,289
    
    
    
    346
    
    
    
    (436
    )
    
    
    13,199U.S. agency mortgage-backed securities
    
    
    52,279
    
    
    
    807
    
    
    
    (80
    )
    
    
    53,006Collateralized mortgage obligations
    
    
    45,309
    
    
    
    306
    
    
    
    (114
    )
    
    
    45,501Corporate notes
    
    
    80,638
    
    
    
    31
    
    
    
    (3,649
    )
    
    
    77,020Total debt securities available for sale
    
    
    202,424
    
    
    
    1,564
    
    
    
    (4,393
    )
    
    
    199,595Equity securities
    
    
    108,268
    
    
    
    2,462
    
    
    
    (1,136
    )
    
    
    109,594Total securities available for sale
    
    $
    310,692
    
    
    $
    4,026
    
    
    
    ($5,529
    )
    
    $
    309,189
 The amortized cost and fair value of debt securities as of December 31, 2004, by contractual
maturity, are shown below. Expected maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations with or without call or prepayment
penalties. In thousands Amortized
    
    
    FairCost
    
    
    ValueDue after one year through five years
    
    $
    160
    
    
    $
    159Due after five years through ten years
    
    
    8,972
    
    
    
    8,868Due after ten years
    
    
    83,018
    
    
    
    81,21092,150
    
    
    
    90,237Mortgage backed securities
    
    
    89,569
    
    
    
    89,395Collateralized mortgage obligations
    
    
    56,317
    
    
    
    55,823Total debt securities
    
    $
    238,036
    
    
    $
    235,455
 44




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) Gains and losses from sales of securities available for sale are as follows: In thousands 2004
    
    
    2003
    
    
    2002Debt securities
Gross gains
    
    $
    797
    
    
    $
    638
    
    
    $
    1,751Gross losses
    
    
    (24
    )
    
    
    (267
    )
    
    
    (103
    )Total debt securities
    
    
    773
    
    
    
    371
    
    
    
    1,648Equity securities, net
    
    
    82
    
    
    
    (22
    )
    
    
    (1,279
    )Total securities gains
    
    $
    855
    
    
    $
    349
    
    
    $
    369
 Proceeds from sales of securities available for sale are as follows: In thousands 2004
    
    
    2003
    
    
    2002Debt securities
    
    $
    51,780
    
    
    $
    64,880
    
    
    $
    100,456Equity securities
    
    
    57,487
    
    
    
    28,495
    
    
    
    19,343Total proceeds
    
    $
    109,267
    
    
    $
    93,375
    
    
    $
    119,799
 Securities with carrying values of $58.9 million and $78.3 million as of December 31, 2004 and 2003
were pledged to secure public and trust deposits, repurchase agreements as well as other purposes. Information pertaining to securities with gross unrealized losses at December 31, 2004 and 2003,
aggregated by investment category and length of time that individual securities have been in a
continuous loss position, is as follows: In thousands December 31, 2004Less Than Twelve Months
    
    
    Over Twelve MonthsGross
    
    
    
    
    
    
    GrossUnrealized
    
    
    Fair
    
    
    Unrealized
    
    
    FairLosses
    
    
    Value
    
    
    Losses
    
    
    ValueU.S. government agencies
    
    $
    14
    
    
    $
    6,960
    
    
    $
    93
    
    
    $
    1,905Obligations of states and political
subdivisions
    
    
    
    
    
    
    
    
    
    
    230
    
    
    
    3,311U.S. agency mortgage-backed securities
    
    
    264
    
    
    
    55,419
    
    
    
    31
    
    
    
    2,991Collateralized mortgage obligations
    
    
    537
    
    
    
    47,167
    
    
    
    1
    
    
    
    79Corporate notes
    
    
    165
    
    
    
    13,685
    
    
    
    1,949
    
    
    
    40,284Total debt securities
    
    
    980
    
    
    
    123,231
    
    
    
    2,304
    
    
    
    48,570Equity securities
    
    
    2,338
    
    
    
    26,469
    
    
    
    286
    
    
    
    4,825Total temporarily impaired securities
    
    $
    3,318
    
    
    $
    149,700
    
    
    $
    2,590
    
    
    $
    53,395
 45




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) In thousands December 31, 2003Less Than Twelve Months
    
    
    Over Twelve MonthsGross
    
    
    
    
    
    
    GrossUnrealized
    
    
    Fair
    
    
    Unrealized
    
    
    FairLosses
    
    
    Value
    
    
    Losses
    
    
    ValueU.S. Treasury securities and other
U.S. government agencies
    
    $
    114
    
    
    $
    4,882
    
    
    $
    
    
    
    $Obligations of states and political
subdivisions
    
    
    
    
    
    
    
    
    
    
    436
    
    
    
    5,331U.S. agency mortgage-backed securities
    
    
    67
    
    
    
    9,948
    
    
    
    14
    
    
    
    3,269Collateralized mortgage obligations
    
    
    60
    
    
    
    6,395
    
    
    
    54
    
    
    
    2,444Corporate notes
    
    
    50
    
    
    
    4,950
    
    
    
    3,599
    
    
    
    51,826Total debt securities
    
    
    291
    
    
    
    26,175
    
    
    
    4,103
    
    
    
    62,870Equity securities
    
    
    57
    
    
    
    12,719
    
    
    
    1,078
    
    
    
    12,216Total temporarily impaired securities
    
    $
    348
    
    
    $
    38,894
    
    
    $
    5,181
    
    
    $
    75,086
 Management evaluates securities for other-than-temporary impairment when economic or market
concerns warrant such evaluation. Consideration is given to the length of time and extent to which
the fair value has been less than cost, the financial condition and near-term prospects of the
issuer and the intent and ability of PennRock to retain its investment in the issuer for a period
sufficient to allow for any anticipated recovery in fair value. For debt securities, management
considers whether the securities are issued by the federal government or its agencies and whether
downgrades by bond rating agencies have occurred. In the case of equity securities, management
reviews industry analysts reports and corporate financial performance. As stated previously, as
of December 31, 2004, PennRock determined that certain equity securities in its AFS portfolio met
the criteria for other-than-temporary impairment and recognized an impairment charge of $1.2
million which is recorded in Non-Interest Income. Other securities with unrealized losses have not
been recognized into income because the issuers obligations are of high credit quality, management
has the intent and ability to hold for the foreseeable future, and the decline in fair value is
largely due to changes in interest rates. The fair value is expected to recover as the bonds
approach maturity. NOTE 4: LOANS The loan portfolio, net of unearned income and deferred loan fees, as of December 31, 2004 and 2003
is as follows: In thousands 2004
    
    
    2003Commercial, financial and agricultural:Commercial, secured by real estate
    
    $
    419,114
    
    
    $
    371,105Agricultural
    
    
    8,654
    
    
    
    7,387Other
    
    
    91,133
    
    
    
    91,934Real estate  construction
    
    
    47,681
    
    
    
    45,319Real estate  mortgage
    
    
    198,217
    
    
    
    187,033Consumer
    
    
    8,525
    
    
    
    9,124Total loans
    
    $
    773,324
    
    
    $
    711,902
 In the ordinary course of business, the Bank has loan, deposit, and other transactions with its
directors, their affiliated companies, executive management and their associates (as defined),
collectively referred to as related parties. Activity for the related party loans for the year
ended December 31, 2004, was as follows: In thousands Balance, January 1, 2004
    
    $
    14,436New loans
    
    
    6,488Repayments
    
    
    (5,986
    )Balance, December 31, 2004
    
    $
    14,938
 46




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) Included in the loan portfolio are loans on which the Bank has ceased the accrual of interest.
Such loans amounted to $277,000 and $951,000 as of December 31, 2004 and 2003. If interest income
had been recorded on all non-accrual loans outstanding during the years 2004, 2003 and 2002,
interest income would have been increased as shown in the following table: In thousands 2004
    
    
    2003
    
    
    2002Interest which would have been recorded
under original terms
    
    $
    76
    
    
    $
    80
    
    
    $
    78Interest income recorded during the year
    
    
    38
    
    
    
    36
    
    
    
    27Net impact on interest income
    
    $
    38
    
    
    $
    44
    
    
    $
    51
 Also included in the loan portfolio are loans which are still accruing but are 90 days past due as
to principal or interest. Such loans amounted to $225,000 and $617,000 as of December 31, 2004 and
2003. These loans generally are well secured and in the process of collection or are expected to
be restored to current status in the near future. PennRock accounts for impaired loans in accordance with SFAS No. 114. Under this standard, once a
loan has been identified as being impaired, management measures impairment using discounted cash
flows, or in the case of collateral dependent loans, the fair value of the collateral. When the
recorded investment in an impaired loan exceeds the estimated fair value, such impairment is
recognized as a valuation allowance that is included in the overall allowance for loan losses.
Impaired loans include all non-accrual loans plus all loans whose original terms have been
restructured as to the payment of principal, interest or both. Impaired loans totaled $3.0 million
as of December 31, 2004 of which $277,000 was in non-accrual status and $958,000 as of December 31,
2003 of which $951,000 was in non-accrual. The following table presents the status of impaired loans. In thousands 2004
    
    
    2003Impaired loans with a reserve
    
    $
    2,802
    
    
    $
    187Impaired loans with no reserve
    
    
    227
    
    
    
    771Total impaired loans
    
    $
    3,029
    
    
    $
    958Reserve for impaired loans (1)
    
    $
    598
    
    
    $
    88Average balance of impaired loans during the year
    
    $
    1,994
    
    
    $
    959Interest income recognized during the year:On an accrual basis
    
    $
    245
    
    
    $
    82On a cash basis
    
    
    207
    
    
    
    38
  (1)
 NOTE 5: LOAN SERVICING Mortgage loans serviced for Fannie Mae and Freddie Mac are not included in the accompanying
Consolidated Balance Sheets. The unpaid principal balances of those loans were $224.0 million as
of December 31, 2004 and $222.9 million as of December 31, 2003. During 2004, $391,000 of originated mortgage servicing rights were capitalized and $329,000 of
amortization and impairment of mortgage servicing rights were recorded. In 2003, $823,000 of
originated mortgage servicing rights were capitalized and $445,000 of amortization and impairment
of mortgage servicing rights were recorded. The carrying amount of mortgage servicing rights,
which is less than the estimated fair value, was $1,083,000 as of December 31, 2004 and $1,021,000
as of December 31, 2003 which are included in Other Intangible Assets in the Consolidated Balance
Sheets. 47




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) NOTE 6: ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses were as follows: In thousands 2004
    
    
    2003
    
    
    2002Balance at beginning of year
    
    $
    8,643
    
    
    $
    7,075
    
    
    $
    7,262Provision charged to expense
    
    
    565
    
    
    
    1,917
    
    
    
    1,750Recoveries of loans charged-off
    
    
    170
    
    
    
    368
    
    
    
    2609,378
    
    
    
    9,360
    
    
    
    9,272Loans charged off
    
    
    (371
    )
    
    
    (717
    )
    
    
    (2,197
    )Balance at end of year
    
    $
    9,007
    
    
    $
    8,643
    
    
    $
    7,075
 NOTE 7: PREMISES AND EQUIPMENT Details of premises and equipment as of December 31 are as follows: In thousands 2004
    
    
    2003Land
    
    $
    2,324
    
    
    $
    2,222Premises
    
    
    15,805
    
    
    
    15,419Furniture and equipment
    
    
    15,238
    
    
    
    14,512Construction in progress
    
    
    639
    
    
    
    112Total cost
    
    
    34,006
    
    
    
    32,265Less accumulated depreciation
    
    
    (16,974
    )
    
    
    (15,982
    )Net book value
    
    $
    17,032
    
    
    $
    16,283
 Depreciation expense was $1.3 million in 2004, 2003 and 2002. Future minimum rental payments that are related to non-cancelable operating leases having initial
terms in excess of one year are: 2005
    
