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, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission File Number: 1-14577
SECURITY OF PENNSYLVANIA FINANCIAL CORP.
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(Name of small business issuer in its charter)
Delaware 23-2980576
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
31 W. Broad Street, Hazleton, Pennsylvania 18201
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (570) 454-0824
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Securities registered under Section 12(b) of the Exchange Act:
Name of each exchange
Title of each class in which registered
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Common Stock, par value $0.01 per share The American Stock Exchange
Securities Registered under 12(g) of the Exchange Act: None
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 [ ]
Check if there is no 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 the 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 ]
The issuer's revenues for the most recent fiscal year were $8,151,479.
<PAGE>
The aggregate market value of the voting and non-voting common equity
held by non-affiliates as of September 9, 1999 was $16,156,683. This figure is
based on the closing price on the American Stock Exchange for a share of the
issuer's common stock on September 9, 1999, which was $10.625 as reported in The
Wall Street Journal on September 10, 1999. For purposes of this calculation, the
issuer is assuming that directors and executive officers are affiliates.
As of September 9, 1999, there were 1,587,000 shares of the
Registrant's Common Stock outstanding.
Transitional Small Business Disclosure Format. Yes [ ] No [ X ]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders
are incorporated by reference in Part III of this Form 10-KSB
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<TABLE>
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INDEX
Page
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PART I
Item 1. Description of Business....................................................... 1
Additional Item. Executive Officers of the Registrant ......................................... 25
Item 2. Description of Property....................................................... 25
Item 3. Legal Proceedings............................................................. 26
Item 4. Submission of Matters to a Vote of Security Holders........................... 26
PART II
Item 5. Market for Common Equity and Related Stockholder Matters ..................... 26
Item 6. Management's Discussion and Analysis or Plan of Operation..................... 26
Item 7. Financial Statements.......................................................... 36
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.......................................................... 37
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act............................. 37
Item 10. Executive Compensation........................................................ 37
Item 11. Security Ownership of Certain Beneficial Owners and
Management ................................................................... 37
Item 12. Certain Relationships and Related Transactions................................ 37
PART IV
Item 13. Exhibits and Reports on Form 8-K.............................................. 38
SIGNATURES................................................................................................ 39
</TABLE>
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
General
Security of Pennsylvania Financial Corp. (the "Company") was
incorporated under Delaware law on August 20, 1998. On December 30, 1998, the
Company acquired Security Savings Association of Hazleton (the "Association") as
a part of the Association's conversion from a Pennsylvania chartered mutual
savings and loan association into a Pennsylvania chartered capital stock savings
and loan association (the "Conversion"). In connection with the Conversion, on
December 30, 1998, the Company issued an aggregate of 1,587,000 shares of its
common stock, par value $0.01 per share (the "Common Stock"), at a purchase
price of $10 per share, of which 1,511,617 shares were sold in a subscription
offering and 75,383 shares were issued to the Security Savings Charitable
Foundation (the "Foundation"), a charitable foundation established by the
Association. The Company is a savings and loan holding company and is subject to
regulation by the Office of Thrift Supervision (the "OTS") and the Federal
Deposit Insurance Corporation ("FDIC"). Currently, the Company does not transact
any material business other than through the Association. References to the
Company include the Association unless the context indicates only the Company is
meant. At June 30, 1999, the Company had total assets of $119.5 million, total
deposits of $95.8 million and stockholders' equity of $22.5 million.
The Association is a community-oriented savings institution
which was originally organized in 1889 as The Middle Coal Field Building and
Loan Association of Hazleton. In January 1987, the Association acquired
Anthracite Building and Loan Association of Weatherly, Pennsylvania. The
Association's principal business consists of attracting retail deposits from the
general public in its primary market area and investing those deposits, together
with funds generated from operations, primarily in one- to four-family mortgage
loans and consumer loans. The Association originates for investment adjustable-
and fixed-rate one- to four-family mortgage loans, as well as a variety of
consumer loans, including home equity loans, lines of credit, automobile and
education loans. To a lesser extent, the Association also originates
multi-family and commercial real estate loans and construction loans. The
Association invests in mortgage-related and investment securities, primarily
U.S. government and agency obligations, and certificates of deposit in other
financial institutions and other permissible investments. The Association's
revenues are derived principally from interest on its loans, and to a lesser
extent, interest and dividends on its investment and mortgage-related securities
and certificates of deposit investments, and other noninterest income. The
Association's primary sources of funds are deposits and principal and interest
payments on loans and mortgage-related securities. The Association operates
through its main office located in Hazleton, Pennsylvania, and its three full
service branch offices.
Market Area and Competition
The Association's lending and deposit gathering is
concentrated in its market area consisting of Luzerne and Carbon counties in
Northeast Pennsylvania. The Association maintains two branch offices in Hazleton
(in Luzerne County), one in Weatherly (in Carbon County) and one in Drums (in
Luzerne County). Hazleton is situated approximately 100 miles from Philadelphia
and New York City and approximately 50 miles from Allentown and the
Wilkes-Barre/Scranton area.
The economy of the greater Hazleton area is characterized by
diversified light manufacturing and is the site of product facilities for
several manufacturers. As a consequence, the manufacturing sector employs more
than one third of the area's work force. The Hazleton area has excellent access
to major highway transportation routes as well as rail transportation. The
population of Luzerne County has remained relatively static and has one of the
oldest average ages for all counties in the United States. The unemployment rate
in the area is greater than the national average. According to Pennsylvania
Labor Market Information, as of June 1999, the unemployment rate for the market
area was 5.9% compared to the national level of 4.0%. The median household
income for 1998 for the market area was approximately $31,000, compared to the
national level of approximately $39,000.
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The Association faces significant competition both in
generating loans and in attracting deposits. The Association's primary market
area is highly competitive and the Association faces direct competition from a
significant number of financial institutions, many with a state wide or regional
presence and, in some cases, a national presence. Many of these financial
institutions are significantly larger and have greater financial resources than
the Association. The Association's competition for loans comes principally from
commercial banks, savings banks, credit unions, mortgage brokers, mortgage
banking companies and insurance companies. Its most direct competition for
deposits has historically come from savings banks and associations, commercial
banks and credit unions. In addition, the Association faces increasing
competition for deposits from non-bank institutions such as brokerage firms and
insurance companies in such instruments as short-term money market funds,
corporate and government securities funds, mutual funds and annuities.
Competition may also increase as a result of the removal of restrictions on the
interstate operations of financial institutions.
In addition, the Association recognizes that its customer base
increasingly focuses on convenience and access to services. The Association has
addressed these customer desires through the implementation of a telephone
banking system, the introduction of a new debit card and the installation of two
ATM machines. Additionally, the Association intends to expand its telephone
banking system to promote bill payment services and has plans to install
additional ATMs. The Association will continue to evaluate and enhance its
service delivery system.
Lending Activities
Loan Portfolio Composition. The Association's loan portfolio
consists primarily of mortgage loans secured by one- to four-family residential
real estate, consumer loans and multi-family and commercial real estate loans.
At June 30, 1999, the Association's loans totaled $73.5 million, of which $52.7
million, or 71.7%, were one- to four-family residential mortgage loans. Total
real estate mortgage loans included 25.8% of adjustable-rate loans, which are
indexed primarily to the United States Treasury Bill rates and the prime rate as
reported in The Wall Street Journal.
The Association's consumer loans at June 30, 1999 aggregated
$8.9 million, or 12.1% of total loans. Such consumer loans included $5.9 million
of home equity loans and lines of credit, $849,000 of loans secured by deposits,
$810,000 of automobile loans, $5,000 of education loans and $1.4 million of
other consumer loans. At June 30, 1999, the Association also had $11.9 million,
or 16.2% of total loans, in multi-family and commercial real estate loans and
construction loans.
The types of loans that the Association may originate are
subject to federal and state laws and regulations. Interest rates charged by the
Association on loans are affected by the demand for such loans and the supply of
money available for lending purposes and the rates offered by competitors. These
factors are, in turn, affected by, among other things, economic conditions,
monetary policies of the federal government, including the Federal Reserve
Board, and legislative tax policies.
2
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The following table sets forth the composition of the
Association's loan portfolio in dollar amounts and as a percentage of the
portfolio at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
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1999 1998 1997
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Percent Percent Percent
Amount of Total Amount of Total Amount of Total
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(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family................................... $52,677 71.71% $54,722 78.24% $53,685 79.59%
Multi-family and commercial........................... 10,745 14.63 4,757 6.80 3,263 4.84
Construction.......................................... 1,136 1.55 523 0.75 194 0.29
------- ------ ------- ------ ------- ------
Total real estate loans......................... 64,558 87.89 60,002 85.79 57,142 84.72
------- ------ ------- ------ ------- ------
Consumer loans:
Home equity loans and lines of credit................. 5,851 7.97 6,306 9.02 6,848 10.15
Automobile............................................ 810 1.10 967 1.38 1,067 1.58
Education............................................. 5 0.01 345 0.49 16 0.02
Secured by deposits................................... 849 1.15 907 1.30 937 1.39
Other................................................. 1,384 1.88 1,410 2.02 1,441 2.14
------- ------ ------- ------ ------- ------
Total consumer loans............................... 8,899 12.11 9,935 14.21 10,309 15.28
------- ------ ------- ------ ------- ------
Total loans..................................... 73,457 100.00% 69,937 100.00% 67,451 100.00%
====== ====== ======
Less:
Deferred loan origination fees
and discounts...................................... 249 274 284
Allowance for loan losses............................. 419 452 429
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Total loans, net................................ $72,789 $69,211 $66,738
======= ======= =======
</TABLE>
Loan Maturity. The following table shows the remaining
contractual maturity of the Association's total loans at June 30, 1999. The
table does not include the effect of future principal prepayments.
<TABLE>
<CAPTION>
At June 30, 1999
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Multi-Family
One- to and
Four- Commercial Total
Family(1) Real Estate Consumer Loans
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(In thousands)
<S> <C> <C> <C> <C>
Amounts due in:
One year or less ............... $ 290 $ 6 $ 579 $ 875
More than one year to five years 1,362 121 3,320 4,803
More than five years ........... 56,322 6,457 5,000 67,779
------- ------- ------- -------
Total amount due ............ $57,974 $ 6,584 $ 8,899 $73,457
======= ======= ======= =======
</TABLE>
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(1) Includes construction loans for the construction of one- to four-family
residences, which generally convert to permanent financing upon
completion of the construction phase.
3
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The following table sets forth, at June 30, 1999, the dollar
amount of loans contractually due after June 30, 2000, and whether such loans
have fixed interest rates or adjustable interest rates.
<TABLE>
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Due After June 30, 2000
---------------------------------
Fixed Adjustable Total
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(In thousands)
<S> <C> <C> <C>
Real estate loans:
One- to four-family (1) ............... $46,640 $11,044 $57,684
Multi-family and commercial real estate 1,002 5,576 6,578
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Total real estate loans ............ 47,642 16,620 64,262
Consumer loans ........................ 7,588 732 8,320
------- ------- -------
Total loans ..................... $55,230 $17,352 $72,582
======= ======= =======
</TABLE>
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(1) Includes construction loans for the construction of one- to four-family
residences, which generally convert to permanent financing upon
completion of the construction phase.
Origination and Sale of Loans. The Association's mortgage
lending activities are conducted primarily by its loan personnel operating at
its banking offices. All loans originated by the Association are underwritten
pursuant to the Association's policies and procedures. For fiscal 1999 and 1998,
the Association originated $17.2 million and $15.2 million of loans,
respectively. The Association originates both adjustable- and fixed-rate loans.
The Association's ability to originate fixed- or adjustable-rate loans is
dependent upon the relative customer demand for such loans, which is affected by
the current and expected future level of interest rates. All real estate loans
originated by the Association are originated for investment.
During fiscal years 1999 and 1998, the Association originated
$9.6 million and $8.6 million, respectively, of one- to four-family mortgage
loans. In addition, during fiscal years 1999 and 1998, the Association
originated $3.1 million and $2.1 million, respectively, of construction loans,
all of which were for owner financing of single-family properties, which, upon
completion of the construction phase, generally will convert to permanent
financing. Also, the Association originated $1.2 million and $1.0 million,
respectively, of multi-family and commercial real estate loans during fiscal
1999 and 1998.
Also, during fiscal 1999 and 1998, respectively, the
Association originated $3.3 million and $3.6 million of consumer loans,
consisting of $1.4 million and $1.4 million, respectively, of home equity loans
and lines of credit, $633,000 and $813,000, respectively, of automobile loans,
$446,000 and $457,000, respectively, of education loans, and $855,000 and
$913,000, respectively, of other consumer loans.
4
<PAGE>
The following table sets forth the Association's loan
originations and principal repayments and prepayments for the periods indicated:
<TABLE>
<CAPTION>
For the Fiscal Years
Ended June 30,
---------------------------------
1999 1998 1997
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Loans at beginning of period ................. $71,047 $68,882 $66,604
Originations:
Real estate:
One- to four-family ................. 9,623 8,567 7,109
Multi-family and commercial ......... 1,172 1,034 872
Construction ........................ 3,127 2,060 1,362
------- ------- -------
Total real estate loans .......... 13,922 11,661 9,343
Consumer:
Home equity loans and lines of credit 1,374 1,374 1,974
Automobile .......................... 633 813 713
Education ........................... 446 457 191
Unsecured lines of credit ........... 20 -- --
Other ............................... 835 913 1,168
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Total consumer loans ............. 3,308 3,557 4,046
------- ------- -------
Total loans originated ........... 17,230 15,218 13,389
Deduct:
Principal loan repayments and prepayments . 12,332 12,335 10,593
Transfers to foreclosed real estate ....... 688 718 518
------- ------- -------
Total deductions ................. 13,020 13,053 11,111
Net loan activity ............................ 4,210 2,165 2,278
------- ------- -------
Loans at end of period (1) ............. $75,257 $71,047 $68,882
======= ======= =======
</TABLE>
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(1) Loans at end of period include loans in process of $1.8 million, $1.1
million and $1.4 million for fiscal years 1999, 1998 and 1997,
respectively.
One- to Four-Family Mortgage Lending. One- to four-family
mortgage loan originations are generally obtained by the Association's in-house
loan representatives, from existing or past customers, and through referrals
from members of the Association's local community. At June 30, 1999, the
Association's one- to four-family mortgage loans totalled $52.7 million, or
71.7% of total loans. Of the one- to four-family mortgage loans outstanding at
that date, 80.9% were fixed-rate mortgage loans and 19.1% were adjustable-rate
mortgage ("ARM") loans.
The Association currently offers a variety of fixed-rate
mortgage loans, including 30-year and 15-year mortgage loans. The Association
also currently offers ARM loans with a term of 30 years and an interest rate
which adjusts annually from the outset of the loan. The interest rates for the
Association's ARM loans adjust in accordance with an index based on United
States Treasury Bill rates. The Association originates ARM loans with initially
discounted rates, often known as "teaser rates." The Association's ARM loans
generally provide for periodic (not more than 2%) caps on the increase or
decrease in the interest at any adjustment date. Currently, the Association has
a contractual rate ceiling of 5% over the life of the loan.
The origination of ARM loans, as opposed to fixed-rate
residential mortgage loans, helps reduce the Association's exposure to increases
in interest rates. However, adjustable-rate loans generally pose credit risks
not inherent in fixed-rate loans, primarily because as interest rates rise, the
underlying payments of the borrower rise,
5
<PAGE>
thereby increasing the potential for default. Periodic and lifetime caps on
interest rate increases help to reduce the credit risks associated with
adjustable-rate loans but also limit the interest rate sensitivity of such
loans.
Most one- to four-family mortgage loans are underwritten
according to Fannie Mae and Freddie Mac guidelines. Generally, the Association
originates one- to four-family residential mortgage loans in amounts up to 80%
of the lower of the appraised value or the selling price of the property
securing the loan and up to 95% of the appraised value or selling price if
private mortgage insurance ("PMI") is obtained. Mortgage loans originated by the
Association generally include due-on-sale clauses which provide the Association
with the contractual right to deem the loan immediately due and payable in the
event the borrower transfers ownership of the property without the Association's
consent. Due-on-sale clauses are an important means of adjusting the yields on
the Association's fixed-rate mortgage loan portfolio and the Association has
generally exercised its rights under these clauses. The Association requires
fire, casualty, title and, in certain cases, flood insurance on all properties
securing real estate loans made by the Association.
Multi-family and Commercial Real Estate Lending. The
Association originates adjustable-rate multi-family and commercial real estate
loans that generally are secured by properties used for a combination of
residential and retail purposes. Also, the Association participates in
commercial real estate loans promoted by a local regional development agency. At
June 30, 1999, the Association had $10.7 million of multi-family and commercial
real estate loans. At that date, the Association's largest multi-family or
commercial real estate loan were eight commercial real estate loans which ranged
from $242,000 to $999,000 and were secured by commercial real estate a
combination of lease assignments, rents and equipment.
A multi-family mortgage loan may be made to an amount up to
70% of the lower of the appraised value or sales price of the underlying
property with a term of up to 30 years. The Association's adjustable-rate
multi-family loans are offered at interest rates which adjust annually. The
Association also generally requires an appraisal on the property conducted by an
independent appraiser and title insurance.
The Association's underwriting procedures for commercial real
estate loans provide that such loans generally may be made in amounts up to 70%
of the lower of the appraised value or purchase price of the property unless the
property is owned by an individual who lives more than 50 miles from the
property. In those cases, a commercial real estate loan may only be made in
amounts up to 65% of the lower of the appraised value or purchase price of the
property. The Association may request PMI on a case by case basis. These
adjustable-rate loans may be made with terms up to 20 years and are generally
offered at interest rates which adjust every five years, in accordance with an
index based on the prime rate as published in The Wall Street Journal. In making
such loans, the Association considers the net operating income of the mortgaged
premises before debt service and depreciation; the debt coverage ratio (the
ratio of net earnings to debt service) and the ratio of loan amount to appraised
value.
Multi-family and commercial real estate loans generally are
considered to involve a higher degree of credit risk than financing on improved,
owner-occupied real estate. Multi-family and commercial real estate loans
generally involve larger principal amounts than one- to four-family residential
mortgage loans. In addition, because multi-family and commercial real estate
loans often are dependent on successful operation and management of the
properties, repayment of such loans may be subject to adverse conditions in the
real estate market or the economy to a greater extent than one- to four-family
residential loans.
Construction Lending. The Association also offers residential
construction loans on properties located in its market area. Such lending has
consisted primarily of loans for the construction of presold one- to four-family
residences which convert into permanent financing upon the completion of
construction. The Association generates residential construction loans primarily
through direct contact with the borrower or home builders. Such loans require
that an appraisal be conducted by a qualified appraiser and the Association
review plans, specifications and cost estimates. The appraiser must also conduct
an inspection following completion of the work. The amount of construction
advances to be made, together with the sum of previous disbursements, may not
exceed the percentage of completion of the construction. The maximum
loan-to-value ratio for such loans is 95%. Furthermore, borrowers have six
months to complete the home and only pay interest on amounts disbursed during
the construction process. The Association requires that it possess the first and
only lien on these types of loans. At June 30, 1999, the Association's largest
6
<PAGE>
construction loan was a performing loan with an aggregate commitment of $325,000
secured by a single-family residence located in Luzerne County. Risk of loss on
a construction loan is dependent largely upon the accuracy of the initial
estimate of the property's value at completion of construction or development.
Consumer Lending. Consumer loans at June 30, 1999 amounted to
$8.9 million or 12.1% of the Association's total loans. These loans include home
equity loans and lines of credit, automobile loans, education loans and other
consumer loans. Such loans are generally originated in the Association's primary
market area and if over $10,000 must be secured by real estate, automobiles or a
titled vehicle. These loans are typically shorter term and generally have higher
interest rates than one- to four-family mortgage loans. The maximum limit on
consumer loans, excluding home equity loans and home equity lines of credit, is
$50,000.
At June 30, 1999, home equity loans and lines of credit
accounted for $5.9 million, or 8.0% of total loans and 65.7% of consumer loans.
The Association generally offers home equity loans with terms of up to 120
months. The Association also offers home equity lines of credit with terms up to
120 months with adjustable rates of interest which adjust on a quarterly basis.
The adjustable rate of interest is indexed to the prime rate as reported in The
Wall Street Journal on the last day of the month preceding adjustment.
