**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

** **

**FORM 10-Q**

 

|                         | **ý** | **Quarterly  Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                                                 |
|------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                         |       | **for the Quarterly Period Ended September  30, 2003,**                                                                                                                                                                                                                                                                                                                        |
|                         |
|                         | **o**      | **Transition  report pursuant to Section 13 or 15 (d) of the Exchange Act**                                                                                                                                                                                                                                                                                                    |
|                         |       | **for the Transition Period from                               to                            .** |
|                         |
| **No. 0-17077**              |
| **(Commission File Number)** |

 

**PENNS WOODS BANCORP, INC.**

(Exact name of Registrant as specified in itscharter)

 

| **PENNSYLVANIA**                                                |   | **23-2226454**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **300  Market Street, Williamsport, Pennsylvania**              |   | **17701**                             |
| (Address of principal executive offices)                        |   | (Zip Code)                            |
|                                                            |   |                                  |
| **(570) 322-1111**                                              |
| Registrant’s telephone number, including  area code        |

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that Registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

YES ý        NO o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12 b-2 of the Exchange Act)

 

YES ý        NO o

 

On November 8, 2003 there were 3,320,875 of the Registrant’s commonstock outstanding.

 

 

----

 

**PENNSWOODS BANCORP, INC.INDEX TO QUARTERLY REPORT ON FORM 10-Q**

 
| **Part  I Financial Information**                                                                        |                                                                                                                         |   |
|----------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                     |                                                                                                                         |   |
| **Item  1. Financial Statements**                                                                        |                                                                                                                         |   |
|                                                                                                     |                                                                                                                         |   |
|                                                                                                     | Consolidated  Balance Sheet (unaudited) as of September 30, 2003 and December 31, 2002                                       |   | 3 |
|                                                                                                     |                                                                                                                         |   |   |
|                                                                                                     | Consolidated Statement of Income  (unaudited) for the Three and Nine Months ended September 30, 2003 and 2002                |   | 4 |
|                                                                                                     |                                                                                                                         |   |   |
|                                                                                                     | Consolidated Statement of Comprehensive  Income (unaudited) For the Three and Nine Months ended September 30, 2003 and  2002 |   | 5 |
|                                                                                                     |                                                                                                                         |   |   |
|                                                                                                     | Consolidated Statement of Changes in  Shareholders’ Equity (unaudited) for the Nine Months ended September 30, 2003     |   | 6 |
|                                                                                                     |                                                                                                                         |   |   |
|                                                                                                     | Consolidated Statement of Cash Flows  (unaudited) for the Nine Months ended September 30, 2003 and 2002                      |   | 7 |
|                                                                                                     |                                                                                                                         |   |   |
|                                                                                                     | Notes to Unaudited Consolidated Financial  Statements                                                                        |   | 8 |
|                                                                                                     |                                                                                                                         |   |   |
| **Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations** |                                                                                                                         | **13** |
|                                                                                                     |                                                                                                                         |   |
| **Item  3. Quantitative and Qualitative Disclosure About Market Risk**                                   |                                                                                                                         | **21** |
|                                                                                                     |                                                                                                                         |   |
| **Item 4. Controls and  Procedures**                                                                     |                                                                                                                         | **21** |
|                                                                                                     |                                                                                                                         |   |
| **Part II Other Information**                                                                            |                                                                                                                         | **22** |
|                                                                                                     |                                                                                                                         |   |
| **Item 1. Legal Proceedings**                                                                            |                                                                                                                         | 22     |
|                                                                                                     |                                                                                                                         |   |
| **Item 2. Changes in Securities and Use of  Proceeds**                                                   |                                                                                                                         | 22     |
|                                                                                                     |                                                                                                                         |   |
| **Item 3. Defaults Upon Senior Securities**                                                              |                                                                                                                         | 22     |
|                                                                                                     |                                                                                                                         |   |
| **Item 4. Submission of Matters to a Vote of  Security Holders**                                         |                                                                                                                         | 22     |
|                                                                                                     |                                                                                                                         |   |
| **Item 5. Other Information**                                                                            |                                                                                                                         | 22     |
|                                                                                                     |                                                                                                                         |   |
| **Item 6.   Exhibits and Reports on Form 8-K**                                                      |                                                                                                                         | 22     |
|                                                                                                     |                                                                                                                         |   |
| **Signatures**                                                                                           |                                                                                                                         | 23     |
| **Exhibits Index**                                                                                       |                                                                                                                         | 23     |

 

2

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PENNS WOODS BANCORP, INC.CONSOLIDATED BALANCE SHEET(UNAUDITED)

 
|                                                                                              |   | **September  30,  2003** |    | **December  31,  2002** |   |
|---------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-------------------------|--------|
|                                                                                              |   | **(in  thousands)**      |    |
| ASSETS:                                                                                           |   |                     |    |                    |   |
| Cash and due from banks                                                                           |   | $                        | 10,567  |                    | $      | 11,731 |   |
| Investment securities  available for sale                                                         |   | 212,513                  |    | 176,436                 |   |
| Investment securities held  to maturity (market value of $957 and $1,289)                         |   | 941                      |    | 1,181                   |   |
| Loans held for sale                                                                               |   | 4,728                    |    | 2,651                   |   |
| Loans, net of unearned  discount of $879 and $769                                                 |   | 265,506                  |    | 257,845                 |   |
| Allowance for loan losses                                                                         |   | (3,080                   | )       | (2,953                  | )      |
| Loans, net                                                                                        |   | 262,426                  |    | 254,892                 |   |
|                                                                                              |   |                     |    |                    |   |
| Bank premises and  equipment, net                                                                 |   | 4,705                    |    | 4,856                   |   |
| Accrued interest  receivable                                                                      |   | 2,286                    |    | 2,460                   |   |
| Bank-owned life insurance                                                                         |   | 8,808                    |    | 8,537                   |   |
| Goodwill                                                                                          |   | 3,032                    |    | 3,032                   |   |
| Other assets                                                                                      |   | 8,467                    |    | 6,430                   |   |
| TOTAL ASSETS                                                                                      |   | $                        | 518,473 |                    | $      | 472,206 |   |
|                                                                                              |   |                     |    |                    |   |
| LIABILITIES:                                                                                      |   |                     |    |                    |   |
| Demand deposits                                                                                   |   | $                        | 56,940  |                    | $      | 67,061 |   |
| Interest-bearing demand  deposits                                                                 |   | 82,049                   |    | 78,590                  |   |
| Savings deposits                                                                                  |   | 64,810                   |    | 60,417                  |   |
| Time deposits                                                                                     |   | 129,795                  |    | 133,780                 |   |
| Total deposits                                                                                    |   | 333,594                  |    | 339,848                 |   |
|                                                                                              |   |                     |    |                    |   |
| Short-term borrowings                                                                             |   | 42,955                   |    | 13,563                  |   |
| Other borrowings                                                                                  |   | 70,878                   |    | 51,778                  |   |
| Accrued interest payable                                                                          |   | 887                      |    | 1,092                   |   |
| Other liabilities                                                                                 |   | 2,759                    |    | 2,783                   |   |
| Total liabilities                                                                                 |   | 451,073                  |    | 409,064                 |   |
| SHAREHOLDERS’ EQUITY:                                                                        |   |                     |    |                    |   |
| Common stock, par value  $10; 10,000,000 shares authorized; 3,138,382 and 3,136,832 shares issued |   | 31,384                   |    | 31,368                  |   |
| Additional paid-in capital                                                                        |   | 18,327                   |    | 18,291                  |   |
| Retained earnings                                                                                 |   | 17,558                   |    | 11,749                  |   |
| Accumulated other  comprehensive income                                                           |   | 3,739                    |    | 5,145                   |   |
| Less: Treasury stock at  cost, 110,290 and 105,503 shares                                         |   | (3,608                   | )       | (3,411                  | )      |
| Total shareholders’ equity                                                                   |   | 67,400                   |    | 63,142                  |   |
| TOTAL LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                  |   | $                        | 518,473 |                    | $      | 472,206 |   |

 

Seeaccompanying notes to the unaudited consolidated financial statements.