    $
    555,0222006
    
    
    498,3522007
    
    
    477,7572008
    
    
    302,0022009
    
    
    256,625Thereafter
    
    
    1,461,025Total
    
    $
    3,550,783
 The lease agreements contain options to extend for various periods. The costs of such rentals is
not included in amounts listed above. Total lease payments were $464,000, $376,000 and $318,000 in
2004, 2003 and 2002. NOTE 8: DEPOSITS The following is a summary of deposit account balances as of December 31, 2004 and 2003: In thousands 2004
    
    
    2003Non-interest bearing deposits
    
    $
    158,104
    
    
    $
    140,753NOW accounts
    
    
    48,593
    
    
    
    48,408Money market deposit accounts
    
    
    178,539
    
    
    
    168,130Savings accounts
    
    
    97,488
    
    
    
    88,438Time deposits
    
    
    346,010
    
    
    
    338,313Total deposits
    
    $
    828,734
    
    
    $
    784,042
 48




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) The following shows the maturity of time deposits by year as of December 31, 2004: In thousands 2005
    
    $
    313,1382006
    
    
    15,1372007
    
    
    6,5742008
    
    
    1,8732009
    
    
    9,2852010
    
    
    22011
    
    
    1Total
    
    $
    346,010
 The aggregate amount of time deposits in denominations of $100,000 or more as of December 31, 2004
and 2003 was $70.2 million and $47.5 million, respectively. NOTE 9: SHORT-TERM BORROWINGS Federal funds purchased, securities sold under agreements to repurchase and the treasury tax and
loan note generally mature within one to thirty days from the transaction date. A summary of short-term borrowings is as follows for the years ended December 31, 2004 and 2003. In thousands 2004
    
    
    2003Securities sold under agreements to repurchase:Federal Home Loan Bank
    
    $
    108,000
    
    
    $
    97,000Customers
    
    
    14,825
    
    
    
    14,181U.S. Treasury tax and loan note
    
    
    2,634
    
    
    
    1,781Total short-term borrowings outstanding at year-end
    
    $
    125,459
    
    
    $
    112,962Average interest rate at year-end
    
    
    2.29
    %
    
    
    1.08
    %Maximum outstanding at any month-end
    
    $
    131,510
    
    
    $
    134,373Average amount outstanding
    
    
    108,298
    
    
    $
    90,245Weighted average interest rate
    
    
    1.51
    %
    
    
    1.14
    %
 The Bank controls all securities that serve as collateral for the securities sold under agreements
to repurchase. The Bank has approved federal funds lines totaling $15.0 million of which none was used as of
December 31, 2004 and a borrowing capacity of $355.3 million at the Federal Home Loan Bank of
Pittsburgh (the FHLB) of which $210,000 was used as of December 31, 2004. NOTE 10: LONG-TERM DEBT Long-term debt consists of fixed rate advances from the FHLB with maturity schedules as follows: In thousands December 31, 2004
    
    December 31, 2003Interest
    
    
    
    
    
    
    
    
    InterestAmount
    
    Maturity Date
    
    Rate
    
    
    Amount
    
    
    Maturity Date
    
    Rate$
    25,000
    
    June 5, 2006
    
    
    5.59
    %
    
    $
    25,000
    
    
    June 5, 2006
    
    
    5.59
    %15,000
    
    June 5, 2006
    
    
    5.05
    %
    
    
    15,000
    
    
    June 5, 2006
    
    
    5.05
    %11,000
    
    June 4, 2007
    
    
    6.76
    %
    
    
    11,000
    
    
    June 4, 2007
    
    
    6.76
    %30,000
    
    March 23, 2011
    
    
    3.94
    %
    
    
    30,000
    
    
    March 23, 2011
    
    
    3.94
    %6,000
    
    July 16, 2012
    
    
    4.09
    %
    
    
    6,000
    
    
    July 16, 2012
    
    
    4.09
    %15,000
    
    September 16, 2012
    
    
    3.41
    %
    
    
    15,000
    
    
    September 16, 2012
    
    
    3.41
    %$
    102,000
    
    
    
    
    
    
    
    $
    102,000
 49




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) At December 31, 2004, $62 million of the long-term advances are convertible advances. $45 million
of these advances permit the FHLB to convert the advance from a fixed-rate to a variable-rate at
its discretion on a specified call date following an initial lock-out period ranging from one
year to five years. $17 million of these advances further restrict the FHLBs ability to call the
advance unless 3-month LIBOR is at or above a specified rate. If the FHLB exercises its option to
convert an advance, PennRock has the option to repay the advance in full. During 2004 and 2003,
the FHLB did not exercise its option to convert any advances. However, in 2003, one fixed-rate
advance bearing interest at 7.11% matured and was not replaced. Also during the second quarter of
2003, two advances totaling $40 million were paid-off and replaced by new advances at lower
interest rates. The prepayment penalty assessed by the FHLB is being amortized over the life of
the new advances in accordance with EITF 96-19 (Debtors Accounting for a Modification or Exchange
of Debt Instruments) issued by the FASB in 1996. All advances from the FHLB are collateralized by a security agreement covering qualified loans, and
treasury, agency and mortgage-backed securities, totaling $327,514 of loans and$137,618 of
securities at December 31, 2004.. NOTE 11: CAPITAL TRANSACTIONS On June 23, 2004, PennRock announced that the Board of Directors had authorized the repurchase of
up to 300,000 shares of PennRocks outstanding common stock. Any repurchased shares will be held
as treasury shares available for issuance with future stock dividends and stock splits, employee
benefit plans, executive compensation plans, for issuance under the Dividend Reinvestment Plan or
for issuance for any other appropriate corporate purpose. PennRock began open market repurchases
of its outstanding common stock in 1995. In 2004, PennRock purchased 90,546 shares for $3.1
million and reissued 143,701 shares. In 2003, PennRock purchased 66,424 shares for $1.7 million
and reissued 92,286 shares. PennRock purchased 129,680 shares for $3.1 million and reissued 99,713
shares in 2002. There were 39,200 shares with a cost of $1.0 million as of December 31, 2004 and
92,355 shares with a cost of $2.1 million as of December 31, 2003 held as treasury stock. NOTE 12: INCOME TAXES An analysis of the provision for income taxes included in the Consolidated Statements of Income is
as follows: In thousands 2004
    
    
    2003
    
    
    2002Current expense
    
    $
    4,468
    
    
    $
    4,064
    
    
    $
    2,870Deferred taxes
    
    
    (406
    )
    
    
    (340
    )
    
    
    (290
    )Total income tax expense
    
    $
    4,062
    
    
    $
    3,724
    
    
    $
    2,580
 A reconciliation between the provision for income taxes and the amount computed by applying the
statutory federal income tax rate to income before provision for income taxes is as follows: 2004
    
    
    2003
    
    
    2002Statutory federal income tax rate
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %Tax exempt income, net
    
    
    (9.2
    %)
    
    
    (10.9
    %)
    
    
    (12.0
    %)Low income housing, rehabilitation
and other tax credits
    
    
    (0.4
    %)
    
    
    (0.4
    %)

    
    
    (5.7
    %)Other, net
    
    
    (1.1
    %)
    
    
    (2.7
    %)
    
    
    (1.0
    %)Effective income tax rate
    
    
    24.3
    %
    
    
    21.0
    %
    
    
    16.3
    %
 The tax effect of tax-exempt income on income tax expense is shown net of TEFRA interest expense
disallowance. 50




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS-(CONTINUED) Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for income tax
purposes. Significant components of PennRocks deferred tax liabilities and assets as of December
31, 2004 and 2003 are as follows: In thousands 2004
    
    
    2003Deferred tax assets:Allowance for loan losses
    
    $
    2,995
    
    
    $
    2,948Net unrealized loss on securities available for sale
    
    
    1,620
    
    
    
    511Goodwill amortization or impairment
    
    
    93
    
    
    
    165Impairment charge on available for sale equity securities
    
    
    428Other
    
    
    187
    
    
    
    50Total deferred tax assets
    
    
    5,323
    
    
    
    3,674Deferred tax liabilities:Depreciation
    
    
    296
    
    
    
    254Investment security discount
    
    
    454
    
    
    
    362Total deferred tax liabilities
    
    
    750
    
    
    
    616Net deferred tax asset
    
    $
    4,573
    
    
    $
    3,058
 Included in the table above is the recognition of unrealized gains and losses on certain
investments in debt and equity securities accounted for under SFAS No. 115 for which no deferred
tax expense or benefit was recognized in the Consolidated Statements of Income. Management believes that it is more likely than not that the net deferred tax asset of $4.6 million
will be realized since PennRock has a long history of earnings and has a carry-back potential
greater than the deferred tax asset. NOTE 13: EMPLOYEE BENEFIT PLAN The Bank has a non-contributory profit sharing plan covering substantially all full time employees
of the Bank. Contributions made to the plan by PennRock were $1.2 million in 2004, $1.4 million in
2003 and $1.3 million in 2002, which have been reflected as salaries and benefit expense in the
consolidated statements of income. NOTE 14: STOCK INCENTIVE PLAN PennRock has a Stock Incentive Plan (the Plan), the terms of which permit the granting of
incentive stock options, nonqualified stock options and bonus stock to key employees of PennRock
and its subsidiaries. All options under this Plan are granted at an exercise price equal to the
market price at the date of the grant and an options maximum term is ten years. The vesting
period generally is for half of the options to vest in three years from the date of the grant with
the remainder to vest in five years. All options vest in the event of a change of control as
defined in the Plan. 51




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##### Table of Contents



PennRock Financial Services Corp. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS-(CONTINUED) A summary of PennRocks options
 outstanding as of December 31 is as follows: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding, beginning
of year
    
    
    275,712
    
    
    $
    18.64
    
    
    
    243,903
    
    
    $
    16.29
    
    
    
    193,878
    
    
    $
    13.76Granted
    
    
    45,000
    
    
    
    28.12
    
    
    
    52,800
    
    
    
    26.82
    
    
    
    65,560
    
    
    
    23.13Exercised
    
    
    (77,916
    )
    
    
    14.57
    
    
    
    (20,991
    )
    
    
    11.96
    
    
    
    (15,535
    )
    
    
    11.96Forfeited
    
    
    (9,633
    )
    
    
    26.30Outstanding, end of
year
    
    
    233,163
    
    
    $
    21.58
    
    
    
    275,712
    
    
    $
    18.64
    
    
    
    243,903
    
    
    $
    16.29Options exercisable at
year-end
    
    
    38,093
    
    
    $
    15.36
    
    
    
    71,594
    
    
    $
    14.58
    
    
    
    92,585
    
    
    $
    11.12
 The weighted average fair values of options granted in the past three years are as follows: 2004
    
    
    2003
    
    
    2002Per
    
    
    
    
    
    
    Per
    
    
    
    
    
    
    PerTotal
    
    Share
    
    
    Total
    
    
    Share
    
    
    Total
    
    
    Share$
    779,400
    
    $
    17.32

    
    
    $
    580,160
    
    
    $
    10.99
    
    
    $
    506,539
    
    
    $
    7.68
 Information pertaining to options outstanding as of December 31, 2004 is as follows: Options Outstanding
    
    
    Options ExercisableWeightedAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedRemaining
    
    
    Average
    
    
    
    
    
    
    AverageNumber
    
    
    Contractual
    
    
    Exercise
    
    
    Number
    
    
    ExerciseRange of Exercise Prices
    
    Outstanding
    
    
    Life
    
    
    Price
    
    
    Exercisable
    
    
    Price$11.95 - $17.32
    
    
    78,488
    
    
    5.42 years
    
    $
    13.44
    
    
    
    34,022
    
    
    $
    14.58$20.46 - $28.12
    
    
    154,675
    
    
    8.26 years
    
    
    25.70
    
    
    
    4,071
    
    
    
    21.82Outstanding at end of
year
    
    
    233,163
    
    
    7.29 years
    
    $
    21.58
    
    
    
    38,093
    
    
    $
    15.36
 The following table sets forth information as of December 31, 2004, with respect to stock
compensation plans under which equity securities are authorized for issuance: Number ofSecurities to be
    