Generally, the maximum loan-to-value ratio on both home equity loans and home
equity lines of credit is 75%.
The Association also offers automobile loans on both new and
used cars. Loans are offered with 60 month terms and loan-to-value ratios of 80%
on new cars. The Association will also finance high dollar new cars for an
extended term greater than 60 months. For used cars, the maximum loan-to-value
ratio is the lesser of the retail value shown in the NADA Used Car Guide or the
contract price and the terms for such loans are determined based on the age of
the vehicle, but are generally limited to 60 months. However, the Association
will not make a loan on an automobile over five years old unless such automobile
is deemed an investment property. In those cases, an inspection is required and
the valuation is determined by the retail value as listed in the Cars of
Particular Interest booklet. The Association also offers loans on recreational
vehicles with terms up to 15 years for new and 84 months for used vehicles and
loan-to-value ratios of 80% for new and used recreational vehicles.
Other consumer loans include education loans which are
federally guaranteed and originated under regulations of the Pennsylvania Higher
Education Assistance Agency, deposit-secured loans, and other personal and
unsecured loans. During the last two years, it has become the policy of the
Association to sell its education loans once the borrower has left school to
Sallie Mae with servicing released.
Loans secured by rapidly depreciable assets such as
automobiles or that are unsecured entail greater risks than one- to four-family
mortgage loans. In such cases, repossessed collateral for a defaulted loan may
not provide an adequate source of repayment of the outstanding loan balance,
since there is a greater likelihood of damage, loss or depreciation of the
underlying collateral. Further, consumer loan collections on these loans are
dependent on the borrower's continuing financial stability and, therefore, are
more likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Finally, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans in the event of a default.
Loan Approval Procedures and Authority. The Board of Directors
establishes the lending policies and loan approval limits of the Association.
Such policies provide that all mortgage loans will be reviewed and either
approved or rejected by the Executive Committee of the Board of Directors or the
full Board of Directors, except those loans made under consumer lending
guidelines. Additionally, the Board of Directors has authorized the following
persons to approve loans up to the amounts indicated: branch managers may
approve loans up to $15,000; the Vice President, Lending may approve loans up to
$75,000; the Senior Vice President, Commercial Lending may approve loans up to
$100,000; loans up to $150,000 may be approved by the Association's President
and Chief Executive Officer or the Chief Operating Officer and loans over
$150,000 require the approval of the Board of Directors. All approved loans are
ratified by the Board of Directors.
7
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Delinquent Loans, Classified Assets and Foreclosed Real Estate
Delinquencies and Classified Assets. Reports listing all
delinquent accounts are generated and reviewed by management and the Board of
Directors on a monthly basis. The procedures taken by the Association with
respect to delinquencies vary depending on the nature of the loan, period and
cause of delinquency and whether the borrower has been habitually delinquent.
When a borrower fails to make a required payment on a loan, the Association
takes a number of steps to have the borrower cure the delinquency and restore
the loan to current status. The Association generally sends the borrower a
written notice of non-payment after the loan is first past due. The
Association's guidelines provide that telephone, written correspondence and/or
face-to-face contact will be attempted to ascertain the reasons for delinquency
and the prospects of repayment. When contact is made with the borrower at any
time prior to foreclosure, the Association will attempt to obtain full payment,
work out a repayment schedule with the borrower to avoid foreclosure or, in some
instances, accept a deed in lieu of foreclosure. In the event payment is not
then received or the loan is not otherwise satisfied, additional letters and
telephone calls generally are made. If the loan is still not brought current or
satisfied and it becomes necessary for the Association to take legal action,
which typically occurs after a loan is 90 days or more delinquent, the
Association will commence foreclosure proceedings against any real or personal
property that secures the loan. If a foreclosure action is instituted and the
loan is not brought current, paid in full, or refinanced before the foreclosure
sale, the property securing the loan generally is sold at foreclosure and, if
purchased by the Association, becomes foreclosed real estate.
Applicable regulations and the Association's Asset
Classification Policy require that the Association utilize an internal asset
classification system as a means of reporting problem and potential problem
assets. The Association has incorporated the OTS internal asset classifications
as a part of its credit monitoring system. The Association currently classifies
problem and potential problem assets as "Substandard," "Doubtful" or "Loss"
assets. An asset is considered "Substandard" if it is inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged, if any. "Substandard" assets include those characterized by the
"distinct possibility" that the insured institution will sustain "some loss" if
the deficiencies are not corrected. Assets classified as "Doubtful" have all of
the weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "Loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
which do not currently expose the insured institution to sufficient risk to
warrant classification in one of the aforementioned categories but possess
weaknesses are required to be designated "Special Mention."
When an insured institution classifies one or more assets, or
portions thereof, as Substandard or Doubtful, it is required to establish a
general valuation allowance for loan losses in an amount deemed prudent by
management. General valuation allowances represent loss allowances which have
been established to recognize the inherent risk associated with lending
activities, but which, unlike specific allowances, have not been allocated to
particular problem assets. When an insured institution classifies one or more
assets, or portions thereof, as "Loss," it is required either to establish a
specific allowance for losses equal to 100% of the amount of the asset so
classified or to charge off such amount.
A savings institution's determination as to the classification
of its assets and the amount of its valuation allowances is subject to review by
the OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies, has
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
Although management believes that, based on information currently available to
it at this time, its allowance for loan losses is adequate, actual losses are
dependent upon future events and, as such, further additions to the level of
allowances for loan losses may become necessary. In addition, the OTS or other
8
<PAGE>
banking agencies may require the Association to recognize additions to the
allowance, based on their judgments about information available to them at the
time of their examination.
The Board of Directors and management review the results of
the reports on a monthly basis. The Association classifies assets in accordance
with the management guidelines described above. At June 30, 1999, the
Association had $1.3 million of assets designated as Substandard which consisted
of 18 one-to four-family loans totaling $1.1 million and 16 consumer loans
totaling approximately $151,000. At that same date the Association had no assets
classified as Loss, Special Mention or Doubtful. The following table sets forth
the delinquencies in the Association's loan portfolio as of the dates indicated.
<TABLE>
<CAPTION>
At June 30, 1999 At June 30, 1998
-------------------------------------------- ------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
-------------------- ------------------- ------------------- -------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
------ -------- ------ -------- ------ --------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family ........ 3 $ 133 18 $1,140 3 $ 112 21 $1,443
Multi-family and
commercial .............. -- -- -- -- -- -- 6 247
Consumer loans:
Home equity loans and
lines of credit ......... 3 9 13 143 -- -- 11 200
Automobile ................. 3 21 1 8 2 9 -- --
Other ...................... -- -- 2 -- 4 7 4 6
------ ------ ------ ------ ------ ------ ------ ------
Total ................... 9 $ 163 34 $1,291 9 $ 128 42 $1,896
====== ====== ====== ====== ====== ====== ====== ======
Delinquent loans to total loans -- 0.22% -- 1.77% -- 0.18% -- 2.74%
<CAPTION>
At June 30, 1997
--------------------------------------------
60-89 Days 90 Days or More
-------------------- -------------------
Number Principal Number Principal
of Balance of Balance
Loans of Loans Loans of Loans
------ -------- ------ --------
Real estate loans:
One- to four-family ........ 9 $ 717 19 $1,188
Multi-family and
commercial .............. -- -- 5 174
Consumer loans:
Home equity loans and
lines of credit ......... 1 40 10 200
Automobile ................. 1 1 2 13
Other ...................... 1 -- 2 11
------ ------ ------ ------
Total ................... 12 $ 758 38 $1,586
====== ====== ====== ======
Delinquent loans to total loans 1.14% 2.38%
</TABLE>
9
<PAGE>
Nonperforming Assets and Impaired Loans. The following table
sets forth information regarding nonaccrual loans, foreclosed real estate
(including a $66,000 loan which was a troubled debt restructuring effect in
1998). At June 30, 1999, nonaccrual loans totalled $1.3 million and consisted of
34 loans. At such date, foreclosed real estate totalled $53,000 and consisted of
three one- to four-family properties. It is the policy of the Association to
cease accruing interest on loans 90 days or more past due (unless the loan
principal and interest are determined by management to be fully secured and in
the process of collection) and to charge off all accrued interest. For the year
ended June 30, 1999, the amount of additional interest income that would have
been recognized on nonaccrual loans if such loans had continued to perform in
accordance with their contractual term was approximately $79,000. At June 30,
1999, the Association had a $188,000 recorded investment in impaired loans,
which had specific allowances of $15,000. At June 30, 1998, there were $291,000
of impaired loans with specific loan loss allowances of $35,000.
<TABLE>
<CAPTION>
At June 30,
--------------------------------
1999 1998 1997
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Nonaccrual loans:
One- to four-family real estate ...... $1,140 $1,477 $1,188
Consumer ............................. 151 206 224
Multi-family and commercial .......... -- 181 174
------ ------ ------
Total(1) .......................... 1,291 1,864 1,586
Foreclosed real estate(2) ............... 53 221 531
------ ------ ------
Total nonperforming assets(3) ..... $1,344 $2,085 $2,117
====== ====== ======
Total nonperforming loans as a
percentage of total loans ............ 1.77% 2.74% 2.38%
Total nonperforming assets as a
percentage of total assets ........... 1.12% 1.86% 1.97%
</TABLE>
- ---------------
(1) Total nonaccrual loans equals total nonperforming loans.
(2) Foreclosed real estate balances are shown net of related loss
allowances.
(3) Nonperforming assets consist of nonperforming loans (and impaired
loans) and foreclosed real estate.
Allowance for Loan Losses. The allowance for loan losses is
established through a provision for loan losses based on management's evaluation
of the risks inherent in its loan portfolio and the general economy. The
allowance for loan losses is maintained at an amount management considers
adequate to cover estimated losses in loans receivable which are deemed probable
and estimable based on information currently known to management. The allowance
is based upon a number of factors, including current economic conditions, actual
loss experience and industry trends. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the
Association's allowance for loan losses. Such agencies may require the
Association to make additional provisions for estimated loan losses based upon
their judgments about information available to them at the time of their
examination. At June 30, 1999 the allowance for loan losses was $419,000
compared to $452,000 at June 30, 1998. The decrease in the allowance from June
30, 1998 to June 30, 1999 was the result of charge-offs against the allowance
and a $600,000 reduction in nonaccrual loans from $1.9 million at June 30, 1998
to $1.3 million at June 30, 1999. As of June 30, 1999, the Association's
allowance for loan losses was 0.57% of total loans and 32.46% of nonperforming
loans compared to 0.65% of total loans and 24.25% of nonperforming loans as of
June 30, 1998. The Association will continue to monitor and modify its
allowances for loan losses as conditions dictate. While management believes the
Association's allowance for loan losses at June 30, 1999 is sufficient to cover
losses inherent in its loan portfolio, no assurances can be given that the
Association's level of allowance for loan losses will be sufficient to cover
future loan losses incurred by the Association or that future adjustments to the
allowance for loan losses will not be necessary if economic and other conditions
differ substantially from the economic and other conditions used by management
to determine the current level of the allowance for loan losses.
10
<PAGE>
The following table sets forth activity in the Association's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
At or For the Fiscal Years Ended June 30,
-----------------------------------------
1999 1998 1997
----- ----- -----
(Dollars in thousands)
<S> <C> <C> <C>
Allowance for loan losses, beginning of year .......... $ 452 $ 429 $ 447
Charged-off loans:
One- to four-family real estate .................... 98 165 20
Multi-family and commercial real estate ............ -- 6 --
Consumer ........................................... 12 7 41
----- ----- -----
Total charged-off loans ......................... 110 178 61
----- ----- -----
Recoveries on loans previously charged off:
One- to four-family real estate .................... -- 22 --
Consumer ........................................... 15 3 9
----- ----- -----
Total recoveries ................................ 15 25 9
----- ----- -----
Net loans charged-off ................................. (95) (153) (52)
Provision for loan losses ............................. 62 176 34
----- ----- -----
Allowance for loan losses, end of period .............. $ 419 $ 452 $ 429
===== ===== =====
Net loans charged-off to average interest-earning loans 0.14% 0.22% 0.08%
Allowance for loan losses to total loans .............. 0.57% 0.65% 0.64%
Allowance for loan losses to nonperforming loans ...... 32.46% 24.25% 27.05%
Net loans charged-off to allowance for loan losses .... (22.67)% (33.85)% (12.12)%
Recoveries to charge-offs ............................. 13.64% 14.04% 14.75%
</TABLE>
The following table sets forth the Association's allowance for
loan losses in each of the categories listed at the dates indicated and the
percentage of such amounts to the total allowance and to total loans.
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------- ------------------------------- -------------------------------
Percent of Percent Percent of Percent Percent of Percent
Allowance of Loans Allowance of Loans Allowance of Loans
in each in Each in each in Each in each in Each
Category Category Category Category Category Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------ --------- ----- ------ --------- ----- ------ --------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate(1)................... $256 61.10% 75.71% $273 60.40% 80.08% $278 64.80% 80.95%
Consumer......................... 112 26.73 12.16 135 29.87 14.25 120 27.97 15.35
Multi-family and commercial...... 45 10.74 12.13 39 8.63 5.67 27 6.30 3.70
Unallocated...................... 6 1.43 -- 5 1.10 -- 4 0.93 --
---- ------ ------ ---- ------ ------ ---- ------ ------
Total allowance for loan
losses.................... $419 100.00% 100.00% $452 100.00% 100.00% $429 100.00% 100.00%
==== ====== ====== ==== ====== ====== ==== ====== ======
</TABLE>
- --------------
(1) Includes one- to four-family real estate loans and construction loans.
11
<PAGE>
Foreclosed Real Estate. At June 30, 1999, the Association had
$53,000 of foreclosed real estate consisting of three one- to four-family
properties. When the Association acquires property through foreclosure or deed
in lieu of foreclosure, it is initially recorded at the lesser of carrying value
of the loan or fair value of the property at the date of acquisition less costs
to sell. Thereafter, if there is a further deterioration in value, the
Association provides for a specific valuation allowance and charges operations
for the diminution in value. It is the policy of the Association to have
obtained an appraisal or broker's price opinion on all real estate subject to
foreclosure proceedings prior to the time of foreclosure. It is the
Association's policy to require appraisals on a periodic basis on foreclosed
properties and conducts inspections on foreclosed properties.
Investment Activities
Pennsylvania-chartered savings institutions have the authority
to invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies and certificates of deposit
of insured banks and savings institutions. Subject to various restrictions,
state-chartered savings institutions may also invest their assets in
investment-grade corporate debt securities and mutual funds whose assets conform
to the investments that a state-chartered savings institution is otherwise
authorized to make directly. Additionally, the Association must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations.
Historically, the Association has maintained liquid assets above the minimum OTS
requirements and at a level considered to be adequate to meet its normal daily
activities.
The investment policy of the Association, as approved by the
Board of Directors, requires management to maintain adequate liquidity, generate
a favorable return on investments without incurring undue interest rate and
credit risk and to complement the Association's lending activities. The
Association primarily utilizes investments in securities for liquidity
management and as a method of deploying excess funding not utilized for loan
originations. Generally, the Association's investment policy is more restrictive
than the OTS regulations allow and, accordingly, the Association has invested
primarily in U.S. Government and agency securities, which qualify as liquid
assets under the OTS regulations, and U.S. Government sponsored agency issued
mortgage-backed securities.
As required by Statement of Financial Accounting Standards No.
115, the Company has established an investment portfolio of securities that are
categorized as held-to-maturity, available-for-sale or held for trading. The
Company generally invests in securities as a method of utilizing funds not
utilized for loan origination activity and as a method of maintaining liquidity
at levels deemed appropriate by management. The Company does not currently
maintain a portfolio of securities categorized as held for trading. At June 30,
1999, the available-for-sale securities portfolio totalled $27.4 million, or
22.9% of assets and the held-to-maturity portfolio totalled $1.5 million, or
1.2% of assets. The shift in the composition of the Company's securities
portfolio from held-to-maturity to available-for-sale was done in accordance
with Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities." Included in the Company's
available-for-sale securities portfolio is an equity-based mutual fund with a
carrying value of $2.0 million.
At June 30, 1999, the Company had invested $3.8 million in
Fannie Mae, Freddie Mac and Ginnie Mae mortgage-related securities, or 3.2% of
total assets, all of which were classified as available-for-sale. In addition,
$12.5 million, or 10.5% of the Company's securities, were debt obligations
issued by federal agencies which generally have stated maturities from 3 to 15
years but which also have call features. Such callable securities allow the
issuer, after a certain time period, to repay the security prior to its stated
maturity. Based on interest rate ranges anticipated by the Company, the Company
estimates that the substantial majority of such securities will be called prior
to their stated maturities. The Company is subject to additional interest rate
risk and reinvestment risk compared to its evaluation of that risk if changes in
interest rates exceed ranges anticipated by the Company in estimating the
anticipated life of such callable investment securities. Investments in
mortgage-related securities involve a risk that actual prepayments will be
greater than estimated prepayments over the life of the security, which may
require adjustments to the amortization of any premium or accretion of any
discount relating to such instruments thereby changing the net yield on such
securities. There is also reinvestment risk associated with the cash flows from
such securities or in the event such securities are redeemed by the issuer. In
addition, the market value of such securities may be adversely affected by
changes in interest rates. Of the Company's investment in mortgage-related
securities at June 30, 1999, all were available-for-sale.
12
<PAGE>
The following table sets forth certain information regarding
the amortized cost and fair value of the Company's securities at the dates
indicated.
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------------------------
1999 1998 1997
-------------------- --------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
------- ------- ------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
Debt securities held to maturity(1):
Obligations of U.S. government agencies ........ $ -- $ -- $ 2,801 $ 2,810 $ 7,425 $ 7,395
Other securities ............................... 1,492 1,492 244 242 116 114
------- ------- ------- ------- ------- -------
Total .................................... $ 1,492 $ 1,492 $ 3,045 $ 3,052 $ 7,541 $ 7,509
======= ======= ======= ======= ======= =======
Debt securities available for sale:
Obligations of U.S. Treasury and U.S.
government agencies ......................... $12,793 $12,527 $ 3,548 $ 3,548 $ -- $ --
Other securities(2) ............................ 11,205 10,512 2,561 2,406 2,188 2,010
------- ------- ------- ------- ------- -------
Total .................................... $23,998 $23,039 $ 6,109 $ 5,954 $ 2,188 $ 2,010
======= ======= ======= ======= ======= =======
Equity securities available for sale:
FHLB stock ..................................... $ 595 $ 595 $ 594 $ 594 $ 566 $ 566
------- ------- ------- ------- ------- -------
Total investment securities .............. $26,085 $25,126 $ 9,748 $ 9,600 $10,295 $10,085
======= ======= ======= ======= ======= =======
Mortgage-related securities:
Mortgage-related securities held to maturity ...... $ -- $ -- $ 2,122 $ 2,138 $ 3,869 $ 3,876
Collateralized mortgage obligations ............... -- -- 159 159 837 831
------- ------- ------- ------- ------- -------
Total mortgage-related securities
held to maturity ...................... $ -- $ -- $ 2,281 $ 2,297 $ 4,706 $ 4,707
======= ======= ======= ======= ======= =======
Mortgage-related securities available for sale .... $ 3,830 $ 3,791 $ 1,318 $ 1,353 $ 1,660 $ 1,672
------- ------- ------- ------- ------- -------
Total mortgage-related securities ........ 3,830 3,791 3,599 3,650 6,366 6,379
------- ------- ------- ------- ------- -------
Total securities ......................... $29,915 $28,917 $13,347 $13,250 $16,661 $16,464
======= ======= ======= ======= ======= =======
</TABLE>
- --------------
(1) The Company had $15.5 million and $12.6 million of certificates of
deposit at June 30, 1998 and June 30, 1997, respectively, classified as
debt securities held-to-maturity. However, these investments, which at
June 30, 1999 totaled $12.3 million, have been reclassified as
interest-bearing deposits with banks.
(2) Includes tax-free municipal bonds.
13
<PAGE>
The following table sets forth the Company's securities
activities for the periods indicated.
