<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
X ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
- ----- OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
OR
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND
- ----- EXCHANGE ACT OF 1934
Commission File No.: 0-21939
PENNWOOD BANCORP, INC.
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(Name of Small Business Issuer in Its Charter)
Pennsylvania 25-1783648
- -------------------------------------------- ----------------------
(State of Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
683 Lincoln Avenue, Pittsburgh, Pennsylvania 15202
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(Address of Principal (Zip Code)
Executive Offices)
Issuer's Telephone Number, Including Area Code: (412) 761-1234
Securities registered under Section 12(b) of the Exchange Act:
NOT APPLICABLE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK (PAR VALUE $.01 PER SHARE)
- --------------------------------------------------------------------------------
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
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Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. X
------
Issuer's revenues for its most recent fiscal year: $3.9 million.
As of September 25, 1998, the aggregate value of the 517,074 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
145,450 shares held by all directors and executive officers of the Registrant
and the Registrant's Employee Stock Ownership Plan ("ESOP") as a group, was
approximately $5.7 million. This figure is based on the closing sales price of
$11.00 per share of the Registrant's Common Stock on September 25, 1998.
Although directors and executive officers and the ESOP were assumed to be
"affiliates" of the Registrant for purposes of this calculation, the
classification is not to be interpreted as an admission of such status.
Number of shares of Common Stock outstanding as of September 25, 1998: 662,524
Transitional Small Business Disclosure Format: Yes No X
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<PAGE> 2
PART I
ITEM 1. BUSINESS
GENERAL
Pennwood Bancorp, Inc. (the "Company)" is a Pennsylvania-incorporated
bank holding company and the sole stockholder of Pennwood Savings Bank (the
"Savings Bank"). The only significant assets of the Company is the capital stock
of the Savings Bank. The business of the Company currently consists of the
business of the Savings Bank. At June 30, 1998, the Company had consolidated
total assets of $46.0 million, total consolidated deposits of $35.7 million, and
total consolidated stockholders' equity of $7.9 million.
The Savings Bank is a Pennsylvania-chartered stock savings bank which was
originally founded in 1910 as a Pennsylvania-chartered mutual savings
association. The Savings Bank converted from a Pennsylvania-chartered mutual
savings association to a Pennsylvania-chartered mutual savings bank in July
1993. In July 1996, the Savings Bank converted from a Pennsylvania- chartered
mutual savings bank to a Pennsylvania-chartered stock savings bank. In January
1997, the Savings Bank organized to the holding company form of ownership and
was acquired by the Company. The Savings Bank conducts business from its main
office in Pittsburgh, Pennsylvania and two branch offices located in Kittanning,
Pennsylvania. The Savings Bank's deposits are insured by the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC") to
the maximum extent permitted by law.
The Savings Bank is primarily engaged in attracting deposits from the
general public through its offices and using those and other available sources
of funds to originate loans secured by single-family residences as well as
consumer loans (consisting primarily of home equity and improvement loans). To a
lesser extent, the Savings Bank originates loans secured by existing
multi-family residential and commercial real estate, as well as construction
loans. The Savings Bank also invests its funds in U.S. Government and agency
obligations, as well as corporate and municipal debt securities, mortgage-backed
securities and various short-term investments.
The Savings Bank is a community-oriented financial institution which
emphasizes customer services and convenience. As part of this strategy, the
Savings Bank has sought to develop a wide variety of products and services which
meet the needs of its retail customers. The Savings Bank generally has sought to
achieve long-term financial strength and stability by increasing the amount and
stability of its net interest income. In pursuit of these goals, the Savings
Bank has adopted a number of complementary business strategies which emphasize
retail lending and deposit products and services traditionally offered by
savings institutions.
The main office of the Savings Bank is located at 683 Lincoln Avenue,
Pittsburgh, Pennsylvania 15202, and its telephone number is (412) 761-1234.
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LENDING ACTIVITIES
GENERAL. At June 30, 1998, the Company's net loan portfolio amounted to
$33.6 million, or 73.0% of total assets at that date. The Company has
traditionally concentrated its lending activities on conventional first mortgage
loans secured by single-family residential properties and consumer loans
(consisting primarily of home equity and improvement loans). Consistent with its
lending orientation, as of June 30, 1998, $22.0 million or 60.7% of the
Company's total loan portfolio consisted of single-family residential loans and
$9.1 million or 25.1% of the Company's total loan portfolio consisted of
consumer and other loans. To a lesser extent, the Company also originates
multi-family residential, commercial real estate and residential construction
loans. At June 30, 1998, such loan categories amounted to $453,000, $1.1 million
and $3.6 million, respectively, or 1.2%, 3.1% and 10.0% of the total loan
portfolio, respectively. Substantially all of the Company's total loan portfolio
consists of conventional loans, which are loans that are neither insured by the
Federal Housing Administration nor partially guaranteed by the Department of
Veteran Affairs. Historically, the Company's lending activities have been
concentrated in its primary market area of Allegheny County and Armstrong
County, Pennsylvania and portions of the surrounding counties. The Company
estimates that a substantial portion of its mortgage loans are secured by
properties located in its primary market area, and that substantially all of its
non-mortgage loan portfolio consists of loans made to residents and businesses
located in such primary market area.
LOAN PORTFOLIO COMPOSITION. The following table sets forth the
composition of the Company's loan portfolio by type of loan at the dates
indicated.
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- ----------------------
Amount Percent Amount Percent Amount Percent
-------- -------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Single-family residential $22,006 60.7% $14,857 50.2% $9,572 40.8%
Multi-family residential 453 1.2 478 1.6 85 0.3
Commercial real estate 1,107 3.1 1,524 5.1 2,582 11.0
Construction 3,631 10.0 3,748 12.7 2,393 10.2
------ ----- ------ ----- ------ -----
Total real estate loans 27,197 75.0 20,607 69.6 14,632 62.3
Consumer loans:
Home improvement/equity 8,217 22.7 8,110 27.4 7,843 33.4
Other(1) 840 2.3 906 3.0 998 4.3
------ ----- ------ ---- ------ -----
Total consumer loans 9,057 25.0 9,016 30.4 8,841 37.7
Commercial business loans - -- -- -- -- --
------ ----- ------ ----- ------ -----
Total loans 36,254 100.0% 29,623 100.0% 23,473 100.0%
====== ===== ------ ===== ------ =====
Less:
Loans in process 1,852 1,924 1,487
Deferred loan origination
fees 310 265 129
Unearned discounts 73 172 352
Allowance for loan losses 394 282 337
----- ------ ------
Net loans $33,625 $26,980 $21,168
====== ====== ======
</TABLE>
- ----------------------------
(1) Consists primarily of unsecured personal loans and lines of credit and
automobile loans.
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CONTRACTUAL PRINCIPAL REPAYMENTS AND INTEREST RATES. The following table
sets forth certain information at June 30, 1998 regarding the dollar amount of
loans maturing in the Company's total loan portfolio, based on the contractual
terms to maturity, before giving effect to net items. Loans having no stated
schedule of repayments and no stated maturity are reported as due in one year or
less.
<TABLE>
<CAPTION>
Due One to Due Five or
Due One Five Years More
Year or After Years After
Less 6/30/98 6/30/98 Total
----------- -------------- ------------- -------------
(In thousands)
<S> <C> <C> <C> <C>
Single-family residential $ 283 $4,739 $16,984 $22,006
Multi-family residential -- 81 372 453
Commercial real estate -- 687 420 1,107
Construction 1,852 397 1,382 3,631
Consumer 644 2,254 6,159 9,057
Commercial business -- -- -- --
----- ----- ------ ------
Total $2,779 $8,158 $25,317 $36,254
===== ===== ====== ======
</TABLE>
The following table sets forth the dollar amount of all loans, before net
items, due after June 30, 1999 which have fixed interest rates or which have
floating or adjustable interest rates.
<TABLE>
<CAPTION>
Floating or Adjustable-
Fixed-Rates Rates Total
----------- ------------------------ --------------
(In Thousands)
<S> <C> <C> <C>
Single-family residential $15,560 $6,163 $21,723
Multi-family residential -- 453 453
Commercial real estate -- 1,107 1,107
Construction 1,567 212 1,779
Consumer 7,573 840 8,413
Commercial business -- -- --
------- ------ -------
Total $24,700 $8,775 $33,475
======= ====== =======
</TABLE>
Scheduled contractual principal repayments do not reflect the actual
maturities of loans. The average maturity of loans is substantially less than
their average contractual terms because of prepayments and, in the case of
conventional mortgage loans, due-on-sale clauses, which generally give the
Company the right to declare a loan immediately due and payable in the event,
among other things, the borrower sells the real property subject to the mortgage
and the loan is not repaid. The average life of mortgage loans tends to increase
when current mortgage loan rates are substantially higher than rates on existing
mortgage loans and, conversely, decrease when rates on existing mortgages are
substantially lower than current mortgage loan rates (due to refinancings of
adjustable-rate and fixed-rate loans at lower rates).
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ORIGINATION, PURCHASE AND SALE OF LOANS. The lending activities of the
Company are subject to the written, non-discriminatory, underwriting standards
and loan origination procedures established by the Company's Board of Directors
and management. Loan originations are obtained from a variety of sources,
including existing customers, builders, realtors, walk-in customers, loan
officers and advertising.
Loan applications originated by the Company are generally processed at
the Company's main office in Pittsburgh. The loan applications are initially
processed by loan processors and, once completed, are submitted first to the
Vice President of Lending for initial approval and then to the Company's
President and Chief Executive Officer who may approve loans up to $150,000.
Loans of up to $227,150 also may be approved by such officers if originated by
NVR Mortgage. Loans between $150,000 to $250,000 are submitted for approval to
the Board of Director's Loan Committee, while loans in excess of $250,000 must
be approved by the Company's Board of Directors. All commercial loans,
regardless of amount, must be approved by the Board of Directors.
Property appraisals on the real estate and improvements securing the
Company's single-family residential loans are made by independent appraisers.
Appraisals are performed in accordance with federal regulations and policies.
The Company obtains title insurance policies on first mortgage real estate loans
originated by it. Borrowers also must obtain hazard insurance prior to closing
and, when required, flood insurance. Borrowers may be required to advance funds,
with each monthly payment of principal and interest, to a loan escrow account
from which the Company makes disbursements for items such as real estate taxes
and mortgage insurance premiums as they become due.
Historically, the Company has originated substantially all of the loans
in its portfolio and has held them until maturity. Nevertheless, the Company's
residential loans are generally made on terms, conditions and documentation
which permit the sale to the Federal Home Loan Mortgage Corporation ("FHLMC"),
the Federal National Mortgage Association ("FNMA") and other institutional
investors in the secondary market. However, the Company has not sold any loans
in the secondary market since July 1993 when it sold $123,000 of single-family
residential loans to the FHLMC. Sales of loans to date generally have been under
terms which do not provide any recourse to the Company by the purchaser in the
event of default on the loan by the borrower. Although the Company is not
currently selling loans in the secondary market, it may in the future consider
resuming the sale of loans to the FHLMC and other institutional investors as
market conditions permit.
Historically, the Company has not been an active purchaser of loans.
However, in fiscal 1998, the Company purchased two single-family loans totaling
$144,000 from FHLMC that the Company had been servicing. In fiscal 1997, the
Company purchased seven commercial participation loans totaling $96,000, in May
1996, the Company purchased a $7,000 participation in a commercial loan, and
prior to 1994 purchased participation interests in loans secured by commercial
real estate and equipment-secured commercial leases. Such loans were generally
purchased from an investment consulting and loan servicing firm located in
Monroeville, Pennsylvania. The Company ceased purchasing such loans and
participation interests as a result of an increase in delinquencies. At June 30,
1998, loans purchased and serviced by others totalled $888,000, of which none
were classified as non-performing.
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The following table shows total loans originated, purchased, sold and repaid
during the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------
1998 1997 1996
---------- --------------- ----------
(In Thousands)
<S> <C> <C> <C>
Loan originations:
Single-family residential $ 5,742 $ 6,014 $ 557
Multi-family residential -- -- --
Commercial real estate -- 180 160
Construction 4,920 3,966 2,644
Consumer 3,461 4,197 2,927
Commercial business -- -- --
------- ------ ------
Total loans originated 14,123 14,357 6,288
Purchases(1) 144 96 7
------- ------ ------
Total loans originated
and purchased 14,267 14,453 6,295
Sales and loan principal
reductions:
Loans sold -- -- --
Loan principal reductions 7,609 9,014 8,532
----- ------ -----
Total loans sold and
principal reductions 7,609 9,014 8,532
Increase (decrease) due to
other items, net(2) (13) 373 (440)
------- ------ ------
Net increase (decrease) in
loan portfolio $ 6,645 $ 5,812 $(2,677)
===== ====== =======
</TABLE>
- --------------------------
(1) In fiscal 1998, consists of two FHLMC loans that the Company had been
servicing.
(2) Other items consist of loans in process, deferred fees and discounts and
allowance for loan losses.
A savings institution generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus, although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. At June 30, 1998, the Company's limit on
loans-to-one borrower was approximately $1.3 million. Nevertheless, except in
certain limited circumstances, the Company's loan policy currently limits its
loans to one borrower to $300,000. At June 30, 1998, the Company's five largest
loans or groups of loans-to-one borrower, including persons or entities related
to the borrower, amounted to $1.5 million in the aggregate, ranged from an
aggregate of $250,000 to $459,000 and were secured primarily by single-family
residential and commercial real estate. At June 30, 1998, $220,000 of the loans
which comprise the Company's largest loans-to-one borrower were classified as
non-performing.
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The Company's largest loans-to-one borrower consists of five loans which
are secured by single-family residential rental properties. The five loans had
an aggregate principal balance of $459,000 as of June 30, 1998, and three of the
loans were over 90 days delinquent (with an aggregate principal balance of
$220,000), one of the loans was 60 days delinquent (with a principal balance of
$110,000) and one loan was 30 days delinquent (with a principal balance of
$129,000), as of such date. Four of the five loans are secured by properties
located within the Company's primary market area. The principal borrower (which
consists of a partnership which is affiliated with the investment consulting and
loan servicing firm with respect to which the Company has purchased commercial
real estate and commercial business loans in the past) is currently negotiating
with the Company in order to bring all of the loans current and, accordingly,
the Company does not presently anticipate any loss of principal at this time.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LOANS. The Company has historically
concentrated its lending activities on the origination of loans secured by first
mortgage liens on existing single-family residences located in its market area.
At June 30, 1998, $22.0 million or 60.7% of the Company's total loan portfolio
consisted of permanent single-family residential real estate loans.
The Company had been emphasizing for its portfolio single-family
residential mortgage loans which provide for periodic adjustments to the
interest rate. The loans emphasized by the Company have up to 30-year terms and
an interest rate which adjusts every year in accordance with a designated index
(the weekly average yield on U.S. Treasury securities adjusted to a constant
comparable maturity of one year, as made available by the Board of Governors of
the Federal Reserve System ("Federal Reserve Board")). Such loans currently have
a 2% cap on the amount of any increase or decrease in the interest rate per
year, and a 6% limit on the amount by which the interest rate can increase or
decrease over the life of the loan. The Company has not engaged in the practice
of using a cap on the payments that could allow the loan balance to increase
rather than decrease, resulting in negative amortization. Most adjustable rate
single-family residential loans originated by the Company can, upon payment of a
fee, be converted into fixed-rate loans during certain periods. Approximately
28.7% of the permanent single-family residential loans in the Company's loan
portfolio at June 30, 1998 had adjustable interest rates. Recently, the Company
has emphasized for its portfolio fixed-rate single-family residential mortgage
loans.
The demand for adjustable-rate loans in the Company's primary market area
has been a function of several factors, including the level of interest rates,
the expectations of changes in the level of interest rates and the difference
between the interest rates and loan fees offered for fixed-rate loans and
adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates. The Company believes that these risks, which have not had a
material adverse effect on the Company to
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date, generally are less than the risks associated with holding fixed-rate loans
in an increasing interest rate environment.
The Company continues to originate long-term, fixed-rate loans in order
to provide a full range of products to its customers, but generally only under
terms, conditions and documentation which permit the sale thereof in the
secondary market. At June 30, 1998, approximately $15.7 million or 71.3% of the
permanent single-family residential loans in the Company's portfolio consisted
of loans which provide for fixed rates of interest. Although these loans provide
for repayments of principal over a fixed period of up to 30 years, it is the
Company's experience that such loans remain outstanding for a substantially
shorter period of time.
The Company is permitted to lend up to 100% of the appraised value of the
real property securing a residential loan (referred to as the loan-to-value
ratio); however, if the amount of a residential loan originated or refinanced
exceeds 90% of the appraised value, the Company is required by federal
regulations to obtain private mortgage insurance on the portion of the principal
amount that exceeds 80% of the appraised value of the security property.
Pursuant to underwriting guidelines adopted by the Board of Directors, the
Company will lend up to 95% of the appraised value of the property securing a
single-family residential loan. However, the Company generally requires private
mortgage insurance on the portion of the principal amount that exceeds 80% of
the appraised value of the secured property.
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LOANS. The Company
originates mortgage loans for the acquisition and refinancing of multi-family
residential properties and properties secured by commercial real estate. The
Company currently does not actively solicit such loans, which do not constitute
an active part of its business, and generally offers such loans to accommodate
its present customers and members of the local community. At June 30, 1998, $1.6
million or 4.4% of the Company's total loan portfolio consisted of loans secured
by multi-family residential and commercial real estate. The majority of the
Company's multi-family residential and commercial real estate loans are secured
by office buildings, restaurants, and other special purpose properties located
within the Company's primary market area. Management does not expect to
emphasize multi-family residential and commercial real estate lending in the
near future.
A substantial portion of the Company's multi-family residential and
commercial real estate loans within the Company's portfolio consist of whole
loans and loan participations which were purchased by the Company through an
investment consulting and loan servicing firm headquartered in Monroeville,
Pennsylvania. The Company has experienced a high level of delinquencies with
respect to such purchased loans and, consequently, no longer engages in the
purchase of commercial real estate loans.
The Company requires appraisals of all properties securing multi-family
residential and commercial real estate loans. Appraisals are performed by an
independent appraiser designated by the Company, all of which are reviewed by
management. The Company considers the quality and location of the real estate,
the credit of the borrower, the cash flow of the project and the quality of
management involved with the property.
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<PAGE> 9
Although terms vary, multi-family residential and commercial real estate
loans generally are amortized over a period of up to 25 years and mature in 15
years or less. The Company originates these loans with interest rates which
adjust in accordance with a designated index, which generally is negotiated at
the time of origination. Loan-to-value ratios on the Company's multi-family
residential and commercial real estate loans are currently limited to 80% or
lower. As part of the criteria for underwriting multi-family residential and
commercial real estate loans, the Company generally imposes a specified debt
coverage ratio (the ratio of net cash from operations before payment of debt
service to debt service). It is also the Company's general policy to obtain
personal guarantees on its multi-family residential and commercial real estate
loans from the principals of the borrower and, when this cannot be obtained, to
impose more stringent loan-to-value, debt service and other underwriting
requirements.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans typically involve large loan balances to single
borrowers and because the payment experience on such loans is typically
dependent on the successful operation of the project or the borrower's business.
These risks can also be significantly affected by supply and demand conditions
in the local market for apartments, offices, warehouses or other commercial
space. The Company attempts to minimize its risk exposure by limiting the extent
of the nonresidential lending generally. In addition, the Company imposes
loan-to-value ratios, requires conservative debt coverage ratios, and
continually monitors the operation and physical condition of the collateral. At
June 30, 1998, $220,000 of the Company's multi-family residential and commercial
real estate loans were non-performing, which constituted 33.6% of total
non-performing loans at such date.
CONSTRUCTION LOANS. The Company also originates residential construction
loans to individuals who have a contract with a builder for the construction of
their residence and, to a much lesser extent, to local real estate builders,
generally with whom it has an established relationship. The Company's
construction loans are secured by property located primarily in the Company's
primary market area. At June 30, 1998, construction loans amounted to $3.6
million or 10.0% of the Company's total loan portfolio.
Prior to making a commitment to fund a construction loan, the Company
requires an appraisal of the property by an independent state-licensed and
qualified appraiser. The appraiser typically reviews and inspects each project
at the commencement of construction and throughout the term of the construction
loan. Loan proceeds are disbursed after inspections of the project by the
appraiser based on the percentage of completion.
Construction lending is generally considered to involve a higher level of
risk as compared to permanent single-family residential lending, due to the
concentration of principal in a limited number of loans and borrowers and the
effects of general economic conditions on developers and builders. Moreover, a
construction loan can involve additional risks because of the inherent
difficulty in estimating both a property's value at completion of the project
and the estimated cost (including interest) of the project. The nature of these
loans is such that they are generally more difficult to evaluate and monitor. In
addition, construction loans to a builder may not always be pre-
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<PAGE> 10
sold and thus could pose a greater potential risk to the Company than
construction loans to individuals on their personal residences. Nevertheless,
the Company has attempted to minimize the foregoing risks by, among other
things, limiting the extent of its construction lending as a proportion of the
total loan portfolio and by limiting its construction lending solely to
residential properties.
