U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________________ to ___________________.
Commission file Number: 33-71712
FIRST LEHIGH CORPORATION
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(Exact name of small business issuer as specified in its charter)
Pennsylvania
--------------------------------------------------------------
(State or other jurisdiction of incorporation or organization)
23-2218479
------------------------------------
(I.R.S. Employer Identification No.)
1620 Pond Road
Allentown, Pennsylvania 18104
----------------------------------------
(Address of principal executive offices)
(Zip Code)
(610) 398-6660
---------------------------
(Issuer's telephone number)
Not Applicable
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(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act of 1934 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
--- ---
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the issuer's classes of common equity, as of the latest
practicable date: 2,000,000 shares of common stock, par value $.01 per share, as
of September 30, 1997.
Transitional Small Business Disclosure Format (check one):
Yes No X
--- ---
<PAGE>
FIRST LEHIGH CORPORATION
FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
INDEX
Part I - Financial Information Page Number
- ------------------------------ -----------
Item 1. Financial Statements:
Consolidated Balance Sheet as of September 30, 1997
and December 31, 1996........................................ 3
Consolidated Statements of Income for the nine months ended
September 30, 1997 and 1996................................. 4- 5
Consolidated Statements of Income for the three months ended
September 30, 1997 and 1996................................. 6- 7
Consolidated Statement of Cash Flows for the nine months ended
September 30, 1997 and 1996................................. 8- 9
Consolidated Statement of Cash Flows for the three months ended
September 30, 1997 and 1996................................. 10-11
Notes to Consolidated Financial Statements.................... 12-18
Item 2. Management's Discussion and Analysis or Plan of Operations..... 19-37
Part II - Other Information
- ---------------------------
Item 1. Legal Proceedings.............................................. 38-39
Item 6. Exhibits and Reports on Form 8-K............................... 40
Signatures.................................................... 41
2
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FIRST LEHIGH CORPORATION
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
(in thousands)
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks .......................................... $ 7,235 $ 2,861
Federal funds sold ............................................... 719 1,759
-------- --------
Cash and cash equivalents ....................... 7,954 4,620
Securities held-to-maturity (estimated fair
value of $3,954 and $3,899, respectively) ....................... 4,087 4,091
Securities available-for-sale .................................... 20,415 21,922
Trading securities ............................................... 6,687 6,309
Loans and leases ................................................. 67,407 66,434
Less: unearned income ......................................... (289) (436)
allowance for loan losses ............................... (1,571) (1,624)
-------- --------
Net loans and leases ............................ 65,547 64,374
Premises and equipment, net ...................................... 2,233 2,022
Real estate and other investments ................................ 0 47
Foreclosed assets held for sale .................................. 4,025 4,850
Other assets ..................................................... 2,612 2,045
-------- --------
Total Assets .................................... $113,560 $110,280
======== ========
LIABILITIES
Deposits:
Noninterest-bearing ........................................... $ 10,553 $ 10,086
Interest-bearing .............................................. 87,751 85,853
-------- --------
Total Deposits .................................. 98,304 95,939
Other liabilities ................................................ 917 859
Other borrowed funds ............................................. 0 1,200
Long-term debt ................................................... 190 272
-------- --------
Total Liabilities ............................... 99,411 98,270
-------- --------
SHAREHOLDERS' INVESTMENT
Senior preferred stock, par value of $.01 per share,
1,500,000 shares authorized, 900,363 shares issued and
outstanding .................................................... 9 9
Series A preferred stock, par value $.01 per share,
1,000,000 shares authorized; 682,000 shares issued and
outstanding (liquidation preference of $2,114) ................. 7 7
Common stock, par value $.01 per share, 10,000,000
authorized; 2,000,000 shares issued and outstanding ............ 20 20
Contributed capital in excess of par value ....................... 9,021 9,021
Retained earnings ................................................ 5,173 3,227
Unrealized depreciation on securities available-for-sale ......... (81) (274)
-------- --------
Total Shareholders' Investment .................. 14,149 12,010
-------- --------
Total Liabilities and Shareholders' Investment... $113,560 $110,280
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
FIRST LEHIGH CORPORATION
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
---------- ----------
(in thousands, except per share data)
(Unaudited)
<S> <C> <C>
INTEREST INCOME:
Interest and fees on loans.................................................... $ 4,442 $ 4,216
Interest and dividends on investment securities:
Taxable interest income ..................................................... 1,281 1,204
Dividends ................................................................... 120 200
Interest on federal funds sold ............................................... 108 78
---------- ----------
Total Interest Income ...................................... 5,951 5,698
---------- ----------
INTEREST EXPENSE:
Interest on deposits ......................................................... 2,701 2,660
Interest on other borrowed funds ............................................. 15 41
Interest on long-term debt ................................................... 16 23
---------- ----------
Total Interest Expense ..................................... 2,732 2,724
---------- ----------
NET INTEREST INCOME .......................................................... 3,219 2,974
PROVISION (CREDIT) FOR LOAN LOSSES ........................................... 603 (667)
---------- ----------
NET INTEREST INCOME AFTER PROVISION (CREDIT)
FOR LOAN LOSSES ............................................................. 2,616 3,641
---------- ----------
OTHER INCOME:
Service charges, fees and other income ....................................... 367 369
Gain on sale of foreclosed assets, net ....................................... 75 46
Gain on sale of real estate investment ....................................... 183 53
Realized gains on investment securities, net ................................. 17 0
Trading securities gains, net................................................. 2,990 842
Litigation Settlement ........................................................ 0 1,539
---------- ----------
Total Other Income ......................................... 3,632 2,849