<TABLE>
<CAPTION>
For the Fiscal Years
Ended June 30,
--------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Mortgage-related securities:
Mortgage-related securities, beginning of period(1) ..... $ 3,634 $ 6,378 $ 7,811
======== ======== ========
Purchases,
Mortgage-related securities - available-for-sale ..... $ 2,290 $ 650 $ 1,850
Maturities and calls,
Mortgage-related securities - held-to-maturity ....... (1,450) (2,300) (1,941)
Repayments and prepayments,
Mortgage-related securities .......................... (609) (1,125) (1,350)
Increase in net premium ................................. -- 8 4
Increase in unrealized gain/(loss) ...................... (74) 23 4
-------- -------- --------
Net increase (decrease) in mortgage-related securities 157 (2,744) (1,433)
-------- -------- --------
Mortgage-related securities, end of period .............. $ 3,791 $ 3,634 $ 6,378
======== ======== ========
Investment securities:
Investment securities, beginning of period(2) ........... $ 9,593 $ 10,117 $ 11,088
======== ======== ========
Purchases,
Investment securities - held-to-maturity ............. $ 1,500 $ 2,459 $ 4,476
Investment securities - available-for-sale ........... 26,015 3,949 25
Sales,
Investment securities - available-for-sale ........... -- -- (1,021)
Repayments and prepayments .............................. (438) (22) (833)
Maturities and calls:
Investment securities - held-to-maturity ............. (2,800) (6,926) (3,622)
Investment securities - available-for-sale ........... (7,900) -- --
Increase (decrease) in net premium ...................... 2 (7) (14)
Increase in unrealized gain/(loss) ...................... (846) 23 18
-------- -------- --------
Net increase (decrease) in investment securities ..... 15,533 (524) (971)
-------- -------- --------
Investment securities, end of period .................... $ 25,126 $ 9,593 $ 10,117
======== ======== ========
</TABLE>
- ------------
(1) Includes mortgage-related securities available-for-sale.
(2) Includes investment securities available-for-sale. Also reflects the
reclassification of $12.3 million, $12.6 million and $11.5 million of
certificates of deposit as interest-bearing deposits with banks for the
years ended 1999, 1998 and 1997, respectively.
14
<PAGE>
The table below sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of the
Company's investment securities and mortgage-related securities as of June 30,
1999.
<TABLE>
<CAPTION>
At June 30, 1999
--------------------------------------------------------------
More than One Year More than 5 Years
One Year or Less to Five Years to 10 Years
------------------- ------------------ ------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Held-to-maturity securities:
Corporate obligations................... $1,492 5.15% $ -- --% $ -- --%
------ ------ ------
Total securities at
amortized cost.................... 1,492 5.15 -- -- -- --
------ ------ ------
Available-for-sale securities:
Investment securities:
Municipal securities (1)............. -- -- -- -- 612 4.33
Obligations of the U.S.
government agencies.............. -- -- 2,998 5.77 5,497 5.82
Equity securities ...................... 595 6.50 -- -- -- --
Other................................... 2,188 -- -- -- 53 6.20
Mortgage-related securities............. 214 6.46 -- -- 1,502 6.42
------ ------ ------
Total securities at fair value....... $2,997 6.43% $2,998 5.77% $7,664 5.82%
====== ====== ======
<CAPTION>
At June 30, 1999
---------------------------------------
More than 10 Years Total
------------------ -------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
-------- -------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Held-to-maturity securities:
Corporate obligations................... $ -- --% $ 1,492 5.15%
------- -------
Total securities at
amortized cost.................... -- -- 1,492 5.15
------- -------
Available-for-sale securities:
Investment securities:
Municipal securities (1)............. 8,352 4.48 8,964 4.47
Obligations of the U.S.
government agencies.............. 4,298 6.99 12,793 6.20
Equity securities ...................... -- -- 595 6.50
Other................................... -- -- 2,241 6.20
Mortgage-related securities............. 2,114 7.02 3,830 6.75
------- -------
Total securities at fair value....... $14,764 5.58% $28,423 5.24%
======= =======
</TABLE>
- --------------
(1) Weighted average yield data for municipal securities is not presented
on a tax equivalent basis. The average balance of tax-exempt
investments was $1.8 million in fiscal 1999 and $894,000 in fiscal
1998. The Company had no tax-exempt investments in 1997.
Sources of Funds
General. Deposits, loan repayments and prepayments and cash
flows generated from operations are the primary sources of the Association's
funds for use in lending, investing and for other general purposes.
Deposits. The Association offers a variety of deposit accounts
with a range of interest rates and terms. The Association's deposits consist of
checking, money market, savings, NOW, club accounts, certificate accounts and
Individual Retirement Accounts. More than 57% of the funds deposited in the
Association are in certificate of deposit accounts. At June 30, 1999, core
deposits (savings, NOW and money market accounts) represented 42.6% of total
deposits. The flow of deposits is influenced significantly by general economic
conditions, changes in money market rates, prevailing interest rates and
competition. Deposits have remained relatively static in recent years. Deposits
decreased $6.8 million, or 6.6%, from $102.6 million at June 30, 1998 to $95.8
million at June 30, 1999.
The Association's deposits are obtained predominantly from the
areas in which its branch offices are located. The Association has historically
relied primarily on customer service and long-standing relationships with
customers to attract and retain these deposits; however, market interest rates
and rates offered by competing financial institutions significantly affect the
Association's ability to attract and retain deposits. The Association uses
traditional means of advertising its deposit products, including radio and print
media and generally does not solicit deposits from outside its market area. The
Association has not actively solicited certificate accounts in excess of
$100,000 or used brokers to obtain deposits in recent years. However, the
Association has used brokers to obtain deposits in the past and if circumstances
warranted, would in the future seek deposits through those methods. At June 30,
1999, 63.0% of the Association's certificate of deposit accounts were to mature
within one year. Further increases in short-term certificate of deposit
accounts, which tend to be more sensitive to movements in market interest rates
than core deposits, may result in the Association's deposit base being less
stable than if it had a large amount of core deposits which, in turn, may result
in further increases in the Association's cost of deposits.
15
<PAGE>
The following table presents the deposit activity of the
Association for the periods indicated:
<TABLE>
<CAPTION>
For the Fiscal Years Ended June 30,
-----------------------------------
1999 1998 1997
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Increase (decrease) before interest credited $(9,782) $ 977 $(4,077)
Interest credited .......................... 2,994 3,162 3,194
------- ------- -------
Net increase (decrease) .................... $(6,788) $ 4,139 $ (883)
======= ======= =======
</TABLE>
At June 30, 1999, the Association had $11.7 million in
certificate accounts in amounts of $100,000 or more maturing as follows:
Maturity Period Amount
--------------- --------------
(In thousands)
Three months or less......................... $ 976
Over 3 through 6 months...................... 1,879
Over 6 through 12 months..................... 4,298
Over 12 months............................... 4,558
---------
Total.................................. $11,711
=======
The following table sets forth the distribution of the
Association's average deposit accounts for the periods indicated and the
weighted average interest rates on each category of deposits presented and such
information at June 30, 1999.
<TABLE>
<CAPTION>
For the Fiscal Years Ended June 30,
----------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- --------------------------- ----------------------------
Percent Percent Percent
of Total Average of Total Average of Total Average
Average Average Rate Average Average Rate Average Average Rate
Balance Deposits Paid Balance Deposits Paid Balance Deposits Paid
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook and statement savings .. $ 28,099 28.41% 2.85% $ 28,788 28.68% 2.76% $ 30,996 31.60% 2.67%
Money market .................... 1,978 2.00 2.68 2,151 2.14 2.46 2,374 2.42 2.53
NOW ............................. 11,158 11.28 1.50 10,081 10.04 1.51 9,065 9.24 1.49
Certificates of deposit ......... 57,679 58.31 5.33 59,342 59.14 5.49 55,653 56.74 5.40
-------- ------ -------- ------ -------- ------
Total average deposits .... $ 98,914 100.00% 4.14% $100,362 100.00% 4.24% $ 98,088 100.00% 4.11%
======== ====== ======== ====== ======== ======
</TABLE>
The following table presents by various rate categories, the
amount of certificate accounts outstanding at the dates indicated and the
periods to maturity of the certificate accounts outstanding at June 30, 1999.
<TABLE>
<CAPTION>
Period to Maturity from June 30, 1999
-----------------------------------------------------------
Less than One to Two to Over
One Year Two Years Three Years Three Years Total
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Certificate accounts:
2.60 to 4.00% ............... $ 103 $ -- $ -- $ -- $ 103
4.01 to 5.00% ............... 22,696 2,672 343 358 26,069
5.01 to 6.00% ............... 7,256 5,205 2,582 2,172 17,215
6.01 to 7.00% ............... 4,610 1,745 1,148 3,561 11,064
7.01 to 8.00% ............... -- -- -- 584 584
------- ------- ------- ------- -------
Total certificate accounts $34,665 $ 9,622 $ 4,073 $ 6,675 $55,035
======= ======= ======= ======= =======
</TABLE>
16
<PAGE>
Subsidiary Activities
As of June 30, 1999, the Company maintained the Association as
a wholly owned subsidiary. The Association has no subsidiaries.
Personnel
As of June 30, 1999, the Association had 40 full-time
employees and one part-time employee. The employees are not represented by a
collective bargaining unit and the Association considers its relationship with
its employees to be good.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, the Company is required
by federal law to file reports with, and otherwise comply with, the rules and
regulations of the OTS. The Association is subject to extensive regulation,
examination and supervision by the Pennsylvania Department of Banking (the
"Pennsylvania Department") as its chartering agency, the OTS, as its primary
federal regulator, and the FDIC, as the deposit insurer. The Association is a
member of the Federal Home Loan Bank System and its deposit accounts are insured
up to applicable limits by the Savings Association Insurance Fund ("SAIF")
managed by the FDIC. The Association must file reports with the Commissioner of
the Pennsylvania Department, the OTS and the FDIC concerning its activities and
financial condition in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with, or acquisitions of,
other savings institutions. The Pennsylvania Department, the OTS and/or the FDIC
conduct periodic examinations to test the Association's safety and soundness and
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 regulatory requirements and
policies, whether by the Pennsylvania Department, the OTS, the FDIC or the
Congress, could have a material adverse impact on the Company, the Association
and their operations. Certain of the regulatory requirements applicable to the
Association and to the Company are referred to below or elsewhere herein. The
description of statutory provisions and regulations applicable to savings
institutions and their holding companies set forth in this Form 10-KSB does not
purport to be a complete description of such statutes and regulations and their
effects on the Association and the Company.
Holding Company Regulation
The Company is a non-diversified unitary savings and loan
holding company within the meaning of federal law. As a unitary savings and loan
holding company, the Company generally is not restricted under existing laws as
to the types of business activities in which it may engage, provided that the
Association continues to be a qualified thrift lender. See "Federal Savings
Institution Regulation--QTL Test." Upon any non-supervisory acquisition by the
Company of another savings institution or savings bank that meets the qualified
thrift lender test and is deemed to be a savings institution by the OTS, the
Company would become a multiple savings and loan holding company (if the
acquired institution is held as a separate subsidiary) and would generally be
limited to activities permissible for bank holding companies under Section
4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the
OTS, and certain activities authorized by OTS regulation.
A savings and loan holding company is prohibited from,
directly or indirectly, acquiring more than 5% of the voting stock of another
savings institution or savings and loan holding company, without prior written
approval of the OTS and from acquiring or retaining control of a depository
institution that is not insured by the FDIC. In evaluating applications by
holding companies to acquire savings institutions, the OTS considers the
financial and managerial
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resources and future prospects of the company and institution involved, the
effect of the acquisition on the risk to the deposit insurance funds, the
convenience and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to
specific capital requirements or specific restrictions on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions as described below. The
Association must notify the OTS 30 days before declaring any dividend to the
Company. In addition, the financial impact of a holding company on its
subsidiary institution is a matter that is evaluated by the OTS and the agency
has authority to order cessation of activities or divestiture of subsidiaries
deemed to pose a threat to the safety and soundness of the institution.
The Secretary of Banking for the Pennsylvania Department (the
"Secretary") may require any savings and loan holding company to furnish such
reports as the Secretary deems appropriate to the proper supervision of such
companies. Unless the Secretary deems otherwise, reports prepared by Federal
authorities are satisfactory to meet such requirement. The Secretary may make
examinations of the Company, the cost of which shall be assessed against and
paid by the Company. Additionally, the Secretary shall have the authority to
issue rules, regulations and orders as may be necessary and the authority to
order a savings and loan holding company to cease and desist from engaging in an
activity which constitutes a services risk to the financial safety, soundness or
stability of the savings association.
Federal Savings Institution Regulation
Business Activities. The activities of Pennsylvania-chartered,
FDIC-insured savings institutions are governed by the Pennsylvania Savings
Association Code of 1967, as amended, and federal law and regulations. These
laws and regulations delineate the nature and extent of the activities in which
savings associations may engage.
Capital Requirements. The OTS capital regulations require
savings institutions to meet three minimum capital standards: a 1.5% tangible
capital ratio, a 3% leverage ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for
institutions receiving the highest rating on the CAMEL financial institution
rating system), and, together with the risk-based capital standard itself, a 4%
Tier 1 risk-based capital standard. The OTS regulations also require that, in
meeting the tangible, leverage and risk-based capital standards, institutions
must generally deduct investments in and loans to subsidiaries engaged in
activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions
requires the maintenance of Tier 1 (core) and total capital (which is defined as
core capital and supplementary capital) to risk-weighted assets of at least 4%
and 8%, respectively. In determining the amount of risk-weighted assets, all
assets, including certain off-balance sheet assets, are multiplied by a
risk-weight factor of 0% to 100%, assigned by the OTS capital regulation based
on the risks believed inherent in the type of asset. Core (Tier 1) capital is
defined as common stockholders' equity (including retained earnings), certain
non-cumulative perpetual preferred stock and related surplus, and minority
interests in equity accounts of consolidated subsidiaries less intangibles other
than certain mortgage servicing rights and credit card relationships. The
components of supplementary capital currently include cumulative preferred
stock, long-term perpetual preferred stock, mandatory convertible securities,
subordinated debt and intermediate preferred stock and the allowance for loan
and lease losses limited to a maximum of 1.25% of risk-weighted assets. Overall,
the amount of supplementary capital included as part of total capital cannot
exceed 100% of core capital.
The capital regulations also incorporate an interest rate risk
component. Savings institutions with "above normal" interest rate risk exposure
are subject to a deduction from total capital for purposes of calculating their
risk-
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based capital requirements. For the present time, the OTS has deferred
implementation of the interest rate risk component. At June 30, 1999, the
Association met each of its capital requirements.
The following table presents the Association's capital
position at June 30, 1999.
<TABLE>
<CAPTION>
Capital
Excess ----------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
------- ------- ------ ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Core (Leverage) $15,898 $ 4,761 $11,137 13.4% 4.0%
Risk-based .... $16,317 $ 4,863 $11,454 26.8% 8.0%
</TABLE>
Prompt Corrective Regulatory Action. The OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of undercapitalization.
Generally, a savings institution that has a ratio of total capital to risk
weighted assets of less than 8%, a ratio of Tier 1 (core) capital to
risk-weighted assets of less than 4% or a ratio of core capital to total assets
of less than 4% (3% or less for institutions with the highest examination
rating) is considered to be "undercapitalized." A savings institution that has a
total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than
3% or a leverage ratio that is less than 3% is considered to be "significantly
undercapitalized" and a savings institution that has a tangible capital to
assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the OTS is required to appoint
a receiver or conservator for an institution that is "critically
undercapitalized." The regulation also provides that a capital restoration plan
must be filed with the OTS within 45 days of the date a savings institution
receives notice that it is "undercapitalized," "significantly undercapitalized"
or "critically undercapitalized." Compliance with the plan must be guaranteed by
any parent holding company. In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. The OTS could also take any one of a number
of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Association are
presently insured by the SAIF. The FDIC maintains a risk-based assessment system
by which institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon the
categories to which it is assigned. Assessment rates for SAIF member
institutions are determined semiannually by the FDIC and currently range from
zero basis points for the healthiest institutions to 27 basis points for the
riskiest.
In addition to the assessment for deposit insurance,
institutions are required to make payments on bonds issued in the late 1980's by
the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF.
During 1998, FICO payments for SAIF members approximated 6.10 basis points,
while Bank Insurance Fund ("BIF") members paid 1.22 basis points. By law, there
will be equal sharing of FICO payments between SAIF and BIF members on the
earlier of January 1, 2000 or the date the SAIF and BIF are merged.
The Association's assessment rate for fiscal 1999 ranged from
15.3 to 15.7 basis points and no premium was paid for this period. Payments
toward the FICO bonds amounted to $31,000. The FDIC has authority to increase
insurance assessments. A significant increase in SAIF insurance premiums would
likely have an adverse effect on the operating expenses and results of
operations of the Association. Management cannot predict what insurance
assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a
finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law,
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regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Association does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. Legislation enacted in 1996
provided that the BIF and SAIF were to have merged on January 1, 1999 if there
were no more savings associations as of that date. Various proposals to
eliminate the federal savings association charter, create a uniform financial
institutions charter, abolish the OTS and restrict savings and loan holding
company activities have been introduced in Congress. The Association is unable
to predict whether such legislation will be enacted or the extent to which the
legislation would restrict or disrupt its operations.
Activities and Investments. The FDI Act imposes certain
restrictions on the activities and investments of state savings associations
such as the Association. No state savings association may engage as principal in
any activity that is not permissible for federally chartered savings
associations unless the association is in compliance with federal regulatory
capital requirements and the FDIC has determined that the activity does not pose
a significant risk to the deposit insurance fund. A state savings association
may engage in an activity that is permissible for a federal savings association,
but in a greater amount, only if the institution is in capital compliance and
the FDIC had not determined that engaging in that amount of activity does not
pose a risk to the affected deposit insurance fund. Also, a state savings
association may not acquire directly an equity investment of a type or in an
amount that is not permissible for a federal association. However, a state
savings association may acquire shares of service corporations so long as the
institution is in capital compliance and the FDIC determines that no significant
risk to the deposit insurance fund is posed by the amount that the institution
seeks to acquire or the activities of the savings association.
Loans to One Borrower. Federal law provides that savings
institutions are generally subject to the limits on loans to one borrower
applicable to national banks. A savings institution may not make a loan or
extend credit to a single or related group of borrowers in excess of 15% of its
unimpaired capital and surplus. An additional amount may be lent, equal to 10%
of unimpaired capital and surplus, if secured by specified readily-marketable
collateral. At June 30, 1999, the Association's limit on loans to one borrower
was $2.3 million, and the Association's largest aggregate outstanding balance of
loans to one borrower was $448,000.
QTL Test. The HOLA requires savings institutions to meet a
qualified thrift lender test. Under the test, a savings association is required
to either qualify as a "domestic building and loan association" under the
Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total
assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed securities)
in at least 9 months out of each 12 month period.
A savings institution that fails the qualified thrift lender
test is subject to certain operating restrictions and may be required to convert
to a bank charter. As of June 30, 1999, the Association maintained 81.5% of its
portfolio assets in qualified thrift investments and, therefore, met the
qualified thrift lender test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose
limitations upon all capital distributions by a savings institution, including
cash dividends, payments to repurchase its shares and payments to shareholders
of another institution in a cash-out merger. The rule effective in 1998
established three tiers of institutions based primarily on an institution's
capital level. An institution that exceeded all capital requirements before and
after a proposed capital distribution ("Tier 1 Association") and had not been
advised by the OTS that it was in need of more than normal supervision, could,
after prior notice but without obtaining approval of the OTS, make capital
distributions during the calendar year equal to the greater of (i) 100% of its
net earnings to date during the calendar year plus the amount that would reduce
by one-half the excess capital over its capital requirements at the beginning of
the calendar year or (ii) 75% of its net income for the previous four quarters.
Any additional capital distributions required prior regulatory approval. At June
30, 1999, the Association was a Tier 1 Association. Effective April 1, 1999, the
OTS's capital distribution regulation changed. Under the new regulation, an
application to and the prior approval of the OTS will be
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<PAGE>
required prior to any capital distribution if the institution does not meet the
criteria for "expedited treatment" of applications under OTS regulations (i.e.,
generally, examination ratings in the two top categories), the total capital
distributions for the calendar year exceed net income for that year plus the
amount of retained net income for the preceding two years, the institution would
be undercapitalized following the distribution or the distribution would
otherwise be contrary to a statute, regulation or agreement with OTS. If an
application is not required, the institution must still provide prior notice to
OTS of the capital distribution. In the event the Association's capital fell
below its regulatory requirements or the OTS notified it that it was in need of
more than normal supervision, the Association's ability to make capital
distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice.