 

3

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PENNS WOODS BANCORP, INC.CONSOLIDATED STATEMENT OF INCOME(UNAUDITED)

 
|                                         |   | **Nine Months Ended  September 30,**     |   | **Three Months Ended  September 30,**    |   |
|----------------------------------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
|                                         |   | **2003**                                 |   | **2002**                                 |   | **2003** |   | **2002** |   |
|                                         |   | **(in thousands except per share data)** |   | **(in thousands except per share data)** |   |
| INTEREST AND DIVIDEND  INCOME:               |   |                                     |   |                                     |   |   |   |   |   |
| Interest and fees on loans                   |   | $                                        | 14,919 |                                     | $      | 15,685 |   | $ | 5,017 |   | $ | 5,231 |   |
| Interest and dividends on  investments:      |   |                                     |   |                                     |   |   |   |   |   |
| Taxable                                      |   | 4,474                                    |   | 3,537                                    |   | 1,705 |   | 1,366 |   |
| Tax-exempt                                   |   | 2,134                                    |   | 2,377                                    |   | 541 |   | 808 |   |
| Other dividend and interest  income          |   | 97                                       |   | 75                                       |   | 18 |   | (6 | ) |
|                                         |   |                                     |   |                                     |   |   |   |   |   |
| Total interest and dividend  income          |   | 21,624                                   |   | 21,674                                   |   | 7,281 |   | 7,399 |   |
| INTEREST EXPENSE:                            |   |                                     |   |                                     |   |   |   |   |   |
| Interest on deposits                         |   | 4,486                                    |   | 5,969                                    |   | 1,364 |   | 1,962 |   |
| Interest on short-term  borrowings           |   | 278                                      |   | 395                                      |   | 106 |   | 119 |   |
| Interest on other  borrowings                |   | 2,344                                    |   | 1,810                                    |   | 857 |   | 634 |   |
| Total interest expense                       |   | 7,108                                    |   | 8,174                                    |   | 2,327 |   | 2,715 |   |
| Net interest income                          |   | 14,516                                   |   | 13,500                                   |   | 4,954 |   | 4,684 |   |
| Provision for loan losses                    |   | 225                                      |   | 275                                      |   | 90 |   | 90 |   |
| Net interest income after  provision for     |   |                                     |   |                                     |   |   |   |   |   |
| loan losses                                  |   | 14,291                                   |   | 13,225                                   |   | 4,864 |   | 4,594 |   |
| OTHER INCOME:                                |   |                                     |   |                                     |   |   |   |   |   |
| Service charges                              |   | 1,415                                    |   | 1,301                                    |   | 478 |   | 469 |   |
| Securities gains, net                        |   | 3,098                                    |   | 90                                       |   | 1,247 |   | 281 |   |
| Earnings on bank-owned life  insurance       |   | 304                                      |   | 301                                      |   | 97 |   | 100 |   |
| Insurance commissions                        |   | 1,175                                    |   | 1,485                                    |   | 425 |   | 373 |   |
| Brokerage Commissions                        |   | 309                                      |   | 257                                      |   | 119 |   | 114 |   |
| Other operating income                       |   | 499                                      |   | 605                                      |   | 164 |   | 175 |   |
| Total other operating  income                |   | 6,800                                    |   | 4,039                                    |   | 2,530 |   | 1,512 |   |
| OTHER EXPENSES:                              |   |                                     |   |                                     |   |   |   |   |   |
| Salaries and employee  benefits              |   | 5,058                                    |   | 5,065                                    |   | 1,738 |   | 1,576 |   |
| Occupancy expense, net                       |   | 687                                      |   | 631                                      |   | 222 |   | 227 |   |
| Furniture and equipment  expense             |   | 808                                      |   | 639                                      |   | 260 |   | 227 |   |
| Advertising Expense                          |   | 305                                      |   | 280                                      |   | 100 |   | 71 |   |
| Pennsylvania Shares Tax  Expense             |   | 342                                      |   | 309                                      |   | 114 |   | 103 |   |
| Other expenses                               |   | 2,415                                    |   | 2,154                                    |   | 814 |   | 866 |   |
| Total other operating  expenses              |   | 9,615                                    |   | 9,078                                    |   | 3,248 |   | 3,070 |   |
| INCOME BEFORE INCOME TAX  PROVISION          |   | 11,476                                   |   | 8,186                                    |   | 4,146 |   | 3,036 |   |
| APPLICABLE INCOME TAX  PROVISION             |   | 2,941                                    |   | 1,673                                    |   | 1,135 |   | 660 |   |
| NET INCOME                                   |   | $                                        | 8,535  |                                     | $      | 6,513 |   | $ | 3,011 |   | $ | 2,376 |   |
| EARNINGS PER SHARE - BASIC                   |   | $                                        | 2.82   |                                     | $      | 2.15 |   | $ | 1.00 |   | $ | 0.79 |   |
|                                         |   |                                     |   |                                     |   |   |   |   |   |
| EARNINGS PER SHARE -  DILUTED                |   | $                                        | 2.81   |                                     | $      | 2.14 |   | $ | 0.99 |   | $ | 0.78 |   |
|                                         |   |                                     |   |                                     |   |   |   |   |   |
| DIVIDENDS PER SHARE                          |   | $                                        | 0.90   |                                     | $      | 0.81 |   | $ | 0.30 |   | $ | 0.27 |   |
|                                         |   |                                     |   |                                     |   |   |   |   |   |
| BASIC WEIGHTED AVERAGE  SHARES OUTSTANDING   |   | 3,029,743                                |   | 3,034,075                                |   | 3,028,686 |   | 3,030,714 |   |
|                                         |   |                                     |   |                                     |   |   |   |   |   |
| DILUTED WEIGHTED AVERAGE  SHARES OUTSTANDING |   | 3,032,229                                |   | 3,036,825                                |   | 3,031,838 |   | 3,033,332 |   |

 

Seeaccompanying notes to the unaudited consolidated financial statements.