The Company also provides construction and permanent financing to
Owner-Builder borrowers, who act in the capacity of general contractor. These
borrowers sub-contract portions of the overall construction project, and realize
a price reduction for performing the balance of the work themselves.
Owner-Builder loans present a higher degree of risk due to the inexperience of
the borrowers in estimating construction costs and in scheduling work to ensure
project completion within the contractual time period.
CONSUMER LOANS. The Company has been originating consumer loans in recent
years in order to provide a full range of financial services to its customers
and because such loans generally have shorter terms and higher interest rates
than mortgage loans. The consumer loans offered by the Company include home
equity lines of credit, home improvement loans, unsecured personal loans and
lines of credit and automobile loans. At June 30, 1998, consumer loans amounted
to $9.1 million or 25.1% of the Company's total loan portfolio.
Home equity lines of credit are originated by the Company for up to 80%
of the appraised value, less the amount of any existing prior liens on the
property. The Company also offers home improvement loans in amounts up to 90% of
the appraised value, less the amount of any existing prior liens. In 1987, the
Company entered into a contractual arrangement with an individual who assisted
the Company in originating and servicing home improvement loans through a
network of dealers. Although the contractual arrangement was terminated in
January 1994 (which resulted in the Company's recognition of $110,000 of expense
during fiscal 1994), the Company continues to originate home improvement loans
through a network of dealers which directly engage in the home improvement
field. Generally, home equity lines of credit have a maximum term of ten years
and interest rates which adjust in accordance with a designated prime rate plus
a margin. Home improvement loans have a maximum term of ten years and generally
carry fixed interest rates. In either case, the Company will secure the loan
with a mortgage on the property (generally a second mortgage) and will originate
the loan even if another institution holds the first mortgage. A combination
home improvement project, plus bill consolidation loan, can result in a home
equity loan over $100,000. Such loans can have terms up to 240 months and
usually require a first lien position if over $50,000. Under this amount, the
loan may be a second mortgage if the overall loan-to-value ratio meets the
bank's underwriting standards. Any loan over $100,000 shall be reported in the
Loan Committee minutes. At June 30, 1998, home equity lines of credit and home
improvement loans totaled $8.2 million or 22.6% of the Company's total loan
portfolio.
The Company also offers unsecured lines of credit up to $3,000 with terms
up to 24 months, unsecured fixed rate loans up to $5,000 for borrowers with
excellent credit support as well as automobile loans up to $25,000 with terms up
to 60 months. The Company generally offers these loans to existing customers. At
June 30, 1998, $840,000 or 9.3% of the Company's total consumer loan portfolio
consisted of unsecured personal loans and lines of credit and automobile loans.
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The underwriting standards employed by the Company for consumer loans
include a determination of the applicant's credit history and an assessment of
the borrower's ability to meet existing obligations and payments on the proposed
loan. The stability of the applicant's monthly income may be determined by
verification of gross monthly income from primary employment, and additionally
from any verifiable secondary income. Creditworthiness of the applicant is of
primary consideration; however, the underwriting process also includes a
comparison of the value of any security in relation to the proposed loan amount.
Upon termination of the Company's consulting arrangement discussed above, the
Company revised its loan underwriting and collection policies in order to
enhance its consumer loan underwriting standards and improve its collection
efforts.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but often involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss, divorce, illness and personal bankruptcy. In
most cases, any repossessed collateral for a defaulted consumer loan will not
provide an adequate source of repayment of the outstanding loan balance because
of improper repair and maintenance of the underlying security. The remaining
deficiency often does not warrant further substantial collection efforts against
the borrower. The Company believes that the generally higher yields earned on
consumer loans compensate for the increased credit risk associated with such
loans and that consumer loans are important to its efforts to increase rate
sensitivity, shorten the average maturity of its loan portfolio and provide a
full range of services to its customers. Nevertheless, at June 30, 1998,
$603,000 of the Company's consumer loans were non-performing, which constituted
92.2% of total non-performing loans and 6.7% of total consumer loans at such
date.
COMMERCIAL BUSINESS LOANS. In years prior to the fiscal year ended 1997,
the Company became involved in purchasing office equipment and other commercial
leases, primarily through the investment consulting and loan servicing firm
located in Monroeville, Pennsylvania which was discussed above. The consulting
firm underwrote the leases pursuant to the Company's underwriting standards and
procedures. The Company then generally reviewed the documents and made a
determination whether to purchase such lease. The Company no longer has any
outstanding lease loans with this firm and does not plan to purchase any
additional loans from them in the future.
LOAN FEE INCOME. In addition to interest earned on loans, the Company
receives income from fees in connection with loan originations, loan
modifications, late payments and for miscellaneous services related to its
loans. Income from these activities varies from period to period depending upon
the volume and type of loans made and competitive conditions.
The Company charges loan origination fees which are calculated as a
percentage of the amount borrowed. Loan origination and commitment fees in
excess of loan origination costs are deferred and recognized over the
contractual remaining lives of the related loans on a level yield basis.
Discounts and premiums on loans purchased are credited and amortized in the same
manner. In accordance with Financial Accounting Standards Board ("FASB")
Statement No. 91, the Company recognized $140,000, $43,000 and $67,000 of
deferred loan fees during the years ended
10
<PAGE> 12
June 30, 1998, 1997, and 1996, respectively, in connection with loan
refinancing, payoffs and ongoing amortization of outstanding loans.
ASSET QUALITY
DELINQUENT LOANS. When a borrower fails to make a required payment on a
loan, the Company attempts to cure the deficiency by contacting the borrower and
seeking the payment. Contacts are generally made at least 15 days after a
payment is due. In most cases, deficiencies are cured promptly. If a delinquency
continues, the loan and payment history are reviewed and efforts are made to
collect the loan. While the Company generally prefers to work with borrowers to
resolve such problems, the Company will institute foreclosure or other
proceedings, as necessary, to minimize any potential loss. The Company generally
initiates such proceedings when a loan becomes 90 days delinquent. The Company
recently hired a full time collector to improve loan recovery efforts.
The following table sets forth information concerning delinquent loans at
June 30, 1998, in dollar amounts and as a percentage of the Company's total loan
portfolio. The amounts presented represent the total outstanding principal
balances of the related loans, rather than the actual payment amounts which are
past due.
<TABLE>
<CAPTION>
June 30, 1998
---------------------------------------------------------------------------------------------------
30-59 90 or More Days
Days Overdue 60-89 Days Overdue Overdue
---------------------------- ------------------------------- -----------------------------
Percent Percent Percent
of Total of Total of Total
Amount Loans Amount Loans Amount Loans
---------- ------------- ----------- ------------ --------- --------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Single-family residential $116 0.34% $205 0.61% $51 0.15%
Multi-family residential
and commercial real
estate 129 0.38 227 0.68 - --
Construction -- -- -- -- -- --
Consumer 205 0.61 141 0.42 603 1.79
Commercial business -- -- -- -- - --
--- ---- --- ---- --- ----
Total delinquent loans $450 1.33% $573 1.71% $654 1.94%
=== ==== === ==== ==== ====
</TABLE>
NON-PERFORMING ASSETS. Loans are placed on non-accrual status when, in
the judgment of management, the probability of collection of interest is deemed
to be insufficient to warrant further accrual. When a loan is placed on
non-accrual status, previously accrued but unpaid interest is deducted from
interest income. As a matter of policy, the Company does not accrue interest on
loans past due 90 days or more except when the estimated value of the collateral
and collection efforts are deemed sufficient to ensure full recovery.
11
<PAGE> 13
Real estate acquired by the Company as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold.
Pursuant to a statement of position ("SOP 92-3") issued by the American
Institute of Certified Public Accountants in April 1992, which provides guidance
on determining the balance sheet treatment of foreclosed assets in annual
financial statements for periods ending on or after December 15, 1992, there is
a rebuttable presumption that foreclosed assets are held for sale and such
assets are recommended to be carried at the lower of fair value minus estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expensed and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value. The Company's accounting for its real estate
acquired by foreclosure complies with the guidance set forth in SOP 92-3.
The following table sets forth the amounts and categories of the
Company's non-performing assets at the dates indicated. The Company did not have
any troubled debt restructurings at any of the dates presented.
<TABLE>
<CAPTION>
June 30,
---------------------------------------
1998 1997 1996
-------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C>
Non-accruing loans:
Single-family residential $51 $ 96 $111
Multi-family residential and
commercial real estate -- 60 60
Construction -- -- --
Consumer 272 117 137
Commercial business -- -- --
--- --- ---
Total non-accruing loans 323 273 308
Accruing loans greater than
90 days delinquent:
Single-family residential -- -- 2
Multi-family residential and
commercial real estate -- -- --
Consumer 331 181 196
--- --- ---
Total accruing loans greater than
90 days delinquent 331 181 198
--- --- ---
Total non-performing loans 654 454 506
Real estate owned 11 37 166
--- --- ---
Total non-performing assets $665 $491 $672
--- === ===
Total non-performing loans
as a percentage of total loans 1.94% 1.68% 2.39%
==== ==== ====
Total non-performing assets
as a percentage of total assets 1.44% 0.98% 1.43%
==== ==== ====
</TABLE>
For the years ended June 30, 1998, 1997 and 1996, approximately $42,000,
$26,000 and $29,000, respectively, in gross interest income would have been
recorded on loans accounted for on
12
<PAGE> 14
a non-accrual basis if such loans had been current in accordance with their
original terms and had been outstanding throughout the year or since origination
if held for part of the year. For the years ended June 30, 1998, 1997 and 1996,
$12,000, $10,000 and $6,000, respectively, were included in interest income for
these same loans.
The $654,000 of non-performing loans at June 30, 1998 included $51,000 of
single-family residential loans, $603,000 of consumer loans (consisting of 56
loans, 40 of which are secured by single-family residential real estate), and no
commercial business loan. The $11,000 of real estate owned at June 30, 1998
consisted of one single family residential property.
The increase in non-performing assets during the year ended June 30, 1998
was primarily due to a $305,000 increase in non-performing consumer loans offset
by a $45,000 decrease in non-performing single-family residential loans, a
$60,000 decrease in non-performing multi-family residential and commercial real
estate loans and a $26,000 decrease in real estate owned. The increase in
non-performing consumer loans reflected a deterioration in credit quality. The
decrease in non-performing single-family residential loans and multi-family
residential and commercial real estate loans reflected the Company's ongoing
collection efforts. The decline in real estate owned resulted from the sale of
property.
ALLOWANCE FOR LOAN LOSSES. It is management's policy to maintain an
allowance for estimated losses based on the perceived risk of loss in the loan
portfolio and the adequacy of the allowance. Management's periodic evaluation of
the adequacy of the allowance is based on the Company's past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower's ability to repay, the estimated value of the
underlying collateral and current economic conditions. The allowance is
increased by provisions for loan losses which are charged against income. See
Notes 1 and 4 of the Notes to the Consolidated Financial Statements in the 1998
Annual Report to Stockholders, filed as Exhibit 13 hereto (the "1998 Annual
Report").
Although management uses the best information available to make
determinations with respect to the provisions for loan losses, additional
provisions for loan losses may be required to be established in the future
should economic or other conditions change substantially. In addition, the
Pennsylvania Department of Banking (the "Department") and the FDIC, as an
integral part of their examination process, periodically review the Company's
allowance for possible loan losses. Such agencies may require the Company to
recognize additions to such allowance based on their judgments about information
available to them at the time of their examination.
The following table sets forth an analysis of the Company's allowance for
loan losses during the periods indicated.
13
<PAGE> 15
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------------
1998 1997 1996
----------- -------------- ------------
(Dollars in Thousands)
<S> <C> <C> <C>
Total loans outstanding (net) $33,625 $26,980 $21,168
====== ====== ======
Average loans outstanding, net $30,152 $22,377 $22,708
====== ====== ======
Balance at beginning of period $ 282 $ 337 $ 531
Charge-offs:
Single-family residential 6 -- --
Multi-family residential and
commercial real estate 60 -- 116
Consumer 146 95 194
Commercial business -- -- 2
----- ----- ------
Total charge-offs 212 95 312
Recoveries:
Consumer 12 11 13
----- ----- ------
Total recoveries 12 11 13
----- ----- ------
Net charge-offs (200) (84) (299)
Provision for loan losses 312 29 105
----- ----- ------
Balance at end of period $394 $ 282 $ 337
=== ====== ======
Allowance for loan losses as a
percent of total loans outstanding 1.17% 1.05% 1.59%
===== ===== =====
Allowance for loan losses as a
percent of total non-performing loans 60.24% 62.11% 66.60%
===== ===== =====
Ratio of net charge-offs to
average loans outstanding 0.66% 0.38% 1.32%
===== ===== =====
</TABLE>
The following table sets forth information concerning the allocation of
the Company's allowance for loan losses by loan categories at the dates
indicated.
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------------------------------------------------------
1998 1997 1996
---------------------------- --------------------------------- ----------------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------- ----------------- ----------- ------------------- --------- -----------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Single-family residential $78 70.7% $ 76 62.9% $ 22 51.0%
loans(1)
Multi-family residential and
commercial real estate loans 66 4.3 130 6.7 170 11.3
Consumer loans 250 25.0 76 30.4 145 37.7
Commercial business loans -- - -- - - --
--- --- --- ----- ------ -----
TOTAL $394 100% $282 100.0% $ 337 100.0%
=== === === ===== ====== =====
</TABLE>
- ----------------
(1) Includes both permanent and construction loans secured by single-family
residential real estate.
14
<PAGE> 16
INVESTMENT ACTIVITIES
The Company invests in various types of securities, including U.S.
Government and agency obligations, corporate and municipal debt securities and
mortgage-backed securities guaranteed by the FHLMC. The investment policy of the
Company, as established by the Board of Directors, is designed primarily to
provide and maintain liquidity and to generate a favorable return on investments
without incurring undue interest rate risk, credit risk, and investment
portfolio asset concentrations. The Company's investment policy is currently
implemented by the Company's President and Chief Executive Officer and is
overseen by the Board of Directors.
Securities that management has the intent and positive ability to hold to
maturity are classified as held to maturity and are reported at amortized cost.
Securities that management has the clear intent of selling in advance of
maturity, or which management is uncertain it will hold until maturity are
classified as available for sale and are reported at their fair value. At June
30, 1998, $7.7 million of the Company's $7.9 million of investment securities
were classified as available for sale and the remaining $210,000 were classified
as held to maturity.
The following table sets forth information relating to the amortized cost
and market value of the Company's investment securities (including investment
securities held to maturity and available for sale).
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------------------------------------
1998 1997 1996
---------------------------- ---------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
------------- ------------- ----------- --------- ---------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities held to
maturity:
U.S. Government and agency
obligations $ -- $ -- $ -- $ -- $ 2,000 $ 2,004
Corporate obligations -- -- 497 500 764 775
Municipal obligations 200 205 200 205 200 202
Mortgage-backed securities 10 10 15 15 20 20
Other -- -- -- -- -- --
---- ---- ---- ---- ---- ----
Total investment securities held
to maturity $ 210 $ 215 $ 712 $ 720 $ 2,984 $ 3,001
=== === ====== ====== ====== ======
Investment securities available for
sale:
U.S. Government and agency
obligations $5,696 $5,735 $15,741 $15,729 $ 8,002 $ 7,919
Corporate obligations -- -- 400 401 398 403
Mortgage-backed securities 1,644 1,693 1,836 1,835 1,980 1,944
Other(1) 313 324 250 259 -- --
--- --- ------ ------ ------ ------
Total investment securities
available for sale $7,653 $7,752 $18,227 $18,224 $10,380 $10,266
===== ===== ====== ====== ====== ======
</TABLE>
- -----------------
(1) Consists of FNMA Preferred Stock.
15
<PAGE> 17
The following table sets forth the amount of the Company's investment
securities which mature during each of the periods indicated and the weighted
average yields for each range of maturities at June 30, 1998.
<TABLE>
<CAPTION>
Contractually Maturing
--------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Over 5 Average
Under 1 Year Yield 1-5 Years Yield Years Yield
------------ ---------- ----------- ---------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities held to
maturity:
U.S. Government and
agency obligations $ - -% $ - -% $-- --%
Corporate obligations -- -- -- -- -- -
Municipal obligations -- -- -- -- 200 5.75
Mortgage-backed securities -- -- -- -- 10 7.50
----- ----- -----
Total investment securities
held to maturity $ - --% $ -- --% $ 210 5.83%
===== ===== ===== ===== === ====
Available for sale(1):
U.S. Government and
agency obligations $ -- --% $1,257 6.97% $4,802 7.27%
Corporate obligations -- -- -- -- -- --
Mortgage-backed securities -- -- -- -- 1,693 7.26
----- ----- -----
Total investment securities
available for sale $ -- --% $1,257 6.97% $6,495 7.27%
===== ===== ===== ==== ===== ====
</TABLE>
- -------------------------------
(1) Reflected at fair value.
The actual maturity of the Company's investment securities may differ
from contractual maturity since certain of the Company's investment securities
are subject to call provisions which allow the issuer to accelerate the maturity
date of the security. In addition, due to repayments of the underlying loans,
the actual maturities of mortgage-backed securities are substantially less than
the scheduled maturities. See Notes 2 and 3 of the Notes to Consolidated
Financial Statements in the 1998 Annual Report, filed as Exhibit 13 hereto.
SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Company's funds for
lending and other investment purposes. In addition to deposits, the Company
derives funds from loan principal repayments and prepayments, the maturity and
sales of investment securities and operations. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows and loan prepayments
are significantly influenced by general interest rates and market conditions.
DEPOSITS. The Company's deposit products include a broad selection of
deposit instruments, including passbook savings and club accounts, NOW accounts,
money market accounts and certificates of deposit. Deposit account terms vary,
with the principal differences being the minimum balance required, the time
periods the funds must remain on deposit and the interest rate.
The Company's deposits are obtained primarily from residents of Allegheny
County and Armstrong County, Pennsylvania. The Company attracts deposit accounts
by offering a wide
16
<PAGE> 18
variety of accounts, competitive interest rates, and convenient office locations
and service hours. The Company utilizes traditional marketing methods to attract
new customers and savings deposits, including print media advertising and direct
mailings. The Company does not advertise for deposits outside of its local
market area or utilize the services of deposit brokers, and management believes
that an insignificant number of deposit accounts were held by non-residents of
Pennsylvania at June 30, 1998.
The following table shows the distribution of and certain other
information relating to the Company's deposits by type as of the dates
indicated.
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- ----------------------- ------------------------
Percent of Percent of Percent of
Amount Deposits Amount Deposits Amount Deposits
---------- ----------- ---------- ----------- ---------- ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Transaction accounts:
Passbook savings and club
accounts $8,669 24.24% $ 9,168 25.60% $10,577 28.28%
NOW accounts 3,322 9.29 3,221 8.99 3,028 8.11
Money market accounts 528 1.48 724 2.02 1,008 2.70
------ ------ ------ ------ ------ ------
Total transaction accounts 12,519 35.01 13,113 36.61 14,593 39.09
------ ------ ------ ------ ------ ------
Certificates of deposit:
Within 1 year 11,983 33.52 12,075 33.71 12,199 32.68
1-2 years 4,462 12.48 4,171 11.64 3,628 9.72
2-3 years 2,722 7.61 2,360 6.59 2,978 7.98
3-4 years 2,089 5.84 1,955 5.46 2,040 5.46
4-5 years 1,979 5.54 2,145 5.99 1,895 5.08
Over 5 years - - -- -- -- --
------ ------ ------ ------ ------ ------
Total certificates of deposit 23,235 64.99 22,706 63.39 22,740 60.91
------ ----- ------ ------ ------ ------
Total deposits $35,754 100.00% $35,819 100.00% $37,333 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
The following table sets forth the savings activities of the Company
during the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------
1998 1997 1996
------------ ------------- -------------
(In Thousands)
<S> <C> <C> <C>
Deposits $34,734 $30,947 $29,221
Withdrawals 35,776 33,404 30,889
------ ------- ------
Net decrease before
interest credited (1,042) (2,457) (1,668)
Interest credited 977 943 1,182
------ ------ ------
Net increase (decrease)
in deposits $ (65) $(1,514) $ (486)
====== ======= =======
</TABLE>
17
<PAGE> 19
The following table shows the interest rate and maturity information for
the Company's certificates of deposit at June 30, 1998.