Liquidity. The Association is required to maintain an average
daily balance of specified liquid assets equal to a monthly average of not less
than a specified percentage of its net withdrawable deposit accounts plus
short-term borrowings. This liquidity requirement is currently 4%, but may be
changed from time to time by the OTS to any amount within the range of 4% to
10%. Monetary penalties may be imposed for failure to meet these liquidity
requirements. The Association's liquidity ratio for June 30, 1999 was 29.4%,
which exceeded the applicable requirements. The Association has never been
subject to monetary penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay
assessments to the OTS to fund the agency's operations. The general assessments,
paid on a semi-annual basis, are computed upon the savings institution's total
assets, including consolidated subsidiaries, as reported in the Association's
latest quarterly thrift financial report. The assessments paid by the
Association for the fiscal year ended June 30, 1999 totaled $37,000.
Transactions with Related Parties. The Association's authority
to engage in transactions with "affiliates" (e.g., any company that controls or
is under common control with an institution, including the Company and its
non-savings institution subsidiaries) is limited by federal law. The aggregate
amount of covered transactions with any individual affiliate is limited to 10%
of the capital and surplus of the savings institution. The aggregate amount of
covered transactions with all affiliates is limited to 20% of the savings
institution's capital and surplus. Certain transactions with affiliates are
required to be secured by collateral in an amount and of a type described in
federal law. The purchase of low quality assets from affiliates is generally
prohibited. The transactions with affiliates must be on terms and under
circumstances that are at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The Association's authority to extend credit to executive
officers, directors and 10% shareholders ("insiders"), as well as entities such
persons control, is also governed by federal law. Such loans are required to be
made on terms substantially the same as those offered to unaffiliated
individuals and not involve more than the normal risk of repayment. Recent
legislation created an exception for loans made pursuant to a benefit or
compensation program that is widely available to all employees of the
institution and does not give preference to insiders over other employees. The
law limits both the individual and aggregate amount of loans the Association may
make to insiders based, in part, on the Association's capital position and
requires certain board approval procedures to be followed.
Enforcement. The OTS has primary enforcement responsibility
over savings institutions and has the authority to bring actions against the
institution and all institution-affiliated parties, including stockholders, and
any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution. Formal enforcement action may range from the issuance of a capital
directive or cease and desist order to removal of officers and/or directors to
institution of receivership, conservatorship or termination of deposit
insurance. Civil penalties cover a wide range of violations and can amount to
$25,000 per day, or even $1 million per day in especially egregious cases. The
FDIC has the authority to recommend to the Director of the OTS that enforcement
action to be taken with respect to a particular savings institution. If action
is not taken by the Director,
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<PAGE>
the FDIC has authority to take such action under certain circumstances. Federal
law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking
agencies have adopted Interagency Guidelines prescribing Standards for Safety
and Soundness. The guidelines set forth the safety and soundness standards that
the federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. If the OTS determines
that a savings institution fails to meet any standard prescribed by the
guidelines, the OTS may require the institution to submit an acceptable plan to
achieve compliance with the standard.
Federal Reserve System
The Federal Reserve Board regulations require savings
institutions to maintain non-interest earning reserves against their transaction
accounts (primarily NOW and regular checking accounts). The regulations
generally provide that reserves be maintained against aggregate transaction
accounts as follows: for accounts aggregating $46.5 million or less (subject to
adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for
accounts aggregating greater than $46.5 million, the reserve requirement is
$1.395 million plus 10% (subject to adjustment by the Federal Reserve Board
between 8% and 14%) against that portion of total transaction accounts in excess
of $46.5 million. The first $4.9 million of otherwise reservable balances
(subject to adjustments by the Federal Reserve Board) are exempted from the
reserve requirements. The Association complies with the foregoing requirements.
Pennsylvania Law
Interstate Acquisitions and Branches. In 1986, Pennsylvania
Act No. 260 (the "Pennsylvania Act") became law. The Pennsylvania Act: (1)
permits federal or state savings and loan associations, federal savings banks,
and bank or savings and loan holding companies (collectively, "Thrift Entities")
that are "located" (as defined below) in a state that offers reciprocal rights
to similar Thrift Entities located in Pennsylvania, to acquire 5% or more of a
Pennsylvania Thrift Entity's voting stock, merge or consolidate with a
Pennsylvania Thrift Entity or purchase the assets and assume the liabilities of
the Pennsylvania Thrift Entity and (2) permits a federal or state savings and
loan association or federal savings bank to establish and maintain branches in
Pennsylvania, provided that the state where such foreign Thrift Entity is
located offers reciprocal rights to similar entities located in Pennsylvania and
provided that each state where any bank holding company or savings and loan
holding company owning or controlling 5% or more of the foreign Thrift Entity's
shares is also located in a state that offers reciprocal rights. The legislation
also provides for nationwide branching by Pennsylvania chartered savings banks
and savings and loan associations, subject to the Pennsylvania Department's
approval and certain other conditions.
Under the Pennsylvania Act, a depository is "located" where
its deposits are largest and a holding company is generally "located" where the
aggregate deposits of its subsidiaries are largest. Whether a foreign state's
laws are "reciprocal" is determined by the Pennsylvania Department, which may
impose limitations and conditions on the branching and acquisition activities of
a Thrift Entity located in a foreign state in order to make the laws of such
state reciprocal to Pennsylvania law with respect to the type of transaction at
issue. In determining whether to approve an interstate thrift acquisition, the
Pennsylvania Department is directed to consider the effects the proposed
acquisition would have on the availability in Pennsylvania of basic banking and
transaction account services. If the Pennsylvania Department determines that the
overall performance of any Pennsylvania Thrift Entity involved in the
transaction has not been materially deficient in providing suitable credit and
financial services to its communities, it may approve the application without
imposing any terms or conditions. Otherwise, the Pennsylvania Department may
impose such terms and conditions as it deems appropriate to improve such overall
performance over a stated period of time. Additionally, the Pennsylvania
Department may impose requirements, both before and after approval of an
acquisition, to assure the availability to the public of those basic transaction
account services deemed necessary by the Pennsylvania Department.
Pennsylvania Savings Association Code. The Association is
incorporated under the Savings Association Code which 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
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aspects of the Association and its affairs. The Savings Association Code
delegates extensive rulemaking power and administrative discretion to the
Pennsylvania Department so that the supervision and regulation of Pennsylvania
chartered association may be flexible and readily responsive to changes in
economic conditions and in savings and lending practices. The Pennsylvania
Department exercises its power through the Savings Association Bureau.
One of the purposes of the Savings Association Code is to
provide associations with the opportunity to be competitive with each other and
with other financial institutions existing under other state, federal and
foreign laws. To this end, the Savings Association Code provides Pennsylvania
chartered savings associations with all of the powers enjoyed by federal savings
associations, subject to regulation by the Pennsylvania Department.
A Pennsylvania savings association may locate or change the
location of its principal place of business, and may establish an office
anywhere in the Commonwealth or in certain states within the Pennsylvania
region, with the prior approval of the Pennsylvania Department.
The Pennsylvania Department shall examine each savings
association at least once each year. The Savings Association Code permits the
Pennsylvania Department to accept the examinations and reports of the Federal
Savings and Loan Insurance Corporation (now the OTS) in lieu of their own
examination. The Pennsylvania Department may order any association to
discontinue any violation of law or unsafe or unsound business practice and may
direct any director, officer, attorney or employee of an association engaged in
an objectionable activity, after the Pennsylvania Department has ordered the
activity to be terminated, to show cause at a hearing before the Savings
Association Bureau of the Pennsylvania Department why such person should not be
removed.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Association will report their
income on a calendar year basis using the accrual method of accounting and will
be subject to federal income taxation in the same manner as other corporations
with some exceptions, including particularly the Association's reserve for bad
debts discussed below. 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 Association or the Company. The Association has not been
audited by the IRS in the past five years.
Bad Debt Reserve. For taxable years beginning after December
31, 1995, the Association is entitled to take a bad debt deduction for federal
income tax purposes which is based on its current or historic net charge-offs.
For tax years beginning prior to December 31, 1995, the Association as a
qualifying thrift had been permitted to establish a reserve for bad debts and to
make annual additions to such reserve, which were deductible for federal income
tax purposes. Under such prior tax law, generally the Association recognized a
bad debt deduction equal to 8% of taxable income.
Under the 1996 Tax Act, the Association is required to
recapture all or a portion of its additions to its bad debt reserve made
subsequent to the base year (which is the Association's last taxable year
beginning before January 1, 1988). This recapture is required to be made, after
a deferral period based on certain specified criteria, ratably over a six-year
period commencing in the Association's calendar 1998 tax year. The Association,
in fiscal 1997, recorded a deferred tax liability for this bad debt recapture.
As a result, the recapture is not anticipated to effect the Association's future
net income or federal income tax expense for financial reporting purposes.
Potential Recapture of Base Year Bad Debt Revenue. The
Association's bad debt reserve as of the base year is not subject to automatic
recapture as long as the Association continues to carry on the business of
banking. If the Association no longer qualifies as a bank, the balance of the
pre-1988 reserves (the base year reserves) are restored to income over a
six-year period beginning in the tax year the Association no longer qualifies as
a bank. Such base year bad debt reserve is subject to recapture to the extent
that the Association makes "non-dividend distributions" that are
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considered as made from the base year bad debt. To the extent that such reserves
exceed the amount that would have been allowed under the experience method
("Excess Distributions"), then an amount based on the amount distributed will be
included in the Association's taxable income. Non-dividend distributions include
distributions in excess of the Association's current and accumulated earnings
and profits, distributions in redemption of stock, and distributions in partial
or complete liquidation. However, dividends paid out of the Association's
current or accumulated earnings and profits, as calculated for federal income
tax purposes, will not be considered to result in a distribution from the
Association's bad debt reserve. Thus, any dividends to the Company that would
reduce amounts appropriated to the Association's bad debt reserve and deducted
for federal income tax purposes would create a tax liability for the
Association. The amount of additional taxable income created from an Excess
Distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Thus, if, after the
Conversion, the Association makes a "non-dividend distribution," then
approximately one and one-half times the amount so used would be includable in
gross income for federal income tax purposes, assuming a 34% corporate income
tax rate (exclusive of state and local taxes). See "Regulation" and "Dividend
Policy" for limits on the payment of dividends of the Association. The
Association does not intend to pay dividends that would result in a recapture of
any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on
alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the
bad debt reserve deduction claimed by the Association over the deduction that
would have been allowable under the experience method is treated as a preference
item for purposes of computing the AMTI. Only 90% of AMTI can be offset by net
operating loss carryovers of which the Association currently has none. AMTI is
increased by an amount equal to 75% of the amount by which the Association's
adjusted current earnings exceeds its AMTI (determined without regard to this
preference and prior to reduction for net operating losses). In addition, for
taxable years beginning after June 30, 1986 and before January 1, 1996, an
environmental tax of 0.12% of the excess of AMTI (with certain modifications)
over $2.0 million is imposed on corporations, including the Association, whether
or not an Alternative Minimum Tax ("AMT") is paid. The Association does not
expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company
may exclude from its income 100% of dividends received from the Association as a
member of the same affiliated group of corporations. The corporate dividends
received deduction is generally 70% in the case of dividends received from
unaffiliated corporations with which the Company and the Association will not
file a consolidated tax return, except that if the Company or the Association
own more than 20% of the stock of a corporation distributing a dividend then 80%
of any dividends received may be deducted.
State and Local Taxation
The Company and its non-thrift Pennsylvania subsidiaries are
subject to the Pennsylvania Corporate Net Income Tax and Capital Stock and
Franchise Tax. The Corporate Net Income Tax rate for 1999 is 9.99% and is
imposed on the Company's and its non-thrift subsidiaries' unconsolidated taxable
income for federal purposes with certain adjustments. In general, the Capital
Stock Tax is a property tax imposed at the rate of 1.275% of a corporation's
capital stock value, which is determined in accordance with a fixed formula.
The Association is taxed under the Pennsylvania Mutual Thrift
Institutions Tax Act (the "MTIT"), as amended, to include thrift institutions
having capital stock. Pursuant to the MTIT, the Company's tax rate is 11.5%. The
MTIT exempts the Company from all other taxes imposed by the Commonwealth of
Pennsylvania for state income tax purposes and from all local taxation imposed
by political subdivisions, except taxes on real estate and real estate
transfers. The MTIT is a tax upon net earnings, determined in accordance with
GAAP with certain adjustments. The MTIT, in computing GAAP income, allows for
the deduction of interest earned on Pennsylvania and federal securities, while
disallowing a percentage of a thrift's interest expense deduction in the
proportion of interest income on those securities to the overall interest income
of the Company. Net operating losses, if any, thereafter can be carried forward
three years for MTIT purposes. The Association has not been audited by the
Commonwealth of Pennsylvania in the last five years.
24
<PAGE>
Delaware Taxation. As a Delaware holding company not earning
income in Delaware, the Company is exempted from Delaware corporate income tax
but is required to file an annual report with and pay an annual franchise tax to
the State of Delaware.
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth certain information regarding
the executive officers of the Company and the Association who are not directors.
Executive officers of the Company and the Association are elected annually and
hold office until their successors have been elected and qualified or until they
are removed or replaced.
<TABLE>
<CAPTION>
Executive
Age at Officer
Name 6/30/99 Position Since
---- ------- -------- -----
<S> <C> <C> <C>
David P. Marchetti, Sr. ......... 46 Vice President-Chief Operating Officer of the 1991
Association and Chief Financial Officer and
Treasurer of the Company
Jan M. Pasdon.................... 47 Senior Vice President of the Association 1999
Joseph P. Correale............... 47 Vice President - Lending of the Association 1992
</TABLE>
ITEM 2. DESCRIPTION OF PROPERTY.
The Association conducts its business through four
full-service banking offices located in Luzerne and Carbon Counties,
Pennsylvania. The following table sets forth certain information regarding the
Association's offices as of June 30, 1999.
<TABLE>
<CAPTION>
Net Book Value
Original of Property Total
Year Date of or Leasehold Deposits at
Leased Leased or Lease Improvements June 30,
Location or Owned Acquired Expiration at June 30, 1999 1999
- -------- -------- -------- ---------- ---------------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Administrative/Home Office:
31 W. Broad Street......................... Owned 1968 -- $102 $59,158
Hazleton, Pennsylvania 18201
25 W. Broad Street (1)..................... Owned 1987 -- 262 --
Hazleton, Pennsylvania 18201
Branch Offices:
Weatherly Office........................... Owned 1975 -- 32 10,211
140 Carbon Street
Weatherly, Pennsylvania 18252
Laurel Mall Office......................... Building 1980 June 1, 308 19,387
345 Laurel Mall owned, land 2000
Hazleton, Pennsylvania 18201 leased
Drums Office............................... Owned 1994 -- 394 7,059
P.O. Box 4040
Drums, Pennsylvania 18222
</TABLE>
- -------------------
(1) This building, which houses the home office's loan department, is
adjacent and connected to the property at 31 W. Broad Street.
25
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any pending legal proceedings
other than routine legal proceedings occurring in the ordinary course of
business. Such routine legal proceedings, in the aggregate, are believed by
management to be immaterial to the Company's financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Security of Pennsylvania Financial Corp.'s Common Stock is
listed on the American Stock Exchange under the symbol "SPN." The stock began
trading on December 30, 1998. As of June 30, 1999, Security of Pennsylvania
Financial Corp. had approximately 498 holders of record. As of June 30, 1999,
the Company had not paid any dividends on its common stock. For information
relating to restrictions on the Company's declaration of dividends, see "Item
1.--Description of Business--Regulation and Supervision." The following table
sets forth for the quarters indicated the range of high and low sale price
information for the Common Stock of the Company as reported on the American
Stock Exchange.
<TABLE>
<CAPTION>
Year Ended June 30, 1999
-------------------------------------------------
4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter
------- ------- -------- -------
<S> <C> <C> <C> <C>
High.............. $10.625 $10.125 $10.5625 N/A
Low............... $ 9.25 $ 9.125 $10.25 N/A
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
General
The Company's results of operations are dependent primarily on
net interest income, which is the difference between the income earned on its
loan and investment portfolios and its cost of funds, consisting of the interest
paid on deposits. Results of operations are also affected by the Company's
provision for loan losses, security sales activities, service charges and other
fee income, and noninterest expense. The Company's noninterest expense
principally consists of compensation and employee benefits, office occupancy and
equipment expense, federal deposit insurance premiums, data processing,
professional fees, advertising and business promotion and other expenses.
Results of operations are also significantly affected by general economic and
competitive conditions, particularly changes in interest rates, government
policies and actions of regulatory authorities.
Management Strategy
The Company's operating strategy has been that of a
community-based banking institution, offering a wide variety of savings products
to its retail customers, while concentrating on residential and consumer lending
and, to a lesser extent, multi-family and commercial real estate and
construction lending. In order to promote long-term financial strength and
profitability, the Company's operating strategy has focused on: (i) maintaining
strong asset quality by originating primarily one- to four-family mortgage loans
and home equity loans and lines of credit secured by residential real estate
located in its market area; (ii) managing its interest rate risk within the
context of its significant fixed-rate one- to four-family mortgage lending
activity; (iii) providing products and delivery systems directed at the needs
and
26
<PAGE>
expectations of its customer base, including through taking advantage of
technological advances when appropriate; and (iv) maintaining a strong
regulatory capital position.
Management of Interest Rate Risk and Market Risk Analysis
Qualitative Analysis
The Company's interest rate risk management has involved the
evaluation of the interest rate risk included in certain balance sheet accounts,
the determination of the level of interest rate risk appropriate given the
Company's business strategy, operating environment, capital and liquidity
requirements and performance objectives, and management of its interest rate
risk pursuant to strategies approved by the Board of Directors to achieve a
level of interest rate risk consistent with guidelines approved by the Board of
Directors. Through such management, the Company seeks to reduce the
vulnerability of its operations to changes in interest rates. The Board of
Directors has established an Investment/Asset Liability Committee ("ALCO"),
which is responsible for reviewing asset/liability policies and the interest
rate risk position. The extent of the movement of interest rates is an
uncertainty that could have a negative impact on the earnings of the Company.
The Company has utilized the following strategies to manage
interest rate risk: (i) originating shorter-term (20 years or less) fixed-rate
mortgage loans, in addition to 30-year fixed-rate loans; (ii) originating
consumer loans which have a generally shorter term and may have a variable
interest rate; (iii) promoting longer-term deposits, particularly three-year
certificates of deposit; and (iv) investing in shorter-term investment and
mortgage-related securities.
Management believes that limiting its exposure to interest
rate risk fluctuations enhances long-term profitability. However, the Company's
strategies also can adversely impact net interest income due to lower yields on
shorter-term investments in comparison to longer-term fixed-rate investments and
whole loans. To promote a higher yield on its investment securities while at the
same time addressing the Company's interest rate risk management policies, the
Company has invested a significant portion of its portfolio of investment
securities in longer-term (more than five years) federal agency obligations
which have call features. Given the rates of such securities in comparison to
current market interest rates, the Company anticipates the substantial majority
of such securities will be called prior to their contractual maturity. However,
if changes in interest rates exceed ranges anticipated by the Company in
estimating the anticipated life of such callable securities, the Company would
be subject to increased interest rate or reinvestment risk, depending on the
direction of the change in market interest rates.
27
<PAGE>
Quantitative Analysis
Net Portfolio Value. The Company's interest rate sensitivity
is primarily monitored by management through the use of a model which generates
estimates of the change in the Company's NPV over a range of interest rate
scenarios. Such model is prepared by a third party for the Company. The OTS also
prepares and sends to the Company a NPV model based upon the Company's quarterly
financial reports to the OTS and assumptions utilized by the OTS. NPV is the
present value of expected cash flows from assets, liabilities, and off-balance
sheet contracts. The NPV ratio, under any interest rate scenario, is defined as
the NPV in that scenario divided by the market value of assets in the same
scenario. The Company's model makes assumptions, among the other things
regarding the annual prepayment rates for residential mortgage loans,
adjustable-rate and fixed-rate, prepayment rates ranged from 6% to 43% annually.