 

4

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CONSOLIDATED STATEMENT OFCOMPREHENSIVE INCOME (UNAUDITED)

 
|                                                                       |   | **Three  Months Ended September 30,** |   |
|----------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                       |   | **2003**                              |   | **2002** |   |
|                                                                       |   | **(in  thousands)**                   |   |   |   |   |   |
| Net Income                                                                 |   |                                  |   | $ | 3,011 |   |   |   | $ | 2,376 |   |
| Other comprehensive income:                                                |   |                                  |   |   |   |   |   |   |   |
| Unrealized gains (losses)  on available for sale securities                |   | $                                     | (4,230 | ) |   |   | $ | 2,844 |   |   |   |
| Less: Reclassification  adjustment for gain included in net income         |   | 1,247                                 |   |   |   | 281 |   |   |   |
| Other comprehensive income  (loss) before tax                              |   |                                  |   | (5,477 | ) |   |   | 2,563 |   |
| Income tax expense  (benefit) related to other comprehensive income (loss) |   |                                  |   | (1,862 | ) |   |   | 871 |   |
| Other comprehensive income  (loss), net of tax                             |   |                                  |   | (3,615 | ) |   |   | 1,692 |   |
| Comprehensive income (loss)                                                |   |                                  |   | $ | (604 | ) |   |   | $ | 4,068 |   |
|                                                                            |        |                                       |        |  |  |  |  |  |  |  |  |  |  |

 
|                                                                       |   | **Nine Months Ended September 30,** |   |
|----------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                       |   | **2003**                            |   | **2002** |   |
|                                                                       |   | **(in thousands)**                  |   |   |   |   |   |
| Net Income                                                                 |   |                                |   | $ | 8,535 |   |   |   | $ | 6,513 |   |
| Other comprehensive income:                                                |   |                                |   |   |   |   |   |   |   |
| Unrealized gains on  available for sale securities                         |   | $                                   | 968    |   |   |   | $ | 3,838 |   |   |   |
| Less: Reclassification  adjustment for gain included in net income         |   | 3,098                               |   |   |   | 90 |   |   |   |
| Other comprehensive income  (loss) before tax                              |   |                                |   | (2,130 | ) |   |   | 3,748 |   |
| Income tax expense  (benefit) related to other comprehensive income (loss) |   |                                |   | (724 | ) |   |   | 1,274 |   |
| Other comprehensive income  (loss), net of tax                             |   |                                |   | (1,406 | ) |   |   | 2,474 |   |
| Comprehensive income                                                       |   |                                |   | $ | 7,129 |   |   |   | $ | 8,987 |   |
|                                                                            |        |                                     |        |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

5

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PENNS WODS BANCORP, INC.CONSOLIDATED STATEMENT OF CHANGESIN SHAREHOLDERS’ EQUITY (UNAUDITED)

(inthousands except per share data)

 
|                                                                                         |   | **COMMON  STOCK** |   | **ADDITIONAL  PAID-IN  CAPITAL** |   | **RETAINED  EARNINGS** |   | **ACCUMULATED  OTHER  COMPREHENSIVE  INCOME** |   | **TREASURY  STOCK** |   | **TOTAL  SHAREHOLDERS’  EQUITY** |   |
|----------------------------------------------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|------------------------|--------|-----------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|
| **SHARES**                                                                                   |   | **AMOUNT**        |
| Balance, December 31, 2002                                                                   |   | 3,136,832         |   | $                                | 31,368 |                   | $      | 18,291                                        |   | $                   | 11,749 |                                  | $      | 5,145 |   | $ | (3,411 | ) | $ | 63,142 |   |
|                                                                                         |   |              |   |                             |   |                   |   |                                          |   |                |   |                                  |   |   |   |
| Net income for the nine  months ended September 30, 2003                                     |   |              |   |                             |   |                   |   | 8,535                                         |   |                |   |                                  |   | 8,535 |   |
| Dividends declared, $0.90                                                                    |   |              |   |                             |   |                   |   | (2,726                                        | )      |                |   |                                  |   | (2,726 | ) |
| Treasury Stock acquired  (4,787 shares)                                                      |   |              |   |                             |   |                   |   |                                          |   |                |   | (197                                  | )      | (197 | ) |
| Net change in unrealized  loss on investments available for sale, net of tax benefit of $724 |   |              |   |                             |   |                   |   |                                          |   | (1,406              | )      |                                  |   | (1,406 | ) |
| Stock options exercised                                                                      |   | 1,550             |   | 16                               |   | 36                     |   |                                          |   |                |   |                                  |   | 52 |   |
| Balance, September 30, 2003                                                                  |   | 3,138,382         |   | $                                | 31,384 |                   | $      | 18,327                                        |   | $                   | 17,558 |                                  | $      | 3,739 |   | $ | (3,608 | ) | $ | 67,400 |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

6

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PENNSWOODS BANCORP, INC.CONSOLIDATED STATEMENT OF CASH FLOWS(UNAUDITED)

 
|                                                                               |     | **Nine Months Ended September 30** |     |
|------------------------------------------------------------------------------------|----------|------------------------------------|----------|
|                                                                               | **2003** |                               | **2002** |
|                                                                               |     | **(in  thousands)**                |     |
| OPERATING ACTIVITIES:                                                              |     |                               |     |   |   |
| Net Income                                                                         |     | $                                  | 8,535    |   | $ | 6,513 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |     |                               |     |   |   |
| Depreciation                                                                       |     | 602                                |     | 423 |   |
| Provision for loan losses                                                          |     | 225                                |     | 275 |   |
| Accretion and amortization  of investment security discounts and premiums          |     | (187                               | )        | (721 | ) |
| Securities gains                                                                   |     | (3,098                             | )        | (90 | ) |
| Originations of loans held  for sale                                               |     | (16,008                            | )        | (12,787 | ) |
| Proceeds of loans held for  sale                                                   |     | 13,931                             |     | 14,248 |   |
| Earnings on bank-owned  life insurance                                             |     | (304                               | )        | (301 | ) |
| Decrease (increase) in all  other assets                                           |     | 1,250                              |     | (596 | ) |
| Increase (decrease) in all  other liabilities                                      |     | (229                               | )        | 618 |   |
| Net cash provided by  operating activities                                         |     | 4,717                              |     | 7,582 |   |
|                                                                               |     |                               |     |   |   |
| INVESTING ACTIVITIES:                                                              |     |                               |     |   |   |
|                                                                               |     |                               |     |   |   |
| Investment securities  available for sale:                                         |     |                               |     |   |   |
| Proceeds from sales                                                                |     | 34,623                             |     | 46,234 |   |
| Proceeds from calls and  maturities                                                |     | 41,392                             |     | 7,092 |   |
| Purchases                                                                          |     | (110,937                           | )        | (84,234 | ) |
| Investment securities held  to maturity:                                           |     |                               |     |   |   |
| Proceeds from calls and maturities                                                 |     | 264                                |     | 124 |   |
| Purchases                                                                          |     | (24                                | )        | (40 | ) |
| Net increase in loans                                                              |     | (7,860                             | )        | (1,930 | ) |
| Acquisition of bank  premises and equipment                                        |     | (451                               | )        | (733 | ) |
| Proceeds from the sale of  foreclosed assets                                       |     | 72                                 |     | 116 |   |
| Gross proceeds from  redemption of regulatory stock                                |     | 196                                |     | 1,262 |   |
| Gross purchases of  regulatory stock                                               |     | (2,523                             | )        | (1,337 | ) |
| Net cash used in investing  activities                                             |     | (45,248                            | )        | (33,446 | ) |
| FINANCING ACTIVITIES:                                                              |     |                               |     |   |   |
| Net increase in  interest-bearing deposits                                         |     | 3,867                              |     | 25,682 |   |
| Net increase (decrease) in  noninterest-bearing deposits                           |     | (10,121                            | )        | 3,206 |   |
| Proceeds of long-term  borrowings                                                  |     | 19,100                             |     | 5,000 |   |
| Net increase (decrease) in  short-term borrowings                                  |     | 29,392                             |     | (1,250 | ) |
| Dividends paid                                                                     |     | (2,726                             | )        | (2,457 | ) |
| Stock options exercised                                                            |     | 52                                 |     | 4 |   |
| Purchase of Treasury Stock                                                         |     | (197                               | )        | (358 | ) |
| Net cash provided by  financing activities                                         |     | 39,367                             |     | 29,827 |   |
| NET INCREASE (DECREASE) IN  CASH AND CASH EQUIVALENTS                              |     | (1,164                             | )        | 3,963 |   |
| CASH AND CASH EQUIVALENTS,  BEGINNING                                              |     | 11,731                             |     | 14,844 |   |
| CASH AND CASH EQUIVALENTS,  ENDING                                                 |     | $                                  | 10,567   |   | $ | 18,807 |   |
|                                                                                    |          |                                    |          |  |  |  |  |  |  |