<TABLE>
<CAPTION>
Maturity Date
-------------------------------------------------------------------------------------------
Interest Rate One Year or Less Over 1-2 Years Over 2-3 Years Over 3 Years Total
- ------------------- ---------------- -------------- ---------------- -------------- ------------
(In Thousands)
<C> <C> <C> <C> <C>
2.00 - 4.00% $ $ 33 $ -- $ -- $ 33
4.01 - 6.00% 11,104 2,888 909 1,202 16,103
6.01 - 8.00% 879 1,541 1,813 2,866 7,099
------- ----- ----- ----- ------
Total $11,983 $4,462 $2,722 $4,068 $23,235
====== ===== ===== ===== ======
</TABLE>
The following table sets forth the maturities of the Company's
certificates of deposit having principal amounts of $100,000 or more at June 30,
1998.
<TABLE>
<CAPTION>
Certificates of deposit maturing
in quarter ending: Amount
---------------------------------------- ---------------------
(In Thousands)
<S> <C>
September 30, 1998 $ 105
December 31, 1998 202
March 31, 1999 422
After March 31, 1999 1,576
-----
Total certificates of deposit with
balances of $100,000 or more $2,305
=====
</TABLE>
COMPETITION
The Company faces significant competition for real estate loans,
principally from mortgage banking companies, other savings institutions,
commercial banks and credit unions. Factors which affect competition generally
include the general and local economic conditions, current interest rate levels
and volatility in the mortgage markets. The Company also faces significant
competition in attracting deposits. Its most direct competition for deposits has
historically come from commercial banks and other savings institutions located
in its market area. The Company faces additional significant competition for
investors' funds from other financial intermediaries. The Company competes for
deposits principally by offering depositors a variety of deposit programs,
convenient branch locations, hours and other services. The Company does not rely
upon any individual group or entity for a material portion of its deposits.
Federal legislation in recent years has eliminated many of the
distinctions between commercial banks and savings institutions and holding
companies and allowed bank holding companies to acquire savings institutions.
Such legislation has generally resulted in an increase in the competition
encountered by savings institutions and has resulted in a decrease in both the
number of savings institutions and the aggregate size of the savings industry.
18
<PAGE> 20
EMPLOYEES
The Company had 11 full-time employees and 9 part-time employees as of
June 30, 1998. None of these employees is represented by a collective bargaining
agent. The Company believes that it enjoys good relations with its personnel.
SUBSIDIARIES
At June 30, 1998, the Company had two wholly-owned subsidiaries, the
Savings Bank and Pennwood Service Corporation, which held no significant assets
and was inactive as of such date.
REGULATION
Set forth below is a brief description of certain laws and regulations
which together with the descriptions of laws and regulation contained elsewhere
herein, are deemed material to an investor's understanding of the extent to
which the Company and the Savings Bank are regulated. The description of these
laws and regulations, as well as descriptions of laws and regulations contained
elsewhere herein, does not purport to be complete and is qualified in its
entirety by reference to applicable laws and regulations.
THE COMPANY
GENERAL. The Company is a registered bank holding company pursuant to the
Bank Holding Company Act of 1956, as amended (the "BHCA") and is subject to
regulation and supervision by the Federal Reserve Board and the Department. The
Company is required to file annually a report of its operations with, and is
subject to examination by, the Federal Reserve Board and the Department.
BHCA ACTIVITIES AND OTHER LIMITATIONS. The BHCA prohibits a bank holding
company from acquiring direct or indirect ownership or control of more than 5%
of the voting shares of any bank, or increasing such ownership or control of any
bank, without prior approval of the Federal Reserve Board. The BHCA also
generally prohibits a bank holding company from acquiring any bank located
outside of the state in which the existing bank subsidiaries of the bank holding
company are located unless specifically authorized by applicable state law. No
approval under the BHCA is required, however, for a bank holding company already
owning or controlling 50% of the voting shares of a bank to acquire additional
shares of such bank.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring more than 5% of the voting shares of any company that is not a
bank and from engaging in any business other than banking or managing or
controlling banks. Under the BHCA, the Federal Reserve Board is authorized to
approve the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve Board has determined to be so closely
related to banking or to managing or controlling banks as to be a proper
incident
19
<PAGE> 21
thereto. In making such determinations, the Federal Reserve Board is required to
weigh the expected benefit to the public, such as greater convenience, increased
competition or gains in efficiency, against the possible adverse effects, such
as undue concentration of resources, decreased or unfair competition, conflicts
of interest or unsound banking practices.
The Federal Reserve Board has by regulation determined that certain
activities are closely related to banking within the meaning of the BHCA. These
activities include operating a mortgage company, finance company, credit card
company, factoring company, trust company or savings association; performing
certain data processing functions; providing limited securities brokerage
services; acting as an investment or financial advisor; acting as an insurance
agent for certain types of credit related insurance; leasing personal property
on a full-payout, non-operating basis; providing tax planning and preparation
services; operating a collection agency; and providing certain courier services.
The Federal Reserve Board also has determined that certain other activities,
including real estate brokerage and syndication, land development, property
management and underwriting of life insurance not related to credit
transactions, are not closely related to banking and a proper incident thereto.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between savings
institutions and any affiliate are governed by Section 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context, the parent holding company of
a savings institution (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
institution. Generally, Section 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and other similar transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no savings
institution may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings institutions.
In addition, Sections 22(h) and (g) of the Federal Reserve Act places
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interest, the savings
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons and also requires prior board
20
<PAGE> 22
approval for certain loans. In addition, the aggregate amount of extensions of
credit by a savings institution to all insiders cannot exceed the institution's
unimpaired capital and surplus. Furthermore, Section 22(g) places additional
restrictions on loans to executive officers.
CAPITAL REQUIREMENTS. The Federal Reserve Board has adopted capital
adequacy guidelines pursuant to which it assesses the adequacy of capital in
examining and supervising a bank holding company and in analyzing applications
to it under the BHCA. The Federal Reserve Board capital adequacy guidelines
generally require bank holding companies to maintain total capital equal to 8%
of total risk-adjusted assets, with at least one-half of that amount consisting
of Tier I or core capital and up to one-half of that amount consisting of Tier
II or supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common stockholders' equity and perpetual preferred stock
(subject in the case of the latter to limitations on the kind and amount of such
stocks which may be included as Tier I capital), less goodwill and, with certain
exceptions, intangibles. Tier II capital generally consists of hybrid capital
instruments; perpetual preferred stock which is not eligible to be included as
Tier I capital; term subordinated debt and intermediate-term preferred stock;
and, subject to limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for the bulk of assets which are
typically held by a bank holding company, including multi-family residential and
commercial real estate loans, commercial business loans and consumer loans.
Single-family residential first mortgage loans which are not past-due (90 days
or more) or non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighing system, as
are certain privately-issued mortgage-backed securities representing indirect
ownership of such loans. Off-balance sheet items also are adjusted to take into
account certain risk characteristics.
In addition to the risk-based capital requirements, the Federal Reserve
Board requires bank holding companies to maintain a minimum leverage capital
ratio of Tier I capital to total assets of 3.0%. Total assets for this purpose
does not include goodwill and any other intangible assets and investments that
the Federal Reserve Board determines should be deducted from Tier I capital. The
Federal Reserve Board has announced that the 3.0% Tier I average capital ratio
requirement is the minimum for the top-rated bank holding companies without any
supervisory, financial or operational weaknesses or deficiencies or those which
are not experiencing or anticipating significant growth. Other bank holding
companies will be expected to maintain Tier I leverage capital ratios of at
least 4.0% to 5.0% or more, depending on the overall condition.
At June 30, 1998, the Company was in compliance with the above-described
Federal Reserve Board regulatory capital requirements.
FINANCIAL SUPPORT OF AFFILIATED INSTITUTIONS. Under Federal Reserve Board
policy, the Company will be expected to act as a source of financial strength to
the Savings Bank and to commit resources to support the Savings Bank in
circumstances when it might not do so absent such policy.
21
<PAGE> 23
THE SAVINGS BANK
The Savings Bank is incorporated under Pennsylvania law under the Banking
Code of 1965, as amended (the "Banking Code") and is subject to extensive
regulation and examination by the Department and by the FDIC, and, is subject to
certain requirements established by the Federal Reserve Board. The federal and
state laws and regulations which are applicable to banks regulate, among other
things, the scope of their business, their investments, their reserves against
deposits, the timing of the availability of deposited funds and the nature and
amount of and collateral for certain loans. There are periodic examinations by
the Department and the FDIC to test the Savings Bank's compliance with various
regulatory requirements. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulation, whether by the Department, the FDIC or the U.S.
Congress could have a material adverse impact on the Company, the Savings Bank
and their operations.
FDIC INSURANCE PREMIUMS. The deposits of the Savings Bank are currently
insured by the SAIF. Both the SAIF and the Bank Insurance Fund ("BIF"), the
federal deposit insurance fund that covers commercial bank deposits, are
required by law to attain and thereafter maintain a reserve ratio of 1.25% of
insured deposits. The BIF fund met its target reserve level in September 1995,
but the SAIF was not expected to meet its target reserve level until at least
2002. Consequently, in late 1995, the FDIC approved a final rule regarding
deposit insurance premiums which, effective with respect to the semiannual
premium assessment beginning January 1, 1996, reduced deposit insurance premiums
for BIF member institutions to zero basis points (subject to an annual minimum
of $2000) for institutions in the lowest risk category. Deposit insurance
premiums for SAIF members were maintained at their existing levels (23 basis
points for institutions in the lowest risk category).
On September 30, 1996 President Clinton signed into law legislation which
eliminated the premium differential between SAIF-insured institutions and
BIF-insured institutions by recapitalizing the SAIF's reserves to the required
ratio. The legislation provided that all SAIF member institutions pay a one-time
special assessment to recapitalize the SAIF, which was sufficient to bring the
reserve ratio in the SAIF to 1.25% of insured deposits. The legislation also
provides for the merger of the BIF and the SAIF, with such merger being
conditioned upon the prior elimination of the thrift charter.
Effective October 8, 1996, FDIC regulations imposed a one-time special
assessment of 65.7 basis points on SAIF-assessable deposits as of March 31,
1995. The Savings Bank's one-time special assessment amounted to $247,000
pre-tax.
22
<PAGE> 24
On October 16, 1996, the FDIC proposed to lower assessment rates for SAIF
members to reduce the disparity in the assessment rates paid by BIF and SAIF
members. Beginning October 1, 1996, effective SAIF rates range from zero basis
points to 27 basis points. From 1998 through 1999, SAIF members will pay 6.4
basis points to fund the Financing Corporation while BIF member institutions
will pay approximately 1.3 basis points.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Savings Bank, if it determines after a hearing that
the institution has engaged or is engaging in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Savings Bank's deposit insurance.
CAPITAL REQUIREMENTS. The FDIC has promulgated regulations and adopted a
statement of policy regarding the capital adequacy of state-chartered banks
which, like the Savings Bank, will not be members of the Federal Reserve System.
The FDIC's capital regulations establish a minimum 3.0% Tier I leverage capital
requirement for the most highly-rated state-chartered, non-member banks, with an
additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively will increase the minimum
Tier I leverage ratio for such other banks to 4.0% to 5.0% or more. Under the
FDIC's regulation, the highest-rated banks are those that the FDIC determines
are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, which are
considered a strong banking organization and are rated composite 1 under the
Uniform Financial Institutions Rating System. Leverage or core capital is
defined as the sum of common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, and minority
interests in consolidated subsidiaries, minus all intangible assets other than
certain qualifying supervisory goodwill and certain purchased mortgage servicing
rights.
The FDIC also requires that savings banks meet a risk-based capital
standard. The risk- based capital standard for savings banks requires the
maintenance of total capital (which is defined as Tier I capital and
supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining
the amount of risk-weighted assets, all assets, plus certain off balance sheet
assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the
FDIC believes are inherent in the type of asset or item. The components of Tier
I capital are equivalent to those discussed above under the 3% leverage capital
standard. The components of supplementary capital include certain perpetual
preferred stock, certain mandatory convertible securities, certain subordinated
debt and intermediate preferred stock and general allowances for loan and lease
losses. Allowance for loan and lease losses includable in supplementary capital
is limited to a maximum of 1.25% of risk- weighted assets. Overall, the amount
of capital counted toward supplementary capital cannot
23
<PAGE> 25
exceed 100% of core capital. At June 30, 1998, the Savings Bank met each of its
capital requirements.
In August 1995, the FDIC and other federal banking agencies published a
final rule modifying their existing risk-based capital standards to provide for
consideration of interest rate risk when assessing capital adequacy of a bank.
Under the final rule, the FDIC must explicitly include a bank's exposure to
declines in the economic value of its capital due to changes in interest rates
as a factor in evaluating a bank's capital adequacy. In addition, in August
1995, the FDIC and the other federal banking agencies published a joint policy
statement for public comment that describes the process the banking agencies
will use to measure and assess the exposure of a bank's net economic value to
changes in interest rates. Under the policy statement, the FDIC will consider
results of supervisory and internal interest rate risk models as one factor in
evaluating capital adequacy. In June 1996, the FDIC and other federal banking
agencies adopted a joint policy statement on interest rate risk policy. Because
market conditions, bank structure, and bank activities vary, the agencies
concluded that each bank needs to develop its own interest rate risk management
program tailored to its needs and circumstances. The policy statement describes
prudent principles and practices that are fundamental to sound interest rate
risk management, including appropriate board and senior management oversight and
a comprehensive risk management process that effectively identifies, measure,
monitors and controls risks.
The Savings Bank is also subject to more stringent Department capital
guidelines. Although not adopted in regulation form, the Department utilizes
capital standards requiring a minimum of 6% leverage capital and 10% risk-based
capital. The components of leverage and risk-based capital are substantially the
same as those defined by the FDIC.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. The
activities and equity investments of FDIC-insured, state-chartered banks are
generally limited to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state bank generally may
not directly or indirectly acquire or retain any equity investment of a type, or
in an amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition, rehabilitation or new construction of a qualified housing project,
provided that such limited partnership investments may not exceed 2% of the
bank's total assets, (iii) acquiring up to 10% of the voting stock of a company
that solely provides or reinsures directors', trustees' and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for insured
depository institutions, and (iv) acquiring or retaining the voting shares of a
depository institution if certain requirements are met. In addition, an insured
state-chartered bank may not, directly, or indirectly through a subsidiary,
engage as "principal" in any activity that is not permissible for a national
bank unless the FDIC has determined that such activities would pose no risk to
the insurance fund of which it is a member and the bank is in compliance with
applicable regulatory capital requirements. Any insured state-chartered bank
directly or indirectly engaged in any activity that is not permitted for a
national bank must cease the impermissible activity.
24
<PAGE> 26
PENNSYLVANIA SAVINGS BANK LAW. The Banking Code contains detailed
provisions governing the organization, location of offices, rights and
responsibilities of directors, officers, employees and members, as well as
corporate powers, savings and investment operations and other aspects of the
Savings Bank and its affairs. The Banking Code delegates extensive rulemaking
power and administrative discretion to the Department so that the supervision
and regulation of state-chartered savings banks may be flexible and readily
responsive to changes in economic conditions and in savings and lending
practices.
One of the purposes of the Banking Code is to provide savings banks with
the opportunity to be competitive with each other and with other financial
institutions existing under other Pennsylvania laws and other state, federal and
foreign laws. A Pennsylvania savings bank may locate or change the location of
its principal place of business and establish an office anywhere in the
Commonwealth of Pennsylvania, with the prior approval of the Department.
The Department generally examines each savings bank not less frequently
than once every two years. Although the Department may accept the examinations
and reports of the FDIC in lieu of the Department's examination, the present
practice is for the Department to conduct individual examinations. The
Department may order any savings bank to discontinue any violation of law or
unsafe or unsound business practice and may direct any trustee, officer,
attorney or employee of a savings bank engaged in an objectionable activity,
after the Department has ordered the activity to be terminated, to show cause at
a hearing before the Department why such person should not be removed.
REGULATORY ENFORCEMENT AUTHORITY. Applicable banking laws include
substantial enforcement powers available to federal banking regulators. This
enforcement authority includes, among other things, the ability to assess civil
money penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution- affiliated
parties, as defined. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities.
FEDERAL AND STATE TAXATION
GENERAL. The Company and the Savings Bank are subject to the corporate
tax provisions of the Internal Revenue Code of 1986, as amended (the "Code"), as
well as certain additional provisions of the Code which apply to thrift and
other types of financial institutions. The following discussion of tax matters
is intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to the Savings Bank.
FISCAL YEAR. The Company and its subsidiaries file a consolidated federal
income tax return on a June 30 year end basis.
25
<PAGE> 27
METHOD OF ACCOUNTING. The Savings Bank maintains its books and records
for federal income tax purposes using the accrual method of accounting. The
accrual method of accounting generally requires that items of income be
recognized when all events have occurred that establish the right to receive the
income and the amount of income can be determined with reasonable accuracy, and
that items of expense be deducted at the later of (i) the time when all events
have occurred that establish the liability to pay the expense and the amount of
such liability can be determined with reasonable accuracy or (ii) the time when
economic performance with respect to the item of expense has occurred.
BAD DEBT RESERVES. Savings institutions, such as the Savings Bank, which
meet certain definitional tests primarily relating to their assets and the
nature of their businesses, are permitted to establish a reserve for bad debts
and to make annual additions to the reserve. These additions may, within
specified formula limits, be deducted in arriving at the institution's taxable
income. For purposes of computing the deductible addition to its bad debt
reserve, the institution's loans are separated into "qualifying real property
loans" (i.e., generally those loans secured by certain interests in real
property) and all other loans ("non-qualifying loans"). The deduction with
respect to non-qualifying loans must be computed under the experience method as
described below. The following formulas may be used to compute the bad debt
deduction with respect to qualifying real property loans: (i) actual loss
experience, or (ii) a percentage of taxable income. Reasonable additions to the
reserve for losses on non-qualifying loans must be based upon actual loss
experience and would reduce the current year's addition to the reserve for
losses on qualifying real property loans, unless that addition is also
determined under the experience method. The sum of the additions to each reserve
for each year is the institution's annual bad debt deduction.
Under the experience method, the deductible annual addition to the
institution's bad debt reserves is the amount necessary to increase the balance
of the reserve at the close of the taxable year to the greater of (a) the amount
which bears the same ratio to loans outstanding at the close of the taxable year
as the total net bad debts sustained during the current and five preceding
taxable years bear to the sum of the loans outstanding at the close of the six
years, or (b) the lower of (i) the balance of the reserve account at the close
of the Savings Bank's "base year," which was its tax year ended June 30, 1988,
or (ii) if the amount of loans outstanding at the close of the taxable year is
less than the amount of loans outstanding at the close of the base year, the
amount which bears the same ratio to loans outstanding at the close of the
taxable year as the balance of the reserve at the close of the base year bears
to the amount of loans outstanding at the close of the base year.
Under the percentage of taxable income method, the bad debt deduction
equals 8% of taxable income determined without regard to that deduction and with
certain adjustments. The availability of the percentage of taxable income method
permits a qualifying savings institution to be taxed at a lower effective
federal income tax rate than that applicable to corporations in general. This
resulted generally in an effective federal income tax rate payable by a
qualifying savings institution fully able to use the maximum deduction permitted
under the percentage of taxable income method, in the absence of other factors
affecting taxable income, of 31.3%
26
<PAGE> 28
exclusive of any minimum tax or environmental tax (as compared to 34% for
corporations generally). For tax years beginning on or after January 1, 1993,
the maximum corporate tax rate was increased to 35%, which increased the maximum
effective federal income tax rate payable by a qualifying savings institution
fully able to use the maximum deduction to 32.2%.
Under the percentage of taxable income method, the bad debt deduction for
an addition to the reserve for qualifying real property loans cannot exceed the
amount necessary to increase the balance in this reserve to an amount equal to
6% of such loans outstanding at the end of the taxable year. The bad debt
deduction is also limited to the amount which, when added to the addition to the
reserve for losses on non-qualifying loans, equals the amount by which 12% of
deposits at the close of the year exceeds the sum of surplus, undivided profits
and reserves at the beginning of the year. In addition, the deduction for
qualifying real property loans is reduced by an amount equal to all or part of
the deduction for non-qualifying loans.
At June 30, 1997 (the most recent date for which a tax return has been
filed), the federal income tax bad debt reserves of the Savings Bank included
$979,000 for which no federal income tax has been provided. Because of these
federal income tax bad debt reserves and the liquidation account established for
the benefit of certain depositors of the Savings Bank in connection with the
conversion of the Savings Bank to stock form, the retained earnings of the
Saving Bank are substantially restricted.