Mortgage-related securities were assumed to prepay at rates between 10% and 60%
annually. Investment securities are presented based on their stated maturities.
Callable obligations, however, are valued using an option adjusted spread model
for each interest rate scenario. Savings accounts, NOW accounts and Money Market
Cash accounts are assumed by the Company to decay at 17%, 37%, and 79%,
respectively. The results of the Company's model may vary from the OTS's model
primarily due to differences in assumptions utilized, including estimated loan
prepayment rates, reinvestment rates and deposit decay rates. The following
table sets forth the Company's NPV as of June 30, 1999.
<TABLE>
<CAPTION>
Change in NPV as % of Portfolio
Interest Rates Net Portfolio Value Value of Assets
In Basis Points --------------------------------- -----------------------
(Rate Shock) Amount $ Change % Change NPV Ratio Change (1)
- --------------- -------- --------- -------- --------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
300 $11,153 $(6,231) (35.8)% 9.94% (451)
200 13,367 (4,019) (23.1) 11.62 (283)
100 15,454 (1,929) (11.1) 13.12 (132)
Static 17,383 -- -- 14.45 --
(100) 18,475 1,092 6.3 15.14 69
(200) 19,042 1,659 9.5 15.44 100
(300) 19,533 2,150 12.4 15.69 125
</TABLE>
- -------------
(1) Expressed in basis points.
Certain shortcomings are inherent in the methodology used in
the above interest rate risk measurements. Modeling changes in NPV require the
making of certain assumptions which may or may not reflect the manner in which
actual yields and costs respond to changes in market interest rates. In this
regard, the NPV model presented assumes that the composition of the Company's
interest sensitive assets and liabilities existing at the beginning of a period
remains constant over the period being measured and also assumes that a
particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the NPV table provides an indication of the
Company's interest rate risk exposure at a particular point in time, such
measurements are not intended to and do not provide a precise forecast of the
effect of changes in market interest rates on the Company's net interest income
and will differ from actual results.
Analysis of Net Interest Income
Net interest income represents the difference between income
on interest-earning assets and expense on interest-bearing liabilities. Net
interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them.
28
<PAGE>
Average Balance Sheet. The following tables set forth certain
information relating to the Company for the fiscal years ended June 30, 1999,
1998 and 1997. The average yields and costs are derived by dividing income or
expense by the average balance of interest-earning assets or interest-bearing
liabilities, respectively, for the periods shown, except where noted, otherwise
and reflect annualized yields and costs. The yields and costs include fees which
are considered adjustments to yields.
<TABLE>
<CAPTION>
For the Fiscal Years Ended June 30,
---------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- ---------------------------- ----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Loans (1):
Real estate (2) .................... $ 58,039 $4,340 7.48% $ 55,841 $ 4,358 7.80% $ 53,399 $ 4,031 7.55%
Consumer ........................... 9,517 742 7.80 10,331 825 7.99 11,212 1,018 9.08
Commercial real estate ............. 2,118 160 7.55 3,131 232 7.41 2,080 132 6.35
-------- ------ -------- ----- -------- --------
Total loans .................... 69,674 5,242 7.52 69,303 5,415 7.81 66,691 5,181 7.77
Mortgage-related securities (3) ...... 2,407 167 6.94 2,629 159 6.05 4,846 196 4.04
Investment securities (4)(5) ......... 14,284 887 6.21 12,563 899 7.15 12,419 958 7.71
Interest-bearing deposits ............ 25,726 1,503 5.84 20,155 1,267 6.29 18,268 1,105 6.05
-------- ------ -------- ----- -------- --------
Total interest-earning assets ... 112,091 7,799 6.96 104,650 7,740 7.40 102,224 7,440 7.28
--------
Noninterest-earning assets:
Cash and due from banks................ 2,311 3,092 2,691
Premises and equipment................. 1,313 1,327 1,101
Other, less allowance for loan losses.. 923 767 919
-------- -------- --------
Total noninterest-earning assets. 4,547 5,186 4,711
-------- -------- --------
Total assets..................... $116,638 $109,836 $106,935
======== ======== ========
Interest-bearing liabilities:
Deposits:
Passbook and statement savings...... 28,099 802 2.85 $ 28,788 795 2.76 $ 30,996 827 2.67
Money market........................ 1,978 53 2.68 2,151 53 2.46 2,374 60 2.53
NOW................................. 11,158 167 1.50 10,081 152 1.51 9,065 135 1.49
Certificates of deposit............. 57,679 3,076 5.33 59,342 3,260 5.49 55,653 3,007 5.40
-------- ------ -------- -------- --------
Total interest-bearing deposits.. 98,914 4,098 4.14 100,362 4,260 4.24 98,088 4,029 4.11
Noninterest-bearing liabilities:
Other liabilities...................... 524 513 513
-------- -------- --------
Total liabilities................ 99,438 100,875 98,601
Equity.................................... 17,200 8,961 8,334
-------- -------- --------
Total liabilities and equity..... $116,638 $109,836 $106,935
======== ======== ========
</TABLE>
- -----------------
(1) Balances are net of deferred loan origination costs, undisbursed
proceeds of construction loans in process, and include nonperforming
loans.
(2) Includes in addition to one- to four-family real estate loans,
multi-family and construction real estate loans which at June 30, 1999
totaled $789,000 and $1.1 million, respectively.
(3) Includes mortgage-related securities available-for-sale and
held-to-maturity.
(4) Includes investment securities available-for-sale and held-to-maturity
and stock in the FHLB of Pittsburgh.
(5) The average balance of tax-exempt investments was $1.8 million in
fiscal 1999 and $894,000 in fiscal 1998. The Company had no tax-exempt
investments in 1997.
29
<PAGE>
<TABLE>
<CAPTION>
For the Fiscal Year Ended June 30,
----------------------------------
1999 1998 1997
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Average net interest-earning assets ................ $13,177 $ 4,288 $ 4,136
Net interest income ................................ 3,701 3,480 3,411
Net interest rate spread (1) ..................... 2.82% 3.16% 3.17%
Net interest margin as a percentage of interest-
earning assets (2) .............................. 3.30% 3.33% 3.34%
Ratio of interest-earning assets to interest-
bearing liabilities ............................. 113.32% 104.27% 104.22%
</TABLE>
- -------------
(1) Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost
of interest-bearing liabilities.
(2) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
Rate/Volume Analysis. The following table presents the extent
to which changes in interest rates and changes in the volume of interest-earning
assets and interest-bearing liabilities have affected the Company's interest
income and interest expense during the periods indicated. Information is
provided in each category with respect to: (i) changes attributable to changes
in volume (changes in volume multiplied by prior rate); (ii) changes
attributable to changes in rate (changes in rate multiplied by prior volume);
and (iii) the net change. The changes attributable to the combined impact of
volume and rate have been allocated on a proportional basis between changes in
rate and volume.
<TABLE>
<CAPTION>
Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended
June 30, 1999 June 30, 1998 June 30, 1997
Compared to Compared to Compared to
Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended
June 30, 1998 June 30, 1997 June 30, 1996
------------------------------ ----------------------------- ----------------------------
Increase (Decrease) Increase (Decrease) Increase (Decrease)
Due to Due To Due to
------------------ ------------------ ------------------
Rate Volume Net Rate Volume Net Rate Volume Net
------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans:
Real estate (1) ................ $ (184) $ 166 $ (18) $ 138 $ 189 $ 327 $ (37) $ 73 $ 36
Consumer ....................... (20) (63) (83) (117) (76) (193) 85 23 108
Commercial real estate ......... 3 (75) (72) 25 75 100 (145) 48 (97)
------- ------- ------- ------- ------- ------- ------- ------- -------
Total ....................... (201) 28 (173) 46 188 234 (97) 144 47
------- ------- ------- ------- ------- ------- ------- ------- -------
Mortgage-related securities .... 22 14 8 74 (111) (37) (1) (69) (70)
Investment securities (2) ...... (126) 114 (12) (70) 11 (59) 5 32 37
Interest-earning deposits ...... (104) 340 236 45 117 162 -- (33) (33)
------- ------- ------- ------- ------- ------- ------- ------- -------
Total interest-earning assets (409) 468 59 95 205 300 (93) 74 (19)
------- ------- ------- ------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits:
Passbook and statement
savings ..................... 26 (19) 7 28 (60) (32) (55) (49) (104)
Money market ................... 4 (4) -- (2) (5) (7) (6) (8) (14)
NOW ............................ (1) 16 15 2 15 17 (54) (1) (55)
Certificate of deposit ......... (94) (90) (184) 51 202 253 (141) 113 (28)
------- ------- ------- ------- ------- ------- ------- ------- -------
Total interest-bearing
liabilities .............. (65) (97) (162) 79 152 231 (256) 55 (201)
------- ------- ------- ------- ------- ------- ------- ------- -------
Increase in net interest income ... $ (344) $ 565 $ 221 $ 16 $ 53 $ 69 $ 163 $ 19 $ 182
======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- --------------
(1) Includes in addition to one- to four-family real estate loans,
multi-family and construction real estate loans which at June 30, 1999
totalled $789,000 and $1.1 million, respectively.
(2) Calculations of rate/volume changes are not presented on a tax
equivalent basis due to the small volume of tax-exempt investments in
1999 and 1998. There were no tax-exempt investments owned in 1997 or
1996.
30
<PAGE>
Comparison of Financial Condition at June 30, 1999 and June 30, 1998.
Total assets increased by $7.5 million, or 6.7%, from $112.0
million at June 30, 1998 to $119.5 million at June 30, 1999. The growth in
assets was primarily due to net proceeds raised in the Company's public offering
of its common stock in connection with the Association's conversion to the stock
form of ownership on December 30, 1998.
Total cash and cash equivalents declined $12.1 million from
June 30, 1998 to June 30, 1999. This decrease, together with net proceeds of
approximately $14.1 in connection with the conversion funded a $15.7 million
increase in investment securities, a $4.9 million increase in commercial loans,
due to the creation of a commercial loan department in February 1999, offset by
a $1.0 million decrease in consumer loans and a $6.8 million decrease in
deposits.
Nonperforming loans decreased from $1.9 million at June 30,
1998 to $1.3 million at June 30, 1999, representing 2.7% and 1.8%, respectively,
of the total loans at such dates. The decrease was primarily due to the
Association's increased collection efforts and more timely commencement of
collection activities. Nonperforming assets decreased from $2.1 million at June
30, 1998 to $1.3 million at June 30, 1999, representing 1.9% and 1.1%,
respectively, of total assets at such dates.
Total deposits decreased $6.8 million, from $102.6 million at
June 30, 1998 to $95.8 million at June 30, 1999. This decrease was primarily due
to a decrease of $5.5 million, or 9.0%, in certificate of deposits and a $1.6
million decrease in passbook accounts. This decrease was partially attributable
to $2.6 million of withdrawals used by depositors to purchase stock in the
conversion. Such decrease was offset by a $518,000 increase in NOW accounts.
Total equity was $22.5 million at June 30, 1999 compared to
$9.2 million at June 30, 1998, an increase of $13.3 million. This increase was
primarily due to the influx of capital generated by the initial public offering
of stock.
Comparison of Operating Results for the Fiscal Years Ended June 30, 1999 and
June 30, 1998.
General. Net income for fiscal 1999 decreased $383,000, or
62.0%, to $234,000 from $617,000 for fiscal year 1998. The decrease was
primarily due to the one-time expense of $754,000 in connection with the funding
of the charitable foundation in December 1998 as part of the conversion of the
Association to the stock form of ownership. When adjusted for the one-time
expense, earnings would have increased by approximately $371,000. Net interest
income increased $221,000 as a result of an increased average balance of
interest-earning assets due to the influx of proceeds from the conversion,
offset in part by lower interest rates earned. Also contributing to the increase
in net interest income was a decrease in interest expense due to the lower
interest rate environment.
Interest Income. Total interest income increased by $59,000,
or 0.8%, due primarily to an increase in the average balance of interest-earning
assets which increased $7.4 million from $104.7 million for fiscal 1998 to
$112.1 for fiscal 1999. The increase in interest income was primarily
attributable to a $5.5 million increase in the average balance of
interest-bearing deposits, which increased from $20.2 million for fiscal 1998 to
$25.7 million for fiscal 1999. This increase was primarily funded through the
proceeds received by the Company in the conversion. Such increase was offset by
a $173,000 decrease in the interest income from loans primarily due to lower
rates earned on such loans due to a lower interest rate environment.
Interest Expense. Interest expense decreased by $162,000, or
3.8%, from $4.3 million for fiscal 1998 to $4.1 million for fiscal 1999. This
decrease was primarily due to the decrease in the average balance of
certificates of deposit which decreased $1.6 million, or 2.8%, from $59.3
million for fiscal 1998 to $57.7 for fiscal 1999. Additionally, passbook and
statement savings accounts decreased $689,000 from $28.8 million for fiscal 1998
to $28.1 million for fiscal 1999. A lower average rate paid on deposits also
contributed to a lower interest expense as the average rate paid on
interest-bearing deposits decreased 10 basis points from 4.24% for fiscal 1998
to 4.14% for fiscal 1999, due primarily to a 16 basis point decrease on
certificate of deposit which decreased from 5.49% for fiscal 1998 to 5.33% for
fiscal 1999.
31
<PAGE>
Provision for Loan Losses. The Company's provision for loan
losses decreased by $114,000, or 65.0%, to $62,000 for fiscal 1999 compared to
$176,000 for fiscal 1999. However, the allowance for loan losses only decreased
by $33,000, or 7.3%, from $452,000 for fiscal 1998 to $419,000 for fiscal 1999
as the Company only charged off $110,000 of loans for fiscal 1999 compared to
charge-offs of $178,000 in the prior year. The decrease in the provision for
loan losses and corresponding decrease in the allowance for loan losses
reflected a decrease in the amount of nonaccrual and substandard loans.
Nonaccrual loans decreased $573,000, or 30.7%, from $1.9 million for the year
ended June 30, 1998 to $1.3 million for the year ended June 30, 1999. The
decrease in nonaccrual loans was the direct result of the Company's increased
collection efforts along with the improved procedures for addressing delinquent
loans. See "Description of Business--Delinquent Loans, Classified Assets and
Foreclosed Real Estate."
Noninterest Income. Noninterest income increased $48,000, or
15.8%, from $304,000 for fiscal year 1998 to $352,000 for fiscal year 1999. This
increase was primarily due to a $40,000 increase in loan fees and service
charges from $267,000 for fiscal 1998 to $307,000 for fiscal 1999 due to an
increase in fees due to increased loan volume and higher ATM fees.
Noninterest Expense. Noninterest expense increased $1.2
million, or 47.1%, from $2.5 million for fiscal year 1998 to $3.7 million for
fiscal year 1999. This increase was primarily due to the $754,000 expense
associated with the funding of the charitable foundation in connection with the
Association's conversion to stock form. Additionally, foreclosed real estate
expenses increased by $173,000, or 126.7%, from $136,000 for fiscal 1998 to
$309,000 for fiscal 1999, primarily due to the additional number of foreclosed
properties held by the Association during this period. Also contributing to the
increase in noninterest expense was a $127,000, or 9.8%, increase in
compensation and employee benefits, primarily due to normal salary increases and
the addition of a commercial loan officer. Occupancy expense increased by
$34,000, or 14.7%, primarily due to an increase in rental expense on the Laurel
Mall office and increased depreciation expense on furniture fixtures and
equipment primarily due to the upgrading of the Association's equipment. The
increase in data processing expense from $138,000 to $158,000 was due to normal
increase in annual fees plus one-time charges related to Y2K testing by the data
center.
Provision for Income Taxes. Income tax expense totalled
$102,000 for fiscal 1999 compared to $506,000 for fiscal 1998. This decrease was
primarily due to the reduction in pre-tax income, primarily as a result of the
one time expense of establishing the charitable foundation and a lower tax
liability due to the purchase of tax-exempt investments.
Comparison of Operating Results for the Fiscal Years Ended June 30, 1998 and
June 30, 1997.
General. Net income for fiscal 1998 increased by $407,000, or
193.8%, to $617,000 from $210,000 for fiscal 1997. The increase was primarily
due to a decrease in noninterest expense resulting from the absence of the one
time special assessment of $620,000 to recapitalize the SAIF which occurred in
the second quarter of fiscal 1997. Net income also increased due to an increase
in net interest income. These items were slightly offset by an increase in the
provision for loan losses and an increase in noninterest expenses.
Interest Income. Total interest income increased by $300,000,
or 4.1%, from $7.4 million for fiscal 1997 to $7.7 million for fiscal 1998,
primarily due to a $2.4 million, or 2.3%, increase in the average balance of
interest-earning assets and a slight increase in the weighted average yield on
interest-earning assets, which increased from 7.28% for fiscal 1997 to 7.40% for
fiscal 1998. Interest income on real estate loans increased $300,000, or 7.5%,
from $4.0 million for fiscal 1997 to $4.3 million for fiscal 1998, primarily due
to a $2.4 million increase in the average balance of real estate loans and a
slight increase in the weighted average yield from 7.55% for fiscal 1997 to
7.80% for fiscal 1998. Interest income on consumer loans decreased $175,000,
from $1.0 million for fiscal 1997 to $825,000 for fiscal 1998. This was
principally due to decreases in the average balance of consumer loans from $11.2
million in 1997 to $10.3 million in fiscal 1998 and a decrease in the yield on
such loans from 9.08% in fiscal 1997 to 7.99% in fiscal 1998. Interest income on
mortgage-related securities decreased $37,000 from $196,000 for fiscal 1997 to
$159,000 for fiscal 1998 due to the increase in weighted average yield from
4.04% in fiscal 1997 to 6.05% in fiscal 1998 being offset by a decrease of $2.2
million in the average balance of such securities from $4.8 million in fiscal
1997 to $2.6 million in fiscal 1998. Interest income on investment securities
increased slightly by $100,000, from $1.6 million for fiscal 1997 to $1.7
million for fiscal 1998 due to an increase in the average balance of investment
securities from $24.4 million in fiscal 1997 to $26.7 million in fiscal 1998,
offset by a decrease in the yield on such investments.
32
<PAGE>
Interest Expense. Interest expense increased by $200,000, or
5.0%, from $4.0 million for fiscal 1997 to $4.2 million for fiscal 1998. The
increase in interest expense was primarily the result of increased expense on
certificates of deposit, which was a result of a $3.7 million, or 6.7% increase
in the average balance of such accounts from $55.6 million for fiscal 1997 to
$59.3 million for fiscal 1998. These net increases were partially offset by a
decrease in interest expense on savings accounts of $32,000 due to the decrease
in the average balance of such accounts, which declined from an average balance
of $30.1 million for fiscal 1997 to $28.8 million for fiscal 1998. The increase
in the average balance of certificates of deposit and the decrease in the
average balance of savings accounts was due primarily to the Company's efforts
to solicit certificate accounts by more competitively pricing such accounts and
by customers shifting funds from lower-yielding savings accounts to
higher-yielding certificates of deposit.
Provision for Loan Losses. The Company's provision for loan
losses for fiscal 1998 was $176,000, compared to $34,000 for fiscal 1997. The
allowance for loan losses increased $23,000 from $429,000 at June 30, 1997 to
$452,000 at June 30, 1998. Total nonaccrual loans also increased from $1.6
million at June 30, 1997 to $1.9 million at June 30, 1998. The increase in the
provision for loan losses and corresponding increase in the Company's allowance
for loan losses reflected an increase in the amount of nonaccrual and
substandard loans. This increase was due to the general decline in real estate
values in its market area which commenced in 1996. Initially, the Company was
slow to handle the increased number of loans which warranted foreclosure. The
Company has improved its procedures for addressing delinquent loans and believes
that real estate values in its market area have stabilized in recent periods. As
a result, at June 30, 1998, the allowance for loan losses was 0.65% of total
loans, compared to 0.64% at June 30, 1997. The Company anticipates that, as a
result of its increasing emphasis on consumer and multi-family and commercial
real estate loans, it may need to maintain an allowance for loan losses in the
future at a level that is higher than that which it maintained in recent periods
to offset any greater risk resulting from the shifting composition of its loan
portfolio. See "Description of Business--Delinquent Loans, Classified Assets and
Foreclosed Real Estate."