 

The Company paidapproximately $7,313,000 and $8,266,000 interest on deposits and otherborrowings during the first three quarters of 2003 and 2002, respectively.

 

The Company made income taxpayments of approximately $2,150,000 and $2,154,000 during the first ninemonths of 2003 and 2002, respectively.

 

See accompanying notes tothe unaudited consolidated financial statements.

 

7

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**PENNS WOODS BANCORP, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

# **NOTE1.  Basis of Presentation**

 

# **The consolidated financialstatements include the accounts of Penns Woods Bancorp, Inc. (the “Company”)and its wholly-owned subsidiaries Woods Investment Company, Inc., Woods RealEstate Development Company, Inc., and Jersey Shore State Bank (the “Bank”) andits wholly-owned subsidiary, The M Group, Inc. D/B/A The ComprehensiveFinancial Group (“The M Group”).  Allsignificant inter-company balances and transactions have been eliminated in theconsolidation.**

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with instructions to Form 10-Q and, therefore, do notnecessarily include all information which would be included in audited financialstatements.  The information furnishedreflects all normal recurring adjustments which are, in the opinion ofmanagement, necessary for the fair statement of the results of the period.  The results of operations for the interimperiods are not necessarily indicative of the results to be expected for thefull year or any other future period. The unaudited consolidated financialstatements should be read in conjunction with Form 10-K for the year endedDecember 31, 2002.

 

**RecentAccounting Pronouncements**

 

In August 2001, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“FAS”) No.143, *Accountingfor Asset Retirement**Obligations*, which requires that the fairvalue of a liability be recognized when incurred for the retirement of along-lived asset and the value of the asset be increased by that amount.  The statement also requires that theliability be maintained at its present value in subsequent periods and outlinescertain disclosures for such obligations. The adoption of this statement, which was effective January 1, 2003, didnot have a material effect on the Company’s financial position or results ofoperations.

 

In July 2002, the FASB issued FAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*, whichrequires companies to recognize costs associated with exit or disposalactivities when they are incurred rather than at the date of a commitment to anexit or disposal plan.  This statementreplaces EITF Issue No. 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (Including CertainCosts Incurred in a Restructuring)*. The new statement is effective for exit or

 

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disposal activities initiated after December 31, 2002.  The adoption of this statement did not havea material effect on the Company’s financial position or results of operations.

 

On December 31, 2002, the FASB issued FAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure,* whichamends FAS No. 123, *Accounting for Stock-Based Compensation.*  FAS No. 148 amends the disclosurerequirements of FAS No. 123 to require more prominent and more frequentdisclosures in financial statements about the effects of stock-basedcompensation.  Under the provisions ofFAS No. 123, companies that adopted the preferable, fair value based methodwere required to apply that method prospectively for new stock option awards.  This contributed to a “ramp-up” effect on stock-basedcompensation expense in the first few years following adoption, which causedconcern for companies and investors because of the lack of consistency inreported results.  To address thatconcern, FAS No. 148 provides two additional methods of transition that reflectan entity’s full complement of stock-based compensation expense immediatelyupon adoption, thereby eliminating the ramp-up effect.  FAS No. 148 also improves the clarity andprominence of disclosures about the pro forma effects of using the fair valuebased method of accounting for stock-based compensation for allcompanies—regardless of the accounting method used—by requiring that the databe presented more prominently and in a more user-friendly format in thefootnotes to the financial statements. In addition, the statement improves the timeliness of those disclosuresby requiring that this information be included in interim as well as annualfinancial statements. The transition guidance and annual disclosure provisionsof FAS No. 148 are effective for fiscal years ending after December 15, 2002,with earlier application permitted in certain circumstances.  The interim disclosure provisions areeffective for financial reports containing financial statements for interimperiods beginning after December 15, 2002. The adoption of this statement did not have a material effect on theCompany’s financial statements.

 

In April, 2003, the FASB issued FAS No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities*.  This statement amends and clarifiesaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts, and for hedging activities under FAS No. 133.  The amendments set forth in FAS No. 149improve financial reporting by requiring that contracts with comparablecharacteristics be accounted for similarly. In particular, this statementclarifies under what circumstances a contract with an initial net investmentmeets the characteristic of a derivative as discussed in FAS No. 133. Inaddition, it clarifies when a derivative contains a financing component thatwarrants special reporting in the statement of cash flows. FAS No. 149 amendscertain other existing pronouncements. Those changes will result in moreconsistent reporting of contracts that are derivatives in their entirety orthat contain embedded derivatives that warrant separate accounting.   This statement is effective for contractsentered into or modified after June 30, 2003, except as stated below and forhedging relationships designated after June 30, 2003. The guidance should beapplied prospectively.  The provisionsof this statement that relate to FAS No. 133 Implementation Issues that havebeen effective for fiscal quarters that began prior to June 15, 2003, shouldcontinue to be applied in accordance with their respective effective dates. Inaddition, certain provisions relating to forward purchases or sales ofwhen-issued securities or other securities that do not yet exist, should beapplied to existing contracts as well as new contracts entered into after June30, 2003. The adoption of this statement did not have a material effect on theCompany’s financial position or results of operations.

 

In May 2003, the FASB issued Statement No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. This Statement

 

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establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities andequity. It requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances). Suchinstruments may have been previously classified as equity. This Statement iseffective for financial instruments entered into or modified after May 31,2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003. The adoption of this statement did not have amaterial effect on the Company’s financial position or results of operations.