On August 20, 1996, President Clinton signed into law the "Small Business
Job Protection Act" which included legislation, effective for tax years
beginning after December 31, 1995, whereby a small thrift institution (one with
an adjusted basis of assets of less than $500 million), such as the Savings
Bank, would no longer be permitted to make additions to its tax bad debt reserve
under the percentage of taxable income method. Such institutions will be
permitted to use the experience method in lieu of deducting bad debts only as
they occur. The legislation will require the Savings Bank to realize increased
current tax liability over a period of at least six years, beginning in the
fiscal year ending June 30, 1998. Specifically, the legislation requires a small
thrift institution to recapture (i.e., take into income) over a multi-year
period the balance of its bad debt reserves in excess of the lesser of (i) the
balance of such reserves as of the end of its last taxable year beginning before
1988 or (ii) an amount that would have been the balance of such reserves had the
institution always computed its additions to its reserves using the experience
method. However, such recapture requirements may be suspended for each of two
successive taxable years beginning on or after January 1, 1996, in which the
Savings Bank originates a minimum amount of certain residential loans based upon
the average of the principal amounts of such loans made by the Savings Bank
during its six taxable years preceding 1996. It is anticipated that any
recapture of the Savings Bank's bad debt reserves accumulated the first tax year
ending after 1987 would not have a material adverse effect on the Savings Bank's
financial condition and results of operations.
MINIMUM TAX. The Code imposes an alternative minimum tax at a rate of
20%. The alternative minimum tax generally applies to a base of regular taxable
income plus certain tax preferences ("alternative minimum taxable income" or
"AMTI") and is payable to the extent such
27
<PAGE> 29
AMTI is in excess of an exemption amount. The Code provides that an item of tax
preference is the excess of the bad debt deduction allowable for a taxable year
pursuant to the percentage of taxable income method over the amount allowable
under the experience method. Other items of tax preference that constitute AMTI
include (a) tax-exempt interest on newly issued (generally, issued on or after
August 8, 1986) private activity bonds other than certain qualified bonds and
(b) 75% of the excess (if any) of (i) adjusted current earnings as defined in
the Code, over (ii) AMTI (determined without regard to this preference and prior
to reduction by net operating losses).
NET OPERATING LOSS CARRYOVERS. A financial institution may carry back net
operating losses ("NOLs") to the preceding three taxable years and forward to
the succeeding 15 taxable years. This provision applies to losses incurred in
taxable years beginning after 1986. At June 30, 1998, the Savings Bank had no
NOL carryforwards for federal income tax purposes.
AUDIT BY IRS. The Savings Bank's federal income tax returns for taxable
years through June 30, 1993 have been closed for the purpose of examination by
the Internal Revenue System.
STATE TAXATION. The Savings Bank is subject to tax under the Pennsylvania
Mutual Thrift Institutions Tax Act, which imposes a tax at the rate of 11.5% on
the Savings Bank's net earnings, determined in accordance with generally
accepted accounting principles, as shown on its books. For fiscal years
beginning in 1983, and thereafter, NOLs may be carried forward and allowed as a
deduction for three succeeding years. This Act exempts the Savings Bank from all
other corporate taxes imposed by Pennsylvania for state tax purposes, and from
all local taxes imposed by political subdivisions thereof, except taxes on real
estate and real estate transfers. At June 30, 1998, the Savings Bank had no net
operating losses.
28
<PAGE> 30
ITEM 2. PROPERTIES
At June 30, 1998, the Company conducted its business from its main office
in Pittsburgh, Pennsylvania and two branch offices in Kittanning, Pennsylvania.
The following tables set forth the net book value (including leasehold
improvement, furnishings and equipment) and certain other information with
respect to the offices and other properties of the Company at June 30, 1998.
<TABLE>
<CAPTION>
Net Book Value of Amount of
Description/Address Leased/Owned Property Deposits
- ---------------------------------------- ----------------- ------------------- -------------
(In Thousands)
<S> <C> <C> <C>
Main Office Owned $ 273 $15,214
683 Lincoln Avenue
Pittsburgh, Pennsylvania 15202
Branch Offices:
125 Market Street Owned $ 712 $12,894
Kittanning, Pennsylvania 16201
4 Hilltop Plaza Leased(1) $ 59 $ 7,646
----- ------
Kittanning, Pennsylvania 16201
Total $1,044 $35,754
===== ======
- -------------------
</TABLE>
(1) This property is subject to a lease which expires on July 2002.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
nonmaterial legal proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
29
<PAGE> 31
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required herein is incorporated by reference from page
60 of the Company's 1998 Annual Report to Stockholders filed as Exhibit 13
hereto ("1998 Annual Report").
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The information required herein is incorporated by reference from pages 4
to 18 of the 1998 Annual Report.
ITEM 7. FINANCIAL STATEMENTS
The information required herein is incorporated by reference from pages
19 to 57 of the 1998 Annual Report.
ITEM 8. CHANGES IN AND DISAGREEMENTS ON WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
II-1
<PAGE> 32
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from the
Registrant's Proxy Statement to be filed within 120 days after the end of the
fiscal year covered by this Form 10-KSB ("Proxy Statement").
ITEM 10. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required herein is incorporated by reference from the
Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein is incorporated by reference from the
Proxy Statement.
ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report and are
incorporated herein by reference from the Registrant's 1998 Annual Report:
Independent Auditors' Report.
Consolidated Statements of Financial Condition as of June 30, 1998
and 1997.
Consolidated Statements of Income for the Years Ended June 30,
1998, 1997 and 1996.
Consolidated Statements of Changes in Shareholders' Equity for the
Years Ended June 30, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for the Years Ended June 30,
1998, 1997 and 1996.
Notes to Consolidated Financial Statements.
III-1
<PAGE> 33
The following exhibits are filed as part of the Form 10-KSB, and this
list includes the Exhibit Index:
<TABLE>
<CAPTION>
No. Exhibits
- --- --------
<S> <C>
3.1 Articles of Incorporation of Pennwood Bancorp, Inc.*
3.2 Bylaws of Pennwood Bancorp, Inc.*
4 Stock Certificate of Pennwood Bancorp, Inc.*
10.1 Pennwood Bancorp, Inc. 1997 Stock Option Plan.**
10.2 Pennwood Bancorp, Inc. 1997 Recognition Plan and Trust Agreement.**
13 Annual Report to Stockholders for
the Year Ended June 30, 1998
21 List of Subsidiaries
(See "Item I. Business - Subsidiaries" in
this Form 10-KSB)
27 Financial Data Schedule
</TABLE>
- -----------------------------
* Incorporated herein by reference from the Company's Registration
Statement on Form 8-B filed with the SEC on January 9, 1998.
** Incorporated herein by reference to the Company's Proxy Statement on
Schedule 14A filed with the SEC on February 21, 1997.
(b) Reports filed on Form 8-K.
The Company did not file any Current Reports on Form 8-K during the fourth
quarter of the fiscal year ended June 30, 1998.
III-2
<PAGE> 34
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.
PENNWOOD BANCORP, INC.
By: /s/ PAUL S. PIEFFER
----------------------------------
Paul S. Pieffer
President, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
/s/ PAUL S. PIEFFER September 28, 1998
- -------------------------------------
Paul S. Pieffer
President, Chief Executive
Officer and Director
/s/ CHARLES R. FRANK
- ------------------------------------- September 28, 1998
Charles R. Frank
Chairman of the Board and
Director
/s/ MARY M. FRANK
- ------------------------------------- September 28, 1998
Mary M. Frank
Vice Chairman of the Board,
Director and Treasurer
/s/ JOHN B. MALLON
- ------------------------------------- September 28, 1998
John B. Mallon
Director
III-3
<PAGE> 35
/s/ C. JOSEPH TOUHILL
- ------------------------------------- September 16, 1998
C. Joseph Touhill
Director
/s/ ROBERT W. HANNAN
- ------------------------------------- September 28, 1998
Robert W. Hannan
Director
/s/ MICHAEL KOTYK
- ------------------------------------- September 28, 1998
Michael Kotyk
Director
/s/ H.J. ZOFFER
- ------------------------------------- September 28, 1998
H.J. Zoffer
Director
/s/ JAMES W. KIHM
- ------------------------------------- September 28, 1998
James W. Kihm
Vice President and Secretary
(also principal accounting officer)
III-4
<PAGE> 1
PENNWOOD BANCORP, INC.
1998 ANNUAL REPORT
TO STOCKHOLDERS
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Financial Highlights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
President's Letter to Stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Consolidated Statements of Financial Condition . . . . . . . . . . . . . . . . . . . . . . 21
Consolidated Statements of Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Consolidated Statements of Shareholders' Equity . . . . . . . . . . . . . . . . . . . . . 24
Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . 27
Directors and Executive Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
Banking Locations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Stockholder Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
</TABLE>
<PAGE> 3
FINANCIAL HIGHLIGHTS
The following selected consolidated financial and other data of the
Company does not purport to be complete and is qualified in its entirety by
reference to the more detailed financial information, including the
Consolidated Financial Statements and Related Notes, appearing elsewhere
herein.
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
SELECTED BALANCE SHEET DATA:
Total assets $46,080 $49,981 $46,900 $42,634 $41,902
Cash and cash equivalents(1) 2,553 1,804 10,106 10,624 11,815
Investment securities(2):
Available for sale 7,752 18,224 10,266 1,313 --
Held to maturity 210 712 2,984 4,634 4,137
Loans receivable, net 33,625 26,980 21,168 23,845 23,664
Deposits 35,754 35,819 37,333 37,819 37,416
Borrowed funds 1,432 4,464 -- -- --
Deposit of stock
subscription rights -- -- 4,569 -- --
Shareholders' equity 7,961 8,726 4,076 3,862 3,737
Full service offices 3 3 3 3 3
</TABLE>
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Total interest income $3,745 $3,711 $3,378 $ 3,146 $ 2,820
Total interest expense 1,774 1,680 1,717 1,570 1,474
----- ----- ------ ------ -------
Net interest income 1,971 2,031 1,661 1,576 1,346
Provision for loan losses 312 29 105 385 58
----- ----- ----- ----- -----
Net interest income after
provision for loan losses 1,659 2,002 1,556 1,191 1,288
Other income 204 107 104 190 124
Other expenses 1,416 1,653 1,201 1,215 1,252
----- ----- ----- ----- -----
Income before income taxes
and cumulative effect
of change in accounting
principle 447 456 459 166 160
Provision for income taxes 168 129 162 51 56
----- ----- ----- ----- -----
Income before cumulative
effect of change in
accounting principle 279 327 297 115 104
Cumulative effect of change
in accounting principle(3) -- -- -- -- 90
----- ----- ----- ----- -----
Net income $ 279 $ 327 $ 297 $ 115 $ 194
===== ===== ===== ====== ======
Basic Earnings Per Share $ .42 $ .45 N/A N/A N/A
Diluted Earnings Per Share $ .41 $ .45 N/A N/A N/A
</TABLE>
Note: The Savings Bank converted to stock form in July 1996.
1
<PAGE> 4
<TABLE>
<CAPTION>
----------------------------------------------------------
At or For the Year Ended June 30,
----------------------------------------------------------
1998 1997 1996 1995 1994
--------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING RATIOS(4):
PERFORMANCE RATIOS:
Return on average assets 0.59% 0.69% 0.70% 0.28% 0.47%
Return on average equity 3.26 3.54 7.34 2.99 5.28
Equity to assets at end of period 17.28 17.46 8.69 9.06 8.92
Interest rate spread(5) 3.68 3.79 3.88 3.84 3.23
Net interest margin(5) 4.42 4.56 4.17 4.06 3.45
Average interest-earning assets to
average interest-bearing liabilities 118.44 120.52 106.94 105.50 105.59
Net interest income after provision
for loan losses to total other
expenses 117.16 121.11 129.55 98.02 102.87
Total other expenses to average
total assets 3.00 3.50 2.82 2.93 3.00
ASSET QUALITY RATIOS:
Non-performing loans to total
loans at end of period(6) 1.94 1.68 2.39 5.31 7.97
Non-performing assets to
total assets at end of period(6) 1.44 0.98 1.43 3.50 5.47
Allowance for loan losses to total
loans at end of period 1.17 1.05 1.59 2.23 1.38
Allowance for loan losses to total
non-performing loans at end of
period(6) 60.24 62.11 66.60 41.98 17.35
CAPITAL RATIOS OF THE
SAVINGS BANK:
Tier 1 risk-based capital ratio 30.89 34.59 16.76 15.78 15.37
Total risk-based capital ratio 32.15 35.72 18.31 17.03 16.62
Tier 1 leverage capital ratio 17.89 19.19 9.32 9.32 8.97
</TABLE>
- ----------------------
(1) Consists of cash, interest-bearing deposits (including certificates of
deposit), money market investments and federal funds sold.
(2) Investment securities consist of U.S. Government and agency obligations,
corporate obligations, municipal obligations and mortgage-backed
securities.
(3) Reflects the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes," effective
July 1, 1993.
(4) With the exception of end of period ratios, all ratios are based on
average monthly balances during the periods.
(5) Interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average rate
on interest-bearing liabilities. Net interest margin represents net
interest income as a percentage of average interest-earning assets.
(6) Non-performing loans consist of non-accrual loans, accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans and real estate acquired by foreclosure
or deed-in-lieu thereof.
2
<PAGE> 5
[Pennwood Bancorp, Inc. Letterhead]
Dear Stockholders,
We are pleased to present Pennwood Bancorp, Inc.'s Annual Report to
Stockholders for the fiscal year ended June 30, 1998.
Our second year of public ownership was marked by our efforts to enhance future
performance by employing sound capital management strategies and by building a
balance sheet poised to generate competitive returns. To improve shareholder
value, $1.1 million of Treasury Stock was repurchased, representing
approximately 10% of the shares outstanding. Prices paid for the stock
repurchases were below the intrinsic value of the company and, therefore,
represented a sound investment and an effective use of capital.
Loan growth was solid for the year with net loan receivables increasing by $6.6
million or 22.4% over the previous year. Expanded loan activity allowed us to
maintain a net interest margin of 4.42%, a reduction of only 14 basis points,
in what was a difficult interest rate environment. Loan portfolio performance
was negatively impacted by an increase of $283,000 to loan loss provisions
mandated by deterioration in consumer loan credit quality and an increase in
lending volumes.
On May 15, 1998, the Company completed a 4 for 3 stock split. This action was
designed to improve liquidity in our stock.
Accomplishments of the past year increased shareholder value and established a
financial base for future earnings growth. The Board of Directors, management
and employees thank you for your continued confidence in our Company.
Sincerely,
/s/ Paul S. Pieffer
Paul S. Pieffer
President and Chief Executive Officer
3
<PAGE> 6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Pennwood Bancorp, Inc. (the "Company") is the holding company for the
Pennwood Savings Bank (the "Savings Bank"). The operating results of the
Savings Bank depend primarily upon its net interest income, which is determined
by the difference between interest income on interest-earning assets, which
consist principally of loans, investment securities and other investments, and
interest expense on interest-bearing liabilities, which consist principally of
deposits and borrowed money. The Savings Bank's net income also is affected by
its provision for loan losses, as well as the level of its other income,
including loan fees and service charges and miscellaneous items, and its other
expenses, including compensation and other employee benefits, premises and
occupancy costs, federal deposit insurance premiums, data processing expense,
net loss on real estate owned and other miscellaneous expenses, and income
taxes.
On July 12, 1996, the Savings Bank completed its conversion from the
mutual to the stock form (the "Conversion"). In the Conversion, the Savings
Bank issued 610,128 shares of common stock, which resulted in net proceeds to
the Savings Bank of approximately $5.7 million. On January 27, 1997, the
Savings Bank completed its Reorganization into the holding company form of
ownership (the "Reorganization"), whereby each outstanding share of common
stock of the Savings Bank was converted into common stock of the Company and
the Company acquired all the capital stock of the Savings Bank.
CHANGES IN FINANCIAL CONDITION
At June 30, 1998, the Company's total assets decreased by $3.9 million
or 7.8% from $49.9 million at June 30, 1997 to $46.0 million at June 30, 1998.
The decrease in total assets was primarily due to a decrease in investment
securities, which was partially offset by increases in net loans receivable and
money market investments. Due to declining rates in the investment
marketplace, the Company restructured its investment portfolio during the year
by shifting funds from cash, federal funds sold and investment securities to
loans. As a result, during the year, the Company's investment and
mortgage-backed securities (classified as available for sale) decreased by
$10.5 million or 57.5% from $18.2 million at June 30, 1997, to $7.7 million at
June 30, 1998, and investment and mortgage backed securities (classified as
held to maturity) decreased by $502,000 or 70.5% , from $712,000 at June 30,
1997 to $210,000 at June 30, 1998, while interest bearing deposits (including
certificates of deposit) increased by $1.2 million or 133.4% from $868,000 at
June 30, 1997 to $2.0 million at June 30, 1998. Net loans receivable increased
by $6.7 million or 24.9% from $26.9 million at June 30, 1997 to $33.6 million
at June 30, 1998. The increase in net loans receivable during the year was
primarily due to $14.1 million of loan originations, which were partially
offset by $7.6 million in loan repayments. Real estate owned declined during
the period by 70.3% from $37,000 at June 30, 1997 to $11,000 on June 30, 1998.
4
<PAGE> 7
Savings deposits decreased $65,000, or 0.2% from $35.8 million at June
30, 1997, to $35.7 million at June 30, 1998. The decrease in savings deposits
during the fiscal year 1998 was primarily due to a $196,000 or 27.1% decrease
in money market accounts and a $499,000 or 5.4% decrease in passbook accounts
which were partially offset by a $530,000 or 2.3% increase in certificates of
deposits and a $101,000 or 3.14% increase in NOW accounts.
Borrowings decreased by $3.0 million or 67.9% from $4.4 million at June
30, 1997, to $1.4 million at June 30, 1998. This was due to the payoff of $3.0
million in FHLB of Pittsburgh variable rate short term advances. A loan to
provide the funds for the purchase of shares for the Company's Employee Stock
Ownership Plan ("ESOP") accounts for $432,000 of the borrowed funds. The ESOP
loan is for a term of ten years and carries an interest rate of prime (8.50% at
June 30, 1998). The remaining $1.0 million in borrowed money is in the form of
a convertible advance with the FHLB of Pittsburgh. The term of the convertible
loan is five years and the interest rate is 5.78%, with the conversion option
being exercisable after two years. Funds from the advance were used to
purchase a security. The security is an agency note with a yield to maturity
of 7.54% and two year call protection.
The Shareholders' Equity decreased by $765,000 or 8.8% from $8.7 million
at June 30, 1997, to $7.9 million at June 30, 1998. The decrease was primarily
due to the purchase of Treasury Stock of $1.1 million which was offset by net
income of $279,000, less dividends paid of $195,000, a $68,000 improvement in
unrealized gains on investment securities, and $150,000 attributable to the
release of earned shares of Common Stock by the Company's employee stock
benefit plans.
5
<PAGE> 8
AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID.
The following table presents for the periods indicated the total dollar amount
of interest income from average interest-earning assets and the resultant
yields, as well as the total dollar amount of interest expense on average
interest-bearing liabilities and the resultant rates, and the net interest
margin. The table does not reflect any effect of income taxes. All average
balances are based on average monthly balances during the periods.
<TABLE>
<CAPTION>
Year Ended June 30,
At June 30, ---------------------------------------------------------------------------------------
1998 1998 1997 1996
------------ ------------------------------ ----------------------------- --------------------------
Average Yield/ Average Yield/ Average Yield/
Yield/Rate Balance Interest Rate Balance Interest Rate Balance Interest Rate
------------ --------- --------- --------- --------- ---------- -------- --------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans receivable, net(1) 8.27% $30,152 $2,727 9.04% $22,377 $2,166 9.68% $22,708 $2,349 10.34%
Investment securities(2) 7.18 10,392 795 7.65 18,057 1,319 7.30 10,582 697 6.59
Money market investments(3) 5.53 3,460 185 5.35 3,726 193 5.18 4,957 228 4.60
Federal funds sold and other
investments 6.45 607 38 6.26 422 33 7.82 1,545 104 6.73
------ ----- ------ ---- ------ ----
Total interest-earning
assets 7.93% 44,611 $3,745 8.39% 44,582 $3,711 8.32% 39,792 $3,378 8.49%
==== ----- ==== ----- ==== ----- ====
Non-interest-earning assets 2,563 2,645 2,730
----- ----- -----
Total assets $47,174 $47,227 $42,522
====== ====== ======
INTEREST-BEARING LIABILITIES:
Deposits:
Passbook savings and club
accounts $ 8,589 $ 260 3.03% $ 9,276 $ 285 3.07% $ 9,911 $ 308 3.10%
NOW accounts 3,216 51 1.59 3,090 54 1.75 2,791 64 2.29
Money market accounts 662 20 3.02 852 24 2.82 985 21 2.13
Certificates of deposit 23,544 1,334 5.67 22,334 1,226 5.49 23,523 1,324 5.63
------ ----- ------ ----- ------ -----
Total deposits 4.56% 36,011 1,665 4.62 35,552 1,589 4.47 37,210 1,717 4.61
-----
Borrowed money 1,655 109 6.59 1,439 91 6.32 -- -- --
----- --- ----- ----- ------ -----
Total interest-bearing
liabilities 6.60% 37,666 $1,774 4.71% 36,991 $1,680 4.54% 37,210 $1,717 4.61%
==== ----- ==== ----- ==== ----- ====
Non-interest-bearing liabilities 951 992 1,268
--- --- -----
Total liabilities 38,617 37,983 38,478
Net worth 8,557 9,244 4,044
----- ----- -----
Total liabilities and
net worth $47,174 $47,227 $42,522
====== ====== ======
Net interest income; interest
rate spread(4) 3.29% $1,971 3.68% $2,031 3.78% $1,661 3.88%
==== ===== ==== ===== ==== ===== ====
Net interest margin(5) 4.42% 4.56% 4.17%
==== ==== ====
Average interest-earning
assets to average interest-
bearing liabilities 118.44% 120.52% 106.94%
====== ====== ======
</TABLE>
(Footnotes on following page)
6
<PAGE> 9
- ------------------------
(1) Non-accrual loans have been included in the average balance of loans,
but unpaid interest on non-accrual loans has not been included for
purposes of determining interest income.