Noninterest Income. In fiscal 1998, the Company experienced a
$20,000 increase in noninterest income from $284,000 in fiscal year 1997 to
$304,000 for fiscal year 1998 due primarily to a $25,000 increase in loan fees
and service charges associated with the implementation of surcharges on
automated teller machine ("ATM") transactions and the increase in the average
balance of loans originated. This increase was offset by a $16,000 reduction in
the gain of sale and calls of securities from $17,000 for fiscal 1997 to $1,000
for fiscal 1998.
Noninterest Expenses. Total noninterest expenses decreased
from $3.1 million for fiscal 1997 to $2.5 million for fiscal 1998 due primarily
to a reduction in the FDIC deposit insurance premiums in fiscal 1998 and the
absence of a one-time charge of $620,000 in order to recapitalize the SAIF fund
which occurred in the fourth quarter of 1997. As a result of the FDIC premium
reduction and absence of the SAIF assessment in fiscal 1998, FDIC insurance
assessments and premiums decreased from $750,000 for fiscal 1997 to $64,000 for
fiscal 1998. Noninterest expenses other than FDIC premiums and the SAIF special
assessment increased approximately $66,000 for fiscal 1998 compared to fiscal
1997. Compensation and employee benefits increased $30,000, or 2.4%, primarily
due to normal increases in salaries as well as increases in benefit costs
offered in part by a decrease of $26,000 in pension expense contribution. This
contribution is determined annually by the Company's pension administrator.
Other noninterest expenses aggregating $510,000 at June 30, 1998 were comprised
of $51,000 of advertising expense, $57,000 of printing and postage, $211,000 of
outside service fees, $31,000 in loan expenses, $20,000 in telephone expense,
$32,000 in insurance, $41,000 in ATM expense, $15,000 in contributions and
$51,000 in other miscellaneous operating expenses. These expenses have remained
fairly constant from year to year.
Provision for Income Taxes. Income tax expense totaled
$506,000 for fiscal 1998, compared to $344,000 for fiscal 1997, resulting in an
effective tax rate of 45.1 % for fiscal 1998 compared to 62.1% for fiscal 1997.
The increase in income tax expense in fiscal 1998 was attributable to higher
pre-tax income, which increased from $554,000 in 1997 to $1.1 million in 1998,
offset in part by a lower effective tax rate. The fiscal 1997 effective tax rate
of 62.1% was inordinately high as a result of a one time recognition of a
deferred tax liability of $136,000 for the recapture of certain of the Company's
bad debt reserve as a result of a change in federal income tax law. The 1997
effective tax rate was
33
<PAGE>
also impacted by a reduced state income tax rate also attributable to the
deferred federal tax expense recognition. Without the one-time adjustment, the
fiscal 1997 effective tax rate would approximate the fiscal 1998 effective tax
rate.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, principal
and interest payments on loans, mortgage-backed and investment securities. The
Company uses the funds generated to support its lending and investment
activities as well as any other demands for liquidity such as deposit outflows.
While maturities and scheduled amortization of loans are predictable sources of
funds, deposit flows, mortgage prepayments and the exercise of call features are
greatly influenced by general interest rates, economic conditions and
competition. The Company has continued to maintain the required levels of liquid
assets as defined by OTS regulations. This requirement of the OTS, which may be
varied at the direction of the OTS depending upon economic conditions and
deposit flows, is based upon a percentage of deposits and short-term borrowings.
The Company's currently required liquidity ratio is 4.0%. At June 30, 1999, 1998
and 1997, the Company's liquidity ratios were 29.5%, 22.9% and 21.1%,
respectively.
At June 30, 1999, the Company exceeded all of its regulatory
capital requirements with a tangible capital level of $15.9 million, or 13.4% of
total adjusted assets, which is above the required level of $1.8 million, or
1.5%; core capital of $15.9 million, or 13.4%, of total adjusted assets, which
is above the required level of $4.8 million, or 4.0%; and risk-based capital of
$16.3 million, or 26.8%, of risk-weighted assets, which is above the required
level of $4.8 million, or 8.0%.
The Company has other sources of liquidity if a need for
additional funds arises, including FHLB advances. At June 30, 1999, the Company
had advances outstanding from the FHLB of $1.0 million and at June 30, 1999 had
an overall borrowing capacity from the FHLB of $51.4 million.
The Company's most liquid assets are cash and due from banks,
interest-bearing deposits with banks and its investment and mortgage-related
securities available-for-sale. The levels of these assets are dependent on the
Company's operating, financing, lending and investing activities during any
given period. At June 30, 1999, cash and due from banks, interest-bearing
deposits with banks and investment securities available for sale totaled $42.7
million, or 35.7% of total assets.
At June 30, 1999, the Company had commitments to originate
loans and unused outstanding lines of credit and undisbursed proceeds of
construction mortgages totaling $5.0 million. The Company anticipates that it
will have sufficient funds available to meet its current loan origination
commitments. Certificate accounts, which are scheduled to mature in less than
one year from June 30, 1999, totaled $34.7 million. The Company expects that
substantially all of the maturing certificate accounts will be retained by the
Company at maturity.
Year 2000 Compliance
As the year 2000 approaches, an important business issue has
emerged regarding how existing application software programs and operating
systems can accommodate this date value. Many existing application software
products were designed to accommodate only two-digits. For example, "96" is
stored on the system and represents 1996. The Association relies significantly
on an outside service bureau for its data processing. While the Association has
not received any guarantee from the outside service bureau that the bureau will
be Year 2000 compliant, the service bureau has completed its assessment of its
Year 2000 compliance and resolved all identified problems. The Association's
service bureau completed its proxy testing of their system and the Association
has conducted on-line testing at each of its offices on February 14, 1999. No
problems were encountered during testing. Additionally, the Association's
service bureau conducting testing with other third parties that communicate with
the service bureau. No problems were encountered during these tests. The
Association has completed its inventory and assessment and has completed
upgrading its internal system to handle the Year 2000 problem. The cost to the
Association for the internal system upgrade, not including staff time, has been
less than $50,000. There can be no assurances, however, that the performance by
the Association and its service bureau will be effective to remedy all potential
problems. To the extent the Company's systems are not fully Year 2000 compliant,
there can be no assurance that potential systems interruptions or the cost
necessary to update software would not have a materially adverse effect on the
Company's business, financial
34
<PAGE>
condition, results of operations and business prospects. The Association has
prepared a contingency plan in the event there are any system interruptions.
Primarily the Association will resort to a manual method for handling customer
transactions and although cumbersome will be adequate. Any Year 2000 failure on
the part of the Association's customers could result in additional expense or
loss to the Association. The Association plans to work with its customers to
address any potential Year 2000 problems.
Impact of Inflation and Changing Prices
The Financial Statements and Notes thereto presented herein
have been prepared in accordance with GAAP, which require the measurement of
financial position and operating results generally in terms of historical dollar
amounts without considering the changes in the relative purchasing power of
money over time due to inflation. The impact of inflation is reflected in the
increased cost of the Company's operations. Unlike industrial companies, nearly
all of the assets and liabilities of the Company are monetary in nature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the prices of goods and
services.
Impact of New Accounting Standards
Reporting Comprehensive Income. In September 1997, the
Financial Accounting Standard Board ("FASB") issued SFAS No. 130, "Reporting
Comprehensive Income, " which establishes standards for the reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. This statement requires that all items
that are required to be recognized as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The statement does not require a specific format for
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. This statement is effective for fiscal years beginning after December
15, 1997. The Company adopted this statement as of July 1, 1998.
Accounting for Derivative Instruments and Hedging Activities.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts 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 those instruments at fair value. In
connection with the implementation of this statement, the Company, as of April
1, 1999, transferred debt securities classified as held-to-maturity to the
available- for-sale category. Such transfer will not call into question the
Company's intention to hold other debt to maturity in the future. This statement
is effective for financial statements for periods beginning after June 15, 1999.
Forward-Looking Statements
Certain forward-looking statements contained in this report
are based on certain assumptions and describe future plans, strategies and
expectations of the Company. These forward-looking statements are generally
identified by use of the words "believe," "expect," "intend," "anticipate,"
"estimate," "project," or similar expressions. The Company's ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Factors which could have a material adverse effect on the operations
of the Company and the subsidiaries include, but are not limited to, changes in:
interest rates, general economic conditions, legislative/regulatory changes,
monetary and fiscal policies of the U.S. Government, including policies of the
U.S. Treasury and the Federal Reserve Board, the quality or composition of the
loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements. The Company does not undertake--and
specifically disclaims any obligation--to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
35
<PAGE>
ITEM 7. FINANCIAL STATEMENTS.
TABLE OF CONTENTS
Page
----
Independent Auditors' Report...............................................F-1
Consolidated Balance Sheet.................................................F-2
Consolidated Statement of Income...........................................F-3
Consolidated Statement of Changes in Stockholders' Equity..................F-4
Consolidated Statement of Cash Flows.......................................F-5
Notes to Consolidated Financial Statements.................................F-7
36
<PAGE>
PARENTE o RANDOLPH o ORLANDO o
CAREY & ASSOCIATES
- ------------------------------
CONSULTANTS & ACCOUNTANTS
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Security of Pennsylvania Financial Corp.
Hazleton, Pennsylvania
We have audited the accompanying consolidated balance sheets of
Security of Pennsylvania Financial Corp. and Subsidiary as of June 30, 1999 and
1998, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended June 30, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
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
Security of Pennsylvania Financial Corp. and Subsidiary as of June 30, 1999 and
1998, and the results of its operations and its cash flows for each of the three
years in the period ended June 30, 1999 in conformity with generally accepted
accounting principles.
As discussed in Note 3 to the financial statements, the Company
adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Investments and Hedging Activities," as of April 1, 1999.
/s/Parente, Randolph, Orlando, Carey & Associates
Hazleton, Pennsylvania
July 30, 1999
F-1
<PAGE>
<TABLE>
<CAPTION>
SECURITY OF PENNSYLVANIA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
JUNE 30, 1999 AND 1998
- -------------------------------------------------------------------------------------------------------------
1999 1998
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks .................................................... $ 1,853,282 $ 3,272,263
Interest-bearing deposits with banks ....................................... 13,382,664 24,042,748
------------- -------------
Total cash and cash equivalents ...................... 15,235,946 27,315,011
Held-to-maturity securities (fair value of $1,492,064 in 1999
and $5,349,589 in 1998) .............................................. 1,492,064 5,325,777
Available-for-sale securities .............................................. 27,424,458 7,900,600
Loans receivable (net of allowance for loan losses
of $418,893 in 1999 and $451,856 in 1998) ........................... 72,788,745 69,211,264
Office premises and equipment, net ......................................... 1,281,341 1,364,352
Accrued interest receivable ................................................ 835,398 618,656
Foreclosed real estate (net of $12,000 allowance
in 1999 and 1998) .................................................... 53,259 220,889
Other assets ............................................................... 419,944 33,948
------------- -------------
TOTAL ASSETS ............... $ 119,531,155 $ 111,990,497
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits ............................................................. $ 95,815,430 $ 102,603,545
Borrowed funds ....................................................... 1,000,000 --
Advances from borrowers for taxes and insurance ...................... 26,214 34,468
Accrued interest payable and other liabilities ....................... 174,170 121,614
------------- -------------
Total liabilities .................................... 97,015,814 102,759,627
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 6,000,000
authorized shares, 1,587,000 shares issued ...................... 15,870 --
Additional paid-in capital ........................................... 14,869,014 --
Unearned employee stock ownership plan (ESOP) shares ................. (1,227,347) --
Retained earnings - substantially restricted ......................... 9,596,474 9,362,089
Accumulated other comprehensive loss ................................. (738,670) (131,219)
------------- -------------
Total stockholders' equity, net ...................... 22,515,341 9,230,870
------------- -------------
TOTAL LIABILITIES AND EQUITY $ 119,531,155 $ 111,990,497
============= =============
</TABLE>
See Notes to Financial Statements
F-2
<PAGE>
<TABLE>
<CAPTION>
SECURITY OF PENNSYLVANIA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
- ----------------------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Loans ..................................... $5,242,435 $5,414,524 $5,181,464
Interest and dividends on securities:
Taxable interest income ............. 866,470 1,018,709 1,118,879
Nontaxable interest income .......... 148,960 2,983 --
Dividends ........................... 38,649 36,835 34,727
Interest-bearing deposits with banks ...... 1,502,535 1,266,675 1,104,903
---------- ---------- ----------
Total interest income ..... 7,799,049 7,739,726 7,439,973
INTEREST EXPENSE, Interest on deposits .......... 4,097,959 4,259,958 4,028,973
---------- ---------- ----------
NET INTEREST INCOME ............................. 3,701,090 3,479,768 3,411,000
PROVISION FOR LOAN LOSSES ....................... 61,535 175,626 34,450
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES ........................... 3,639,555 3,304,142 3,376,550
---------- ---------- ----------
NONINTEREST INCOME:
Other loan fees and service charges ....... 306,832 266,628 241,342
Net realized gain on sale and calls of
available-for-sale securities ....... -- 701 16,776
Other ..................................... 45,598 36,748 25,736
---------- ---------- ----------
Total noninterest income .. 352,430 304,077 283,854
---------- ---------- ----------
NONINTEREST EXPENSES:
Salaries and employee benefits ............ 1,426,087 1,298,666 1,268,649
Occupancy and equipment expenses .......... 268,182 233,788 214,289
FDIC deposit insurance premiums ........... 63,078 64,457 752,450
Data processing ........................... 157,687 138,096 132,943
Professional fees ......................... 108,261 103,919 98,238
Foreclosed real estate expenses, net ...... 309,083 136,331 142,127
Charitable contributions .................. 765,728 14,942 13,232
Other noninterest expenses ................ 557,910 494,496 484,944
---------- ---------- ----------
Total noninterest expenses 3,656,016 2,484,695 3,106,872
---------- ---------- ----------
INCOME BEFORE PROVISION FOR INCOME TAXES ........ 335,969 1,123,524 553,532
PROVISION FOR INCOME TAXES ...................... 101,584 506,300 343,981
---------- ---------- ----------
NET INCOME ...................................... $ 234,385 $ 617,224 $ 209,551
========== ========== ==========
EARNINGS PER SHARE - BASIC AND DILUTED .......... $ 0.04 N/A N/A
========== ========== ==========
</TABLE>
See Notes to Financial Statements
F-3
<PAGE>
<TABLE>
<CAPTION>
SECURITY OF PENNSYLVANIA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
- ------------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
ADDITIONAL UNEARNED OTHER
COMMON PAID-IN ESOP RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK CAPITAL SHARES EARNINGS INCOME EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JUNE 30, 1996 $ -- $ -- $ -- $8,535,314 $(210,673) $ 8,324,641
COMPREHENSIVE INCOME: -----------
NET INCOME 209,551 209,551
NET CHANGE IN UNREALIZED LOSSES ON
AVAILABLE-FOR-SALE SECURITIES 49,247 49,247
-----------
TOTAL COMPREHENSIVE INCOME 258,798
------- ----------- ----------- ---------- --------- -----------
BALANCES, JUNE 30, 1997 -- -- -- 8,744,865 (161,426) 8,583,439
-----------
COMPREHENSIVE INCOME:
NET INCOME 617,224 617,224
NET CHANGE IN UNREALIZED LOSSES ON
AVAILABLE-FOR-SALE SECURITIES 30,207 30,207
-----------
TOTAL COMPREHENSIVE INCOME 647,431
-----------
BALANCES, JUNE 30, 1998 -- -- -- 9,362,089 (131,219) 9,230,870
-----------
COMPREHENSIVE INCOME:
NET INCOME 234,385 234,385
-----------
NET CHANGE IN UNREALIZED LOSSES ON
AVAILABLE-FOR-SALE SECURITIES (607,451) (607,451)
-----------
TOTAL COMPREHENSIVE LOSS (373,066)
-----------
PROCEEDS FROM SALE OF STOCK 15,870 14,868,258 14,884,128
UNEARNED ESOP SHARES (1,269,600) (1,269,600)
ESOP SHARES COMMITTED TO BE RELEASED 756 42,253 43,009
------- ----------- ----------- ---------- --------- -----------
BALANCES, JUNE 30, 1999 $15,870 $14,869,014 $(1,227,347) $9,596,474 $(738,670) $22,515,341
======= =========== =========== ========== ========= ===========
</TABLE>
See Notes to Financial Statements
F-4
<PAGE>
<TABLE>
<CAPTION>
SECURITY OF PENNSYLVANIA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
- ----------------------------------------------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income ............................................... $ 234,385 $ 617,224 $ 209,551
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan and foreclosed
real estate losses ...................... 61,535 197,626 94,336
Amortization and accretion on
investment securities ................... (2,473) 108 10,532
Depreciation and amortization ................. 126,394 98,071 82,109
Deferred income taxes ......................... (36,246) 46,160 148,892
Loss on sale of foreclosed real estate ........ 63,377 47,894 62,985
Net realized gain on sales and calls
of securities ........................... -- (701) (16,776)
Funding of Security Savings
Charitable Foundation ................... 753,820 -- --
ESOP shares committed to be released .......... 43,009 -- --
Changes in assets and liabilities:
Accrued interest receivable ............. (216,742) 46,346 39,421
Other assets ............................ (73,067) 162,399 225,285
Accrued interest payable and other
liabilities ........................ 88,802 (192,312) (96,869)
------------ ------------ ------------
Net cash provided by
operating activities .... 1,042,794 1,022,815 759,466
------------ ------------ ------------
INVESTMENT ACTIVITIES:
Purchases of held-to-maturity securities ................. (1,500,000) (3,109,478) (6,325,938)
Purchases of securities available-for-sale ............... (28,305,243) (3,948,894) (24,900)
Proceeds from maturities of held-to-maturity
securities ......................................... 550,000 9,020,948 5,562,915
Proceeds from the call of held-to-maturity
securities ......................................... 3,400,000 204,758 --
Proceeds from maturities and principal
paydowns on available-for-sale securities .......... 8,956,226 340,561 1,075,920
Proceeds from principal paydowns of
held-to-maturity securities ........................ 290,965 806,635 1,106,292
Proceeds from the sale of available-for-sale
securities ......................................... -- -- 1,038,300
Loans made to customers, net of principal
collected .......................................... (4,168,129) (3,128,008) (2,459,676)
Acquisition of office premises and equipment ............. (43,383) (283,919) (155,210)
Proceeds from sale of foreclosed real estate ............. 633,366 718,790 276,144
------------ ------------ ------------
Net cash (used in) provided by
investing activities .... (20,186,198) 621,393 93,847
------------ ------------ ------------
F-5
<PAGE>
<CAPTION>
SECURITY OF PENNSYLVANIA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
- ----------------------------------------------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Net change in deposit accounts ........................... $ (6,788,115) $ 4,138,828 $ (883,425)
Net (decrease) increase in advances from
borrowers for taxes and insurance .................. (8,254) (96,446) 76,095
Increase in borrowed funds ............................... 1,000,000 -- --
Net proceeds from sale of common stock ................... 12,860,708 -- --
------------ ------------ ------------
Net cash provided by (used in)
financing activities ..... 7,064,339 4,042,382 (807,330)
------------ ------------ ------------
(DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS ......................................... (12,079,065) 5,686,590 45,983
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR ........................................ 27,315,011 21,628,421 21,582,438
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR .............................................. $ 15,235,946 $ 27,315,011 $ 21,628,421
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid on deposits .......................... $ 4,057,775 $ 4,207,744 $ 4,007,074
Income taxes paid .................................. $ 256,750 $ 422,408 $ 139,732
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING ACTIVITIES:
Transfer from loans to foreclosed real estate ...... $ 687,598 $ 717,928 $ 517,672
Shares purchased by ESOP, net of shares
to be released ................................ $ 1,227,347 $ -- $ --
Transfer of held-to-maturity securities to
available-for-sale ............................ $ 1,087,285 $ -- $ --
</TABLE>
See Notes to Financial Statements
F-6
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Security of Pennsylvania Financial Corp. provides a variety of
financial services to individual and corporate customers through its
wholly-owned subsidiary Security Savings Association of Hazleton's
four offices in Hazleton, Weatherly and Butler Township,
Pennsylvania. These communities have diversified economies. The
primary deposit products are regular savings accounts, certificates
of deposit, and checking accounts. Its primary lending products are
single-family residential loans and secured consumer loans. The
Company is subject to competition from other financial institutions
and other companies that provide financial services. The Company is
subject to the regulations of certain federal and state agencies and
undergoes periodic examinations by those regulatory authorities.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of
Security of Pennsylvania Financial Corp. and its wholly-owned
subsidiary, Security Savings Association of Hazleton
("Association"), collectively referred to as the "Company". All
significant intercompany transactions and balances have been
eliminated in consolidation.