    
    Weighted
    
    
    Number ofIssued Upon
    
    
    Average
    
    
    SecuritiesExercise of
    
    
    Exercise Price
    
    
    RemainingOutstanding
    
    
    of Outstanding
    
    
    Available forOptions
    
    
    Options
    
    
    Future IssuesStock based compensation plans approved
by stockholders
    
    
    232,780
    
    
    $
    21.60
    
    
    
    441,200Stock based compensation plans not
approved by stockholders
    
    
    383
    
    
    $
    11.95Total
    
    
    233,163
    
    
    $
    21.58
    
    
    
    441,200
 Of the shares outstanding under stock based compensation plans approved by stockholders, 80,966
were issued under the Omnibus Stock Plan of 1992 and 151,814 were issued under the Stock Incentive
Plan of 2002. 52




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) NOTE 15:
    
    COMMITMENTS AND CONTINGENT LIABILITIES AND CONCENTRATIONS OF CREDIT
RISK
 PennRocks financial statements do not reflect certain off-balance sheet arrangements that include
various commitments and contingent liabilities that arise in the normal course of business to meet
the financing needs of its customers and that involve elements of credit risk, interest rate risk
and liquidity risk. These financial instruments include commitments to extend credit, standby
letters of credit, guarantees, and liability for assets held in trust. PennRocks exposure to
credit loss in the event of nonperformance by the other party on the financial instrument is
represented by the contractual amount and the collateral value, if any, of those instruments.
PennRock uses the same credit policies in commitments and conditional obligations as it does for
on-balance sheet instruments. A summary of PennRocks commitments and contingent liabilities as of December 31, 2004 and 2003 are
as follows: In thousands 2004
    
    
    2003Commitments to extend credit
    
    $
    179,921
    
    
    $
    137,838Financial and performance standby letters of credit
    
    
    40,131
    
    
    
    37,197
 Substantially all of the unused commitments to extend credit are at variable rates or will be
provided at the prevailing fixed rate when the loans are originated or the lines are used. Commitments to extend credit are agreements to lend to a customer to the extent that there is no
violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total commitment amounts do not
represent future cash requirements. Management evaluates each customers creditworthiness on a
case-by-case basis. The amount of collateral obtained if deemed necessary by management upon
extension of credit is based on a credit evaluation of the customer. Stand-by letters of credit are conditional commitments issued by PennRock to guarantee the
performance of a customer to a third party. The term of the letters of credit varies from one
month to 36 months and may have renewal features. Fees collected on standby letters of credit
represent the fair value of those commitments and are amortized over the term of the commitment.
The credit risk involved in issuing letters of credit is essentially the same as that involved in
extending loans to customers. PennRock holds collateral supporting those commitments for which
collateral is deemed necessary. Most of PennRocks business activity is with customers located within PennRocks defined market
area. Investments in state and municipal securities may also involve government entities within
PennRocks market area. The concentrations by loan type are set forth in Note 4: Loans in the
Notes to Consolidated Financial Statements. The distribution of commitments to extend credit
approximates the distribution of loans outstanding. The Bank, as a matter of policy, does not
extend credit to any single borrower or group of related borrowers in excess of 65% of its legal
lending limit. As of December 31, 2004, our legal lending limit was $16.3 million while our
in-house lending limit was $10.6 million. A PennRock non-bank subsidiary has been named as a defendant in a binding, nonappealable
arbitration proceeding in which the claimants seek to recover damages of approximately $4.6
million. The subsidiary is vigorously defending against these claims and is strongly contesting
the amount of recoverable damages, if any. Any award against the subsidiary would be subject to
offsets and insurance coverage aggregating approximately $1.0 million and PennRock believes that it
has valid claims for indemnity and contribution against various third parties. PennRock is unable
to determine at the present time whether a loss may be incurred relative to this matter, or, if a
loss is incurred, the extent thereof net of insurance, offsets and amounts recoverable from third
parties. PennRock and its subsidiaries, from time to time, are involved as plaintiff or defendant in various
legal actions arising in the normal course of their businesses. While the ultimate outcome of any
such proceedings cannot be predicted with certainty, it is the opinion of management that no other
proceedings exist, either individually or in the aggregate, which, if determined adversely to
PennRock, would have a material effect on PennRocks consolidated financial condition, results of
operations or cash flows. 53




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) NOTE 16: RESTRICTIONS ON RETAINED EARNINGS Certain restrictions exist regarding the ability of the Bank to transfer funds to PennRock and for
PFA to transfer funds to the Bank in the form of cash dividends. The approval of the Comptroller
of the Currency is required if the total dividends declared by a national bank in any calendar year
exceeds the banks net profits (as defined) for that year combined with its retained net profits
for the preceding two calendar years. Under this formula, the Bank can declare dividends during
2005, without approval of the Comptroller of the Currency, of approximately $13.1 million plus an
additional amount equal to the Banks net profit (as defined) for 2005 up to the date of any such
dividend declaration. PFA would not be allowed to pay any dividends to the Bank without approval
of the Comptroller of the Currency except to the extent of PFAs net profit (as defined) for 2005
up to the date of any such dividend declaration. NOTE 17: COMPREHENSIVE INCOME PennRock has elected to report its comprehensive income in the Consolidated Statements of
Stockholders Equity. The only element of other comprehensive income applicable to PennRock is
the net unrealized gain or loss on available for sale securities. The components of the change in unrealized gains (losses) on securities available for sale are as
follows: In thousands 2004
    
    
    2003
    
    
    2002Net unrealized holding gains (losses) arising during the year
    
    ($
    3,492
    )
    
    $
    4,020
    
    
    $
    3,120Reclassification adjustments :Impairment charge on available for sale equity securities
    
    
    1,221Net gains realized in net income
    
    
    (855
    )
    
    
    (349
    )
    
    
    (369
    )Net unrealized holding gains (losses) before taxes
    
    
    (3,126
    )
    
    
    3,671
    
    
    
    2,751Tax effect
    
    
    1,109
    
    
    
    (1,285
    )
    
    
    (963
    )Net change
    
    ($
    2,017
    )
    
    $
    2,386
    
    
    $
    1,788
 NOTE 18: REGULATORY MATTERS PennRock and the Bank are subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on PennRocks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action,
PennRock and the Bank must meet specific capital guidelines that involve quantitative measures of
PennRocks assets, liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. PennRocks and the Banks capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk weightings and other
factors. Quantitative measures established by regulation to ensure capital adequacy require PennRock and the
Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital
(as defined) to average assets (as defined). Management believes, as of December 31, 2004, that
PennRock and the Bank meet all capital adequacy requirements to which they are subject. Prompt
corrective action provisions are not applicable to bank holding companies. 54




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) As of December 31, 2004, the most recent notification from the Federal Reserve Bank categorized
PennRock as well capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, PennRock must maintain minimum total risk-based, Tier 1 risk-based
and Tier 1 leverage ratios as set forth below. There are no conditions or events since that
notification that management believes have changed this category. PennRocks and the Banks actual
capital amounts and ratios are also presented in the following table. To Be WellCapitalized UnderPrompt Corrective
    
    
    For CapitalActual
    
    
    Action Provisions
    
    
    Adequacy PurposesAmount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioPennRock Financial
Services Corp.As of December 31, 2004:Total capital to
risk-weighted assets
    
    $
    104,015
    
    
    
    11.62
    %
    
    
    
    
    
    
    
    
    
    $
    71,596
    
    
    
    8.0
    %Tier 1 capital:to risk-weighted assets
    
    
    95,008
    
    
    
    10.62
    %
    
    
    
    
    
    
    
    
    
    
    35,798
    
    
    
    4.0
    %to average assets
    
    
    95,008
    
    
    
    8.24
    %
    
    
    
    
    
    
    
    
    
    
    45,540
    
    
    
    4.0
    %As of December 31, 2003:Total capital to
risk-weighted assets
    
    $
    98,078
    
    
    
    11.64
    %
    
    
    
    
    
    
    
    
    
    $
    67,418
    
    
    
    8.0
    %Tier 1 capital:to risk-weighted assets
    
    
    88,838
    
    
    
    10.54
    %
    
    
    
    
    
    
    
    
    
    
    33,709
    
    
    
    4.0
    %to average assets
    
    
    88,838
    
    
    
    8.23
    %
    
    
    
    
    
    
    
    
    
    
    43,168
    
    
    
    4.0
    %Blue Ball National BankAs of December 31, 2004:Total capital to
risk-weighted assets
    
    $
    99,153
    
    
    
    11.12
    %
    
    $
    89,191
    
    
    
    10.0
    %
    
    $
    71,353
    
    
    
    8.0
    %Tier 1 capital:to risk-weighted assets
    
    
    90,146
    
    
    
    10.11
    %
    
    
    53,515
    
    
    
    6.0
    %
    
    
    35,676
    
    
    
    4.0
    %to average assets
    
    
    90,146
    
    
    
    7.84
    %
    
    
    57,493
    
    
    
    5.0
    %
    
    
    45,994
    
    
    
    4.0
    %As of December 31, 2003:Total capital to
risk-weighted assets
    
    $
    95,409
    
    
    
    11.37
    %
    
    $
    83,940
    
    
    
    10.0
    %
    
    $
    67,152
    
    
    
    8.0
    %Tier 1 capital:to risk-weighted assets
    
    
    86,021
    
    
    
    10.25
    %
    
    
    50,364
    
    
    
    6.0
    %
    
    
    33,576
    
    
    
    4.0
    %to average assets
    
    
    86,021
    
    
    
    7.99
    %
    
    
    53,829
    
    
    
    5.0
    %
    
    
    43,063
    
    
    
    4.0
    %
 NOTE 19: FAIR VALUE OF FINANCIAL INSTRUMENTS The information set forth below provides disclosure of the estimated fair value of PennRocks
financial instruments. Management has made estimates of fair value discount rates that it believes
to be reasonable. However, because there is no readily available market for some of these
financial instruments, management has no basis to determine whether the fair value presented would
be indicative of the value negotiated in an actual sale. The fair value estimates do not consider
the tax effect that would be associated with the disposition of the assets or liabilities at their
fair value estimates. We used the following methods and assumptions in estimating the fair value of PennRocks financial
instruments: Cash and cash equivalents: The carrying amounts reported in the Consolidated Balance Sheets for cash and short-term
investments approximate their fair values. Mortgages held for sale: The fair value of mortgages held for sale is estimated using current secondary market rates. 55




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) Securities: Fair values for securities are based on quoted prices, where available. If quoted prices are
not available, fair values are based on quoted prices of comparable instruments. Loans: Loans are segregated by category, such as commercial, commercial real estate, residential
mortgage, and installment. Each loan category is further segmented into fixed and adjustable
rate interest terms and by performing and non-performing status. The fair value of loans is
calculated by discounting scheduled cash flows through the estimated maturity using estimated
market discount rates that reflect the credit risk inherent in the loan. The estimate of
average maturity is based on historical experience with prepayments for each loan classification
modified, as required, by an estimate of the effect of current economic and lending conditions.
The carrying amount of accrued interest receivable approximates its fair value. Deposit liabilities: The fair value of deposits with no stated maturity such as interest bearing and non-interest
bearing demand deposits, saving and money market accounts is equal to the amount payable on
demand. The fair value of certificates of deposit is based on the discounted value of
contractual cash flows. Short-term borrowings: The carrying amounts of federal funds purchased and securities sold under agreements to
repurchase, advances from the Federal Home Loan Bank and other short-term borrowings approximate
their fair values. Long-term debt: The fair values of long-term debt are estimated using discounted cash flow analyses, based on
PennRocks incremental borrowing rates for similar types of borrowing arrangements. Accrued interest payable: The fair value of accrued interest payable is estimated to be the current book value. As of December 31, 2004 and 2003, the estimated fair values of financial instruments based on
disclosed assumptions are as follows: In thousands 2004
    