(2) Includes investment and mortgage-backed securities classified as
available for sale.
(3) Money market investments consist of interest-bearing deposits in other
financial institutions (including certificates of deposit).
(4) Interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average rate
on interest-bearing liabilities.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
7
<PAGE> 10
RATE/VOLUME ANALYSIS. The following table describes the extent to
which changes in interest rates and changes in volume of interest-related
assets and liabilities have affected the Savings Bank's interest income and
interest expense during the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (change in volume
multiplied by prior year rate), (ii) changes in rate (change in rate multiplied
by prior year volume), and (iii) total change in rate and volume. The combined
effect of changes in both rate and volume has been allocated proportionately to
the change due to rate and the change due to volume.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
--------------------------------------- ----------------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Total Due to Total
------------------------- Increase ------------------------- Increase
Rate Volume (Decrease) Rate Volume (Decrease)
------------ ----------- ------------ ----------- ----------- ------------
(In Thousands) (In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net $(150) $ 711 $ 561 $(149) $(34) $(183)
Investment and mortgage-backed
securities(1) 60 (584) (524) 83 539 622
Money market investments(2) 6 (14) (8) 26 (61) (35)
Federal funds sold and other
investments (7) 12 5 15 (86) (71)
--- --- -- --- --- ----
Total interest-earning assets $ (91) 125 34 $ (25) $358 $ 333
---- --- --- ---- --- ----
Interest-bearing liabilities:
Passbook and club accounts $ (4) $ (21) $ (25) $ (2) $(20) $ (22)
NOW accounts (5) 2 (3) (16) 6 (10)
Money market accounts 2 (6) (4) 6 (3) 3
Certificates of deposit 39 69 108 (33) (66) (99)
Borrowed Money 4 14 18 0 91 91
--- --- --- --- --- ----
Total interest-bearing
liabilities 36 58 94 (46) $ 9 $ (37)
--- --- --- --- --- ---
Increase in net interest income $(127) $ 67 $ (60) $ 21 $349 $ 370
===== === ==== === === ===
</TABLE>
- ---------------------
(1) Includes investment securities classified as available for sale.
(2) Money market investments consist of interest-bearing deposits in other
financial institutions (including certificates of deposit).
8
<PAGE> 11
RESULTS OF OPERATIONS
NET INCOME. The Company reported net income of $279,000, $327,000 and
$297,000 for the years ended June 30, 1998, 1997 and 1996 respectively. The
$48,000 or 14.7% decrease in net income for fiscal 1998 was primarily due to a
$60,000 or 2.9% decrease in net interest income, a $39,000 or 30.2% increase in
the provision for income taxes and a $283,000 or 975.8% increase in loan loss
provisions, which were offset by a $237,000 or 14.3% decrease in non interest
expenses (due to a special assessment of $247,000 to recapitalize the Savings
Association Insurance Fund ("SAIF"), which occurred on September 30, 1996) and
a $97,000 or 90.7% increase in non interest income.
For the year ended June 30, 1998, the Company's net interest margin
decreased by 14 basis points to 4.42% from 4.56% for fiscal 1998. The average
yield earned on the Company's interest-earning assets increased by 7 basis
points, which was offset by a 17 basis point increase in the average rate paid
on the Company's interest-bearing liabilities. The increase in the average
yield earned on interest-earning assets was primarily attributable to the
Company's increase in average loans receivable from $22.4 million at the year
ended June 30, 1997, to $30.1 million at the year ended June 30, 1998. The
increase in the average rate paid on interest-bearing liabilities reflected a
shift in the Company's deposit accounts from lower rates paid on passbook
accounts to higher rates paid on certificates of deposit, and by an increase in
the average rate paid on borrowed money.
For the year ended June 30, 1997, the Company's net interest margin
increased by 39 basis points to 4.56% from 4.17% for fiscal 1996. The average
yield earned on the Company's interest-earning assets decreased by 17 basis
points, which offset a 7 basis point decrease in the average rate paid on the
Company's interest-bearing liabilities. The decrease in the average yield
earned on interest-earning assets was primarily attributable to the Company's
increase in average assets from $39.8 million at June 30, 1996 to $44.6 million
at the year ended June 30, 1997, together with a decrease in the average yield
on loans receivable from 10.34% at the year ended June 30, 1996, to 9.68% at
the year ended June 30, 1997. The decrease in the average rate paid on
interest-bearing liabilities reflected a shift in the Company's deposit
accounts to lower rates paid on passbook and certificates of deposit, which
were offset by rates paid on borrowed money.
NET INTEREST INCOME. Net interest income decreased by $60,000 or 2.9%
during the year ended June 30, 1998, as compared to the prior fiscal year, due
to a $7.7 million or 42.5% decrease in the average balance of investment
securities together with a $675,000 or 1.8% increase in the average balance of
interest-bearing liabilities and a 17 basis point increase in the average rate
paid thereon, which were offset by a $7.7 million or 34.4% increase in the
average balance of loans receivable.
During the year ended June 30, 1998, total interest income increased
by $34,000 or 0.9%, as compared to the prior fiscal year, primarily due to a
$561,000 or 25.9% increase in interest earned on loans receivable and a $5,000
or 15.5% increase in interest earned on federal funds sold. This increase was
partially offset by a $524,000 or 39.7% decrease in interest earned on
investment
9
<PAGE> 12
securities and an $8,000 or 4.3% decrease in interest earned on money market
investments. The increase in interest earned on loans receivable was due
primarily to a $7.7 million or 34.4% increase in the average balance of loans
receivable. The decrease in interest earned on investment securities was due
the reduction of the average balance of investment securities from $18.1
million at June 30, 1997 to $10.7 million as of June 30, 1998. The decrease in
the average balance of the Company's investment securities reflected the
Company's reinvestment of a portion of its U.S. government and agency
obligations into loans receivable due to calls and maturities.
During the year ended June 30, 1998, total interest expense increased
$94,000 or 5.6% as compared to the prior fiscal year, due to the combined
effect of an increase of $459,000 or 1.3% in the average balance of savings
deposits and a 15 basis point increase on the average rate paid thereon and by
a $216,000 or 15.0% increase in the average balance of borrowed money and a 27
basis point increase on the average rate paid thereon. The average cost on
interest bearing liabilities increased by 17 basis points from 4.54% for the
year ending June 30, 1997 to 4.71% for the year ending June 30, 1998.
Net interest income increased by $370,000 or 22.3% during the year
ended June 30, 1997, as compared to the prior fiscal year, due to a $4.8
million or 12.0% increase in the average balance of interest-earning assets
together with a 17 basis point decrease in the average yield earned thereon,
which was offset by a $219,00 decrease in the average balance of
interest-bearing liabilities and a 7 basis point decrease in the average rate
paid thereon.
During the year ended June 30, 1997, total interest income increased
by $333,000 or 9.9%, as compared to the prior fiscal year, primarily due to a
$622,000 or 89.2% increase in interest earned on investment securities. This
increase was partially offset by a $71,000 or 68.3% decrease in interest earned
on federal funds sold, a $35,000 or 15.3% decrease in interest earned on money
market investments and a $183,000 or 7.8% decrease in interest earned on loans.
The increase in interest earned on investment securities was due primarily to a
$7.5 million or 70.1% increase in the average balance of investment securities,
together with a 71 basis point increase in the average yield earned thereon.
The decrease in interest earned on federal funds sold was due to the reduction
of the amount of federal funds sold. The increase in the average balance of
the Company's investment securities reflected the Company's reinvestment of a
portion of its money market investments and federal funds into higher yielding
U.S. government and agency obligations. The decrease in interest earned on
loans was due to 66 basis point decrease in the average yield earned thereon,
together with a $331,000 or 1.5% decrease in the average balance of loans
outstanding.
During the year ended June 30, 1997, total interest expense decreased
$37,000 or 2.2% as compared to the prior fiscal year, due to the combined
effect of a decrease of $1.7 million or 4.5% in the average balance of savings
deposits and a 14 basis point decrease on the average rate paid thereon. This
was partially offset by a $1.4 million increase in the average balance of
borrowed money, which, when combined with the change in the average balance of
the savings deposits resulted in a 7 basis point decrease for the fiscal year.
10
<PAGE> 13
PROVISION FOR LOAN LOSSES. The Company establishes provisions for
losses on loans, which are charged to operations, in order to maintain the
allowance for loan losses at a level which is deemed to be appropriate based
upon an assessment of prior loss experience, the volume and type of lending
presently being conducted by the Company, industry standards, past due loans,
economic conditions in the Company's market area generally and other factors
related to the collectability of the Company's loan portfolio. During the
years ended June 30, 1998 and 1997, the Company established provisions for loan
losses of $312,000 and $29,000, respectively. The increase in the provision
for loan losses during fiscal 1998 reflects an increase in the total amount of
loans held during the period and an increase in the level of non-performing
loans. In fiscal 1998, total non-performing loans increased $200,000 or 44.1%.
In addition, during fiscal 1998 the Company experienced loan charge offs of
$212,000, an increase of 123.0% over the previous year. The deterioration in
credit quality primarily related to consumer loans. The Company has recently
enhanced its collection efforts by hiring a full time individual with
significant prior collections experience to monitor and supervise collection
efforts with respect to the portfolio of loans. At June 30, 1998, the
Company's allowance for loan losses amounted to $394,000 or 60.2% of
non-performing loans and 1.2% of total loans outstanding.
The decrease in the provision for loan losses during fiscal 1997
reflected the decline in the level of non-performing loans as well as the
decline in the total amount of loans held in the Company's portfolio during the
period. The amount of the provision for loan losses during fiscal 1996
reflected a deterioration in credit quality with respect to several of the
Company's commercial real estate and consumer loans. This deterioration in
credit quality occurred notwithstanding an overall decline in the level of
non-performing assets during these years. In addition, in January 1994, the
Company terminated its consulting arrangement with an individual who had
previously assisted the Company in originating and servicing consumer loans.
In connection with the termination of such agreement, during fiscal 1995, the
Company enhanced its loan underwriting and collection efforts with respect to
its consumer loans which initially resulted in an increase in the level of
consumer loan charge-off during the year.
Although management utilized its best judgment in providing for
possible loan losses, there can be no assurance that the Company will not have
to increase its provisions for losses on loans in the future as a result of
future increases in non-performing loans or for other reasons, which could
adversely affect the Company's results of operations. In addition, various
regulatory agencies, as an integral part of their examinations process,
periodically review the Company's provision for loan losses and the carrying
value of its other non-performing assets based on their judgments about
information available to them at the time of their examination.
OTHER INCOME. Total other income increased by $97,000 or 90.6% during
the year ended June 30, 1998, as compared to the prior year. The increase was
primarily due to an increase in other miscellaneous income which consists
primarily of rental income earned on real estate owned, late charges, service
charges, an adjustment to real estate tax assessment and other miscellaneous
fees.
11
<PAGE> 14
Total other income increased by $3,000 or 2.9% during the year ended
June 30, 1997, as compared to the prior year. The increase was primarily due
to an increase of $10,000 or 15.4% in other miscellaneous income. These were
partially offset by an $8,000 or 20.5% decrease in service charges.
OTHER EXPENSES. Total other expenses decreased by $237,000 or 14.3%
during the year ended June 30, 1998, as compared to the prior year. The
primary reasons for the decrease were a $54,000 or 45.4% decrease in expenses
pertaining to the formation of the holding company and the establishment of
employee benefit plans, a $12,000 or 5.6% decrease in premises and occupancy
costs, a $53,000 or 86.9% decrease in loss on real estate owned and a $262,000
or 91.9% decrease in federal insurance premiums. This decrease was the result
of a special assessment of $247,000 to recapitalize the Savings Association
Insurance Fund ("SAIF") which occurred on September 30, 1996. These decreases
were offset by a $133,000 or 22.1% increase in compensation and employee
benefits, a $6,000 or 7.7% increase in data processing expense and a $5,000 or
1.7% increase in miscellaneous operating expenses. The decrease in premises and
occupancy costs was due to a real estate tax expense reduction due to a change
in the assessed value of one of the Company's branch offices. The decrease in
loss on real estate owned expense related to the decrease of real estate owned
from $37,000 to $11,000. Management anticipates that its other expenses will
increase as a result of additional expenses relating to the Company preparing
for the Year 2,000 by upgrading its data processing system and additional
expenses relating to premises and occupancy as the Company has purchased a
property for expansion of its main office.
Total other expenses increased by $452,000 or 37.6% during the year
ended June 30, 1997, as compared to the prior year. The primary reasons for
the increase were an $81,000 increase in legal expenses pertaining to the
conversion to a public company, a $102,000 or 20.4% increase in compensation
and employee benefits due to the addition of an employee ESOP plan and a
management recognition plan, a $9,000 or 4.3% increase in premises and
occupancy costs and a $193,000 or 209.8% increase in federal insurance
premiums. This increase was the result of a special assessment of $247,000 to
recapitalize the SAIF which occurred on September 30, 1996. The increase in
premises and occupancy costs was due to the assumption of a new lease with
respect to one of the Company's branch offices together with renovation costs
and an increase in depreciation expense. The increase in other miscellaneous
operating expenses reflected increases due to the completion of the Conversion
and a provision of $65,000 established for potential expenses related to a
regulatory determination that the Company will be required to reimburse certain
borrowers for violations of Regulation Z (Truth in Lending).
PROVISION FOR INCOME TAXES. The Company incurred income tax expense
of $168,000 for the year ended June 30, 1998, as compared to $129,000 for
fiscal 1997. The Company's effective tax rate amounted to 37.6% and 28.4% for
fiscal 1998 and 1997, respectively.
12
<PAGE> 15
ASSET AND LIABILITY MANAGEMENT
In general, financial institutions are vulnerable to an increase in
interest rates to the extent that interest-bearing liabilities mature or
reprice more rapidly than interest-earning assets. The lending activities of
most savings institutions have historically emphasized the origination of
long-term, fixed-rate loans secured by single-family residences, and the
primary source of funds of such institutions has been deposits, which largely
mature or are subject to repricing within a short period of time. These
factors have historically caused the income earned by such institutions on
their loan portfolios to adjust more slowly to changes in interest rates than
their cost of funds. While having liabilities that reprice more frequently than
assets is generally beneficial to net interest income in times of declining
interest rates, such an asset/liability mismatch is generally detrimental
during periods of rising interest rates. In contrast to the typical thrift
institution, the Savings Bank's assets generally reprice more frequently than
its liabilities, which is generally beneficial to net interest income during
periods of rising interest rates, while detrimental to net interest income
during periods of declining interest rates.
The Company has (in recent periods) implemented asset and liability
management strategies and policies designed to better match the maturities and
repricing terms of the Company's interest-earning assets and interest-bearing
liabilities in order to minimize the adverse effects on the Company's results
of operations of material and prolonged increases in interest rates. The
Company has undertaken a variety of strategies to reduce its exposure to
interest rate fluctuations, including (i) emphasizing investment in
adjustable-rate single-family residential loans; (ii) continuing to emphasize
the origination of consumer loans, which generally have shorter terms and
higher interest rates than traditional mortgage loans; (iii) maintaining a
significant percentage of the Company's total assets in short-term investments
and cash equivalents; and (iv) attempting to attract, to the extent possible,
longer-term, fixed-rate deposit accounts.
As a result of implementing these asset and liability initiatives, at
June 30, 1998, $8.9 million or 24.5% of the Company's total loan portfolio had
adjustable interest rates. As of such date, $6.3 million or 28.7% of the
Company's portfolio of single-family residential mortgage loans consisted of
adjustable-rate loans. In addition, at June 30, 1998, $1.3 million or 16.8% of
the Company's investment securities portfolio had scheduled maturities of five
years or less and the Company maintained $2.5 million or 5.5% of its assets in
cash and cash equivalents (consisting of cash and amounts due from depository
institutions, money market investments and federal funds sold) as of such date.
Moreover, during the years ended June 30, 1998 and 1997, the Company
originated $3.5 million and $4.1 million of consumer loans, respectively. At
June 30, 1998, the Company's total loan portfolio included $9.0 million or
26.9% of consumer loans.
Finally, the Company has also elected to offer competitive rates and
experience some attrition in deposits in order to manage interest rate expense
more effectively. The Company has generally not engaged in sporadic increases
or decreases in interest rates paid or offered the highest
13
<PAGE> 16
rates available in its deposit market except upon specific occasions when
market conditions have created opportunities to attract longer-term deposits.
This policy has assisted the Company in controlling its cost of funds.
The effect of interest rate changes on a financial institution's
assets and liabilities may be analyzed by examining the extent to which such
assets and liabilities are "interest rate sensitive" and by monitoring an
institution's interest rate sensitivity "gap." An asset or liability is said
to be interest rate sensitive within a specific time period if it will mature
or reprice within that time period. The interest rate sensitivity "gap" is
defined as the difference between interest-earning assets and interest-bearing
liabilities maturing or repricing within a given time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is considered
negative when the amount of interest rate sensitive liabilities exceeds the
amount of interest rate sensitive assets. During a period of falling interest
rates, a positive gap would tend to adversely affect net interest income, while
a negative gap would tend to result in an increase in net interest income.
During a period of rising interest rates, a positive gap would tend to result
in an increase in net interest income while a negative gap would tend to affect
net interest income adversely.
As a result of the implementation of the foregoing asset and liability
strategies, the Company's one-year interest rate sensitivity gap amounted to
6.97% of total assets at June 30, 1998. The one-year interest rate sensitivity
gap is defined as the difference between the Company's interest-earning assets
which are scheduled to mature or reprice within one year and its
interest-bearing liabilities which are scheduled to mature or reprice within
one year. At June 30, 1998, the Company's interest-earning assets maturing or
repricing within one year totaled $18.9 million while the Company's
interest-bearing liabilities maturing or repricing within one year was $15.7
million, providing as excess of interest-earning assets over interest-bearing
liabilities of $3.2 million. At June 30, 1998, the percentage of the Company's
interest-earning assets to interest-bearing liabilities maturing or repricing
within one year was 120.4%.
14
<PAGE> 17
The following table summarizes the anticipated maturities or repricing
of the Company's interest-earning assets and interest-bearing liabilities as of
June 30, 1998, based on the information and assumptions set forth in the notes
to the table.
<TABLE>
<CAPTION>
Six to More Than More Than
Within Six Twelve One Year to Three Years to Over Five
Months Months Three Years Five Years Years Total
------------ -------- --------------- ---------------- ---------- ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities(1)(2) $ 4,715 $ 507 $ 512 $ 273 $ 1,955 $ 7,962
Loans receivable, net(3) 6,614 4,806 8,171 4,837 9,197 33,625
Money market investments 2,026 -- -- -- -- 2,026
Federal funds sold and other
investments 284 -- -- -- 284
----- ------ ------ ----- ------ ------
Total interest-earning
assets 13,639 5,313 8,683 5,110 11,152 43,897
------ ----- ----- ----- ------ ------
Interest-bearing liabilities:
Deposits(4) 7,134 7,608 10,210 5,758 5,044 35,754
Borrowed Money 1,000 -- -- -- 432 1,432
----- ----- ------ ----- ----- ------
Total interest-bearing
liabilities 8,134 7,608 10,210 5,758 5,476 37,186
----- ----- ------ ----- ----- ------
Excess (deficiency) of
interest-earning assets over
interest-bearing liabilities $ 5,505 $(2,295) $(1,527) $ (648) $ 5,676 $ 6,711
===== ===== ===== ==== ===== =====
Cumulative excess of
interest-earning assets over
interest-bearing liabilities $ 5,505 $ 3,210 $ 1,683 $1,035 $ 6,711
===== ===== ===== ===== =====
Cumulative excess of
interest-earning assets over
interest-bearing liabilities as a
percentage of total assets 11.95% 6.97% 3.65% 2.25% 14.56%
===== ==== ==== ==== =====
</TABLE>
- --------------------------
(1) Reflects repricing, contractual maturity or anticipated call date.