 

In November, 2002, the FASB issued Interpretation No.45, *Guarantor’sAccounting and Disclosure requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*.  This interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. This interpretation clarifies that a guarantor is required to disclose(a) the nature of the guarantee, including the approximate term of theguarantee, how the guarantee arose, and the events or circumstances that wouldrequire the guarantor to perform under the guarantee; (b) the maximum potentialamount of future payments under the guarantee; (c) the carrying amount of theliability, if any, for the guarantor’s obligations under the guarantee; and (d)the nature and extent of any recourse provisions or available collateral thatwould enable the guarantor to recover the amounts paid under theguarantee.  This interpretation alsoclarifies that a guarantor is required to recognize, at the inception of aguarantee, a liability for the obligations it has undertaken in issuing theguarantee, including its ongoing obligation to stand ready to perform over theterm of the guarantee in the event that the specified triggering events orconditions occur.  The objective of theinitial measurement of that liability is the fair value of the guarantee at itsinception.  The initial recognition andinitial measurement provisions of this interpretation are applicable on aprospective basis to guarantees issued or modified after December 31, 2002,irrespective of the guarantor’s fiscal year-end. The disclosure requirements inthis interpretation are effective for financial statements of interim or annualperiods ending after December 15, 2002. The adoption of this interpretation did not have a material effect onthe Company’s financial position or results of operations.

 

In January, 2003, the FASB issued Interpretation No. 46, *Consolidationof Variable Interest Entities,*in an effort to expand upon andstrengthen existing accounting guidance that addresses when a company shouldinclude in its financial statements the assets, liabilities and activities ofanother entity.  The objective of thisinterpretation is not to restrict the use of variable interest entities but toimprove financial reporting by companies involved with variable interestentities.  Until now, one companygenerally has included another entity in its consolidated financial statementsonly if it controlled the entity through voting interests.  This interpretation changes that byrequiring a variable interest entity to be consolidated by a company if thatcompany is subject to a majority of the risk of loss from the variable interestentity’s activities or entitled to receive a majority of the entity’s residualreturns or both. The consolidation requirements of this interpretation applyimmediately to variable interest entities created after January 31, 2003.  The consolidation requirements apply toolder entities in the first fiscal year or interim period beginning after June15, 2003. Certain of the disclosure requirements apply in all financial statementsissued after January 31, 2003, regardless of when the

 

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variable interest entity was established.  The adoption of this interpretation has not and is not expectedto have a material effect on the Company’s financial position or results of operations.  In October, 2003, the FASB decided to deferto the fourth quarter from the third quarter the implementation date forInterpretation No. 46. This deferral only applies to variable interest entitiesthat existed prior to February 1, 2003.

 

**NOTE2.  Per Share Data**

 

There are no convertible securities, whichwould affect the numerator in calculating basic and dilutive earnings pershare, therefore, net income as presented on the consolidated statement ofincome will be used as the numerator. The following table sets forth the composition of the weighted averagecommon shares (denominator) used in the basic and dilutive per sharecomputation.

 

Options to purchase 9,900 shares of commonstock at the price of $53.18 were outstanding during the three and nine monthsended September 30, 2003, and 20,350 shares of common stock at the prices of$42.00 and $53.18 per share were outstanding during the three and nine monthsended September 30, 2002, but were not included in the computation of dilutedearnings per share because to do so would have been anti-dilutive.

 
|                                                                                                       |   | **Three Months Ended September 30** |   | **Nine Months Ended September 30** |   |
|------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|--------|------------------------------------|--------|
|                                                                                                       |   | **2003**                            |   | **2002**                           |   | **2003** |   | **2002** |   |
|                                                                                                       |   |                                |   |                               |   |   |   |   |   |
| Weighted average common  shares outstanding                                                                |   | 3,138,146                           |   | 3,131,732                          |   | 3,137,793 |   | 3,131,674 |   |
|                                                                                                       |   |                                |   |                               |   |   |   |   |   |
| Average treasury stock  shares                                                                             |   | (109,460                            | )      | (101,018                           | )      | (108,050 | ) | (97,599 | ) |
|                                                                                                       |   |                                |   |                               |   |   |   |   |   |
| Weighted average common  shares and common stock equivalents used to calculate basic earnings per  share   |   | 3,028,686                           |   | 3,030,714                          |   | 3,029,743 |   | 3,034,075 |   |
|                                                                                                       |   |                                |   |                               |   |   |   |   |   |
| Additional common stock  equivalents (stock options) used to calculate diluted earnings per share          |   | 3,152                               |   | 2,618                              |   | 2,486 |   | 2,750 |   |
|                                                                                                       |   |                                |   |                               |   |   |   |   |   |
| Weighted average common  shares and common stock equivalents used to calculate diluted earnings per  share |   | 3,031,838                           |   | 3,033,332                          |   | 3,032,229 |   | 3,036,825 |   |

 

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**Reclassification of Comparative Amounts**

 

Certain comparativeamounts for the prior periods have been reclassified to conform to currentperiod presentations.  Suchreclassifications had no effect on net income or stockholders’ equity.

 

**CAUTIONARY STATEMENTFOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

 

This Report containscertain “forward-looking statements” including statements concerning plans,objectives, future events or performance and assumptions and other statementswhich are other than statements of historical fact.  The Company wishes to caution readers that the followingimportant factors, among others, may have affected and could in the futureaffect the Company’s actual results and could cause the Company’s actualresults for subsequent periods to differ materially from those expressed in anyforward-looking statement made by or on behalf of the Company herein:  (i) the effect of changes in laws andregulations, including federal and state banking laws and regulations, whichthe Company must comply, and the associated costs of compliance with such lawsand regulations either currently or in the future as applicable; (ii) theeffect of changes in accounting policies and practices, as may be adopted bythe regulatory agencies as well as by the Financial Accounting Standards Board,or of changes in the Company’s organization, compensation and benefit plans; (iii)the effect on the Company’s competitive position within its market area ofthe  increasing consolidation within thebanking and financial services industries, including the increased competitionfrom larger regional and out-of-state banking organizations as well as non-bankproviders of various financial services; (iv) the effect of changes in interestrates; and (v) the effect of changes in the business cycle and downturns in thelocal, regional or national economies.

 

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**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATION**

 

# **EARNINGSSUMMARY**

 

# **Comparisonof the Nine Months Ended September 30, 2003 and 2002**

 

**Interest Income**

 

For the nine months ended September 30, 2003, total interest anddividends on investments increased $716,000 and interest and fees on loansdecreased $766,000.  The decrease intotal interest income of $50,000 is the result of an increase of $46,940,000 inthe average balance of investment securities held for the current periodrelative to the same period a year ago offset by a decrease in the return on loans of approximately 57 basispoints.  Overall, interest incomegenerated from the net increase in volume of interest earning assets of $51,791,000was offset by a general decline in rates of approximately 93 basis points.

 

On atax equivalent basis, calculated utilizing the statutory tax rate of 34%,investment security income increased $590,000 for the first nine months of 2003compared to the first nine months of 2002. The increase of taxable security income of $959,000 is due to thesignificant purchase of U.S. Government securities over the past year, with the average of these securitiesincreasing $73,098,000,  while thedecrease in the average of tax-exempt States & Political securitiesdecreased tax equivalent interest income $369,000.  Management has repositioned the investment portfolio from longerterm assets to shorter term assets to take advantage of the cash flowopportunities for reinvestment in anticipation of rising rates. The net growthin the volume of investment holdings has generated additional interest incomethat has offset the 112 basis point decline in the overall portfolios weightedaverage interest rates.