    
    2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    ValueFinancial assets:Cash and due from banks
    
    $
    17,994
    
    
    $
    17,994
    
    
    $
    17,858
    
    
    $
    17,858Short-term investments
    
    
    4,358
    
    
    
    4,358
    
    
    
    6,283
    
    
    
    6,283Mortgages held for sale
    
    
    3,758
    
    
    
    3,758
    
    
    
    2,004
    
    
    
    2,004Securities available for sale
    
    
    302,623
    
    
    
    302,623
    
    
    
    309,189
    
    
    
    309,189Net loans
    
    
    764,317
    
    
    
    775,265
    
    
    
    703,259
    
    
    
    713,426Accrued interest receivable
    
    
    3,463
    
    
    
    3,463
    
    
    
    3,100
    
    
    
    3,100Financial liabilities:Deposits
    
    
    828,734
    
    
    
    829,919
    
    
    
    784,042
    
    
    
    787,329Short-term borrowings
    
    
    125,459
    
    
    
    125,459
    
    
    
    112,962
    
    
    
    112,962Long-term debt
    
    
    102,000
    
    
    
    102,829
    
    
    
    102,000
    
    
    
    109,106Accrued interest payable
    
    
    2,926
    
    
    
    2,926
    
    
    
    2,353
    
    
    
    2,353
 56




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) NOTE 20: PARENT COMPANY ONLY FINANCIAL INFORMATION The following represents parent only financial information: PennRock Financial Services Corp. (Parent Company Only) Balance Sheets In thousands December 31,2004
    
    
    2003ASSETS:Cash and cash equivalents
    
    $
    152
    
    
    $
    635Securities available for sale
    
    
    1,880
    
    
    
    1,769Investment in subsidiaries
    
    
    98,628
    
    
    
    95,500Receivable from subsidiary
    
    
    4,215
    
    
    
    2,002Other assets
    
    
    1,254
    
    
    
    1,307Total assets
    
    $
    106,129
    
    
    $
    101,213LIABILITIES AND STOCKHOLDERS EQUITY:Liabilities:Dividends payable
    
    $
    1,686
    
    
    $
    1,523Note payable to subsidiary
    
    
    
    
    
    
    850Other liabilities

    
    
    953
    
    
    
    833Total liabilities
    
    
    2,639
    
    
    
    3,206Stockholders equity:Common stock
    
    
    19,296
    
    
    
    19,296Surplus
    
    
    54,798
    
    
    
    53,677Accumulated other comprehensive loss, net of tax
    
    
    (3,008
    )
    
    
    (991
    )Retained earnings
    
    
    33,416
    
    
    
    28,134Treasury stock at cost
    
    
    (1,012
    )
    
    
    (2,109
    )Total stockholders equity
    
    
    103,490
    
    
    
    98,007Total liabilities and stockholders equity
    
    $
    106,129
    
    
    $
    101,213
 PennRock Financial Services Corp. (Parent Company Only) Statements of Income In thousands Year Ended December 31,2004
    
    
    2003
    
    
    2002Income:Dividends from bank subsidiary
    
    $
    8,200
    
    
    $
    8,150
    
    
    $
    6,400Securities available for sale
    
    
    58
    
    
    
    28
    
    
    
    14Management fee from (paid to) subsidiaries
    
    
    (91
    )
    
    
    (872
    )
    
    
    337Impairment charge on available for sale equity
securities
    
    
    (383
    )Net realized losses on sales of available for sale
securities
    
    
    (154
    )
    
    
    (118
    )
    
    
    (1,645
    )Total income
    
    
    7,630
    
    
    
    7,188
    
    
    
    5,106Compensation expense from purchase of treasury shares
    
    
    1,076General and administrative expenses
    
    
    367
    
    
    
    607
    
    
    
    636Income before income taxes and undistributed net income
of subsidiaries
    
    
    6,187
    
    
    
    6,581
    
    
    
    4,470Income tax expense (benefit)
    
    
    (714
    )
    
    
    (672
    )
    
    
    (659
    )Equity in undistributed net income of subsidiaries
    
    
    5,780
    
    
    
    6,747
    
    
    
    8,097Net income
    
    $
    12,681
    
    
    $
    14,000
    
    
    $
    13,226
 57




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) PennRock Financial Services Corp. (Parent Company Only) Statements of Cash Flows In thousands Year Ended December 31,2004
    
    
    2003
    
    
    2002OPERATING ACTIVITIESNet income
    
    $
    12,681
    
    
    $
    14,000
    
    
    $
    13,226Adjustments to reconcile net income to net cash
provided by operating activities:Equity in undistributed net income from subsidiaries
    
    
    (5,780
    )
    
    
    (6,747
    )
    
    
    (8,097
    )Net realized losses on sale of available for sale
securities
    
    
    154
    
    
    
    118
    
    
    
    1,645Impairment charge on available for sale equity
securities
    
    
    383Compensation expense from purchase of treasury
shares
    
    
    1,076(Increase) decrease in receivable from subsidiary
    
    
    (2,213
    )
    
    
    (1,986
    )
    
    
    1,737Other, net
    
    
    261
    
    
    
    3
    
    
    
    (401
    )Net cash provided by operating activities
    
    
    6,562
    
    
    
    5,388
    
    
    
    8,110INVESTING ACTIVITIESNet cash paid for business acquisition
    
    
    
    
    
    
    
    
    
    
    (1,665
    )Proceeds from sale of securities available for sale
    
    
    430
    
    
    
    1,407
    
    
    
    720Purchases of securities available for sale
    
    
    (531
    )
    
    
    (906
    )
    
    
    (584
    )Net cash provided by (used in) investing activities
    
    
    (101
    )
    
    
    501
    
    
    
    (1,529
    )FINANCING ACTIVITIESNet decrease in short-term borrowings
    
    
    (850
    )
    
    
    
    
    
    
    (59
    )Issuance of common and treasury stock
    
    
    3,129
    
    
    
    2,153
    
    
    
    2,085Purchase of treasury stock
    
    
    (3,113
    )
    
    
    (1,744
    )
    
    
    (3,139
    )Cash dividends paid
    
    
    (6,110
    )
    
    
    (5,737
    )
    
    
    (5,355
    )Cash paid with stock dividend
    
    
    
    
    
    
    (29
    )
    
    
    (30
    )Net cash used in financing activities
    
    
    (6,944
    )
    
    
    (5,357
    )
    
    
    (6,498
    )Increase (decrease) in cash and cash equivalents
    
    
    (483
    )
    
    
    532
    
    
    
    83Cash and cash equivalents at beginning of year
    
    
    635
    
    
    
    103
    
    
    
    20Cash and cash equivalents at end of year
    
    $
    152
    
    
    $
    635
    
    
    $
    103
 58




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PennRock Financial Services Corp. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) NOTE 21: CONSOLIDATED QUARTERLY FINANCIAL DATA (Unaudited) In thousands except per share data 2004First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterInterest income
    
    $
    13,335
    
    
    $
    13,449
    
    
    $
    13,862
    
    
    $
    14,694Interest expense
    
    
    4,312
    
    
    
    4,316
    
    
    
    4,856
    
    
    
    5,167Net interest income
    
    
    9,023
    
    
    
    9,133
    
    
    
    9,006
    
    
    
    9,527Provision for loan losses
    
    
    398
    
    
    
    167Non-interest income
    
    
    4,050
    
    
    
    3,089
    
    
    
    3,390
    
    
    
    1,706Non-interest expense
    
    
    7,460
    
    
    
    7,836
    
    
    
    7,683
    
    
    
    8,637Income before income taxes
    
    
    5,215
    
    
    
    4,219
    
    
    
    4,713
    
    
    
    2,596Income taxes
    
    
    1,096
    
    
    
    1,100
    
    
    
    1,104
    
    
    
    762Net income
    
    $
    4,119
    
    
    $
    3,119
    
    
    $
    3,609
    
    
    $
    1,834Basic earnings per share
    
    $
    0.54
    
    
    $
    0.41
    
    
    $
    0.47
    
    
    $
    0.24Dividends declared per share
    
    $
    0.20
    
    
    $
    0.20
    
    
    $
    0.20
    
    
    $
    0.22
 2003First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterInterest income
    
    $
    13,356
    
    
    $
    13,546
    
    
    $
    13,070
    
    
    $
    13,422Interest expense
    
    
    4,812
    
    
    
    4,448
    
    
    
    4,258
    
    
    
    4,307Net interest income
    
    
    8,544
    
    
    
    9,098
    
    
    
    8,812
    
    
    
    9,115Provision for loan losses
    
    
    450
    
    
    
    455
    
    
    
    460
    
    
    
    552Non-interest income
    
    
    3,325
    
    
    
    3,289
    
    
    
    3,425
    
    
    
    3,711Non-interest expense
    
    
    7,083
    
    
    
    7,417
    
    
    
    7,638
    
    
    
    7,540Income before income taxes
    
    
    4,336
    
    
    
    4,515
    
    
    
    4,139
    
    
    
    4,734Income taxes
    
    
    740
    
    
    
    849
    
    
    
    856
    
    
    
    1,279Net income
    
    $
    3,596
    
    
    $
    3,666
    
    
    $
    3,283
    
    
    $
    3,455Basic earnings per share
    
    $
    0.48
    
    
    $
    0.48
    
    
    $
    0.43
    
    
    $
    0.45Dividends declared per share
    
    $
    0.18
    
    
    $
    0.19
    
    
    $
    0.19
    
    
    $
    0.20
 Non-interest income for the fourth quarter of 2004 was negatively impacted by an impairment charge
totaling $1.2 million on securities available for sale which were determined to be other than
temporarily impaired and a loss on bank owned real estate of $246,000. Non-interest expense for
the fourth quarter of 2004 was impacted by the recognition of compensation expense of $1.1 million
representing the difference between the exercise price and market value of options on 41, 928
shares of PennRock stock. NOTE 22: PENDING MERGER On November 16, 2004, PennRock announced that it had signed a definitive agreement pursuant to
which PennRock will combine with Community Banks, Inc. (Community) under Communitys charter.
Under the terms of the agreement, each PennRock shareholder will receive 1.4 shares of Community in
exchange for each share of PennRock common stock. At the time of the announcement, the value of
the transaction was approximately $326 million. Following consummation, the joint franchise will
include 69 banking offices in central and south-central Pennsylvania and northern Maryland. The
merger is subject to regulatory approval and the separate approvals of the shareholders of both
PennRock and Community. 59




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PennRock Financial Services Corp. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND



FINANCIAL DISCLOSURE During the fiscal year ended December 31, 2004, there were no disagreements between PennRock and
Crowe Chizek and Company LLC on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedure, which disagreements, if not resolved to Crowe
Chizek and Company LLCs satisfaction, would have caused Crowe Chizek and Company LLC to make
reference to the subject matter of the disagreement in connection with its reports on PennRocks
consolidated financial statements for the period ended December 31, 2004. During the fiscal years ending December 31, 2003 and 2002, there were no disagreements with Simon
Lever LLP and their report on PennRocks consolidated financial statements for 2003 and 2002
contained no adverse opinion or disclaimer of opinion or qualification or modification as to
uncertainty, audit scope or accounting principles. Disclosure relating to a change in accountants is set forth in a Current Report on Form 8-K dated
September 30, 2003 previously filed by the Registrant. 
 ITEM 9A. CONTROLS AND PROCEDURES As of the end of the period covered by this Annual Report on Form 10-K, an evaluation was carried
out by PennRocks management, with the participation of the Chief Executive Officer (CEO) and
Chief Financial Officer (CFO), of the effectiveness of the design and operation of PennRocks
disclosure controls and procedures (as defined in Section 13(a)-15(e) and 15d-15(e) of the
Securities and Exchange Act of 1934) pursuant to Exchange Act Rule 13a-15. Based on that
evaluation, our CEO and CFO concluded that PennRocks disclosure controls and procedures as of
December 31, 2004 are effective in timely alerting them to material information relating to
PennRock (including its consolidated subsidiaries) to be included in PennRocks periodic filings
under the Exchange Act. Pursuant to the SECs Exemptive Order in Release No. 34-50154, PennRock will file managements
annual report on internal control over financial reporting and the related attestation report of
the registered public accounting firm by an amendment to this Form 10-K not later than 45 days
after the date this Form 10-K was due. 
 ITEM 9B. OTHER INFORMATION No changes were made to PennRocks internal controls over financial reporting (as defined in Rule
13a- 15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the fourth quarter of
year ended December 31, 2004 that materially affected, or are reasonably likely to materially
affect, PennRocks internal control over financial reporting. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information Concerning Directors and Executive Officers Information concerning the directors of PennRock is set forth below. The following table also
includes information concerning shares of PennRock common stock owned beneficially by executive
officers who are named in the Summary Compensation Table appearing elsewhere in this Form 10-K and
by all directors and executive officers as a group. 60