(2) Includes investment and mortgage-backed securities classified as
available for sale.
(3) Fixed-rate loans are included in the periods in which they are
scheduled to be repaid, based on scheduled amortization, adjusted to
take into account estimated prepayments. Adjustable-rate loans are
included in the periods in which interest rates are next scheduled to
reset, adjusted to take into account estimated prepayments.
(4) Adjusted to reflect various decay rate assumptions.
15
<PAGE> 18
Although interest rate sensitivity gap is a useful measurement and
contributes toward effective asset and liability management, it is difficult to
predict the effect of changing interest rates based solely on that measure. As
a result, management also regularly reviews interest rate risk by forecasting
the impact of alternative interest rate environments on net interest income and
net portfolio value ("NPV"), which is defined as the net present value of a
savings bank's existing assets, liabilities and off-balance sheet instruments,
and evaluating such impacts against the maximum potential changes in net
interest income and NPV. The following table presents the Company's NPV as of
June 30, 1998.
<TABLE>
<CAPTION>
Net Portfolio Value
- ------------------------------------------------------------------------------------------
Estimated
Change in NPV as a Change as a
Interest Rates Estimated Percentage Amount Percentage
(basis points) NPV of Assets of Change of Assets
- ---------------- ------------ -------------- --------------- ---------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
+400 $6,956 15.98% (2,532) (26.7)%
+300 7,630 17.14 (1,858) (19.6)
+200 8,357 18.34 (1,131) (11.9)
+100 8,979 19.30 (509) (5.4)
-- 9,488 20.02 0 0
-100 9,899 20.56 411 4.3
-200 10,010 20.59 522 5.5
-300 10,257 20.83 769 8.1
-400 10,544 21.13 1,056 11.1
</TABLE>
Management of the Company believes that the assumptions used by it to
evaluate the vulnerability of the Company's operations to changes in interest
rates approximate actual experience and considers them reasonable; however, the
interest rate sensitivity of the Company's assets and liabilities and the
estimated effects of changes in interest rates on the Company's net interest
income and NPV indicated in the above tables could vary substantially if
different assumptions were used or actual experience differs from the
historical experience on which they are based.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are deposits, repayments,
prepayments and maturities of outstanding loans, maturities of investment
securities and other short-term investments, and funds provided from
operations. While scheduled loan repayments and maturing investment securities
and short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by the movement of interest
rates in general, economic conditions and competition. The Company manages the
pricing of its deposits to maintain a deposit balance deemed appropriate and
desirable. In addition, the Company invests in short-term investment
securities and other interest-earning assets which provide liquidity to meet
lending requirements. Although the Company has been able to generate enough
cash through the retail
16
<PAGE> 19
deposit market, its traditional funding source, the Company has, to the extent
deemed necessary, utilized other borrowing sources, consisting primarily of
advances from the FHLB of Pittsburgh.
Liquidity management is both a daily and long-term function. Excess
liquidity is generally invested in short-term investments such as cash and cash
equivalents, including money market investments and federal funds sold, and
U.S. Government and agency obligations. On a longer-term basis, the Company
invests in various lending products and investment securities. The Company
uses its sources of funds primarily to meet its ongoing commitments to pay
maturing savings certificates and savings withdrawals, fund loan commitments
and maintain an investment securities portfolio. At June 30, 1998, the total
commitments outstanding (excluding undisbursed portions of loans in process)
amounted to $7.6 million in mortgage loans, $676,000 in unused lines of credit
and $250,000 to purchase an investment security. At the same date, the
unadvanced portion of loans in process approximated $1.9 million. Certificates
of deposit scheduled to mature in one year or less at June 30, 1998, totalled
$12.0 million. Management of the Company believes that the Company has
adequate resources, including principal prepayments and repayments of loans and
maturing investments, to fund all of its commitments to the extent required.
Based upon its historical run-off experience, management believes that a
significant portion of maturing deposits will remain with the Company. See
Note 8 of the Notes to Consolidated Financial Statements.
As of June 30, 1998, the Company had regulatory capital which was in
excess of applicable limits. See Note 11 of the Notes to Consolidated
Financial Statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial
statements. Comprehensive income is defined as "the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from nonowner sources. It includes all changes in equity during
a period except those resulting from investment by owners and distributions to
owners." The comprehensive income and related cumulative equity impact of
comprehensive income items are required to be disclosed prominently as part of
the notes or the financial statements. Only the impact of unrealized gains or
losses on securities available for sale is expected to be disclosed as an
additional component of the Company's income under the requirements of SFAS No.
130. This statement is effective for fiscal years beginning after December 15,
1997.
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial statements issued to shareholders. This statement also establishes
standards for related disclosures about products and services, geographic areas
and major customers. This statement is effective for fiscal years beginning
after December 15, 1997. Management believes that adoption
17
<PAGE> 20
of this statement will not materially affect the Company's financial condition,
results of operations or reporting thereof.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure of those
instruments at fair value. The accounting for changes in the fair value of a
derivative depends on the intended use of the derivative and whether it is
designated as a hedging instrument. This statement is effective for fiscal
years beginning after June 15, 1999. Management believes that adoption of this
statement will not materially affect the Company's financial condition, results
of operations or reporting thereof.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements of the Company and related notes
presented herein have been prepared in accordance with generally accepted
accounting principles ("GAAP") which require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services, since such prices are affected by inflation to a
larger extent than interest rates. In the current interest rate environment,
liquidity and the maturity structure of the Company's assets and liabilities
are critical to the maintenance of acceptable performance levels.
YEAR 2000 COMPLIANCE
The Company has developed a plan of action to help ensure that its
operational and financial systems will not be adversely affected by year 2000
software/hardware failures due to processing errors arising from calculations
using the year 2000 date. While the Company believes it is doing everything
technologically and operationally possible to assure year 2000 compliance, it
is to a large extent dependent upon vendor cooperation. The Company is
requiring its computer systems and software vendors to represent that the
products provided are or will be year 2000 compliant. Any year 2000 compliance
failures could result in additional expenses or business disruption to the
Company which are currently unknown and are believed to be immaterial. The
Company does not itself internally program any major operating system of the
Company; therefore, the Company does not expect to incur material costs for
remediation efforts.
18
<PAGE> 21
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Financial Statements
June 30, 1998 and 1997
(With Independent Auditors' Report Thereon)
19
<PAGE> 22
Independent Auditors' Report
The Board of Directors and Shareholders
Pennwood Bancorp, Inc. and Subsidiary:
We have audited the accompanying consolidated statements of financial condition
of Pennwood Bancorp, Inc. and subsidiary (the Company) as of June 30, 1998 and
1997, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the years in the three-year period ended June 30,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pennwood Bancorp,
Inc. and subsidiary as of June 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended June 30, 1998, in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
Pittsburgh, Pennsylvania
August 12, 1998
20
<PAGE> 23
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
June 30, 1998 and 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Assets
------
Cash and amounts due from depository institutions $ 527 936
Interest-bearing deposits 2,026 868
Investment and mortgage-backed securities (notes 2 and 3):
Available-for-sale (amortized cost $7,653 and $18,227) 7,752 18,224
Held-to-maturity (market value $215 and $720) 210 712
Loans receivable, net (note 4) 33,625 26,980
Real estate owned, net 11 37
Federal Home Loan Bank stock, at cost (notes 5 and 9) 284 345
Premises and equipment, net (note 6) 1,044 1,089
Accrued interest receivable (note 7) 331 534
Prepaid expenses and other assets 270 256
------ ------
Total assets 46,080 49,981
------ ------
</TABLE>
(Continued)
21
<PAGE> 24
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition, Continued
(Dollars in thousands except share data)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Liabilities and Shareholders' Equity
------------------------------------
Liabilities:
Savings deposits (note 8) $ 35,754 35,819
Borrowed funds (note 9) 1,432 4,464
Advances from borrowers for taxes and insurance 392 320
Accrued interest payable 441 410
Accrued expenses and other liabilities 100 242
------- -------
Total liabilities 38,119 41,255
Shareholders' Equity (notes 10 and 11):
Preferred stock, $.01 par value, 1,000,000 shares authorized,
none issued - -
Common stock, $.01 par value, 4,000,000 shares authorized,
813,419 and 610,128 shares issued at June 30, 1998 and
1997, respectively 8 6
Additional paid-in capital 5,642 5,603
Retained earnings, substantially restricted 4,427 4,355
Treasury stock, at cost, 116,025 and 30,506 shares at
June 30, 1998 and 1997, respectively (1,526) (458)
Unearned Employee Stock Ownership Plan shares (390) (439)
Unearned common stock - Recognition and Retention Plan (267) (339)
Unrealized gain (loss) on investment securities available-
for-sale, net 67 (2)
------ ------
Total shareholders' equity 7,961 8,726
------ ------
Total liabilities and shareholders' equity $ 46,080 49,981
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 25
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
Years Ended June 30, 1998, 1997 and 1996
(Dollars in thousands except share data)
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Interest income:
Loans $ 2,727 2,166 2,349
Investment and mortgage-backed securities 795 1,319 697
Federal funds sold and other investments 38 33 104
Interest-bearing deposits 185 193 228
----- ----- -----
Total interest income 3,745 3,711 3,378
Interest expense:
Interest on savings deposits (note 8) 1,665 1,589 1,717
Interest on borrowed funds 109 91
----- ----- -----
Total interest expense 1,774 1,680 1,717
----- ----- -----
Net interest income 1,971 2,031 1,661
Provision for loan losses 312 29 105
----- ----- -----
Net interest income after provision
for loan losses 1,659 2,002 1,556
Other income:
Service charges 32 32 62
Other 172 75 42
----- ----- -----
Total other income 204 107 104
----- ----- -----
Other expenses:
Compensation and employee benefits (note 12) 736 603 501
Premises and occupancy costs 204 216 207
Federal insurance premiums 23 38 92
FDIC-SAIF assessment (note 14) - 247 -
Data processing expense 84 78 81
Net loss on real estate owned 9 61 72
Legal and professional 118 119 42
Other operating expenses 242 291 206
----- ----- -----
Total other expenses 1,416 1,653 1,201
----- ----- -----
Income before income taxes 447 456 459
Provision for income taxes (note 10):
Federal 153 141 140
State 15 (12) 22
----- ----- -----
Total provision for income taxes 168 129 162
----- ----- -----
Net Income $ 279 327 297
===== ===== =====
Basic earnings per share $ .42 .45 N/A
=== === ===
Diluted earnings per share $ .41 .45 N/A
=== === ===
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 26
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Shareholders' Equity
Years Ended June 30, 1998, 1997 and 1996
(Dollars in thousands except share data)
<TABLE>
<CAPTION>
Additional
Common paid-in Retained Treasury
stock capital earnings stock
----- ------- -------- -----
<S> <C> <C> <C> <C>
Balance at June 30, 1995 $ - - 3,852 -
Net income - - 297 -
Change in unrealized gain (loss) on securities
available-for-sale, net of tax - - - -
---- ----- ----- ----
Balance at June 30, 1996 - - 4,149 -
Net income - - 327 -
Proceeds from stock offering (note 17) 6 5,589 - -
Shares acquired for ESOP - 48,810 shares - - - -
Principal repayment of ESOP debt - 14 - -
Shares acquired for RRP - 24,405 shares - - - -
Amortization of RRP - - - -
Purchase of treasury stock - 30,506 shares - - - (458)
Cash dividends declared at $.22 per share - - (121) -
Change in unrealized gain (loss) on securities
available-for-sale, net of tax - - - -
---- ----- ----- ----
Balance at June 30, 1997 6 5,603 4,355 (458)
Net income - - 279 -
Four-for-three stock split 2 (2) - -
Principal repayment of ESOP debt - 41 (12) -
Amortization of RRP - - - -
Purchase of treasury stock - 75,350 shares - - - (1,068)
Cash dividends declared at $.27 per share - - (195) -
Change in unrealized gain (loss) on securities
available-for-sale, net of tax - - - -
----- ----- ----- -----
Balance at June 30, 1998 $ 8 5,642 4,427 (1,526)
===== ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
Unrealized
gain (loss)
on securities
Unearned Unearned available-for-
ESOP RRP sale, net
shares shares of taxes Total
------ ------ -------- -----
<S> <C> <C> <C> <C>
Balance at June 30, 1995 - - 10 3,862
Net income - - - 297
Change in unrealized gain (loss) on securities
available-for-sale, net of tax - - (83) (83)
---- ---- -- -----
Balance at June 30, 1996 - - (73) 4,076
Net income - - - 327
Proceeds from stock offering (note 17) - - - 5,595
Shares acquired for ESOP - 48,810 shares (488) - - (488)
Principal repayment of ESOP debt 49 - - 63
Shares acquired for RRP - 24,405 shares - (357) - (357)
Amortization of RRP - 18 - 18
Purchase of treasury stock - 30,506 shares - - - (458)
Cash dividends declared at $.22 per share - - - (121)
Change in unrealized gain (loss) on securities
available-for-sale, net of tax - - 71 71
---- ----- -- ------
Balance at June 30, 1997 (439) (339) (2) 8,726
Net income - - - 279
Four-for-three stock split - - - -
Principal repayment of ESOP debt 49 - - 78
Amortization of RRP - 72 - 72
Purchase of treasury stock - 75,350 shares - - - (1,068)
Cash dividends declared at $.27 per share - - - (195)
Change in unrealized gain (loss) on securities
available-for-sale, net of tax - - 69 69
---- ---- -- ------
Balance at June 30, 1998 (390) (267) 67 7,961
=== === == =====
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 27
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended June 30, 1998, 1997 and 1996
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Operating activities:
Net income $ 279 327 297
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense 50 54 57
Provision for loan losses 312 29 105
Decrease (increase) in accrued interest receivable 203 (193) (64)
(Increase) decrease in prepaid expenses and
other assets (14) 279 (130)
Increase in accrued interest payable on
savings deposits 31 15 5
Increase (decrease) in accrued expenses and
other liabilities (142) (9) 119
Increase (decrease) in stock subscription
deposits - (4,569) 4,569
Noncash compensation expense related to stock
benefit plans 150 81 -
Other, net 7 6 69
------- ------ ------
Total adjustments 597 (4,307) 4,730
------- ------ ------
Net cash (used) provided by operating
activities 876 (3,980) 5,027
Investing activities:
Purchases of premises and equipment (8) (9) -
Purchases of investment securities held-to-maturity (998) - (700)
Purchases of investment and mortgage-backed
securities available-for-sale (2,763) (10,941) (11,882)
Proceeds from maturities of investment
securities held-to-maturity 1,500 2,272 2,350
Proceeds from maturities and principal
repayments of investment and mortgage-
backed securities available-for-sale 13,344 2,949 2,800
Proceeds from sale of real estate owned 18 101 111
Net (increase) decrease in loans receivable (6,957) (5,828) 2,476
Decrease (increase) in FHLB stock 61 (164) -
Other (36) 24 (59)
------ ------- ------
Net cash used in investing activities 4,161 (11,596) (4,904)
</TABLE>
(Continued)
25
<PAGE> 28
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows, Continued
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Financing activities:
Net (decrease) increase in passbook, club,
money market and NOW accounts $ (594) (1,479) 190
Net (decrease) increase in certificates of
deposit accounts 529 (35) (676)
Net (decrease) increase in advances from
borrowers for taxes and insurance 72 44 (155)
Proceeds from issuance of common stock - 5,595 -
Stock acquired for ESOP - (488) -
Stock acquired for RRP - (357) -
Purchase of Treasury stock (1,068) (458) -
Dividends paid (192) (75) -
(Decrease) increase in FHLB advances (3,000) 4,000 -
Proceeds from ESOP loan - 488 -
Other (35) 39 -
------ ------ ------
Net cash provided (used) by financing
activities (4,288) 7,274 (641)
----- ------ ------
Net decrease in cash and cash equivalents 749 (8,302) (518)
Cash and cash equivalents, beginning of period 1,804 10,106 10,624
----- ------- ------
Cash and cash equivalents, end of period $ 2,553 1,804 10,106
===== ======= ======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,743 1,665 1,717
===== ======= ======
Income taxes $ 162 106 51
===== ======= ======
Supplemental schedule of noncash investing activities:
Loan transferred to real estate owned $ - 16 111
===== ======= ======
Dividends declared but not paid $ 49 46 -
===== ======= ======
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 29
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998, 1997 and 1996
(Dollars in thousands except share data)
(1) Summary of Significant Accounting Policies
Pennwood Bancorp, Inc. and subsidiary (the Company) is primarily engaged
in the business of attracting retail deposits from the general public
and using such funds to invest in residential and commercial mortgage
and consumer loans. The Company is subject to competition from other
financial institutions. The Company is also subject to the regulations
of certain federal and state agencies and undergoes periodic
examinations by those regulatory authorities.
The following comprise the significant accounting policies which the
Company follows in preparing and presenting their consolidated
financial statements:
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiary, Pennwood Savings Bank.
All significant intercompany transactions and balances have been
eliminated in consolidation.
Basis of Presentation
The financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the financial
statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the
date of the balance sheet, disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and
expenses for the period. Actual results could differ significantly
from those estimates.
Cash and Cash Equivalents
For the purposes of the statements of cash flows, cash and cash
equivalents include cash on hand and amounts due from depository
institutions, federal funds sold and interest-bearing deposits.
(Continued)
27
<PAGE> 30
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Investment and Mortgage-Backed Securities
The Company classifies securities at the time of their purchase as either
"held-to-maturity," "trading" or "available-for-sale." If it is
management's intent and the Company has the ability to hold such
securities until their maturity, these securities are classified as
held-to-maturity and are carried at cost, adjusted for amortization of
premiums and accretion of discounts. Alternatively, if it is management's
intent at the time of purchase to hold securities for the purpose of
resale in the near future, the securities are classified as trading and
are carried at market value with unrealized gains and losses reported in
current period earnings. At June 30, 1998 and 1997, the Company had no
securities classified as trading. Securities not classified as
held-to-maturity or trading are classified as available-for-sale and are
carried at market value with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders' equity, net
of tax. Investments available-for-sale include investment securities
which may be sold in response to changes in interest rates, resultant
prepayment risk and other factors related to interest rate, prepayment
risk or liquidity needs.
Purchases and sales of securities are accounted for on a settlement-date
basis which is not materially different than use of the trade-date basis.
Gains and losses on the sale of securities are recognized upon realization
using the specific identification method. Amortization of premiums and
accretion of discounts are calculated using a method which approximates
the level-yield method.
The Financial Accounting Standards Board (FASB) SFAS 119 requires
disclosure about amounts, nature and terms of derivative financial
instruments. The Company has no involvement with derivative financial
instruments that meet the definition of a derivative as defined by SFAS
119.
(Continued)
28
<PAGE> 31
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Loans Receivable
Loans are stated at their unpaid principal balances less allowances for
anticipated losses. Monthly loan payments are scheduled to include
interest. Interest on loans is credited to income as earned. Interest
earned on loans for which no payments were received during the month is
accrued. An allowance is established for accrued interest deemed to be
uncollectible, generally when a loan is ninety days or more delinquent,
except when the estimated value of the collateral and collection efforts
are deemed sufficient to ensure full recovery. Such interest ultimately
collected is credited to income in the period received. Monthly mortgage
loan payments are adjusted annually to cover insurance and tax
requirements.
Loan origination fees and certain direct loan costs are deferred, and the
net fee or cost is recognized in income using a method which approximates
the level-yield method over the contractual life of the loans.
A loan is considered to be impaired when it is probable that the Company
will be unable to collect all principal and interest amounts due according
to the contractual terms of the loan agreement. All nonperforming loans
are considered to be impaired loans. Impaired loans are required to be
measured based upon the present value of expected future cash flows,
discounted at the loan's initial effective interest rate, or at the loan's
market price or fair value of the collateral if the loan is collateral
dependent. If the loan valuation is less than the recorded value of the
loan, an impairment reserve must be established for the difference by
either an allocation of the allowance for loan losses or by a provision
for loan losses, depending on the adequacy of the allowance for loan
losses. As of June 30, 1998 and 1997, impaired loans consisted of $654
and $394 of nonperforming consumer and single family residential loans,
respectively, that have been collectively evaluated for impairment.
Estimated impairment losses for the loans are based on various factors
including past loss experience, recent economic conditions, portfolio
delinquency rates and fair value of the underlying collateral. There were
no impairment reserves at June 30, 1998 and 1997. Average impaired loans
during the years ended June 30, 1998 and 1997, were $693 and $178,
respectively. During the years ended June 30, 1998, 1997 and 1996, the
Bank recognized $12, $10 and $5 of interest revenue on impaired loans,
respectively, all of which was recognized using the cash basis method of
income recognition.