 

Withinthe loan portfolio, a 57 basis point decrease of the tax equivalent return onloans was partially offset by an increase in the average balance of loans of$4,851,000 in comparing the nine months ended September 30, 2003 to the sameperiod for 2002.  Variable rate loanswithin the portfolio and other new loan originations at lower effective rateshave aided in the reduction of net income compared to a year ago because of thehistorically low rates.  The averagePrime rate during the quarter was the lowest it had been for the past 30 years.

 

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**InterestExpense**

 

For the nine months ended September 30, 2003, total interest expensedecreased by $1,066,000 or 13% compared to the first nine months of 2002.  Low interest rates have contributed to thedecline of interest expense.  Lowerrates for all deposit accounts contribute the most substantial decrease ininterest expense.  The weighted averagerate on interest paid on deposits declined 90 basis points for the nine monthsended September 30, 2003 since the same period in 2002.  Interest expense on savings depositsdecreased $609,000 and interest expense on time deposits decreased $874,000 forthe nine months ended September 30, 2003 compared to the same period in 2002.

 

Favorable long-term borrowing rates offer opportunities to reduceinterest expenses over the coming years. Throughout the first three quarters of 2003, the Company borrowed anadditional $20 million in long term advances through the FHLB to minimizefuture borrowing costs and to enhance asset and liability positioning.  These additional borrowings were utilized bymanagement to take advantage of current investment opportunities whileminimizing interest rate risk.  The$534,000 increase in expense on long-term borrowings is the result of theseadditional advances with average advances of $20,527,000 offset by the 61 basispoint decline in the resulting weighted average interest rate for the firstthree quarters of 2003 compared to the same period of 2002. Interest paid onshort-term borrowings decreased $117,000 as a result of an overall decline inthe weighted average interest rate of 136 basis points while the averagebalances outstanding during the nine month period increased $3,510,000.

 

# **Provisionfor Loan Losses**

 

Theprovision for loan losses is based upon management’s quarterly review of theloan portfolio.  The purpose of thereview is to assess loan quality, identify impaired loans, analyzedelinquencies, ascertain loan growth, evaluate potential charge-offs andrecoveries, and assess general economic conditions in the markets served.  An external independent loan review is alsoperformed annually for the Bank. Management remains committed to an aggressive program of problem loanidentification and resolution.

 

The allowance is calculated by applying loss factors to outstandingloans by type, excluding loans for which a specific allowance has beendetermined.  Loss factors are based onmanagement’s consideration of the nature of the portfolio segments, changes inmix and volume of the loan portfolio, and historical loan loss experience.  In addition, management considers industrystandards and trends with respect to nonperforming loans and its knowledge andexperience with specific lending segments.

 

Although management believes that it uses the best informationavailable to make such determinations and that the allowance for loan losses isadequate at September 30, 2003, future adjustments could be necessary ifcircumstances or economic conditions differ substantially from the assumptionsused in making the initial determinations. A downturn in the local economy, employment and delays in receivingfinancial information from borrowers could result in increased levels ofnon-performing assets and charge-offs, increased loan loss provisions andreductions in income.  Additionally, asan 

 

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integral part of theexamination process, bank regulatory agencies periodically review the Bank’sloan loss allowance.  The bankingagencies could require the recognition of additions to the loan loss allowancebased on their judgment of information available to them at the time of theirexamination.

 

The allowance for loan lossesincreased from $2,953,000 at December 31, 2002 to $3,080,000 at September 30,2003.  At September 30, 2003, allowancefor loan losses was 1.1% of total loans at September 30, 2003, as well asDecember 31, 2002.  This percentage isconsistent with the Bank’s historical experience and peer banks.  Management’s conclusion is that theallowance for loan losses is adequate to provide for probable losses inherentin its loan portfolio as of the balance sheet date.

 

The provision for loan losses totaled $225,000 for the nine monthsended September 30, 2003.  The provisionfor the same period in 2002 was $275,000. For the nine months period ending September 30, 2003, charge-offsexceeded recoveries by $98,000 compared to the same period ended September 30,2002, when charge-offs exceeded recoveries by $174,000.  The $79,000 change in charge-offs inaddition to other factors previously stated has prompted management to reducethe provision for loan losses.

 

An overall decrease was experienced in non-performing loans from theDecember 31, 2002 total of $2,096,000 to $1,314,000 on September 30, 2003.  This decline consisted of a commercial andindustrial loans decrease of $35,000, a real estate secured loan decrease of$722,000 and an installment loans decrease of $25,000.  The primary reason for the change in  nonperforming loans was a real estate securedloan began paying and deemed by management to meet the classifications of aperforming loan.

 

Based upon this analysis, as well as the others noted above, seniormanagement has concluded that the allowance for loan losses remains at a leveladequate to provide for probable losses inherent in its loan portfolio.

 

## **Other Operating Income**

 

Other operating income for the nine months ended September 30, 2003increased $2,761,000.  Net securitygains represented an increase of $3,008,000 resulting from managements reactingto the opportunities available to sell investment securities withoutsignificantly impacting the overall effective yield of the investmentportfolio.  Management continues toclosely monitor the investment portfolio for other similar opportunities whichmay become available.  Excluding netsecurity gains, other income decreased $247,000.  Service charges increased $114,000 due to the increase of boththe fee charged for overdrafts and the quantity of overdrafts.  Insurance and brokerage commissions andearned by the Bank’s subsidiary, The M Group, decreased $258,000.  Sales of long term investments are difficultin the current market environment.  Thecommissions earned are related to the interest rates which are at an historicallow.  Other income decreased $54,000primarily due to the payment of life insurance proceeds of $116,000 received inthe first three quarters of 2002.  Thisdecrease was offset by income generated from the use of debit cards provided$23,000 of additional other income.

 

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Management has analyzed its equity portfolio for impairment that wouldqualify as other than temporary. Impairment is determined using factors such as length of time andthe extent to which the market value is less than cost; the financial conditionand the near-term prospects of the issuer; and the intent and ability of theCompany to retain its investment to allow for the market to recover.  In doing so, management has identifiedsecurities within the equity portfolio that have an other than temporarydecline in market value.  Management hasreserved an additional $292,000, which was charged against realized securitygains and losses.  Excluding the$292,000 for 2003 and the $108,000 charge for 2002, security gains increased$3,192,000.  The Company sold securitiesthat were determined to have attained their maximum long-term potential valuewhich thereby resulted in gains on securities.

 

# **OtherOperating Expense**

 

An overall increase inother expenses totaled $537,000 for the first three quarters of 2003 comparedto the same period in 2002 and is the result of normal operational costincreases.  Occupancy expensesexperienced an overall increase of $56,000 primarily due to rent, maintenance,and utilities for the new State College Wal-Mart Branch.  The increase in furniture and equipment expense of $169,000 is a result ofthe depreciation of a Wide Area Network system.  The salary expense decrease of $7,000 for the period endedSeptember 30, 2003 compared to the same period in 2002 was due to the declinein commission earned by the M Group and the retirement of an executive officeroffset by the standard cost of living salary increases.  Advertising expense increased this year as aresult of new brochures purchased.