RISKS AND UNCERTAINTIES
In the normal course of its business, the Company encounters two
significant types of risk: economic and regulatory. There are three
main components of economic risk: interest rate risk, credit risk,
and market risk. The Company is subject to interest rate risk to the
degree that its interest-bearing liabilities mature or reprice at
different speeds, or on different bases from its interest-earning
assets. The Company's primary credit risk is the risk of default on
the Company's loan portfolio that results from the borrowers
inability or unwillingness to make contractually required payments.
The Company's lending activities are concentrated in Pennsylvania.
The largest concentration of the Company's loan portfolio is located
in Northeastern Pennsylvania. The ability of the Company's borrowers
to repay amounts owed is dependent on several factors, including the
economic conditions in the borrower's geographic region and the
borrower's financial condition. Market risk reflects changes in the
value of collateral underlying loans and valuation of real estate
held by the Company.
F-7
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Company is subject to the regulations of various government
agencies. These regulations can and do change significantly from
period to period. The Company also undergoes periodic examinations
by the regulatory agencies which may subject it to further changes
with respect to asset valuations, amounts of required loss
allowances, and operating restrictions resulting from the
regulators' judgements based on information available to them at the
time of their examination.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Material estimates that are particularly susceptible to significant
change relate to the determination for the allowance for loan losses
and the valuation of property acquired in connection with
foreclosures or in satisfaction of loans. In connection with the
determination of allowances for loan losses and foreclosed assets,
management obtains independent appraisals for significant
properties.
A majority of the Company's loan portfolio consist of single-family
residential loans in the Hazleton, Weatherly and Butler Township
areas. Although these local economies are diversified and fairly
stable, a substantial portion of its debtor's ability to honor their
contracts is dependent on the economic sector in which the Company
operates.
While management uses available information to recognize losses on
loans and foreclosed assets, future additions to the allowances may
be necessary based on changes in local economic conditions. In
addition, regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowances
for losses on loans and foreclosed assets. Such agencies may require
the Company to recognize additions to the allowances based on their
judgments about information available to them at the time of their
examination. Company management has no reason to believe that the
allowances for loan losses and foreclosed assets will change
materially in the near term.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, cash and cash
equivalents include cash on hand and amounts due from banks.
F-8
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
DEBT AND EQUITY SECURITIES
The Company classifies each of its investments in debt and equity
securities into one of two categories:
Held-To-Maturity Securities - Securities that the institution
has the positive intent and ability to hold to maturity.
Available-For-Sale Securities - Securities that are not
eligible for classification as held-to-maturity.
Held-to-maturity securities are carried at amortized cost. Those
securities classified as available-for-sale are carried at fair
value. The change in net unrealized holding gain or loss on
available-for-sale securities, net of taxes is included in other
comprehensive income.
LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans are stated at the amount of unpaid principal, reduced by
unamortized loan fees and an allowance for loan losses. Interest on
loans is calculated by using the simple interest method on daily
balances of the principal amount outstanding.
The allowance for loan losses is established through a provision for
loan losses charged to expense. Loans are charged against the
allowance for loan losses when management believes that the
collectibility of the principal is unlikely. The allowance is an
amount that management believes will be adequate to absorb probable
losses on existing loans that may become uncollectible, based on
evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such factors as
changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific impaired loans, and current
economic conditions and trends that may affect the borrowers'
ability to pay.
Loans are deemed to be "impaired" if management's assessment of the
relevant facts and circumstances, it is probable that the Company
will be unable to collect all proceeds due according to the
contractual terms of the loan agreement. For purposes of applying
the measurement criteria for impaired loans, the Company excludes
large groups of smaller balance homogeneous loans, primarily
consisting of residential real estate and consumer loans.
F-9
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Accrual of interest on impaired loans is discontinued when payments
are past due ninety days or more when collateral is inadequate to
cover principal and interest or immediately if management believes,
after considering economic and business conditions and collection
efforts, that the borrowers' financial condition is such that
collection is doubtful.
Nonrefundable loan origination fees and certain direct loan
origination costs for loans are recognized over the contractual life
of the related loans as an adjustment of yield.
FORECLOSED REAL ESTATE
Foreclosed real estate comprised of property acquired in the
settlement of loans, is recorded at the lower of the related
principal balance and accrued interest upon foreclosure or its fair
value. Costs of developing and improving such properties are
capitalized. Expenses related to holding such real estate, net of
rental and other income, are charged against income as incurred. An
allowance for foreclosed real estate losses is established through a
provision for foreclosed real estate losses for declines in fair
value after acquisition. Any subsequent writedowns are charged to
the allowance and any recoveries of amounts previously written down
are added to the allowance.
OFFICE PREMISES AND EQUIPMENT
AND DEPRECIATION
Office premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed using straight-line and
accelerated methods over the estimated useful lives of the assets
(office premises, 30-50 years; equipment, 5-10 years).
INCOME TAXES
Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income
taxes.
ADVERTISING COSTS
The Company follows the policy of charging the production costs of
advertising to expense as incurred.
F-10
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
DERIVATIVES
The Company has no derivative financial instruments requiring
disclosure under Statement of Financial Accounting Standards ("SFAS") No. 119.
COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, "Reporting Comprehensive Income,"
as of July 1, 1998. Accounting principles generally require that
recognized revenue, expenses, gains and losses be included in net
income. Although certain changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, are
reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income. The adoption of SFAS No. 130 had no effect on
the Company's net income or stockholders' equity.
The components of other comprehensive income and related tax effects
are as follows:
<TABLE>
<CAPTION>
YEARS ENDED
JUNE 30,
1999 1998 1997
----------- ----------- -----------
(In thousands)
<S> <C> <C> <C>
Unrealized holding (losses) gains on
securities available-for-sale ......... $(1,008,369) $ 50,144 $ 81,750
Less reclassification adjustment
for (losses) gains realized in income . -- -- --
----------- ----------- -----------
Net unrealized (losses) gains (1,008,369) 50,144 81,750
Tax effect ................................. 400,918 (19,937) (32,503)
----------- ----------- -----------
Net-of-tax amount .......................... $ (607,451) $ 30,207 $ 49,247
=========== =========== ===========
</TABLE>
RECLASSIFICATIONS
Certain items in the 1998 and 1997 financial statements have been
reclassified to conform to the 1999 financial statement presentation
format. These reclassifications had no effect on net income.
F-11
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. CONVERSION TO STOCK FORM
OF OWNERSHIP
On December 30, 1998,: (i) the Company converted from a state chartered
mutual savings and loan association to a state chartered stock savings
bank; (ii) the Company issued all of its outstanding capital stock to
Security of Pennsylvania Financial Corp.; and (iii) the Company
consummated its initial public offering of common stock, par value $.01
per share (the "Common Stock"), by selling at a price of $10.00 per
share, 1,384,658 shares of Common Stock to certain eligible account
holders of the Company who had subscribed for such shares (collectively,
the "Conversion"), by selling 126,960 shares to the Company's Employee
Stock Ownership Plan and related trust ("ESOP") and by contributing
75,382 shares of Common Stock to Security Savings Charitable Foundation
(the "Foundation"). The Conversion resulted in net proceeds of $12.9
million, after expenses of $986,000. The Company also established the
Foundation, dedicated to the communities served by the Company. In
connection with the Conversion, the common stock contributed by the
Company to the Foundation at a value of $753,820 was charged to expense.
Prior to the initial public offering and as a part of the subscription
offering, in order to grant priority to eligible depositors, the Company
established an off-balance-sheet liquidation account (restricted
retained earnings) at the time of the conversion in an amount equal to
the equity of the Company as of the date of its latest balance sheet
date, June 30, 1998, contained in the final prospectus used in
connection with the Conversion. In the unlikely event of a complete
liquidation of the Company, (and only in such an event), eligible
depositors who continue to maintain accounts at the Company shall be
entitled to receive a distribution from the liquidation account. The
total amount of the liquidation account, which decreases if the balances
of eligible deposits decreases at the annual determination dates,
approximated $9.2 million at the date of conversion.
The Company may not declare nor pay dividends on its stock if such
declaration and payment would violate statutory or regulatory
requirements.
F-12
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
3. DEBT AND EQUITY SECURITIES
Held-to-maturity securities at June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999
----------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Commercial paper .......... $1,492,064 $ -- $ -- $1,492,064
========== ========== ========== ==========
<CAPTION>
1998
----------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U. S. government agency
securities ............ $2,801,355 $ 9,127 -- $2,810,482
Corporate obligations ..... 79,012 -- -- 79,012
Mortgage-backed
securities (FNMA, GNMA) 2,281,088 16,893 $ 649 2,297,332
State and political
subdivisions .......... 164,322 -- 1,559 162,763
---------- ---------- ---------- ----------
Total ....... $5,325,777 $ 26,020 $ 2,208 $5,349,589
========== ========== ========== ==========
</TABLE>
F-13
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Available-for-sale securities at June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999
--------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Corporate obligations ........ $ 53,424 -- $ 584 $ 52,840
U. S. Government agency
securities ............... 12,793,305 -- 266,336 12,526,969
Mortgage-backed securities
(FNMA, GNMA) ............. 3,830,401 $ 22,863 62,418 3,790,846
State and political
subdivisions ............. 8,963,769 -- 458,140 8,505,629
----------- ----------- ----------- -----------
Total debt securities 25,640,899 22,863 787,478 24,876,284
Mutual funds ................. 2,187,598 -- 234,024 1,953,574
Federal Home Loan Bank
of Pittsburgh stock ...... 594,600 -- -- 594,600
----------- ----------- ----------- -----------
Total .......... $28,423,097 $ 22,863 $ 1,021,502 $27,424,458
=========== =========== =========== ===========
<CAPTION>
1998
--------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
U. S. Government agency
securities ............... $ 3,547,627 $ 2,293 $ 2,313 $ 3,547,607
Mortgage-backed securities
(FNMA, GNMA) ............. 1,317,978 34,546 -- 1,352,524
State and political
subdivisions ............. 373,558 -- 3,767 369,791
----------- ----------- ----------- -----------
Total debt securities 5,239,163 36,839 6,080 5,269,922
Mutual funds ................. 2,187,598 -- 151,520 2,036,078
Federal Home Loan Bank
of Pittsburgh stock ...... 594,600 -- -- 594,600
----------- ----------- ----------- -----------
Total .......... $ 8,021,361 $ 36,839 $ 157,600 $ 7,900,600
=========== =========== =========== ===========
</TABLE>
F-14
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Unamortized premiums on mortgage-backed securities held-to-maturity were
$25,321 and $2,868 at June 30, 1999 and 1998, respectively. Unaccreted
discounts on mortgage-backed securities held-to-maturity were $41,346
and $11,089 at June 30, 1999 and 1998, respectively.
The amortized cost and fair value of held-to-maturity and
available-for-sale debt securities at June 30, 1999, by contractual
maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
HELD-TO-MATURITY AVAILABLE-FOR-SALE
SECURITIES SECURITIES
---------------------------- ----------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Due in one year or less .. $ 1,492,064 $ 1,492,064 $ 214,110 $ 213,590
Due after one year through
five years .......... -- -- 2,998,243 2,956,905
Due after five years
through ten years ... -- -- 7,664,177 7,470,833
Due after ten years ...... -- -- 14,764,369 14,234,956
----------- ----------- ----------- -----------
Total ..... $ 1,492,064 $ 1,492,064 $25,640,899 $24,876,284
=========== =========== =========== ===========
</TABLE>
There were no sales of any available-for-sale securities in 1999. Gross
gains of $701 were realized on the call of a held-to-maturity security
in 1998. Gross gains of $47,038 and gross losses of $30,262 were
realized on the sale of available-for-sale securities in 1997.
Securities with an amortized cost of $1,912,321 and $1,057,559 at June
30, 1999 and 1998, respectively were pledged as collateral on public
deposits and for other purposes as required or permitted by law.
F-15
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities."
This statement established accounting and reporting standards for
derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as "derivatives")
and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and
measure 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 the resulting designation. If certain conditions are met,
a derivative may be specifically designated as (a) a hedge of the
exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of
certain foreign currency exposures.
On April 1, 1999, the Company transferred certain held-to-maturity
securities to the available-for-sale investment portfolio. The amortized
cost of the securities was $1,087,285 with an unrealized gain, net of
taxes of $1,431. This transfer was in accordance with special
reassessment provision contained within SFAS No. 133 which was adopted
by the Company as of April 1, 1999.
4. LOANS RECEIVABLE
Loans receivable at June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Mortgage .................................. $ 54,601,895 $ 56,056,778
Commercial real estate .................... 9,956,024 3,945,708
Consumer .................................. 8,898,691 9,934,736
------------ ------------
73,456,610 69,937,222
Less:
Net deferred loan-origination fees (248,972) (274,102)
Allowance for loan losses ........ (418,893) (451,856)
------------ ------------
Loans receivable, net .. $ 72,788,745 $ 69,211,264
============ ============
</TABLE>
One-to-four family residential mortgage loans included in real estate
loans totaled $52,677,160 and $54,721,745 at June 30, 1999 and 1998,
respectively.
F-16
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The recorded investment in impaired loans, not requiring an allowance
for loan losses, was $1,102,893 and $1,572,855 at June 30, 1999 and
1998, respectively. The recorded investment in impaired loans requiring
an allowance for loan losses was $188,188 and $291,027 at June 30, 1999
and 1998, respectively. At June 30, 1999 and 1998, the related allowance
associated with those loans, which is included in the allowance for loan
losses was $15,000 and $35,000, respectively. For the years ended June
30, 1999 and 1998, the average recorded investment in these impaired
loans was approximately $1,344,198 and $1,864,000, respectively. There
was no interest income recognized on impaired loans in 1999, 1998 or
1997. Interest income that would have been recognized on impaired loans
would have approximated $79,000, $102,000 and $134,000 in 1999,1998 and
1997, respectively. The Company has no commitments to lend additional
funds to borrowers whose loans were classified as nonperforming or
troubled debt restructuring.
An analysis of the allowance for loan losses for the years ended June
30, 1999, 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Balance, beginning ................... $ 451,856 $ 428,857 $ 447,000
Provision for loan losses ............ 61,535 175,626 34,450
Loans charged off .................... (110,126) (177,505) (61,763)
Recoveries of loans charged off ...... 15,628 24,878 9,170
--------- --------- ---------
Balance, ending ...................... $ 418,893 $ 451,856 $ 428,857
========= ========= =========
</TABLE>
At June 30, 1999 and 1998, the Company serviced loans for others of
$85,000 and $140,000, respectively.
In the ordinary course of business, the Company has and expects to
continue to have transactions, including borrowings, with its executive
officers, directors and their affiliates. In the opinion of management,
such transactions were on substantially the same terms, as those
prevailing at the time of comparable transactions with other persons and
did not involve more than a normal risk of collectibility or present any
other unfavorable features to the Company. The Company offers officers
and full-time employees of the Company who satisfy the general
underwriting standards of the Company, loans with interest rates up to
1% below the current interest rate in effect.
F-17
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
An analysis of the activity in loans to directors and executive officers
for the years ended June 30, 1999, 1998 and 1997 follows:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Balance, beginning of year .............. $ 273,262 $ 219,364 $ 211,747
New loans ............................... 113,100 51,972 35,721
Repayments .............................. (54,074) (41,700) (28,104)
Loan balance of new executive officer ... -- 43,626 --
--------- --------- ---------
Balance, end of year .................... $ 332,288 $ 273,262 $ 219,364
========= ========= =========
</TABLE>
5. OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Land and building .................................. $ 927,459 $ 938,870
Improvements ....................................... 854,155 848,784
Furniture and equipment ............................ 932,913 883,490
---------- ----------
Total ................................ 2,714,527 2,671,144
Less accumulated depreciation and amortization ..... 1,433,186 1,306,792
---------- ----------
Office premises and equipment, net ................. $1,281,341 $1,364,352
========== ==========
</TABLE>
6. FORECLOSED REAL ESTATE
An analysis of the allowance for foreclosed real estate losses for the
years ended June 30, 1999, 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Balance, beginning .......................... $ 12,000 $ 24,852 $ 44,000
Provision for foreclosed real estate losses . -- 22,000 59,886
Writedowns .................................. -- (63,546) (79,034)
Recoveries .................................. -- 28,694 --
-------- -------- --------
Balance, ending ............................. $ 12,000 $ 12,000 $ 24,852
======== ======== ========
</TABLE>
F-18
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
7. DEPOSITS
Deposits at June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999
--------------------------------------------------------------------
WEIGHTED
AVERAGE
AMOUNT PERCENT RATE
------ ------- ----
<S> <C> <C> <C>
Passbook and statement savings ....... $ 27,407,304 28.60 2.60%
Variable rate money market ........... 1,872,567 1.96 2.57%
Negotiable order of withdrawal ....... 11,500,683 12.00 1.76%
Certificates of deposit .............. 55,034,876 57.44 5.29%
------------ ------
Total ...................... $ 95,815,430 100.00%
============ ======
<CAPTION>
1998
--------------------------------------------------------------------
WEIGHTED
AVERAGE
AMOUNT PERCENT RATE
------ ------- ----
<S> <C> <C> <C>
Passbook and statement savings ....... $ 29,052,601 28.32% 2.61%
Variable rate money market ........... 2,083,512 2.03 2.56%
Negotiable order of withdrawal ....... 10,983,296 10.70 1.74%
Certificates of deposit .............. 60,484,136 58.95 5.59%
------------ ------
Total ...................... $102,603,545 100.00%
============ ======
</TABLE>
Scheduled maturities of certificates of deposits at June 30, 1999 are as
follows:
YEAR ENDED JUNE 30:
-------------------
2000 ......................... $34,665,411
2001 ......................... 9,621,329
2002 ......................... 4,073,378
2003 ......................... 3,920,540
2004 ......................... 1,250,089
Thereafter ................... 1,504,129
-----------
Total ......... $55,034,876
===========
F-19
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Certificates of deposit in denominations of $100,000 or more amounted to
$11,711,165 and $13,552,029 at June 30, 1999 and 1998, respectively.
Certificates of deposits in denominations of greater than $100,000 are
not insured by the FDIC.
Interest expense on deposits for the years ended June 30, 1999, 1998 and
1997 is summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Certificates of deposit ........ $3,075,680 $3,260,039 $3,007,740
Passbook savings ............... 801,860 795,011 826,597
Money market ................... 53,069 53,142 59,527
NOW ............................ 167,350 151,766 135,109
---------- ---------- ----------
Total ...... $4,097,959 $4,259,958 $4,028,973
========== ========== ==========
</TABLE>
8. BORROWED FUNDS
At June 30, 1999, the Company had $1,000,000 in short-term borrowings
from the Federal Home Loan Bank of Pittsburgh ("FHLB") due September 29,
1999 with interest at 5.33%.
The Company also has a FHLB "Flex" credit line of $5,863,000 which
expires March 25, 2000. There were no borrowings under the Flex credit
line at June 30, 1999. The short term borrowings and Flex credit line
are secured by the Company's FHLB stock, certain investment securities
with a fair value of approximately $13,500,000 and approximately
$53,000,000 of mortgage loans under a collateral pledge and security
agreement.
9. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
On November 12, 1998, the Company's Board of Directors approved the
creation of a leveraged employee stock ownership plan ("ESOP") for the
benefit of employees who meet the eligibility requirements which include
having completed one year of service with the Company and having
attained age twenty-one. The ESOP purchased shares of the Company's
common stock with proceeds from a loan from the Company. The Company
makes cash contributions to the ESOP on an annual basis sufficient to
enable the ESOP to make the required loan payments. The loan bears
interest at the prime rate adjusted annually. Interest is payable
quarterly and principal payable in equal quarterly installments over
twelve years. The loan is secured by the shares of the stock purchased.