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PennRock Financial Services Corp. Shares of PennRockCommon Stock
    
    
    PercentDirector
    
    
    Beneficially Owned as
    
    
    of
    
    
    Principal Occupation for the Past 5 Years and OtherName and Age
    
    
    Since
    
    
    of February 4, 20052,3
    
    
    Class
    
    
    Directorships4CLASS A (TERM EXPIRES IN 2006)Norman Hahn (68)
(Retired as of 1-1-05)
    
    
    19761
    
    
    
    176,440
    
    
    
    
    2.30
    %
    
    
    Chairman of the
Board, Conestoga
Wood Specialties,
Corp. (manufacturer
of wood products)Melvin Pankuch (65)
    
    
    
    1988
    
    
    
    
    13,219
    
    
    
    
    *
    
    
    
    Executive Vice
President and Chief
Executive Officer,
PennRock and
President and Chief
Executive Officer,
Blue Ball National
BankRobert L. Spotts (75)
    
    
    19851
    
    
    
    26,277
    
    
    
    
    *
    
    
    
    Retired. Formerly
President, Martin
Limestone, Inc.
(quarry)Dale M. Weaver (66)
    
    
    19771
    
    
    
    139,935
    
    
    
    
    1.82
    %
    
    
    Partner, D & L
Partners (real
estate investment);
formerly,
President, NewDale M. Weaver (66)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Holland Custom
Woodwork, Ltd.
(church furniture
and millwork)CLASS B (TERM EXPIRES IN 2004)Irving E. Bressler (54)
    
    
    
    1997
    
    
    
    
    1,700
    
    
    
    
    *
    
    
    
    President, Bressler
Auto Specialties,
d/b/a Autospa of
Wyomissing Hills
(car wash and auto
detailing)Sandra J. Bricker (57)
    
    
    
    1999
    
    
    
    
    763
    
    
    
    
    *
    
    
    
    President, The
Bricker Group
(consultant to and
owner and operator
of retirement
communities)Elton Horning (74)
    
    
    
    1989
    
    
    
    
    46,090
    
    
    
    
    *
    
    
    
    Auctioneer, Owner
of Elton Horning
Farm Agency and
Partner of Horning
Farm Agency (real
estate agency)Glenn H. Weaver (70)
    
    
    19851
    
    
    
    130,022
    
    
    
    
    1.69
    %
    
    
    President,
PennRock; Partner,
Old Sycamore
Associates (real
estate investment)CLASS C (TERM EXPIRES IN 2005)Dennis L. Dinger (54)
    
    
    
    2003
    
    
    
    
    1,000
    
    
    
    
    *
    
    
    
    Financial
Consultant;
formerly Executive
Vice President and
Chief Financial
Officer,
Everybrook, Inc.
(software
development),
Director of
Finance, Keen
Transport, Inc.
(trucking and
warehouse services)
and Chief Financial
Officer, Dauphin
Deposit Bank &
Trust CompanyLewis M. Good (46)
    
    
    
    1991
    
    
    
    
    5,659
    
    
    
    
    *
    
    
    
    President, Original
Goods Potato
Chips, Inc. (food
products)Aaron S. Kurtz (66)
    
    
    19801
    
    
    
    7,444
    
    
    
    
    *
    
    
    
    President, Ludwig
Office Furniture,
Inc. (office
furniture)Robert K. Weaver (56)
    
    
    19751
    
    
    
    27,392
    
    
    
    
    *
    
    
    
    Area Director,
Eastern
Pennsylvania, Joni
and Friends
(charitable
organization);
formerly Partner,
Wentz, Weaver &
Kling, LLP (law
firm)NAMED EXECUTIVE OFFICERS WHO ARE NOT DIRECTORSGeorge B. Crisp
    
    
    
    
    
    
    
    
    12,461
    
    
    
    
    *Joseph C. Spada
    
    
    
    
    
    
    
    
    17,894
    
    
    
    
    *Michael H. Peuler
    
    
    
    
    
    
    
    
    16,602
    
    
    
    
    *All Directors and
Executive Officers as
a group (15 persons)
    
    
    
    
    
    
    
    
    622,898
    
    
    
    
    8.11
    %
   *
    
    Less than one percent of the total number of shares of common stock outstanding. FOOTNOTES  1.
    Includes service as a director of Blue Ball National Bank, predecessor to PennRock.2.
    Beneficial ownership of shares of the common stock of PennRock is determined in
accordance with SEC Rule 13d-3(d)(1), which provides that a person shall be deemed to own
any stock with respect to which he, directly or indirectly, through any contract,
arrangement, understanding, relationship or otherwise has or shares: (i) voting power,
which includes the power to vote or to direct the voting of the stock, or 61




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PennRock Financial Services Corp.  (ii)
    investment power, which includes the power to dispose or direct the disposition of the
stock.  3.
    Beneficial ownership of shares of the common stock of PennRock is determined in
accordance with SEC Rule 13d-3(d)(1), which provides that a person shall be deemed to own
any stock with respect to which he, directly or indirectly, through any contract,
arrangement, understanding, relationship or otherwise has or shares: (i) voting power,
which includes the power to vote or to direct the voting of the stock, or (ii) investment
power, which includes the power to dispose or direct the disposition of the stock.4.
    Each person named in this table has sole voting and investment power with respect to
the shares listed above, except that voting and investment power with respect to a total of
96,995 shares is shared with spouses, children or other family members. The shares shown
above include a total of 199,297 shares which are held by spouses, children or other family
members or by trusts or estates with respect to which a director or executive officer
serves as trustee or executor, beneficial ownership of which is in each case disclaimed.
Also included in the shares shown above are a total of 31,125 shares which may be acquired
pursuant to the exercise of stock options which are currently vested or which will vest
within 60 days, which shares are treated as issued and outstanding for purposes of
determining ownership percentage.5.
    No nominee or continuing director is a director of any other company which has one or
more classes of securities registered with the SEC pursuant to Section 12 or which is
required to file periodic reports with the SEC pursuant to Section 15(d) of the Securities
Exchange Act of 1934. Executive Officers of PennRock The following persons are the executive officers of PennRock: Name
    
    Age
    
    Office Held and Term of OfficeMelvin Pankuch
    
    
    65
    
    
    Executive Vice President and Chief Executive
Officer of PennRock since 1989; President and
Chief Executive Officer of Blue Ball National
Bank since 1988.George B. Crisp
    
    
    57
    
    
    Vice President and Treasurer of PennRock since
1989; Executive Vice President Operations of
Blue Ball National Bank since 2003 (previously,
Senior Vice President since 1993).Joseph C. Spada
    
    
    54
    
    
    Executive Vice President  Sales of Blue Ball
National Bank since 2003 (previously, Senior
Vice President since 1993).Michael H. Peuler
    
    
    54
    
    
    Executive Vice President  Financial Services
of Blue Ball National Bank since 2003
(previously, Senior Vice President since 1995);
President of PennRock Financial Advisors, N.A.
since 2004.
 Audit Committee and Audit Committee Financial Expert The Board of Directors has a standing Audit Committee. Members of the Audit Committee during 2004
were Dennis L. Dinger, Chairman, and Irving E. Bressler, Sandra J. Bricker, Lewis M. Good, Norman
Hahn, Elton Horning and Robert L. Spotts. The Board of Directors has determined that Mr. Dinger is
an independent director as such term is defined in the Marketplace Rules of the National
Associates of Securities Dealers, Inc. (the NASD) and qualifies as an audit committee financial
expert in accordance with the requirements of the Sarbanes-Oxley Act and applicable SEC rules and
regulations. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires that the directors and certain
officers of PennRock file with the SEC reports of ownership and changes in ownership with respect
to shares of PennRock common stock beneficially owned by them. Based solely upon its review of
copies of such reports furnished to it and written representations made by its directors and those
officers who are subject to such reporting requirements, PennRock 62




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PennRock Financial Services Corp. believes that during the calendar year ended December 31, 2004, all Section 16(a) filing
requirements applicable to its directors and officers were complied with. Information About Code of Ethics The Board of Directors has adopted a Code of Business Conduct and Ethics which is applicable to
PennRocks Chief Executive Officer and to its senior financial officers, as well as to all
directors, other officers and employees of PennRock and its subsidiaries. This Code focuses
specifically upon principles of ethical business conduct, assuring the integrity of PennRocks
periodic reports and other public communications, and compliance with all applicable government
rules and regulations, and is intended to comply with the requirements with the Sarbanes-Oxley Act
and related SEC rules and regulations, as well as those of the Marketplace Rules of the NASD. A
copy of PennRocks Code of Business Conduct and Ethics is posted on PennRocks website at
www.pennrock.com. 
 ITEM 11. EXECUTIVE COMPENSATION Director Compensation The directors of PennRock do not receive any additional compensation for their services as such,
beyond the compensation paid to them as directors of Blue Ball National Bank. Each member of the
Board of Directors of Blue Ball National Bank, other than the Chairman of the Board, is paid an
annual fee of $2,200 for his services as a director, a fee of $435 for each regular meeting of the
Board of Directors which he attends, and $185 for each meeting of a committee of the Board of
Directors which he attends. In addition to the regular directors compensation, the Secretary of
the Board of Directors also receives an additional fee of $6,500. The Chairman of the Board
receives an annual fee of $16,000 and a fee of $185 for each committee meeting of the Board of
Directors which he attends. No directors fees are paid to any director who is also a full-time
salaried officer of Blue Ball National Bank or PennRock. Executive Compensation and Related Matters Summary of Cash and Certain Other Compensation The following table provides certain summary information concerning compensation paid or accrued by
PennRock and Blue Ball National Bank to the chief executive officer of PennRock and to each of the
other most highly compensated executive officers of PennRock whose combined salary and bonus
compensation exceeded $100,000 for the year ended December 31, 2004. 63




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PennRock Financial Services Corp. SUMMARY COMPENSATION TABLE Long Term CompensationAnnual Compensation
    
    Awards
    
    Payouts(a)
    
    (b)
    
    (c)
    
    (d)
    
    (e)
    
    (f)
    
    (g)
    
    (h)
    
    (i)Other
    
    
    
    
    
    
    
    
    SecuritiesName
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Annual
    
    
    
    Restricted
    
    
    
    Underlying
    
    
    
    
    
    
    
    
    All OtherAnd
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Compen-
    
    
    
    Stock
    
    
    
    Options/
    
    
    
    LTIP
    
    
    
    Compen-Principal
    
    
    
    
    
    
    
    Salary
    
    
    
    Bonus1
    
    
    
    sation
    
    
    
    Awards
    
    
    
    SARs2
    
    
    
    Payouts
    
    
    
    sation3Position
    
    
    Year
    
    
    
    ($)
    
    
    
    ($)
    
    
    
    ($)
    
    
    
    ($)
    
    
    
    (#)
    
    
    
    ($)
    
    
    
    ($)Melvin Pankuch,
Executive Vice
President and
    
    
    
    2004
    
    
    
    $
    345,986
    
    
    
    $
    54,506
    
    
    
    None
    
    
    None
    
    
    
    12,000
    
    
    