 

# **Provisionfor Income Taxes**

 

The provision for income taxes for the nine months ended September 30,2003 resulted in an effective income tax rate of 25.63% compared to 20.44% forthe corresponding period in 2002.  Thisincreasing effective tax rate is the result management’s repositioning of theinvestment portfolio from tax-exempt securities to taxable securities and thesubstantial security gains taken in the first three quarters of 2003.  The tax effects of the repositioning wereexamined by management as part of the strategic plan.

 

# **Comparisonof the Three Months Ended September 30, 2003 and 2002**

 

**Interest Income**

 

During the third quarterof 2003 interest income earned was $7,281,000, a decrease of $118,000 over thesame quarter in 2002.

 

Interest income on loans decreased $214,000 due to a decline in averageprime rates during 2003 relative to the third quarter of 2002.  The reduction of loan interest income

 

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was  due to a 54 basis pointdecrease of the rate on loans, offset slightly by the increase in the averageloan balance.

 

An increase of $96,000 occurred in interest and dividends oninvestments. Taxable interest increased $363,000, primarily due to the largepurchase of short-term, taxable securities in the second quarter of 2003.  Non-taxable interest decreased $267,000, theresult of repositioning the balance sheet from non-taxable securities totaxable securities, and dividends increased $20,000.

 

# **InterestExpense**

 

Interest expense duringthe third quarter of 2003 decreased by $388,000 or 14% over interest expenseincurred during the third quarter of 2002. Interest expense on savings deposits decreased $291,000 primarily as aresult of a 100 basis point decline in the effective weighted average interestrate for the periods.  The weightedaverage interest rate for time deposit decreased 76 basis points for a savingsof $307,000.  The weighted averagebalance of short-term borrowings increased $13,658,000 while the 127 basispoint decline in the weighted average interest rate had a greater effect oninterest expense resulting in a net decrease of $13,000.  Interest paid on long-term borrowingsincreased $223,000 due to the substantial increase in volume offset partiallyby the 71 basis point decrease in the weighted average interest rate.

 

# **OtherOperating Income**

 

## Total other operatingincome for the quarter ended September 30, 2003 compared to the same period in2002 increased $1,018,000.  The increaseis due to an increase of security gains of $966,000, an increase of $57,000 ofthe insurance and brokerage commissions earned by the Bank’s subsidiary, The MGroup, Inc. during the third quarter of this year.  Service charges rose $9,000, earnings on bank-owned lifeinsurance decreased $3,000 and other operating income decreased $11,000.

 

# **OtherOperating Expense**

 

Total other operatingexpenses increased $178,000. Salaries and employee benefits increased $162,000attributed to both the increase on commissions earned by The M Group, Inc. andthe standard cost of living salary increases offset by the retirement of anexecutive officer. Occupancy expense decreased by $5,000 and furniture andequipment expense increased $33,000 during the third quarter of 2003 comparedto the third quarter of 2002. Advertising expense rose $29,000 due to thepurchase of new brochures and Pennsylvania shares tax increased $11,000 for thethird quarter of 2003 compared to that of 2002. Other operating expensesdecreased during the three month period in 2003 when compared to the sameperiod in 2002 by $52,000.

 

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**Provisionfor Income Taxes**

 

Income taxes increased$475,000 for the quarter ended September 30,2003 compared to the third quarterof 2002. The effective tax rates for the quarter ended September 30, 2003 and2002 are 27.38% and 21.74%, respectively.

 

# **ASSET/LIABILITYMANAGEMENT**

 

# **Assets**

 

At September 30, 2003,total assets were $518.4 million compared to $472.2 million at December 31,2002.  Cash and due from banks decreased$1.2 million during the first nine months of 2003.  Investment securities totaled $213.4 million at September 30,2003 for a net increase of $35.8 million over the corresponding balance atDecember 31, 2002.  During this period,net loans increased by $7.5 million to $262.4 million.  Loans held for resale increased $2 millionto $4.7 million.  The investment growthis largely attributed to management’s strategic plan to benefit from the lowborrowing rates by taking advantage of over a 200 basis point interest ratespread of investments with similar maturity periods.

 

# **Deposits**

 

At September 30, 2003, total deposits amounted to $333.6 millionrepresenting a decrease of $6.3 million from total deposits at December 31,2002.  Non-interest bearing demanddeposits decreased $10.1 million and interest-bearing demand deposits increased$3.4 million from year end 2002 to September 30, 2003. Savings accountsincreased $4.4 million and time deposits decreased $4.0 million.  The current low interest rate environmenthas resulted in consumers shifting their deposits from time deposits withlocked interest rates to interest-bearing demand and savings accounts inanticipation of a rise in interest rates.

 

# **Capital**

 

## The adequacy of theCompany’s capital is reviewed on an ongoing basis with reference to the size,composition and quality of the Company’s resources and regulatoryguidelines.  Management seeks tomaintain a level of capital sufficient to support existing assets andanticipated asset growth, maintain favorable access to capital markets andpreserve high quality credit ratings. 

 

## Bank holding companiesare required to comply with the Federal Reserve Board’s risk-based capitalguidelines.  The risk-based capital rulesare designed to make regulatory capital requirements more sensitive todifferences in risk profiles among banks and bank holding companies and tominimize disincentives for holding liquid assets. Specifically, each isrequired to maintain certain minimum dollar amounts and ratios of Totalrisk-based, Tier I risk-based and Tier I leverage capital requirements. Inaddition to the capital requirements, the Federal Deposit Insurance CorporationImprovements Act

##  

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## (FDICIA) established fivecapital categories ranging from “well capitalized” to “criticallyundercapitalized.” To be classified as “well capitalized”, Total risk-based,Tier I risked-based and Tier I leverage capital ratios must be at least 10%,6%, and 5% respectively.

 

## At September 30, 2003,the Company was “well capitalized” with a total risk based capital ratio of23.24%, a Tier I capital ratio of 21.37% and a Tier I leverage ratio of 11.06%.

 

# **Liquidityand Interest Rate Sensitivity**

 

## The asset/liabilitycommittee addresses the liquidity needs of the Bank to see that sufficientfunds are available to meet credit demands and deposit withdrawals as well asto the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equalconsideration is given to the current position as well as the future outlook.

 

The following liquidity measures are monitored and kept within thelimits cited.

 

1.  Net Loans to Total Assets,  70% maximum

 

2.  Net Loans to Total Deposits, 92.5% maximum

 

3.  Net Loans to Core Deposits, 100% maximum

 

4.  Investments to Total Assets, 40% maximum

 

5.  Investments to Total Deposits, 50% maximum

 

6.  Total Liquid Assets to Total Assets, 25% minimum

 

7.  Total Liquid Assets to Total Liabilities, 25% minimum

 

8.  Net Core Funding Dependence,35% maximum

 

Fundamental objectives of the Company’s asset/liability managementprocess are to maintain adequate liquidity while minimizing interest raterisk.  The maintenance of adequateliquidity provides the Company with the ability to meet its financialobligations to depositors, loan customers and stockholders.  Additionally, it provides funds for normaloperating expenditures and business opportunities as they arise.  The objective of interest rate sensitivitymanagement is to increase net interest income by managing interest sensitiveassets and liabilities in such a way that they can be repriced in response tochanges in market interest rates.