F-20
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
As the debt is repaid, shares are released from collateral and allocated
to qualified employees based on the proportion of debt service paid each
quarter. The Company accounts for its leveraged ESOP in accordance with
Statement of Position 93-6. Accordingly, the shares pledged as
collateral are reported as unallocated ESOP shares in the consolidated
balance sheet. As shares are released from collateral, the Company
reports compensation expense equal to the current market price of the
shares, and the shares become outstanding for earnings per share
computations. Dividends on allocated ESOP shares are recorded as a
reduction of retained earnings; dividends or unallocated ESOP shares are
recorded as a reduction of debt.
Compensation expense for the ESOP was $43,009 for the year ended June
30, 1999.
ESOP share transactions for the year ended June 30, 1999 were as
follows:
ESOP shares purchased 126,960
ESOP shares committed to be released (4,225)
----------
Unreleased ESOP shares at end of year 122,735
==========
Fair value of unreleased shares $1,304,059
==========
10. INCOME TAXES
The Small Business Job Protection Act of 1996, enacted August 20, 1996,
provided for the repeal of the tax bad debt deduction computed under the
percentage of taxable income method. The repeal of the use of this
method was effective for tax years beginning after December 31, 1995.
Prior to the change in law, the Association had qualified under the
provisions of the Internal Revenue Service Code which permitted it to
deduct from taxable income an allowance for bad debts based on 8% of
taxable income.
The Association is required to recapture into income, over a six year
period, the portion of its tax bad debt reserves that exceed its base
year reserves (i.e., tax reserves for tax years beginning before 1988).
The base year tax reserves, which may be subject to recapture if the
Association ceases to qualify as an Association for federal income tax
purposes, are restricted with respect to certain distributions. The
Association's total tax bad debt reserves at June 30, 1998, are
approximately $2.3 million, of which $1.9 million represents the base
year amount and $400,000 is subject to recapture. The Association has
previously recorded a deferred tax liability for the amount to be
recaptured; therefore, this recapture will not impact the statement of
income.
F-21
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The provision for income taxes is comprised of the following:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Currently payable ................... $ 137,830 $ 460,140 $ 195,089
Deferred ............................ (36,246) 46,160 148,892
--------- --------- ---------
Total provision ...... $ 101,584 $ 506,300 $ 343,981
========= ========= =========
</TABLE>
The effective income tax rate for the years ended June 30, 1999, 1998
and 1997 was 30.2%, 45.1% and 62.1%, respectively. A reconciliation
between the expected statutory income tax rate and the effective income
tax rate on income before taxes follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
--------- ---- --------- ---- --------- ----
<S> <C> <C> <C> <C> <C> <C>
Provision at statutory
rate ............... $ 114,229 34.0% $ 381,998 34.0% $ 188,201 34.0%
State income tax, net
of federal benefit . 48,576 14.5 117,744 10.5 17,424 3.1
Tax exempt income ...... (50,646) (15.1) -- -- --
Other, primarily bad
debt deduction ..... (10,575) (3.2) 6,558 .6 138,356 25.0
--------- ---- --------- ---- --------- ----
Total $ 101,584 30.2% $ 506,300 45.1% $ 343,981 62.1%
========= ==== ========= ==== ========= ====
</TABLE>
The components of the net deferred tax asset (liability) are as follows
at June 30:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Deferred tax asset:
Deferred loan fees, net ......... $ 57,288 $ 60,959 $ 95,072
Unrealized holding losses ....... 259,969
Deferred tax liabilities:
Unrealized holding gains ........ -- (10,458) (4,881)
Allowance for loan losses ....... (100,194) (141,052) (135,981)
Depreciation .................... (18,934) (17,993) (11,017)
--------- --------- ---------
Total ........ $ 198,129 $(108,544) $ (56,807)
========= ========= =========
</TABLE>
F-22
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The deferred tax asset (liability) is included in other assets
(liabilities) on the balance sheet.
11. OTHER NONINTEREST EXPENSE
Other noninterest expense amounts are summarized as follows for the
years ended June 30, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Outside service fees ................. $203,461 $210,924 $200,053
Advertising and promotion ............ 53,509 50,725 44,014
All other expenses ................... 300,940 232,847 240,877
-------- -------- --------
Total ............ $557,910 $494,496 $484,944
======== ======== ========
</TABLE>
12. PENSION PLAN
The Company participates in a contributory defined benefit
multi-employer pension plan administered through Pentegra. The Company
makes annual contributions to the Plan equal to amounts accrued for
pension expense. Total pension expense for the years ended June 30,
1999, 1998 and 1997 was $3,431, $3,581 and $29,364, respectively. The
relative position of the Company regarding the accumulated plan benefits
and net assets of the Plan is not readily determinable by the Company.
13. EARNINGS PER SHARE
Earnings per share, basic and diluted, were $.04 for the six months
ended June 30, 1999. Proforma earnings per share would have been $.16
had the shares been outstanding for the entire twelve month period. Due
to the Association's December 1998 conversion and the formation of
Security of Pennsylvania Financial Corp., earnings per share figures for
prior year periods are not applicable.
F-23
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following table presents the earnings per share computation:
Net income for the six months ended June 30, 1999 .... $ 60,032
============
Weighted average shares outstanding for the six
months ended June 30, 1999 ...................... 1,461,797
============
Earnings per share ................................... $ .04
============
Basic and diluted earnings per share are the same since the Company has
no potential dilutive common stock.
14. FEDERAL DEPOSIT INSURANCE CORPORATION
(FDIC) SPECIAL ASSESSMENT
On September 30, 1996, legislation was enacted to bring the funding
level of the Savings Association Insurance Fund (of which Security
Savings Association is a member) of the FDIC to the same level as the
Bank Insurance Fund of the FDIC. As a result of that legislation, the
Company paid a single premium payment of $619,763 for the year ended
June 30, 1997. The impact of this single premium payment, net of
estimated federal and state taxes on 1997 net income tax was
approximately $372,000. The single premium payment was assessed at 65.7
basis points of the March 31, 1995 deposit base of the Company. With the
enactment of the legislation, the regular assessment rate for the fourth
quarter, October 1 to December 31, 1996, was lowered retroactively from
57.5 to 16.25 basis points. Beginning January 1, 1997, annual premium
assessments further decreased to an annual premium level of 15.75 basis
points. During the year ended June 30, 1999, the premium level ranged
from 15.25 to 15.70 basis points.
15. RELATED PARTY TRANSACTIONS
The Company retains a law firm, in which a member of the Company's Board
of Directors also is a member, that provides general legal counsel to
the Company. The Company paid $35,487, $25,513 and $25,874 in legal fees
to this firm for the years ended June 30, 1999, 1998 and 1997,
respectively.
F-24
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
16. FINANCIAL INSTRUMENTS WITH
OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments are commitments to extend credit.
These commitments involve, to varying degrees, elements of credit,
interest rate or liquidity risk in excess of the amount recognized in
the balance sheet. The contract or notional amounts of these commitments
express the extent of involvement the Company has in particular classes
of financial instruments.
The Company's exposure to credit loss from nonperformance by the other
party to the financial instruments for commitments to extend credit is
represented by the contractual amount of those instruments. The Company
uses the same credit policies in making commitments as it does for
on-balance-sheet instruments.
The Company's contract amounts of commitments to extend credit which
represent credit risk at June 30, 1999 and 1998 were $3,088,122 and
$2,011,917, respectively. These amounts exclude undisbursed portions of
loans in process amounting to $1,871,867 and $1,109,499 at June 30, 1999
and 1998, respectively.
Commitments to extend credit are legally binding agreements to lend to
customers. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of fees. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future liquidity
requirements. The Company evaluates each customer's credit-worthiness on
a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company on extension of credit, is based on
management's credit assessment of the counterparty.
F-25
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
17. REGULATORY MATTERS
The Association is subject to various regulatory capital requirements
administered by federal and state 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 Association's
financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Association must
meet specific capital guidelines that involve quantitative measures of
the Association's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The
Association'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 Association 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 total assets (as defined). Management believes,
as of June 30, 1999, that the Association meets all capital adequacy
requirements to which it is subject.
F-26
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
To be categorized as well capitalized the Association must maintain
minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the following table. The Association's actual capital
amounts and ratios are presented in the following table. No deductions
were made in either year from capital for interest-rate risk.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
-----------------------------------------------------------------------------
TO BE WELL
FOR CAPITAL CAPITALIZED UNDER
ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
------------------ --------------- ---------------
JUNE 30, 1999 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital (to Risk Weighted
Assets) (risk-based capital ratio) $16,317 26.8% $4,863 =>8.0% $6,079 =>10.0%
Tier I Capital (to Risk Weighted
Assets) $15,898 26.2% $2,431 =>4.0% $3,647 =>6.0%
Tier I Capital (to Total Assets)
(core capital ratio) $15,898 13.4% $4,761 =>4.0% $5,952 =>5.0%
<CAPTION>
(DOLLARS IN THOUSANDS)
-----------------------------------------------------------------------------
TO BE WELL
FOR CAPITAL CAPITALIZED UNDER
ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
------------------ --------------- ---------------
JUNE 30, 1998 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital (to Risk Weighted
Assets) (risk-based capital ratio) $9,814 16.9% $4,641 =>8.0% $5,801 =>10.0%
Tier I Capital (to Risk Weighted
Assets) $9,362 16.1% $2,321 =>4.0% $3,481 =>6.0%
Tier I Capital (to Total Assets)
(core capital ratio) $9,362 8.4% $4,485 =>4.0% $5,606 =>5.0%
</TABLE>
F-27
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30,
------------------
1999 1998
------- -------
<S> <C> <C>
Regulatory capital reconciliation (in thousands):
Total equity ........................................ $15,159 $ 9,231
Unrealized losses on certain available-for-sale
securities, net of taxes ....................... 739 131
------- -------
Tangible and core capital ........................... 15,898 9,362
Allowance for loan losses ........................... 419 452
------- -------
Risk based capital .................................. $16,317 $ 9,814
======= =======
</TABLE>
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
requires that the Company disclose estimated fair values for its
financial instruments. Fair value estimates are made at a specific point
in time, based on relevant market information and information about the
financial instrument. These estimates do not reflect any premium or
discount that could result from offering for sale at one time the
Company's entire holdings of a particular financial instrument. Also, it
is the Company's general practice and intention to hold most of its
financial instruments to maturity and not to engage in trading or sales
activities. Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on
judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments and
other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot
be determined with precision. Changes in assumptions can significantly
affect the estimates.
F-28
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Estimated fair values have been determined by the Company using
historical data, as generally provided in the Company's regulatory
reports, and an estimation methodology suitable for each category of
financial instruments. The estimated fair value of the Company's
investment securities is described in Note 3. The Company's fair value
estimates, methods and assumptions are set forth below for the Company's
other financial instruments.
Cash and due from banks and interest-bearing deposits with banks:
The carrying amounts for cash and due from banks and
interest-bearing deposits with banks approximate fair value because
they generally mature in 90 days or less and do not present
unanticipated credit concerns.
Loans:
Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as
commercial, commercial real estate, residential mortgage, credit
card and other consumer. Each loan category is further segmented
into fixed and adjustable rate interest terms and by performing and
nonperforming categories.
The fair value of performing loans, except residential mortgage is
calculated by discounting schedules cash flows through the estimated
maturity using estimated market discount rates that reflect the
credit and interest rate risk inherent in the loan. The estimate of
maturity is based on the Company's historical experience with
repayments for each loan classification, modified, as required, by
an estimate of the effect of current economic and lending
conditions. For performing residential mortgage loans, fair value is
estimated using discounted rates based on secondary market sources
adjusted to reflect differences in servicing and credit costs.
Fair value for significant nonperforming loans is based on recent
external appraisals. If appraisals are not available, estimated cash
flows are discounted using a rate commensurate with the risk
associated with the estimated cash flows. Assumptions regarding
credit risk, cash flows, and discounted rates are judgmentally
determined using available market information and specific borrower
information.
F-29
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Deposits:
The fair value of deposits with no stated maturity, such as
noninterest bearing demand deposits, savings and NOW accounts, and
money market and checking accounts, is equal to the amount payable
on demand as of the valuation date. The fair value of certificates
of deposit is based on the discounted value of contractual cash
flows. The discount rate is estimated using the rates currently
offered for deposits of similar remaining maturities.
The fair value estimates above do not include the benefit that
results from the low-cost funding provided by the deposit
liabilities compared to the cost of borrowing funds in the market,
commonly referred to as the core deposit intangible.
Borrowed Funds:
The fair value of borrowed funds was estimated using rates currently
available to the Company for debt with similar terms and remaining
maturities.
Accrued Interest:
The carrying amounts of accrued interest approximate their fair
values.
Off-balance-sheet instruments:
The fair values of commitments to extend credit are estimated using
the fees currently charged to enter into similar agreements, taking
into account the remaining terms of the agreements and the
counterparties' credit standing.
F-30
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The estimated fair values of the Company's financial instruments are as
follows at June 30 (in thousands):
<TABLE>
<CAPTION>
1999 1998
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks ............ $ 1,853 $ 1,853 $ 3,272 $ 3,272
Interest-bearing deposits
with banks .................... 13,383 13,383 24,043 24,043
Held-to-maturity securities ........ 1,492 1,492 5,326 5,350
Available-for-sale
securities .................... 27,424 27,424 7,901 7,901
Loans, net of allowance ............ 72,789 73,223 69,211 70,123
Accrued interest receivable ........ 835 835 619 619
Financial liabilities:
Deposits ........................... 95,815 95,650 102,604 102,672
Accrued interest payable ........... 281 281 206 206
Borrowed funds ..................... 1,000 1,000 -- --
Off-balance sheet financial instruments:
Commitments to extend
credit ................... -- 3,088 -- 2,012
</TABLE>
F-31
<PAGE>
SECURITY OF PENNSYLVANIA FINANCIAL
CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
19. YEAR 2000 RISKS (UNAUDITED)
Like virtually every organization, the Company is subject to risks
associated with the Year 2000 Issue (the "Issue"). The Issue is the
result of shortcomings in electronic data processing systems which
affect computer software and hardware, transactions with customers,
vendors and other organizations; and equipment dependent on microchips.
The Company is in the process of assessing and implementing necessary
changes related to the Issue but has not completed the process of
identifying and remediating potential year 2000 problems. It is not
possible for any organization to guarantee the results of its own
remediation efforts or to accurately predict the impact of the Issue on
third parties with which the Company does business.
Because of the unprecedented nature of the Issue, its effects and the
success of related remediation efforts will not be fully determinable
until the year 2000 and thereafter. Management cannot assure that the
Company is or will be year 2000 ready, that the Company's remediation
efforts will be successful in whole or in part, or that entities with
whom the Company does business will be year 2000 ready. If the Company's
efforts or those of third parties with which it does business are not
successful, the Issue could adversely affect the Company's operations
and financial condition.
- --------------------------------------------------------------------------------
F-32
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information relating to Directors, Executive Officers,
Promoters and Control Persons of the Registrant is incorporated herein by
reference to the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on October 25, 1999 at pages 4 through 6 and 9.
ITEM 10. EXECUTIVE COMPENSATION.
The information relating to executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held in October 25, 1999 at pages 7 through
9.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information relating to security ownership of certain
beneficial owners and management is incorporated herein by reference to the
Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held
on October 25, 1999, at page 5.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information relating to certain relationships and related
transactions is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on October 25, 1999,
at pages 9 through 10.
37
<PAGE>
PART IV
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements
The following consolidated financial statements of the Company
and its subsidiaries are filed as part of this document under Item 7:
o Independent Auditors' Report
o Consolidated Balance Sheet as of June 30, 1999 and 1998
o Consolidated Statement of Income for the Years Ended June
30, 1999, 1998 and 1997
o Consolidated Statement of Changes in Stockholders'
Equity for the Years Ended June 30, 1999, 1998 and 1997
o Consolidated Statement of Cash Flows for the Years Ended
June 30, 1999, 1998 and 1997
o Notes to Consolidated Financial Statements
(a) 2. Financial Statement Schedules
Financial Statement Schedules have been omitted because they
are not applicable or the required information is shown in the Consolidated
Financial Statements or notes thereto.
(b) Reports on Form 8-K filed during the last quarter of 1999
No reports were filed on Form 8-K during the last quarter of
1999.
(c) Exhibits Required by Securities and Exchange Commission
Regulation S-B
Exhibit
Number
- --------
2.1 Amended Plan of Conversion (including the Stock Articles of
Incorporation and Bylaws of the Security Savings Association
of Hazleton) (1)
3.1 Certificate of Incorporation of Security of Pennsylvania
Financial Corp. (1)
3.2 Bylaws of Security of Pennsylvania Financial Corp. (1)
10.1 Employment Agreement between Richard C. Laubach and Security
of Pennsylvania Financial Corp.(2)
10.2 Employment Agreement between Richard C. Laubach and Security
Savings Association of Hazleton(2)
10.7 Form of Security Savings Association Supplemental Executive
Retirement Plan (1)
10.8 Form of Security Savings Association of Hazleton Employee
Severance Compensation Plan (1)
27.0 Financial Data Schedule
- -------------------------
(1) Incorporated by reference into this document from the Exhibits filed
with the Registration Statement on Form SB-2, and any amendments
thereto, Registration No. 333-63271.
(2) Incorporated by reference into the document from the Exhibits filed
with the Form 10-QSB for the quarter ended December 31, 1998.
38
<PAGE>
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.
SECURITY OF PENNSYLVANIA FINANCIAL CORP.
/s/ Richard C. Laubach
-----------------------------------------------
Richard C. Laubach
President, Chief Executive Officer and Director
In accordance with the requirements of the Securities Act of
1933, this Registration Statement was signed by the following persons in the
capacities and on the dates stated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ Richard C. Laubach President, Chief Executive September 16, 1999
- ---------------------------- Officer and Director
Richard C. Laubach (principal executive officer)
/s/ David P. Marchetti, Sr. Chief Financial Officer September 16, 1999
- ---------------------------- and Treasurer (principal accounting
David P. Marchetti, Sr. and financial officer)
/s/ Vincent L. Marusak Chairman of the Board September 16, 1999
- ----------------------------
Vincent L. Marusak
/s/ Frederick L. Barletta Director September 16, 1999
- ----------------------------
Frederick L. Barletta
/s/ Peter B. Deisroth Director September 16, 1999
- ----------------------------
Peter B. Deisroth
/s/ George J. Hayden Director September 16, 1999
- ----------------------------
George J. Hayden
/s/ Joseph E. Lundy Director September 16, 1999
- ----------------------------
Joseph E. Lundy
/s/ John J. Raynock Director September 16, 1999
- ----------------------------
John J. Raynock
/s/ Anthony P. Sidari Director September 16, 1999
- ----------------------------
Anthony P. Sidari
</TABLE>
39
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the Annual
Report on Form 10-KSB and is qualified in its entirety by reference to the
audited consolidated financial statements contained therein.
</LEGEND>
<CIK> 0001069880
<NAME> SECURITY OF PENNSYLVANIA FINANCIAL CORP.
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<EXCHANGE-RATE> 1
<CASH> 1,853
<INT-BEARING-DEPOSITS> 13,383
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 27,454
<INVESTMENTS-CARRYING> 1,492
<INVESTMENTS-MARKET> 27,424
<LOANS> 73,280
<ALLOWANCE> 419
<TOTAL-ASSETS> 119,531
<DEPOSITS> 95,815
<SHORT-TERM> 1,000
<LIABILITIES-OTHER> 174
<LONG-TERM> 0
16
0
<COMMON> 0
<OTHER-SE> 22,499
<TOTAL-LIABILITIES-AND-EQUITY> 119,531
<INTEREST-LOAN> 5,549
<INTEREST-INVEST> 1,054
<INTEREST-OTHER> 1,502
<INTEREST-TOTAL> 7,799
<INTEREST-DEPOSIT> 4,098
<INTEREST-EXPENSE> 4,098
<INTEREST-INCOME-NET> 3,701
<LOAN-LOSSES> 62
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 3,656
<INCOME-PRETAX> 336
<INCOME-PRE-EXTRAORDINARY> 234
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 234
<EPS-BASIC> 0.04
<EPS-DILUTED> 0.04
<YIELD-ACTUAL> 0.20
<LOANS-NON> 1,291
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 452
<CHARGE-OFFS> 110
<RECOVERIES> 15
<ALLOWANCE-CLOSE> 419
<ALLOWANCE-DOMESTIC> 419
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