    None
    
    
    $
    17,963Chief Executive
    
    
    
    2003
    
    
    
    
    335,879
    
    
    
    
    46,841
    
    
    
    None
    
    
    None
    
    
    
    13,200
    
    
    
    None
    
    
    
    24,949Officer
    
    
    
    2002
    
    
    
    
    321,487
    
    
    
    
    37,267
    
    
    
    None
    
    
    None
    
    
    
    14,520
    
    
    
    None
    
    
    
    25,256George B. Crisp,
    
    
    
    2004
    
    
    
    $
    185,819
    
    
    
    $
    26,767
    
    
    
    None
    
    
    None
    
    
    
    6,000
    
    
    
    None
    
    
    $
    17,963Vice President
    
    
    
    2003
    
    
    
    
    161,322
    
    
    
    
    23,287
    
    
    
    None
    
    
    None
    
    
    
    6,600
    
    
    
    None
    
    
    
    23,029and Treasurer
    
    
    
    2002
    
    
    
    
    141,623
    
    
    
    
    17,552
    
    
    
    None
    
    
    None
    
    
    
    7,260
    
    
    
    None
    
    
    
    20,034Joseph C. Spada,
Executive Vice
President, Blue
    
    
    
    2004
    
    
    
    $
    194,822
    
    
    
    $
    26,691
    
    
    
    None
    
    
    None
    
    
    
    6,000
    
    
    
    None
    
    
    $
    17,963Ball National
    
    
    
    2003
    
    
    
    
    170,629
    
    
    
    
    23,605
    
    
    
    None
    
    
    None
    
    
    
    6,600
    
    
    
    None
    
    
    
    24,178Bank
    
    
    
    2002
    
    
    
    
    145,713
    
    
    
    
    18,062
    
    
    
    None
    
    
    None
    
    
    
    7,260
    
    
    
    None
    
    
    
    20,614Michael H. Peuler,
Executive Vice
President, Blue
    
    
    
    2004
    
    
    
    $
    163,850
    
    
    
    $
    26,259
    
    
    
    None
    
    
    None
    
    
    
    6,000
    
    
    
    None
    
    
    $
    17,753Ball National
    
    
    
    2003
    
    
    
    
    161,683
    
    
    
    
    23,379
    
    
    
    None
    
    
    None
    
    
    
    6,600
    
    
    
    None
    
    
    
    23,085Bank
    
    
    
    2002
    
    
    
    
    142,643
    
    
    
    
    17,681
    
    
    
    None
    
    
    None
    
    
    
    7,260
    
    
    
    None
    
    
    
    20,179
 FOOTNOTES  1.
    Consists of the cash and PennRock common stock components of: (i) the bonus
compensation awarded under the Bonus Compensation Plan, and (ii) the bonus compensation
awarded under the Executive Incentive Compensation Plan.2.
    Adjusted to reflect stock splits and stock dividends since date of grant.3.
    Consists of the non-cash component of the bonus awarded under the Bonus Compensation
Plan in the form of a contribution to the Profit Sharing Plan maintained by Blue Ball
National Bank. 64




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PennRock Financial Services Corp. Stock Options Granted in 2004 The following table sets forth certain information relating to stock options granted during 2004 to
the executive officers named in the Summary Compensation Table appearing above. No stock
appreciation rights (SARs) were granted in 2004. OPTION/SAR GRANTS IN 2004 Individual GrantsNumber of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Potential RealizableValue at AssumedShares
    
    
    
    Percent of Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    Annual Rates of StockUnderlying
    
    
    
    Options/SARs
    
    
    
    
    
    
    
    
    
    
    
    
    
    Price Appreciation forOptions/SARs
    
    
    
    Granted to Employees
    
    
    
    Exercise or
    
    
    
    
    
    
    
    Option Term4Granted in 20041,2
    
    
    
    in Fiscal Year
    
    
    
    Base Price2,3
    
    
    
    Expiration
    
    
    
    5%
    
    
    
    10%Name
    
    
    (#)
    
    
    
    (%)
    
    
    
    ($/Share)
    
    
    
    Date
    
    
    
    ($)
    
    
    
    ($)Melvin Pankuch
    
    
    
    12,000
    
    
    
    
    27
    %
    
    
    $
    28.12
    
    
    
    
    6-14-14
    
    
    
    $
    212,214
    
    
    
    $
    537,792Joseph C. Spada
    
    
    
    6,000
    
    
    
    
    13
    %
    
    
    
    28.12
    
    
    
    
    6-14-14
    
    
    
    
    106,080
    
    
    
    
    268,920George B. Crisp
    
    
    
    6,000
    
    
    
    
    13
    %
    
    
    
    28.12
    
    
    
    
    6-14-14
    
    
    
    
    106,080
    
    
    
    
    268,920Michael H. Peuler
    
    
    

6,000
    
    
    
    
    13
    %
    
    
    
    28.12
    
    
    
    
    6-14-14
    
    
    
    
    106,080
    
    
    
    
    268,920
 FOOTNOTES   1.
    
    Represents the grant of incentive stock options on June 14, 2004 pursuant to the terms
of the Stock Incentive Plan of 2002. Each option vests and becomes exercisable one-half
after the expiration of three years from the date of grant and the balance after the
expiration of five years from the date of grant; provided, however, that, to the extent not
previously vested, each option vests upon the occurrence of a change in control of
PennRock. Each option expires, to the extent not previously exercised, upon termination of
employment for reasons other than retirement, disability or death.2.
    
    Adjusted to reflect stock splits and stock dividends since date of grant.3.
    
    Exercise price in each case is equal to 100% of fair market value on the date of grant.4.
    
    The dollar amounts set forth in these columns are based upon assumed annual
appreciation rates of 5% and 10% as required under applicable SEC regulations and are not
intended to indicate the possible future price appreciation, if any, of PennRock common
stock. No gain will be realized by the option holder in the absence of an increase in the
market price of PennRock common stock, which will benefit all shareholders. Stock Option Exercises and 2004 Year-End Values The following table sets forth with respect to the executive officers named in the Summary
Compensation Table certain information relating to the exercise of stock options during 2004 and
relating to the number and value of unexercised stock options and SARs held as of December 31,
2004. No SARs were either granted or exercised in 2003 and none were outstanding on December 31,
2004. 65




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PennRock Financial Services Corp. 2004 OPTION EXERCISE AND YEAR-END VALUES Value of Unexercised In-The-Value Realized
    
    
    
    Number of
    
    
    
    Money(Market Value
    
    
    
    Unexercised
    
    
    
    Options/SARs at Fiscal Year-Shares
    
    
    
    at Exercise,
    
    
    
    Options/SARs at
    
    
    
    EndAcquired on
    
    
    
    Less Exercise
    
    
    
    Fiscal Year-End
    
    
    
    12-31-2004Exercise
    
    
    
    Price)
    
    
    (#)
    
    ($)Name
    
    (#)

    
    
    ($)
    
    
    
    Exercisable
    
    
    
    Unexercisable
    
    
    
    Exercisable
    
    
    
    UnexercisableMelvin Pankuch
    
    
    
    32,399
    
    
    
    $
    811,201
    
    
    
    
    --0--
    
    
    
    
    52,425
    
    
    
    
    --0--
    
    
    
    
    $ 894,237George B. Crisp
    
    
    
    6,352
    
    
    
    
    176,395
    
    
    
    
    8,896
    
    
    
    
    26,213
    
    
    
    $
    200,033
    
    
    
    
    447,129Joseph C. Spada
    
    
    
    13,977
    
    
    
    
    362,750
    
    
    
    
    --0--
    
    
    
    
    26,213
    
    
    
    
    --0--
    
    
    
    
    447,129Michael H. Peuler
    
    
    
    8,894
    
    
    
    
    166,894
    
    
    
    
    6,354
    
    
    
    
    26,213
    
    
    
    
    141,885
    
    
    
    
    447,129
 Compensation Committee Interlocks and Insider Participation Each director of PennRock, other than the Chief Executive Officer, was a member of the Executive
Compensation Committee in 2004. No member of the Executive Compensation Committee was an employee
of PennRock (or of any PennRock subsidiary) at any time during 2004. Glenn H. Weaver, who was an
employee of Blue Ball National Bank until 1989, is not now an employee of PennRock (or of any
PennRock subsidiary), but serves as President of PennRock. There were no compensation committee
interlocks during 2004, which in general terms means that no executive officer or director of
PennRock served as a director or member of the compensation committee of another entity, one of
whose executive officers served as a director of PennRock. Executive Employment Agreements On December 17, 1999 PennRock and its wholly owned subsidiary, Blue Ball National Bank
(collectively, the Employers), entered into an Employment Agreement with Melvin Pankuch ( the
Employment Agreement), under the terms of which PennRock engaged Mr. Pankuch as its Executive
Vice President and Chief Executive Officer and Blue Ball National Bank engaged Mr. Pankuch as its
President and Chief Executive Officer. The Employment Agreement provides for an initial term of
two years and is subject to automatic renewal for successive additional periods of two years each,
unless either Mr. Pankuch or the Employers elect not to renew by giving written notice to the other
180 days in advance of the expiration of the then current term. The Employment Agreement provides that Mr. Pankuch shall receive a salary of not less than $265,000
per year, subject to annual review and adjustment. The Employment Agreement also entitles Mr.
Pankuch to participate in the incentive compensation and employee benefits plans maintained by the
Employers. The Employment Agreement terminates in the event of Mr. Pankuchs disability or death and may be
terminated by the Employers at any time, with or without cause. Mr. Pankuch has the right to
terminate the Employment Agreement, with or without cause, by resigning upon 180 days advance
written notice and has the right to terminate his employment for good reason (as defined in the
Employment Agreement) upon 60 days advance written notice following the occurrence of a change in
control (as defined in the Employment Agreement). Mr. Pankuch is entitled to receive certain severance benefits in the event that the Employers elect
not to renew the Employment Agreement or in the event that the Employers elect to terminate the
Employment Agreement without cause. The severance benefits to which Mr. Pankuch would be entitled
include salary continuation for up to 24 months, except that the Employers are not obligated to
continue to make salary continuation payments after the expiration of 12 months from the date of
termination if Mr. Pankuch obtains a comparable executive level position with another employer. In
addition, if Mr. Pankuch elects to purchase continuation coverage under the Employers medical
insurance plan, the Employers are required to reimburse him for such expense. Mr. Pankuch is,
however, obligated to mitigate the obligation of the Employers to pay the foregoing severance
benefits by using his best efforts to obtain a comparable executive level position with another
employer. Mr. Pankuch is also entitled to receive severance benefits following the occurrence of a
change in control in the event that he elects to terminate the 66