 

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The Company, like other financial institutions, must havesufficient funds available to meet its liquidity needs for deposit withdrawals,loan commitments and expenses.   Inorder to control cash flow, the bank estimates future flows of cash fromdeposits and loan payments.  The primarysources of funds are deposits, principal and interest payments on loans andmortgage-backed securities, as well as Federal Home Loan Bank borrowings.  Funds generated are used principally to fundloans and purchase investment securities. Management believes the Company has adequate resources to meet itsnormal funding requirements.

 

Management monitors the Company’s liquidity on both a long andshort-term basis thereby, providing management necessary information to reactto current balance sheet trends.  Cashflow needs are assessed and sources of funds are determined.  Funding strategies consider both customerneeds and economical cost.  Both shortand long term funding needs are addressed by maturities and sales of availablefor sale investment securities, loan repayments and maturities, and liquidatingmoney market investments such as federal funds sold.  The use of these resources, in conjunction with access to creditprovides core ingredients to satisfy depositor, borrower and creditor needs.

 

Management monitors and determines the desirable level ofliquidity.  Consideration is given toloan demand, investment opportunities, deposit pricing and growth potential aswell as the current cost of borrowing funds. The Company has a current borrowing capacity at the Federal Home LoanBank of $261.4 million.  In addition tothis credit arrangement the Company has additional lines of credit withcorrespondent banks of $10,500,000. The Company’s management believes that ithas sufficient liquidity to satisfy estimated short-term and long-term fundingneeds.  Federal Home Loan Bank advancestotaled $98.2 million as of September 30, 2003.

 

Interest rate sensitivity, which is closely related to liquiditymanagement, is a function of the repricing characteristics of the Company’sportfolio of assets and liabilities. Asset/liability management strives to match maturities and rates betweenloan and investment security assets with the deposit liabilities and borrowingsthat fund them.  Successful asset/liabilitymanagement results in a balance sheet structure which can cope effectively withmarket rate fluctuations. The matching process is affected by segmenting bothassets and liabilities into future time periods (usually 12 months, or less)based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities, for aspecific time period to determine the “gap”, or difference. Once known, the gapis managed based on predictions about future market interest rates.  Intentional mismatching, or gapping, canenhance net interest income if market rates move as predicted.  However, if market rates behave in a mannercontrary to predictions, net interest income will suffer.  Gaps, therefore, contain an element of riskand must be prudently managed.  Inaddition to gap management, the Company has an asset liability managementpolicy which incorporates a market value at risk calculation which is used todetermine the effects of interest rate movements on shareholders’ equity and asimulation analysis to monitor the effects of interest rate changes on theCompany’s balance sheets.

 

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There has been no substantial changes in the Company’s GAP analyses orsimulation analyses compared to the information provided in the Company’s SEC10-K for the period ended December 31, 2002.

 

Generally, management believes the Company is well positioned torespond expeditiously when the market interest rate outlook changes.

 

# **Inflation**

 

The asset and liability structure of a financial institution isprimarily monetary in nature, therefore, interest rates rather than inflationhave a more significant impact on the Corporation’s performance.  Interest rates are not always affected inthe same direction or magnitude as prices of other goods and services, but arereflective of fiscal policy initiatives or economic factors which are notmeasured by a price index.

 

In reference to the attached financial statements, all adjustments areof a normal recurring nature pursuant to Rule 10-01 (b) (8) of Regulation S-X`.

 

**Item 3. Quantitative and Qualitative Disclosure About Market Risk**

 

Market risk for the Company is comprised primarily from interest raterisk exposure and liquidity risk. Interest rate risk and liquidity risk management is performed at the Bank level as well as the Companylevel.  The Company’s interest ratesensitivity is monitored by management through selected interest rate riskmeasures produced internally.  There hasbeen no substantial changes in the Company’s GAP analyses or simulationanalyses compared to the information provided in the Company’s SEC 10-K for theperiod ended December 31, 2002. Additional information and details are provided in the InterestSensitivity section of Item 2. Management’s Discussion and Analysis ofFinancial Condition  and Results ofOperations.

 

Generally, management believes the Company is well positioned torespond expeditiously when the market interest rate outlook changes.

 

**Item 4.  Controls andProcedures**

 

(a)          Evaluation of disclosure controls andprocedures.  Based on theirevaluation as of a date within 90 days of the filing date of this QuarterlyReport on Form-10Q, the Registrant’s principal executive officer and principalfinancial officer have concluded that the Registrant’s disclosure controls andprocedures (as defined in Rules 13a-14(c) under the Securities Exchange Act of1934 (the “Exchange Act”)) are effective to ensure that information required tobe disclosed by the Company in reports that it files or submits under the

 

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Exchange Act is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms.

(b)         Changes in internal controls.  There were no significant changes in theRegistrant’s internal controls or in other factors that could significantlyaffect these controls subsequent to the date of their evaluation, including anycorrective actions with regard to significant deficiencies and materialweakness.

 

### **Part II.  OTHER INFORMATION**

### ** **

**Item 1. Legal Proceedings.**

None

 

**Item 2. Changes in Securities and Use of Proceeds.**

None

 

**Item 3. Defaults Upon Senior Securities.**

None

 

**Item 4. Submission of Matters to a Vote of Security Holders.**

None

 

### **Item 5.  Other Information**

None

 

**Item6.  Exhibits and Reports on Form 8-K.**

(A) Exhibits

 

(3)  (i)              Articlesof Incorporation of the Registrant, as presently in effect (incorporated byreference to Exhibit 3.1 of  theRegistrant’s Registration Statement on Form S-4, No. 333-65821).

(3)  (ii)             Bylawsof the Registrant as presently in effect (incorporated by reference to Exhibit3.2 of the Registrant’s Registration Statement on Form S-4, No. 333-65821).

(31) (i)             Section302 Certification of Chief Executive Officer

(31) (ii)            Section302 Certification of Chief Financial Officer

(32) (i)             Certificationof Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

(32) (ii)            Certificationof Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

 

(B) Reports on Form 8-K

 

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July 8, 2003-SecondQuarter Earnings Press Release

July 29, 2003-Second Quarter Shareholders’ Report

October 10, 2003-Third Quarter Press Release

 

## **SIGNATURES**

 

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

 

 

PENNS WOODS BANCORP, INC.

(Registrant)

 
| Date:   November 13, 2003 | /s/ Ronald A. Walko                                     |   |
|------------------------------------------|---------------------------------------------------------|--------|
|                                     | Ronald A. Walko, President and Chief  Executive Officer |
|                                     |                                                    |   |
|                                     |                                                    |   |
|                                     |                                                    |   |
| Date:   November 13, 2003 | /s/ Sonya E. Scott                                      |   |
|                                     | Sonya E. Scott, Secretary                               |
|                                     |                                                    |   |

 

**EXHIBIT INDEX**

 

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