(Continued)
29
<PAGE> 32
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Provision for Loan Losses
Provisions for estimated losses on loans are charged to earnings in an
amount that results in an allowance for loan losses sufficient, in
management's judgment, to cover anticipated losses based on management's
periodic evaluation of known and inherent risks in the loan portfolio,
past and expected future loss experience of the Bank, current economic
conditions, adverse situations which may affect a specific borrower's
ability to repay, the estimated value of any underlying collateral and
other relevant factors.
Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of the allowance for loan
losses. Management believes that the allowance for loan losses is
adequate. While management uses available information to recognize losses
on loans, 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
Bank's allowance for loan losses. Such agencies can require the Bank to
adjust the allowance based on their judgments about information available
to them at the time of their examination.
Real Estate Owned
Real estate owned (properties acquired by foreclosure or voluntarily
conveyed by delinquent borrowers in lieu of foreclosure) is recorded as of
the acquisition date at the lower of cost or fair value less estimated
costs to sell as established by a current appraisal. Costs relating to
development and improvement of the property are capitalized, whereas costs
relating to the holding of such real estate are expensed as incurred.
Subsequent to acquisition, valuations are periodically performed by
management; and the carrying value of the real estate acquired is
subsequently adjusted by establishing a valuation allowance and recording
a charge to operations if the carrying value of a property exceeds its
estimated fair value less estimated costs to sell. Gains and losses from
the sale of real estate are recognized upon sale and are based upon the
net carrying value of the related property.
(Continued)
30
<PAGE> 33
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation for financial reporting purposes is
computed using the straight-line method over the estimated useful lives of
the related assets of five to forty years. Leasehold improvements are
amortized on a straight-line basis over the shorter of the related lease
or the estimated useful life of the improvement. Accelerated methods are
used for income tax purposes.
Interest on Savings Deposits
Interest on savings deposits is accrued and charged to expense monthly and
is paid or credited in accordance with the terms of the respective
accounts.
Income Taxes
Income taxes are based on financial statement income after giving effect
to special rules applicable to savings banks under income tax laws.
Deferred taxes are provided for under the asset and liability method of
accounting for income taxes. Under the asset and liability method,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Pension Plan
Current costs of the pension plan are charged to expense and funded as
accrued. There are no unfunded vested benefits as of June 30, 1998 and
1997.
(Continued)
31
<PAGE> 34
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Earnings Per Share
In February 1997, the Financial Accounting Standards Board (the FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share." SFAS No. 128 supersedes APB Opinion No. 15,
"Earnings per Share" (Opinion No. 15) and requires the calculation and
dual presentation of basic and diluted earnings per share (EPS), replacing
the measures of primary and fully-diluted EPS as reported under Opinion
No. 15. SFAS No. 128 is effective for financial statements issued for
periods ending December 31, 1997. Prior period EPS data is restated to
conform with SFAS No. 128.
The following weighted average shares and share equivalents are used to
calculate basic and diluted EPS for the years ended June 30, 1998 and
1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Weighted average number of shares outstanding 662,734 720,265
used to calculate basic EPS
Dilutive securities 23,460 -
------- -------
Weighted average number of shares and share
equivalents outstanding used to calculate
diluted EPS 686,194 720,265
======= =======
</TABLE>
Options to purchase 69,148 shares of common stock at $10.59 per share and
Recognition and Retention Plan awards of 27,659 were outstanding during
1997 but were not included in the computation of diluted EPS because to do
so would have been anti-dilutive.
Stock Split
On May 15 1998, the Company completed a four-for-three stock split. Share
amounts and prior period EPS data have been restated to reflect the impact
of the split.
(Continued)
32
<PAGE> 35
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(2) Investment and Mortgage-Backed Securities Available-for-Sale
The carrying values and estimated market value of securities
available-for-sale as of June 30, 1998 and 1997, are summarized as
follows:
<TABLE>
<CAPTION>
June 30, 1998
-----------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. agency obligations $ 5,696 39 - 5,735
Mortgage-backed securities 1,644 49 - 1,693
FNMA preferred stock 313 13 (2) 324
------ ----- ---- -------
Total $ 7,653 101 (2) 7,752
===== === === =====
</TABLE>
<TABLE>
<CAPTION>
June 30, 1997
-----------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. agency obligations $ 15,741 27 39 15,729
Mortgage-backed securities 1,836 13 14 1,835
Corporate obligations 400 3 2 401
FNMA preferred stock 250 9 - 259
------ -- -- ------
Total $ 18,227 52 55 18,224
====== == == ======
</TABLE>
(Continued)
33
<PAGE> 36
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
The carrying value and estimated market value of securities
available-for-sale by contractual maturity are as follows:
<TABLE>
<CAPTION>
June 30, 1998 June 30, 1997
----------------------------- --------------------------------
Estimated Estimated
Amortized market Amortized market
cost value cost value
---- ----- ---- -----
<S> <C> <C> <C> <C>
U.S. agency and corporate
obligations:
Due in one year or less $ - - 198 201
Due after one year
through five years 1,249 1,257 3,352 3,347
Due after five years
through ten years 3,547 3,566 12,591 12,582
Due after ten years 900 912 - -
----- ------ ------- ------
5,696 5,735 16,141 16,130
FNMA preferred stock 313 324 250 259
Mortgage-backed securities 1,644 1,693 1,836 1,835
----- ----- ------- ------
$ 7,653 7,752 18,227 18,224
===== ===== ======= ======
</TABLE>
There were no sales of securities available-for-sale during 1998, 1997 or
1996. Commitments to purchase investment securities available-for-sale
totaled $250,000 at June 30, 1998.
(Continued)
34
<PAGE> 37
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(3) Investment Securities Held-to-Maturity
The carrying values and estimated market values of investment securities
held-to-maturity as of June 30, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
June 30, 1998
--------------------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Municipal obligations $ 200 5 - 205
Mortgage-backed securities 10 - - 10
--- --- --- ---
Total investments $ 210 5 - 215
=== === === ===
</TABLE>
<TABLE>
<CAPTION>
June 30, 1997
--------------------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Corporate obligations $ 497 3 - 500
Municipal obligations 200 5 - 205
Mortgage-backed securities 15 - - 15
--- -- -- ---
Total investments $ 712 8 - 720
=== == == ===
</TABLE>
(Continued)
35
<PAGE> 38
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
The amortized cost and estimated market value of securities
held-to-maturity, by contractual maturity, are shown below. Actual
maturities may differ from contractual maturities because issuers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------
1998 1997
--------------------------------------------------------------
Estimated Estimated
Amortized market Amortized market
cost value cost value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Due in one year or less $ - - 497 500
Due after one year through five years - - - -
Due after five years through ten years - - - -
Due after ten years 200 205 200 205
--- ---- ---- ----
200 205 697 705
Mortgage-backed securities 10 10 15 15
---- ----- ----- -----
$ 210 215 712 720
=== === === ===
</TABLE>
(4) Loans Receivable
Loans receivable as of June 30, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Mortgage loans:
Conventional, 1 - 4 family $ 21,800 15,085
Commercial and multifamily 1,560 1,524
Construction 3,631 3,748
Insured and guaranteed 206 250
------ ------
27,197 20,607
Other:
Consumer loans 8,217 8,110
Lines of credit 840 906
------ ------
9,057 9,016
Less:
Unearned interest on consumer loans 73 172
Undisbursed loan proceeds 1,852 1,924
Deferred loan fees 310 265
Allowance for loan losses 394 282
------ ------
$ 33,625 26,980
====== ======
</TABLE>
(Continued)
36
<PAGE> 39
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. The Bank
evaluates each customer's credit worthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Bank upon
extension of credit, is based on management's credit evaluation of the
borrower. The collateral consists primarily of residential real estate
and personal property. As of June 30, 1998 and 1997, the Bank had
outstanding commitments to originate and fund first mortgage loans and
construction loans of approximately $7,615 and $2,260, respectively.
Unused customer lines of credit as of June 30, 1998 and 1997,
approximated $676 and $658, respectively.
Nonaccrual loans totaled approximately $323, $273 and $308 as of June
30, 1998, 1997 and 1996, respectively. The interest that would have
been recorded on these loans for the years ended June 30, 1998, 1997
and 1996, was approximately $42, $26 and $29, respectively. The amount
of interest income recognized for the same periods was approximately
$12, $10 and $6. The Company is not committed to lend additional funds
to debtors whose loans have been placed on nonaccrual status.
Allowances for Estimated Losses
Activity with respect to the allowances for estimated losses is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Loans receivable
----------------
Balance at beginning of period $ 282 337 531
Provision charged to income 312 29 105
Charge-offs (212) (95) (312)
Recoveries 12 11 13
----- ----- -----
Balance at end of period $ 394 282 337
=== === ===
Real Estate Owned
-----------------
Balance at beginning of period 45 38 81
Provision charged to income - 45 18
Charge-offs (45) (38) (61)
Recoveries - - -
------ ---- ----
Balance at end of period $ - 45 38
===== ==== ====
</TABLE>
(Continued)
37
<PAGE> 40
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(5) Federal Home Loan Bank Stock
The Bank is a member of the Federal Home Loan Bank System and, as a
member, maintains an investment in the capital stock of the Federal
Home Loan Bank of Pittsburgh. The investment is based on a
predetermined formula and is carried at cost.
(6) Premises and Equipment
Premises and equipment as of June 30, 1998 and 1997, are summarized by
major classification as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Land $ 145 145
Office buildings and improvements 1,157 1,135
Leasehold improvements 56 68
Furniture, fixtures and equipment 323 328
----- -----
Total, at cost 1,681 1,676
Less accumulated depreciation and
amortization 637 587
----- -----
Premises and equipment, net $ 1,044 1,089
===== =====
</TABLE>
Depreciation and amortization expense for the years ended June 30, 1998, 1997
and 1996, was $50, $54 and $57, respectively.
The Bank maintains operating leases with respect to a branch office
facility and equipment which expire on July 31, 2002, and various dates
through June 30, 2001, respectively. Lease expense approximated $47,
$28 and $16 for the years ended June 30, 1998, 1997 and 1996,
respectively. Minimum annual lease commitments approximate $97, $86,
$51 and $18 for the years ended June 30, 1999, 2000, 2001 and 2002,
respectively.
(Continued)
38
<PAGE> 41
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(7) Accrued Interest Receivable
Accrued interest receivable as of June 30, 1998 and 1997, is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Loans receivable $ 216 160
Investment and mortgage-backed securities
and other interest-bearing deposits 115 374
--- ---
Total $ 331 534
=== ===
</TABLE>
(8) Savings Deposits
Savings deposits as of June 30, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------
1998 1997
-------------------------- -----------------------------
Weighted Weighted
average average
rate Amount rate Amount
---- ------ ---- ------
<S> <C> <C> <C> <C>
Passbook savings accounts % 2.71 $ 4,855 % 2.96 $ 4,775
Premium savings and club
accounts 2.37 3,814 3.19 4,392
Money market and NOW accounts 1.72 2,608 1.97 2,777
Noninterest-bearing checking
accounts - 1,242 - 1,169
-------- --------
12,519 13,113
Certificates of deposit:
3.01% to 4.00% 3.50 33 3.50 36
4.01% to 5.00% 4.92 2,462 4.94 2,417
5.01% to 6.00% 5.43 13,641 5.38 13,526
6.01% to 7.00% 6.28 6,029 6.36 5,707
7.01% to 8.00% 7.25 1,070 7.25 1,020
------- -------
23,235 22,706
------ ------
Total 4.41 $ 35,754 4.60 $ 35,819
====== ======
</TABLE>
(Continued)
39
<PAGE> 42
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Certificates of deposit with balances of $100,000 or more totaled
approximately $2,305 and $1,871 as of June 30, 1998 and 1997,
respectively.
The scheduled contractual maturities of certificates of deposit are summarized
as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Within one year $ 11,983 12,075
Beyond one year but within two years 4,462 4,171
Beyond two years but within three years 2,722 2,360
Beyond three years but within four years 2,089 1,955
Beyond four years but within five years 1,979 2,145
------ ------
Total $ 23,235 22,706
====== ======
</TABLE>
Interest expense on savings deposits for the years ended June 30, 1998,
1997 and 1996, is summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Passbook savings accounts $ 135 142 150
Premium savings and club accounts 125 143 158
Money market and NOW accounts 71 78 85
Certificates of deposit 1,334 1,226 1,324
----- ------ ------
Total $ 1,665 1,589 1,717
===== ===== =====
</TABLE>
(Continued)
40
<PAGE> 43
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(9) Borrowed Funds
Borrowed funds at June 30, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------------
1998 1997
-------------------------- -------------------------
Weighted Weighted
average average
rate Amount rate Amount
---- ------ ---- ------
<S> <C> <C> <C> <C>
Advances from the Federal Home
Loan Bank of Pittsburgh:
Due within one year % - $ - % 5.67 $ 3,000
Due between three and four
years 5.78 1,000 - -
Due between four and five
years - - 5.78 1,000
----- -----
Total advances 1,000 4,000
ESOP term loan, payable through
2006 432 464
----- -----
Borrowed funds $ 1,432 $ 4,464
===== =====
</TABLE>
The ESOP term loan is secured by all unallocated shares of the
Company's securities held by the ESOP. Principal and interest are
payable in forty equal quarterly payments. The term loan has a
variable interest rate equal to the prime rate. The interest rate at
June 30, 1998, was 8.5%.
The advances payable to the FHLB of Pittsburgh are secured by the
Company's stock in the FHLB of Pittsburgh, qualifying residential
mortgage loans and other mortgage-backed securities to the extent the
fair market value of such pledged collateral must be at least equal to
the advances outstanding.
Interest expense on FHLB advances was $76, $52 and $-0- and on the ESOP
term loan $33, $39 and $-0- for the years ended June 30, 1998, 1997 and
1996, respectively.
(Continued)
41
<PAGE> 44
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(10) Income Taxes
The Bank qualifies to be taxed under income tax rules applicable to
savings banks.
The provision for income taxes for the years ended June 30, 1998, 1997 and
1996, consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current tax expense (benefit):
Federal $ 190 138 45
State 15 (12) 22
---- ---- ----
205 126 67
Deferred tax expense (benefit):
Federal (37) 3 95
---- --- ----
Provision for taxes on income 168 129 162
Income tax expense (benefit) reported in net
worth related to securities available-for-
sale 29 37 (44)
--- --- ---
Total income tax expense $ 197 166 118
=== === ===
</TABLE>
A reconciliation from the expected federal statutory income tax rate to
the effective rate, expressed as a percentage of pretax income, for the
years ended June 30, 1998, 1997 and 1996, is summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Expected federal tax rate % 34.0 34.0 34.0
State tax (net of federal benefit) 2.2 (1.8) 3.1
Exempt income on investment securities (2.0) (2.0) (2.5)
Other 3.4 (1.8) .6
---- ---- ----
% 37.6 28.4 35.2
==== ==== ====
</TABLE>
(Continued)
42
<PAGE> 45
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
The tax effect of temporary differences which give rise to a
significant portion of deferred tax assets (liabilities) as of June 30,
1998, 1997 and 1996, are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Deferred tax assets:
Deferred loan fees $ 28 26 35
Book loan loss reserve 134 96 114
Tax loan loss reserve 6 - -
Unrealized loss on securities available-
for-sale - 1 38
Employee stock ownership plan 14 11 -
Uncollected interest 3 25 27
Other 7 10 4
--- --- ----
Total deferred tax asset 192 169 218
Deferred tax liabilities:
Fixed assets (6) (14) (28)
Unrealized gain on securities available
for sale (28) - -
Tax loan loss reserve - (5) -
--- --- ----
Total deferred tax liability (34) (19) (28)
--- --- ---
Net deferred tax asset $ 158 150 190
=== === ====
</TABLE>
The Bank has determined that it was not required to establish a
valuation allowance for deferred tax assets since it is more likely
than not that the deferred tax asset will be realized through
carryback to taxable income in prior years, future reversal of
existing temporary differences and, to a lesser extent, future
taxable income. The net deferred tax asset is included as a
component of prepaid expenses and other assets in the consolidated
balance sheets.
(Continued)
43
<PAGE> 46
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
As a result of the special tax treatment accorded the Bank under income
tax regulations, approximately $979 of balances in retained earnings at
June 30, 1997 (the most recent date for which a tax return has been
filed), represent allocations of income to bad debt deductions for tax
purposes only. No provision for federal income tax has been made for
such amount. If any portion of that amount is used other than to
absorb loan losses (which is not anticipated), taxable income will be
generated subject to tax at the rate then in effect.
On August 20, 1996, President Clinton signed legislation which eliminated
the percentage of taxable income bad debt deduction for thrift
institutions for tax years beginning after December 31, 1995. This new
legislation also requires a thrift to generally recapture the excess of
its current tax reserves in excess of its 1987 base year reserves. As
the Bank has previously provided deferred taxes on this amount, no
financial statement tax expense should result from this new
legislation.
(11) Net Worth
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory - and, possibly
additional discretionary - actions by regulators that, if undertaken,
could have a direct material effect on the Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. 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 the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I Capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I
Capital (as defined) to average assets (as defined). Management
believes, as of June 30, 1998, that the Bank meets all capital
adequacy requirements to which it is subject.
(Continued)
44
<PAGE> 47
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
As of June 30, 1997, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as "well
capitalized" under the regulatory framework for prompt corrective
action. To be categorized as "well capitalized" the Bank must maintain
minimum total risk-based, Tier I risk based, Tier I leverage ratios as
set forth in the table. There are no conditions or events since that
notification that management believes have changed the Bank's category.
The Bank's actual capital amounts and ratios are also presented in the
following table.
<TABLE>
<CAPTION>
To be well
capitalized under
For capital prompt corrective
Actual adequacy purpose actions provisions
-------------------------- ------------------ ---------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1998:
Total capital (to
risk-weighted
assets) $ 8,561 % 32.15 $ 2,130 % > 8.00 $ 2,663 % > 10.00
- -
Tier I Capital (to
risk-weighted
assets) 8,227 30.89 1,065 > 4.00 1,331 > 5.00
- -
Tier I Capital (to
average assets) 8,227 17.89 1,839 > 4.00 2,299 > 5.00
- -
As of June 30, 1997:
Total capital (to
risk-weighted
assets) 9,360 35.72 2,096 > 8.00 2,620 > 10.00
- -
Tier I Capital (to
risk-weighted
assets) 9,065 34.59 1,048 4.00 1,572 5.00
Tier I Capital (to
average assets) 9,065 19.19 1,889 4.00 2,361 5.00
</TABLE>
(Continued)
45
<PAGE> 48
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(12) Employee Benefit Plans
Pension Plan
The Bank participates in a retirement plan which covers substantially
all employees through the Financial Institution Retirement Fund (the
Fund), a qualified multi-employer defined benefit plan. The Fund does
not compute and provide separate actuarial valuations or segregation of
plan assets by employer. Pension expense was $-0- for the years ended
June 30, 1998, 1997 and 1996. The Bank has been notified by the plan
administrator that the plan is fully funded for the plan year beginning
July 1, 1997.
Recognition and Retention Plan
On March 26, 1997, shareholders of the Company approved the adoption of
the 1997 Recognition and Retention Plan (RRP). The purpose of the RRP
is to retain qualified personnel in key positions, provide officers,
key employees and directors with a proprietary interest in the Company
as an incentive to contribute to its success and reward key employees
for outstanding performance. The aggregate number of RRP shares
granted was 27,660 which shares were purchased in open market
transactions at a price ranging from $10.60 per share to $11.06 per
share. These shares vest 20% annually beginning one year from the date
of grant. This expense is being amortized over the life of the grant
using a $10.97 average purchase price and amounted to $72 and $18 for
the years ended June 30, 1998 and 1997, respectively.
Stock Option Plan
The Board of Directors and shareholders of the Company have adopted the
1997 Stock Option Plan (1997 Plan) which authorizes the grant of stock
options. The maximum number of shares of common stock of the Company
which may be issued under the 1997 Plan is 81,350, of which 24,405
shares may be granted to non-employee directors. Shares become vested
and exercisable at the rate of 20% annually beginning on one year from
the date of grant and have a term of ten years.
(Continued)
46
<PAGE> 49
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
A summary of the Company's stock option plan as of June 30, 1998, and the
changes for the year then ended is as follows:
<TABLE>
<CAPTION>
Shares Average
subject exercise
Stock option activity to option price
- --------------------- --------- -----
<S> <C> <C>
Balance at June 30, 1996 - $ -
Granted 69,148 10.5938 (1)
Exercised - -
Forfeited - -
------ ---------
Balance at June 30, 1997 69,148 10.5938
Granted - -
Exercised - -
Forfeited - -
------ ---------
Balance at June 30, 1998 69,148 10.5938
====== =======
</TABLE>
(1) Using a Black-Scholes Option Valuation Model, the weighted-average
fair value of options granted in 1997 was estimated at $4.32 per
share.