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PennRock Financial Services Corp. Employment Agreement for good reason or if the successor to the Employers elects to terminate the
Employment Agreement prior to the end of its then current term other than for cause. The severance
benefits to which Mr. Pankuch would be entitled under these circumstances include a severance
payment in an amount equal to three times his then current annual compensation (which amount is
subject to reduction so as to avoid the imposition of an excise tax under Section 4999 of the
Internal Revenue Code of 1986) and reimbursement of the expense incurred by Mr. Pankuch if he
elects to purchase continuation coverage under the Employers medical insurance plan. Blue Ball National Bank entered into employment agreements with each of George B. Crisp, Joseph C.
Spada and Michael H. Peuler in April of 2000. These agreements are substantially similar to the
Employment Agreement entered into with Mr. Pankuch, except that: (i) the base salaries payable to
Messrs. Crisp, Spada and Peuler are $130,268, $132,798 and $130,308, respectively, and (ii) the
severance payment provided for in the event of termination following a change in control is equal
to two times then current annual compensation. PennRocks chief executive officer and the other executive officers named in the Summary
Compensation Table appearing above are eligible to participate in the Blue Ball National Bank
Deferred Compensation Plan (the Deferred Compensation Plan). Under the Deferred Compensation
Plan, a participant may elect to defer receipt of a portion of his compensation and the amounts so
deferred are credited with interest at a rate of not less than eight percent (8%) per year. A
participant who retires after attaining age 65 is entitled to receive the balance in his account in
15 equal annual installments with interest credited at the rate of eight percent (8%) per year. If
a participant dies after becoming entitled to receive retirement benefits under the Deferred
Compensation Plan, the remaining payments are payable to his designated beneficiary. In the event
that a participant retires before attaining age 65 or in the event that his employment otherwise
terminates prior to his attaining age 65 for any reason other than disability or death, the
participant is entitled to receive in a lump sum payment the aggregate amount of compensation
deferred by him and the interest otherwise credited to his account is forfeited. In the event that
a participants employment is terminated by reason of disability or death, he or his designated
beneficiary is entitled to receive the balance in his account in 15 equal annual installments with
interest credited at the rate of eight percent (8%) per year. Finally, in the event that PennRock
is acquired by another entity and in the further event that a participants employment is
thereafter involuntarily terminated prior to his attaining age 65, then in such event the
participant is entitled to receive the then current balance in his account, including accrued
interest, in a single lump sum payment. Board Compensation Committee Report on Executive Compensation PennRocks executive compensation policies are established and administered by the Executive
Compensation Committee of the Board of Directors. The Executive Compensation Committee is
responsible for, among other things, administering and making grants and awards under the Bonus
Compensation Plan, the Executive Compensation Plan and the Stock Incentive Plan of 2002. The
Executive Compensation Committee is also responsible for evaluating and determining the
compensation of the Chief Executive Officer and PennRocks other executive officers. Each director
of PennRock, other than the Chief Executive Officer, was a member of the Executive Compensation
Committee in 2004. The Executive Compensation Committee annually evaluates the Chief Executive Officer and determines
his salary and awards under the Compensation Plans referred to above. The salaries of PennRocks
other executive officers, as well as awards under the Compensation Plans referred to above, are
also determined by the Executive Compensation Committee based upon recommendations made by Mr.
Pankuch. Mr. Pankuch, in his capacity as Chief Executive Officer, regularly reviews executive
compensation matters with the Executive Compensation Committee and with the Personnel Committee of
Blue Ball National Bank. The Executive Compensation Committee is responsible for establishing appropriate compensation
policies applicable to the executive officers of PennRock and for overseeing the administration of
that policy. The overall objective of the Executive Compensation Committees policy is to provide
competitive levels of compensation that integrate pay with annual and long term performance goals,
reward above average performance, recognize individual initiative and achievements and assist
PennRock in attracting, motivating and retaining capable senior executive officers. The
Committees policy provides for competitive base salary compensation which reflects individual
performance and for annual performance incentive compensation opportunities earned through the
achievement of financial performance and other goals established by the Committee and management.
In addition, the Executive Compensation Committee intends in the future to place greater emphasis
upon longer-term stock-based incentive opportunities through the implementation of the Stock
Incentive Plan of 2002, which was approved by the shareholders at the 2002 annual meeting. The
Committee is of the view that stock ownership by senior 67




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PennRock Financial Services Corp. executive officers and stock-based incentive compensation arrangements are beneficial in aligning
the interests of management and shareholders in the overall enhancement of profitability and
shareholder value. The Committee believes for this reason that it may in the future rely more
heavily upon stock-based incentive compensation arrangements in designing the compensation packages
of the executive officers of PennRock. In designing and administering the individual elements of its executive compensation policy, the
Executive Compensation Committee strives to balance short-term and long-term incentive objectives
and to employ prudent judgment in establishing performance criteria, evaluating performance and in
determining the amount of overall compensation. What follows is a discussion of each of the
elements of the Committees compensation policy, together with a summary of decisions made by the
Committee in 2004 with respect to the compensation of Mr. Pankuch. The Omnibus Budget Reconciliation Act of 1993 (the Act) imposes certain limitations on the
deductibility for federal income tax purposes of annual compensation in excess of $1 million
payable to certain officers of PennRock. Because the Executive Compensation Committee does not
anticipate that the annual compensation of any officer will exceed $1 million, it does not intend
to modify the compensation policy of PennRock in response to the provisions of the Act. Base Salary The base salary component of an executive officers compensation is determined annually by
reference to salary surveys and other data and is adjusted as necessary to be competitive with
average salaries paid to executive officers at other banks and bank holding companies of equivalent
size and characteristics. The actual salary paid to an executive officer is determined through an
annual performance appraisal, which evaluates performance by reference to the following factors:
supervisory and management performance, marketing and sales plan performance, internal cooperation,
reporting and communication, customer and public relations, strategic and business plan development
and achievement, and profit planning and budgeting. The Executive Compensation Committee also
considers the financial goals that were set at the beginning of the year by the Committee and
management and relates them to year-end results. These goals include growth in assets, growth in
deposits, percentage increase in net income for the year, growth in loans, return on equity and
return on assets. Bonus Compensation Plan The Bonus Compensation Plan is an annual incentive program for all employees, including executive
officers and other key management employees. The purpose of the Plan is to provide a direct
financial incentive in the form of an annual bonus that is related to return on equity. Bonuses
under the Bonus Compensation Plan are paid partly in cash and partly in the form of a contribution
to an employees account under the Blue Ball National Bank Profit Sharing Plan. Executive Incentive Compensation Plan The Executive Incentive Compensation Plan is a compensation plan under which key officers (vice
presidents and above) of PennRock and Blue Ball National Bank are eligible to receive bonuses equal
to a percentage of salary. The Plan was adopted by the Board of Directors in 1994. The amount of
bonus, if any, awarded under the Plan is determined on the basis of an objective two-part formula.
The first part of the formula is based upon return on equity relative to peer group bank holding
company performance. (The peer group used for this purpose consists of the approximately 207 bank
holding companies comprising Peer Group No. 3 as published by the Federal Reserve Board in its
annual Bank Holding Company Performance Report.) The second part of the formula is based upon
year-to-year comparative growth in PennRocks net income. Historically, a bonus earned under the
Plan with respect to current year performance was paid in the spring of the following year and was
payable 70% in cash and 30% in shares of PennRock common stock valued at fair market value.
However, bonuses which would historically have been paid in the spring of 2005 were (in the case of
the Chief Executive Officer and the other three executive officers) paid in cash in December of
2004 and the amount of such bonuses was in the case of each of the four officers involved equal to
the amount of the bonus paid to him in the spring of 2004. Stock Incentive Plan of 2002 The Stock Incentive Plan of 2002 (the Stock Incentive Plan), which was approved by the
shareholders at the 2002 annual meeting, is a long-term incentive plan for senior executives of
PennRock. The objectives sought to be 68




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PennRock Financial Services Corp. achieved by the grant of awards under the Stock Incentive Plan are to align executive and
shareholder long-term interests by creating a strong and direct link between overall executive
compensation and shareholder return and to enable senior officers to develop and maintain a
significant, long-term stock ownership position in PennRock common stock. Awards may be granted
under the Stock Incentive Plan in the form of incentive stock options, non-qualified stock options,
and bonus stock. Messrs. Pankuch, Crisp, Peuler and Spada were each granted incentive stock
options to purchase shares of PennRock common stock as described in the Option/SAR Grants in 2004
Table appearing above. Compensation of the Chief Executive Officer Mr. Pankuchs compensation is determined in accordance with the compensation policy of the
Executive Compensation Committee described above and he is eligible to participate in the
Compensation Plans described above. The general approach adopted by the Executive Compensation
Committee in determining Mr. Pankuchs annual compensation is to seek to be competitive with other
bank holding companies of equivalent size and characteristics, but to have a significant percentage
of his total compensation based upon the achievement of short-term and long-term performance goals.
This approach provides a strong incentive to achieve or surpass the goals established by the
Committee, while simultaneously providing an element of stability in Mr. Pankuchs compensation. Mr. Pankuchs base salary during 2003 was $335,879 and was set by the Executive Compensation
Committee at $345,986 for 2004 (an increase of approximately 3.0%, based upon the factors discussed
above and upon an evaluation conducted by the Committee. Mr. Pankuch received in 2004 a bonus of $39,491 under the Bonus Compensation Plan, which is
reflected in the Summary Compensation Table set forth above. The amount of this bonus was
determined by the Executive Compensation Committee in accordance with the terms of the Bonus
Compensation Plan. Specifically, $21,528 was paid in cash and $17,963 was contributed to Mr.
Pankuchs account under the Blue Ball National Bank Profit Sharing Plan. In addition, Mr. Pankuch
received under the Executive Incentive Compensation Plan in 2004 a bonus of $16,489 with respect to
PennRocks 2003 financial performance and a bonus of $16,489 with respect to PennRocks 2004
financial performance, which bonuses are reflected in the Summary Compensation Table set forth
above. This report is not intended to be soliciting material, is not intended to be filed with the
SEC, and is not intended to be incorporated by reference into any filing made by PennRock with the
SEC under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether such filing is
made before or after the date hereof and notwithstanding any general incorporation language
contained in any such filing
The foregoing report is submitted by Dennis L. Dinger, Chairman of the Executive
Compensation Committee, and Irving E. Bressler, Sandra J. Bricker, Elton Horning,
Lewis M. Good, Aaron S. Kurtz, Robert L. Spotts, Dale M. Weaver, Glenn H. Weaver
and Robert K. Weaver. 69




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PennRock Financial Services Corp. Stock Performance Graph The SEC requires that a publicly held company include in its proxy statement a graph comparing five
year cumulative total shareholder returns (assuming the reinvestment of dividends) with a broad
market index and with a published industry or line-of-business index or an index of peer group
companies. The graph appearing below illustrates the five-year cumulative return to a shareholder
of PennRock as compared to the Russell 3000 Index and a peer group of ten other comparable bank
holding companies, in each case weighted by market capitalization and assuming an initial
investment of $100.00 on December 31, 1999 and the reinvestment of all dividends over the periods
indicated. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
AMONG PENNROCK FINANCIAL SERVICES CORP.,
RUSSELL 3000 INDEX, AND PEER GROUP INDEX (PERFORMANCE GRAPH) December 31,
    
    
    
    December 31,
    
    
    
    December 31,
    
    
    
    December 31,
    
    
    
    December 31,
    
    
    
    December 31,1999
    
    
    
    2000
    
    
    
    2001
    
    
    
    2002
    
    
    
    2003
    
    
    
    2004PennRock
    
    
    $
    100.00
    
    
    
    $
    85.01
    
    
    
    $
    147.77
    
    
    
    $
    208.65
    
    
    
    $
    264.04
    
    
    
    $
    339.58Russell 3000
    
    
    
    100.00
    
    
    
    
    92.54
    
    
    
    
    81.94
    
    
    
    
    64.29
    
    
    
    
    84.25
    
    
    
    
    94.32Peer Group
    
    
    
    100.00
    
    
    
    
    78.07
    
    
    
    
    113.89
    
    
    
    
    139.39
    
    
    
    
    185.23
    
    
    
    
    206.35
 70




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PennRock Financial Services Corp. PEER GROUP SPECIFICATIONS1. Total assets of $546 million to $2.7 billion.2. Market capitalization of at least $88 million.3. Headquartered in Pennsylvania.Institution
    
    
    HeadquartersACNB Corporation
    
    
    GettysburgCNB Financial Corporation
    
    
    ClearfieldCitizens & Northern Corporation
    
    
    WellsboroCommunity Banks, Inc.
    
    
    HarrisburgFirst Chester County Corporation
    
    
    West ChesterFranklin Financial Services Corporation
    
    
    ChambersburgPenseco Financial Services Corp.
    
    
    ScrantonPennRock Financial Services Corp.
    
    
    Blue BallPenns Woods Bancorp, Inc.
    