SFAS 123 establishes a fair value based method of accounting for
stock-based compensation plans. Effective for fiscal years beginning
after December 15, 1995, SFAS allows entities to expense an estimated
fair value of stock options or to continue to measure compensation
expense for stock option plans using the intrinsic value method
prescribed by APB No. 25. Entities that elect to continue to measure
compensation expense based on APB No. 25 must provide pro forma
disclosures of net income and earnings per share as if the fair value
method of accounting had been applied. The Company has elected to
measure compensation cost using the intrinsic value method prescribed
by APB No. 25. Had the company used the fair value method, net income
and earnings per share for the years ended June 30, 1998 and 1997,
would have been as follows (in thousands, except for per share data):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net income:
As reported $ 279 327
Pro forma 219 312
</TABLE>
(Continued)
47
<PAGE> 50
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Earnings per share:
As reported:
Basic $ .42 .45
Diluted .41 .45
Pro forma:
Basic .33 .43
Diluted .32 .43
</TABLE>
The fair value for these options was estimated at the date of grant
using a Black-Scholes Option Valuation Model with the following
assumptions for 1997: risk-free interest rate of 6.07%; dividend yield
of 2.1%; volatility factor of the expected market price of the
Company's common stock of 20%; and an expected life of the options of
10 years.
The Black-Scholes Option Valuation Model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of
traded options and because changes in the subjectivity input
assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock
options.
The following table summarizes the characteristics of stock options
outstanding at June 30, 1998:
<TABLE>
<CAPTION>
Outstanding Exercisable
------------------------ ----------------------
Average Average
Exercise Average exercise exercise
price Shares life (2) price Shares price
----- ------ -------- ----- ------ -----
<S> <C> <C> <C> <C> <C>
$ 10.5938 69,148 8.75 $ 10.5938 13,830 $ 10.5938
</TABLE>
(2) Average contractual life remaining in years.
(Continued)
48
<PAGE> 51
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Employee Stock Ownership Plan
The Company has established an Employee Stock Ownership Plan (ESOP)
which covers employees who have been credited with at least 1,000 hours
of service during a twelve month period and have attained the age of
21. The ESOP Trust borrowed $489 from an independent third-party
lender and purchased 48,810 shares, equal to 8% of the total number of
shares issued in the conversion. The Company makes scheduled
discretionary contributions to the ESOP sufficient to service the debt.
The ESOP shares are pledged as collateral for the debt. As the debt is
repaid, shares are released from collateral and become eligible for
allocation to participants. Shares are allocated to participants based
on compensation. The cost of shares not committed to be released and
unallocated (suspense shares) is reported as a reduction in
shareholders' equity. Dividends on allocated and unallocated shares
are used for debt service.
The Company accounts for its ESOP in accordance with AICPA Statement of
Position 93-6 (SOP 93-6). SOP 93-6 requires that (1) compensation
expense be recognized based on the average fair value of the ESOP
shares committed to be released; (2) dividends on unallocated shares
used to pay debt service be reported as a reduction of debt or of
accrued interest payable and that dividends on allocated shares be
charged to retained earnings; and (3) ESOP shares which have not been
committed to be released not be considered outstanding for the purpose
of computing earnings per share and book value per share.
Compensation expense related to the ESOP amounted to $90 and $63 for
the years ended June 30, 1998 and 1997, from the 6,508 shares committed
to be released each year. Unallocated ESOP shares at June 30, 1998,
amounted to 58,572 with a total fair value of $670. Dividends received
on unallocated ESOP shares during the year ended June 30, 1998,
amounted to $16.
(13) Concentration of Credit Risk
The Bank is primarily engaged in the business of attracting retail
deposits from the general public and using such funds to invest in
residential and commercial mortgage loans and consumer loans. The
Bank conducts its business through three offices located in the
Pittsburgh and Kittanning areas of Pennsylvania. As of June 30, 1998,
the majority of the Bank's loan portfolio was secured by properties
located in these geographical areas. The Bank utilizes established
loan underwriting procedures which generally require the taking of
collateral to secure loans. Given its underwriting and collateral
requirements, the Bank does not believe it has significant
concentrations of credit risk to any one group of borrowers.
(Continued)
49
<PAGE> 52
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(14) SAIF Assessment
On September 30, 1996, President Clinton signed into law the Deposit
Funds Act of 1996 (the Act). Among other things, the Act imposed a
one-time special assessment on deposits insured by the SAIF designed to
fully capitalize the SAIF to the level required by law. The result of
this one-time charge was $247 to the Bank. The Act also provides for
the eventual merger of the SAIF with the Bank Insurance Fund ("BIF")
and reallocates payment of Financing Corporation bond obligations to
both SAIF and BIF insured institutions. In addition, the Act contains
prohibitions on insured institutions facilitating or encouraging the
migration of SAIF deposits to the BIF until the end of 1999. As a
result of the recapitalization of the SAIF, deposit insurance premiums
were significantly reduced beginning in calendar year 1997 for all SAIF
insured institutions.
(15) Contingencies
The Company is subject to asserted and unasserted potential claims
encountered in the normal course of business. In the opinion of
management and legal counsel, the resolution of these claims will not
have a material adverse effect on the Company's financial position or
results of operations.
(16) Disclosures About Fair Value of Financial Instruments
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount
rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be sustained by comparison of independent
markets and, in many cases, could not be realized in immediate
settlement of the instrument. SFAS No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts do not
represent the underlying value of the Company.
(Continued)
50
<PAGE> 53
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Management has made estimates of fair value discount rates that it
believes to be reasonable considering expected prepayment rates, rates
offered in the geographic areas in which the Company competes, credit
risk and liquidity risk. However, because there is not active market
for many of these financial instruments, management has no basis to
verify whether the resulting fair value estimates would be indicative
of the value negotiated in an actual sale.
The following methods and assumptions were used by the Company at
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the
consolidated statement of financial condition for cash, federal funds
sold and interest-bearing deposits approximate those assets' fair
values.
Investment and mortgage-backed securities: Fair values for investment
securities are based on quoted market prices where available, dealer
quotes or prices obtained from independent pricing services. See notes
2 and 3 of the consolidated financial statements for a detail breakdown
of these securities.
Loans receivable: The fair values for one- to four-family residential
loans are estimated using discounted cash flow analyses using yields
from similar products in the secondary markets. The carrying amount of
construction loans approximates its fair value given their short-term
nature. The fair values of consumer and other loans are estimated
using discounted cash flow analyses, using interest rates reported in
various government releases and the Company's own product pricing
schedule for loans with terms similar to the Company's. The fair
values of multi-family and nonresidential mortgages are estimated using
discounted cash flow analysis, using interest rates based on a national
survey of similar loans. The carrying amount of accrued interest
approximate its fair value.
(Continued)
51
<PAGE> 54
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Savings deposits: The fair values for demand deposits (e.g., passbook,
savings accounts) are, by definition, equal to the amount payable on
demand at the repricing date (i.e., their carrying amounts). Fair
values of time deposits (e.g., certificates of deposit) are estimated
using a discounted cash flow calculation that applies a comparable
Federal Home Loan Bank advance rate to the aggregated weighted average
maturity on time deposits.
Off-balance-sheet instruments: Fair values for the Company's
off-balance-sheet instruments (e.g., lending commitments) are based on
their carrying value, taking into account the remaining terms and
conditions of the agreements.
The following table includes financial instruments as defined by SFAS
No. 107, whose estimated fair value is not represented by the carrying
value as reported on the Bank's balance sheet as of June 30, 1998 and
1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
---------------------------- -------------------------
Estimated Estimated
Carrying fair Carrying fair
value value value value
----- ----- ----- -----
<S> <C> <C> <C> <C>
Financial assets
----------------
Loans receivable $ 33,625 34,735 26,980 27,749
Financial liabilities
---------------------
Time deposits 23,325 23,625 22,706 22,596
Borrowed funds 1,432 1,448 4,464 4,461
</TABLE>
(17) Conversion to Stock Form of Ownership
On February 20, 1996, as amended on April 6, 1996, the Board of
Trustees adopted a plan of conversion whereby the Bank would be
converted from a Pennsylvania mutual savings bank to a Pennsylvania
stock savings bank. The conversion was completed on July 12, 1996, and
the Bank issued 610,128 shares of its common stock resulting in $6,101
of gross proceeds to the Bank. Costs of the common stock offering of
$506 were deducted from the offering proceeds.
(Continued)
52
<PAGE> 55
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
At the completion of the conversion to stock form, the Bank established
a liquidation account in the amount of retained earnings set forth in
the offering circular utilized in the conversion. The liquidation
account will be maintained for the benefit of eligible savings account
holders who maintain deposit accounts in the Bank after conversion. In
the event of a complete liquidation (and only in such event), each
eligible savings account holder will be entitled to receive a
liquidation distribution from the liquidation account in the amount of
the then current adjusted balance of deposit accounts held, before any
liquidation distribution may be made with respect to the shares of the
Company's common stock, par value $.01 per share (Company Common Stock)
(see reorganization discussion below). Except for the repurchase of
stock and payment of dividends by the Company, the existence of the
liquidation account will not restrict the use or further application of
such retained earnings.
The Company may not declare or pay a cash dividend on, or repurchase
any of, its common shares if the effect thereof would cause the
Company's shareholders' equity to be reduced below either the amount
required for the liquidation account or the regulatory capital
requirements for insured institutions.
On January 27, 1997, the Company became a bank holding company in
accordance with the terms of an Agreement and Plan of Reorganization,
dated September 18, 1996 (the Agreement), by and among the Savings
Bank, Pennwood Interim Savings Bank (Interim) and the Company.
Pursuant to the Agreement: (1) the Company was organized as a wholly
owned subsidiary of the Savings Bank; (2) Interim was organized as a
wholly owned subsidiary of the Company; (3) Interim merged with and
into the Savings Bank, with the Savings Bank as the surviving
institution; and (4) upon such merger, (i) the outstanding shares of
the Savings Bank Common Stock became, by operation of law, on a
one-for-one basis, common stock par value $.01 per share, of the
Company (Company Common Stock), (ii) the common stock of Interim held
by the Company was converted into common stock of the Savings Bank and
(iii) the common stock of the Company held by the Savings Bank was
canceled. Accordingly, the Savings Bank became a wholly owned
subsidiary of the Company and the shareholders of the Savings Bank
became shareholders of the Company.
(Continued)
53
<PAGE> 56
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(18) Selected Quarterly Financial Data (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------
September 30 December 31 March 31 June 30
------------ ----------- -------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
1998
Interest income $ 967 948 910 921
Interest expense 465 448 431 428
--- --- --- ---
Net interest income before provision
for loan losses 502 500 479 493
Provision for loan losses 15 12 115 170
Noninterest income 37 74 48 44
Noninterest expense 347 376 339 356
--- --- --- ---
Income before income taxes 177 186 73 11
Provision for income taxes 49 74 44 1
--- --- --- ---
Net income $ 128 112 29 10
=== === === ===
Basic earnings per share .18 .17 .05 .02
Diluted earning per share .18 .16 .05 .02
1997
Interest income 904 930 914 956
Interest expense 408 412 417 442
--- --- --- ---
Net interest income before provision
for loan losses 496 518 497 514
Provision for loan losses 8 - 15 6
Noninterest income 27 27 27 28
Noninterest expense 571 367 334 376
--- --- --- ---
Income (loss) before income taxes (56) 178 175 160
Provision (benefit) for income taxes (39) 51 54 63
---- --- --- ---
Net (loss) income $ (17) 127 121 97
==== === === ===
Basic earnings per share (.02) .17 .17 .13
Diluted earning per share (.02) .17 .17 .13
</TABLE>
(Continued)
54
<PAGE> 57
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
(19) Pennwood Bancorp, Inc. (Parent Company Only)
The following are condensed financial statements for the parent company
which was formed on January 27, 1997:
Condensed Statements of Financial Condition
<TABLE>
<CAPTION>
June 30,
------------------
1998 1997
---- ----
Assets
------
<S> <C> <C>
Interest-earning deposits in other institutions $ 107 232
Investment in subsidiary 8,228 8,993
Other assets 111 4
----- -----
Total assets $ 8,446 9,229
===== =====
Liabilities and Shareholders' Equity
------------------------------------
Liabilities:
ESOP loan payable 432 464
Accrued expenses and other liabilities 53 39
----- -----
Total liabilities 485 503
Shareholders' equity:
Preferred stock, $.01 par value; 1,000,000 shares
authorized - none issued - -
Common stock, $.01 par value; 4,000,000 shares
authorized - 813,419 and 610,128 shares issued
at June 30, 1998 and 1997, respectively 8 6
Additional paid-in capital 5,642 5,603
Retained earnings 4,427 4,355
Treasury stock at cost; 116,025 and 30,506 shares
at June 30, 1998 and 1997, respectively (1,526) (458)
Unearned ESOP shares (390) (439)
Unearned common stock held by Recognition and
Retention Plan (267) (339)
Unrealized gain (loss) on investment securities
available-for-sale, net 67 (2)
----- -----
Total shareholders' equity 7,961 8,726
----- -----
Total liabilities and shareholders' equity $ 8,446 9,229
===== =====
</TABLE>
(Continued)
55
<PAGE> 58
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Condensed Statements of Income
<TABLE>
<CAPTION>
For the five-
Year month period
ended ended
June 30, June 30,
1998 1997
---- ----
<S> <C> <C>
Income:
Equity in earnings of subsidiary $ 338 371
Management fee 104 -
--- ---
Total income 442 371
Expense:
Interest expense on ESOP loan 33 16
Personnel costs 71 18
Other operating expenses 59 10
--- ---
Total expense 163 44
--- ---
Income before income taxes 279 327
Income tax provision (benefit) - -
--- ---
Net income $ 279 327
=== ===
</TABLE>
(Continued)
56
<PAGE> 59
PENNWOOD BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(Dollars in thousands except share data)
Condensed Statement of Cash Flows
<TABLE>
<CAPTION>
For the five-
Year month period
ended ended
June 30, June 30,
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 279 327
Equity in undistributed earnings of subsidiary (338) (371)
Other (24) (76)
----- -----
Net cash used in operating activities (83) (120)
Cash flows from investing activities:
Dividends from subsidiary 1,250 1,282
----- -----
Net cash provided by investing
activities 1,250 1,282
Cash flows from financing activities:
Purchase of RRP shares - (357)
Purchase of treasury stock (1,068) (458)
Dividends paid (192) (75)
Other (32) (41)
------ -----
Net cash used in financing activities (1,292) (931)
----- -----
Net (decrease) increase in cash (125) 231
Cash at beginning of period 232 1
------ -----
Cash at end of period $ 107 232
====== =====
</TABLE>
57
<PAGE> 60
PENNWOOD BANCORP, INC.
DIRECTORS
<TABLE>
<S> <C>
Charles R. Frank Mary M. Frank
Chairman of the Board of Vice Chairman of the Board and
the Company Treasurer of the Company
Paul S. Pieffer John B. Mallon
President and Chief Executive Officer Retired, Formerly President of
of the Company Suburban General Hospital
C. Joseph Touhill Robert W. Hannan
Principal, Touhill Retired, President and Chief Executive
Technology Management Officer, Thrift Drug Company
Michael Kotyk H. J. Zoffer
Retired, formerly Technical Director Professor of Business Administration and
of Materials Technology at Dean Emeritus, Joseph M. Katz Graduate
U.S. Steel Corporation School of Business at the University of
Pittsburgh
</TABLE>
EXECUTIVE OFFICERS
<TABLE>
<S> <C>
Charles R. Frank Mary M. Frank
Chairman of the Board Vice Chairman of the Board and
Treasurer
Paul S. Pieffer Joseph W. Messner
President and Chief Executive Officer Vice President of Lending
James W. Kihm
Vice President and Secretary
</TABLE>
58
<PAGE> 61
PENNWOOD SAVINGS BANK
DIRECTORS
<TABLE>
<S> <C>
Charles R. Frank Mary M. Frank
Chairman of the Board of Vice Chairman of the Board and
the Savings Bank Treasurer of the Savings Bank
Paul S. Pieffer John B. Mallon
President and Chief Executive Officer Retired, Formerly President of
of the Savings Bank Suburban General Hospital
C. Joseph Touhill Robert W. Hannan
Principal, Touhill Retired, President and Chief Executive
Technology Management Officer, Thrift Drug Company
Michael Kotyk H. J. Zoffer
Retired, formerly Technical Director Professor of Business Administration
of Materials Technology at and Dean Emeritus, Joseph M. Katz
U.S. Steel Corporation Graduate School of Business at the
University of Pittsburgh
</TABLE>
EXECUTIVE OFFICERS
<TABLE>
<S> <C>
Charles R. Frank Mary M. Frank
Chairman of the Board Vice Chairman of the Board and
Treasurer
Paul S. Pieffer Joseph W. Messner
President and Chief Executive Officer Vice President of Lending
James W. Kihm
Vice President and Secretary
</TABLE>
BANKING LOCATIONS
MAIN OFFICE
683 Lincoln Avenue
Pittsburgh, Pennsylvania 15202
BRANCH OFFICES
125 Market Street 4 Hilltop Plaza
Kittanning, Pennsylvania 16201 Kittanning, Pennsylvania 16201
59
<PAGE> 62
STOCKHOLDER INFORMATION
Pennwood Bancorp, Inc. is a Pennsylvania-incorporated bank holding
company conducting business through its wholly-owned subsidiary, Pennwood
Savings Bank (the "Savings Bank"). The Savings Bank is a
Pennsylvania-chartered, SAIF-insured stock savings bank operating through its
main office located in Pittsburgh, Pennsylvania and two branch offices located
in Kittanning, Pennsylvania.
TRANSFER AGENT/REGISTRAR:
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
(908) 272-8511
STOCKHOLDER REQUESTS:
Requests for annual reports, quarterly reports and related stockholder
literature should be directed to James W. Kihm, Vice President and Secretary,
Pennwood Bancorp, Inc., 683 Lincoln Avenue, Pittsburgh, Pennsylvania 15202.
Stockholders needing assistance with stock records, transfers or lost
certificates, please contact the Company's transfer agent, Registrar and
Transfer Company.
MARKET PRICES AND DIVIDENDS:
Shares of Pennwood Bancorp, Inc.'s common stock are traded under the
symbol "PWBK" on the Nasdaq Stock Market, Small-Cap Market System. At June 30,
1998, the Company had 193 stockholders of record. The table below sets forth
the range of high and low bid information for the common stock for each quarter
as well as dividends paid since July 12, 1996, the date of the Savings Bank's
conversion from the mutual form of ownership to the stock form of ownership.
On January 27, 1997, shares of the Savings Bank's common stock were converted
into shares of common stock of the Company in the Reorganization. The Company
effected a 4-for-3 split of its common stock on May 15, 1998.
<TABLE>
<CAPTION>
Quotations
---------------------------------
Dividend
Amount
Quarter Ended High Bid Low Bid Per Share
------------------------- ------------------- ------------- -------------
<S> <C> <C> <C>
September 30, 1996 $10.75 $8.75 --
December 31, 1996 12.875 10.50 $.07
March 31, 1997 14.00 12.875 $.07
June 30, 1997 14.750 13.750 $.08
September 30, 1997 13.3125 13.3125 $.08
December 31, 1997 14.8125 14.25 $.09
March 31, 1998 16.125 16.0625 $.09
June 30, 1998 13.500 13.500 $.07
</TABLE>
60
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 527
<INT-BEARING-DEPOSITS> 2,026
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7,752
<INVESTMENTS-CARRYING> 210
<INVESTMENTS-MARKET> 216
<LOANS> 33,625
<ALLOWANCE> 394
<TOTAL-ASSETS> 46,080
<DEPOSITS> 35,754
<SHORT-TERM> 1,000
<LIABILITIES-OTHER> 933
<LONG-TERM> 432
0
0
<COMMON> 8
<OTHER-SE> 7,953
<TOTAL-LIABILITIES-AND-EQUITY> 46,080
<INTEREST-LOAN> 2,727
<INTEREST-INVEST> 795
<INTEREST-OTHER> 223
<INTEREST-TOTAL> 3,745
<INTEREST-DEPOSIT> 1,665
<INTEREST-EXPENSE> 1,774
<INTEREST-INCOME-NET> 1,971
<LOAN-LOSSES> 312
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,416
<INCOME-PRETAX> 447
<INCOME-PRE-EXTRAORDINARY> 279
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 279
<EPS-PRIMARY> 42
<EPS-DILUTED> 41
<YIELD-ACTUAL> 7.94
<LOANS-NON> 323
<LOANS-PAST> 331
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 282
<CHARGE-OFFS> 212
<RECOVERIES> 12
<ALLOWANCE-CLOSE> 394
<ALLOWANCE-DOMESTIC> 394
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