    
    Jersey ShoreRoyal Bancshares of Pennsylvania
    
    
    NarberthSterling Financial Corporation
    
    
    Lancaster
 Source: SNL Securities 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information Concerning Securities Authorized for Issuance Under Equity Compensation Plans Information concerning securities authorized for issuance under PennRocks equity compensation
plans is set forth in Note 14 to the Notes to Consolidated Financial Statements and is incorporated
herein by reference. Security Ownership of Certain Beneficial Owners To the knowledge of PennRock, as of February 4, 2005, no person owned of record or beneficially
more than five percent of the outstanding common stock of PennRock. Security Ownership of Management Information concerning the security ownership of management is set forth in the table appearing in
Item 10 above, which is incorporated herein by reference. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Transactions with Management and Others Some of the directors and executive officers of PennRock and Blue Ball National Bank and the
companies with which they are associated were customers of and had banking transactions with Blue
Ball National Bank in the ordinary course of the Banks business during 2004. All loans and
commitments to loan made to such persons and to the companies with which they are associated were
made on substantially the same terms, including interest rates, collateral and repayment terms, as
those prevailing at the time for comparable transactions with other persons and did not involve
more than a normal risk of collectibility or present other unfavorable features. It is anticipated
that the Bank will enter into similar transactions in the future. As a matter of policy and as an employee benefit, Blue Ball National Bank makes available home
mortgage loans and other loans on a nondiscriminatory basis to all employees of PennRock and its
subsidiaries at interest rates below those prevailing for comparable transactions with other
persons. The amount of these loans is not considered material and it is anticipated that the Bank
will continue its present policy. Loans at preferential rates are not, however, extended to any
executive officer or director of PennRock or Blue Ball National Bank. 71




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PennRock Financial Services Corp. Aaron S. Kurtz, who is a PennRock director, is also the President and owner of Ludwig Office
Furniture, Inc. (Ludwig). During 2004, the Bank purchased approximately $118,000 of office
furniture from Ludwig in connection with the furnishing of two new branch offices which the Bank
opened that year. Although the prices paid to Ludwig were not determined on a competitive bid
basis, PennRock believes that such prices were consistent with market prices for comparable
products and were no greater than the Bank would have paid to an unrelated third party vendor. On November 30, 2004, PennRock purchased from Chief Executive Officer Melvin Pankuch 26,849 shares
of PennRock common stock at a price of $40.34 per share (being equal to the closing price of such
shares on November 29, 2004), representing a total purchase price of $1, 083,089. The shares sold
by Mr. Pankuch were acquired by him for $416,166 pursuant to the exercise of certain incentive
stock options granted to him under the Stock Incentive Plan of 2002. On November 30, 2004,
PennRock also paid Mr. Pankuch $144,278 in exchange for the surrender by him of certain
non-qualified options to acquire 5,550 shares of PennRock common stock, which options had also been
granted to him under the Stock Incentive Plan of 2002. The price paid to Mr. Pankuch in exchange
for his surrender of these options was equal to the difference between: (i) the aggregate value of
the underlying 5,550 shares PennRock common stock (determined on the basis of a price of $40.34 per
share, being equal to the closing price of such shares on November 29, 2004), and (ii) the
aggregate exercise price payable under the terms of the options involved. On November 30, 2004,
PennRock purchased from Vice President and Treasurer George B. Crisp 6,352 shares of PennRock
common stock at a price of $40.34 per share (being equal to the closing price of such shares on
November 29, 2004), representing a total purchase price of $256,240. The shares sold by Mr. Crisp
were acquired by him for $79,844 pursuant to the exercise of certain incentive stock options
granted to him under the Stock Incentive Plan of 2002. On November 30, 2004, PennRock purchased
from Michael H. Peuler, Executive Vice President of the Bank, 3,177 shares of PennRock common stock
at a price of $40.34 per share (being equal to the closing price of such shares on November 29,
2004), representing a total purchase price of $128,160. The shares sold by Mr. Peuler were
acquired by him for $39,681 pursuant to the exercise of certain incentive stock options granted to
him under the Stock Incentive Plan of 2002. On December 9, 2004, PennRock purchased from Joseph
C. Spada, Executive Vice President of the Bank, 2,795 shares of PennRock common stock at a price of
$40.23 per share (being equal to the closing price of such shares on December 8, 2004),
representing a total purchase price of $112,443. The shares sold by Mr. Spada were acquired by him
for $60,897 pursuant to open market purchases and purchases through the dividend reinvestment plan. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information Concerning Independent Public Accountants For the year ended December 31, 2003, PennRock engaged Simon Lever LLP, independent certified
public accountants (Simon Lever), to audit its financial statements and to provide certain
non-audit services, including advice on accounting, tax and reporting matters. On September 23,
2003, PennRocks Board of Directors elected to not to renew the appointment of Simon Lever as
PennRocks independent public accountants, effective upon the completion of their audit of
PennRocks consolidated financial statements for the year ended December 31, 2003, and engaged
Crowe Chizek and Company LLC (Crowe Chizek) to serve as PennRocks independent public accountants
for fiscal year 2004. Audit Fees Audit fees billed to PennRock by Crowe Chizek during 2004 and by Simon Lever during 2003 for
services related to the audit of PennRocks annual consolidated financial statements and the review
of the unaudited financial statements included in PennRocks Quarterly Reports on Form 10-Q totaled
$152,680 and $55,686, respectively. Audit Related Fees Crowe Chizek did not perform any audit related services in 2004. Fees billed to PennRock by Simon
Lever during 2003 for audit related services totaled $3,200 and $16,100, respectively. Audit
related services performed by Simon Lever consisted principally of the audit of the Blue Ball
National Bank Profit Sharing Plan, a FNMA annual eligibility compliance review, and matters
relating to managements review and assessment of the effectiveness of PennRocks internal
controls. 72




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PennRock Financial Services Corp. Tax Fees Crowe Chizek did not perform any tax related services in 2004. Fees billed to PennRock by Simon
Lever during 2003 for tax related services totaled $6,045. Tax related services performed by Simon
Lever consisted principally of tax compliance, tax advice and tax planning. All Other Fees Fees billed to PennRock by Crowe Chizek during 2004 and by Simon Lever during 2003 for all services
other than those identified above totaled $4,274 and $10,254, respectively. The other services
performed by Crowe Chizek and by Simon Lever consisted principally of research and advice on
various accounting issues. Audit Committee Pre-Approval Policies and Procedures The Audit Committee pre-approves all audit and non prohibited, non-audit services provided by the
independent auditors. These services may include audit services, audit-related services, tax
services and other services. The Audit Committee has adopted a policy for the pre-approval of
services provided by the independent auditors. Under the policy, pre-approval is generally
provided for up to one year and any pre-approval is detailed as to the particular service or
category of services and is subject to a specific budget. In addition, the Audit Committee may
also pre-approve particular services on a case-by-case basis. For each proposed service, the
independent auditor is required to provide detailed back-up documentation at the time of approval
or such other detailed information as the Audit Committee deems appropriate. The Audit Committee
may delegate pre-approval authority to one or more of its members. Such a member must report any
decisions to the Audit Committee at the next scheduled meeting. There were no waivers by the Audit
Committee of the pre-approval requirement for permissible non-audit services in 2004. 73




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PennRock Financial Services Corp. 
 PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Annual Report on Form 10-K:  1.
    Consolidated Financial Statements. required in response to this Item are incorporated by
reference to Part II, Item 8 of this Report. The following consolidated financial statements of PennRock and the report of the independent
certified public accountants thereon filed with this report are incorporated by reference to
Part II, Item 8 of this Report.: Report of Independent Registered Public Accounting Firm       2.
    Financial Statement Schedules. These Financial Statement Schedules are omitted because the required information is either not
applicable, not required or is shown in the respective financial statements or in the note
thereto.  3.
    The Exhibits to this Annual Report filed herewith or incorporated by reference as a part
are set forth in (c) below. (b) PennRock filed the following Current Reports on Form 8-K from October 1, 2004 to December 31,
2004: Current
Report on Form 8-K dated October 18, 2004, announcing PennRocks earnings for the quarter ended September 30, 2003. Current Report on Form 8-K dated November 16, 2004, announcing that PennRock and Community
Banks, Inc. had signed an agreement wherein PennRock will be merged with and into Community Banks,
Inc. Current Report on Form 8-K dated November 22, 2004, announcing that PennRock and Community
Banks, Inc. had signed a definitive agreement which sets forth the terms and conditions for the
merger of PennRock with and into Community Banks, Inc. Current
Report on Form 8-K dated December 14, 2004, announcing that PennRocks Board of Directors had declared a quarterly cash dividend. (c)        Exhibit Index 3(a)
    
    Articles of Incorporation of PennRock, incorporated by reference to Exhibit 3(a) of
PennRocks Annual Report on Form 10-K for the year ended December 31, 2000.3(b)
    
    Bylaws of PennRock, incorporated by
reference to Exhibit 3(b) of PennRocks Annual Report on
Form 10-K for the year ended December 31, 2003.10(a)
    
    Omnibus Stock Plan, incorporated by reference to Exhibit 4.1 to PennRocks
Registration Statement Number 33-53022 of Form S-8 dated October 8, 1992.10(b)
    
    Executive Incentive Compensation Plan, incorporated by reference to Exhibit 10(b)
of PennRocks Annual Report on Form 10-K for the year ended December 31, 2000.
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PennRock Financial Services Corp. 10(c)
    
    Melvin Pankuch Deferred Compensation Agreement Plan, incorporated by reference
to Exhibit 10(c) of PennRocks Annual Report on Form 10-K for the year ended
December 31, 2000.10(d)
    
    Melvin Pankuch Employment Agreement, incorporated by reference to
Exhibit 10(d) of PennRocks Annual Report on Form 10-K for the year ended
December 31, 2000.10(e)
    
    Employment Agreement with Certain Executive Officers, incorporated by reference
to Exhibit 10(e) of PennRocks Annual Report on Form 10-K for the year ended
December 31, 2000.10(f)
    
    Stock Incentive Plan of 2002, incorporated by reference to Exhibit 10(f) of PennRocks
Quarterly Report on Form 10-Q for the quarter ended March 31, 2002.10(g)
    
    Joseph C. Spada Deferred Compensation Plan Trust Declaration incorporated by
reference to Exhibit 10(g) of PennRocks Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003.10(h)
    
    George B. Crisp Deferred Compensation Plan Trust Declaration incorporated by
reference to Exhibit 10(h) of PennRocks Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003.11
    
    Statement re: Computation of Earnings per share (Included herein in Note 1: Summary of
Significant Accounting Policies in the Notes to Consolidated Financial Statements included
under Part II, Item 8 of this Report.)21
    
    Subsidiaries of the Registrant23.1
    
    Consent of Crowe Chizek and Company LLC23.2
    
    Consent of Simon Lever LLP31.1
    
    Rule 13a-14(a) Certification of Chief Executive Officer.31.2
    
    Rule 13a-14(a) Certification of Chief Financial Officer.32
    
    Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer.
 (d)    Financial Statement Schedules  None required. 75




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PennRock Financial Services Corp. 
 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. PENNROCK FINANCIAL SERVICES CORP.(Registrant)Dated:
    
    By  /s/
    
    Glenn H. WeaverGlenn H. Weaver, President
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant in the capacities indicated on the
8th of March 2005. Signatures
    
    Title/s/ Melvin Pankuch
    
    Executive Vice President, ChiefExecutive Officer and DirectorMelvin Pankuch/s/ George B. Crisp
    
    Vice President and Treasurer(Principal Financial and Accounting Officer)George B. Crisp/s/ Dennis L. DingerChairman and directorDennis L. Dinger/s/ Glenn H. WeaverPresident and directorGlenn H. Weaver/s/ Robert K. WeaverSecretary and directorRobert K. Weaver/s/ Dale M. WeaverDirectorDale M. Weaver/s/ Aaron S. KurtzDirectorAaron S. Kurtz/s/ Robert L. SpottsDirectorRobert L. Spotts/s/ Elton HorningDirectorElton Horning/s/ Lewis M. GoodDirectorLewis M. Good/s/ Irving E. BresslerDirectorIrving E. Bressler/s/ Sandra J. BrickerDirectorSandra J. Bricker
 76