---------- ----------
OTHER EXPENSES:
Salaries and employee benefits................................................ 1,142 954
Net occupancy expense......................................................... 321 398
Equipment expense............................................................. 158 158
FDIC insurance ............................................................... 96 116
Foreclosed asset expenses .................................................... 482 510
Other ........................................................................ 1,364 1,616
---------- ----------
Total Other Expenses ....................................... 3,563 3,752
---------- ----------
</TABLE>
4
<PAGE>
<TABLE>
<S> <C> <C>
INCOME BEFORE PROVISION FOR INCOME TAXES...................................... 2,685 2,738
PROVISION FOR INCOME TAXES.................................................... 0 0
---------- ----------
NET INCOME.................................................................... $2,685 $2,738
========== ==========
PRIMARY EARNINGS PER SHARE.................................................... $ 0.81 $ 0.85
========== ==========
FULLY DILUTED EARNINGS PER SHARE.............................................. $ 0.68 $ 0.71
========== ==========
WEIGHTED AVERAGE COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING:
Primary.................................................................... 2,900,363 2,848,902
Fully Diluted.............................................................. 3,466,893 3,414,502
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE>
FIRST LEHIGH CORPORATION
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1996
---------- ----------
(in thousands, except per share data)
(Unaudited)
<S> <C> <C>
INTEREST INCOME:
Interest and fees on loans.................................................... $ 1,482 $ 1,468
Interest and dividends on investment securities:
Taxable interest income ..................................................... 406 434
Dividends ................................................................... 35 59
Interest on federal funds sold ............................................... 62 20
---------- ----------
Total Interest Income ...................................... 1,985 1,981
---------- ----------
INTEREST EXPENSE:
Interest on deposits ......................................................... 934 897
Interest on other borrowed funds ............................................. 0 24
Interest on long-term debt ................................................... 5 7
---------- ----------
Total Interest Expense ..................................... 939 928
---------- ----------
NET INTEREST INCOME .......................................................... 1,046 1,053
PROVISION FOR LOAN LOSSES .................................................... 513 0
---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES ............................................................. 533 1,053
---------- ----------
OTHER INCOME:
Service charges, fees and other income ....................................... 123 121
Gain on sale of foreclosed assets, net ....................................... 49 28
Trading securities gains, net ............................................... 1,478 576
---------- ----------
Total Other Income ......................................... 1,650 725
---------- ----------
OTHER EXPENSES:
Salaries and employee benefits................................................ 423 320
Net occupancy expense......................................................... 108 131
Equipment expense ............................................................ 51 55
FDIC insurance ............................................................... 10 38
Foreclosed asset expenses .................................................... 320 140
Other ........................................................................ 542 632
---------- ----------
Total Other Expenses ....................................... 1,454 1,316
---------- ----------
</TABLE>
6
<PAGE>
<TABLE>
<S> <C> <C>
INCOME BEFORE PROVISION FOR INCOME TAXES...................................... 729 462
PROVISION FOR INCOME TAXES.................................................... 0 0
---------- ----------
NET INCOME.................................................................... $ 729 $ 462
========== ==========
PRIMARY EARNINGS PER SHARE.................................................... $ 0.21 $ 0.12
========== ==========
FULLY DILUTED EARNINGS PER SHARE.............................................. $ 0.18 $ 0.10
========== ==========
WEIGHTED AVERAGE COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING:
Primary.................................................................... 2,900,363 2,848,902
Fully Diluted.............................................................. 3,466,893 3,414,502
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
7
<PAGE>
FIRST LEHIGH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
------ ------
(in thousands)
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................ $2,685 $2,738
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision (credit) for loan losses ........................ 603 (667)
Provision for foreclosed asset losses ..................... 222 160
Depreciation .............................................. 131 122
Amortization and accretion ................................ 11 69
Realized gain on investment securities, net ............... (17) 0
Net increase in trading securities ........................ (378) (950)
Gain on sale of foreclosed assets held for sale ........... (75) (46)
Gain on sale of real estate and other investments ......... (183) (397)
Gain on sale/disposal of equipment ........................ 0 (7)
Change in:
Other assets ........................................... (364) (162)
Other liabilities ...................................... (165) (29)
------ ------
NET CASH PROVIDED BY
OPERATING ACTIVITIES .................................. 2,470 831
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available-for-sale:
Proceeds from maturities ................................ 1,710 2,224
Proceeds from sales ..................................... 0 773
Purchase of securities .................................. 0 (3,999)
Net increase in loans and leases .......................... (3,476) (7,318)
Proceeds from sales of premises and equipment ............. 27 7
Capital expenditures for premises and equipment ........... (369) (38)
Proceeds from sales of foreclosed assets .................. 2,120 1,105
Capitalized expenditures for foreclosed assets ............ (81) (36)
Proceeds from sales of real estate and other investments... 174 614
Proceeds from sales of other assets ....................... 192 37
------ ------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES ................................... 297 (6,631)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits .................................. 2,365 2,908
Net increase (decrease) in other borrowed funds ........... (1,200) 2,400
Payment on long-term debt ................................. (82) (82)
Dividend payments ......................................... (516) 0
------ ------
NET CASH PROVIDED BY
FINANCING ACTIVITIES ..................................... 567 5,226
------ ------
</TABLE>
8
<PAGE>
<TABLE>
<S> <C> <C>
NET INCREASE (DECREASE)
IN CASH AND CASH EQUIVALENTS................................. 3,334 (574)
CASH AND CASH EQUIVALENTS, BEGINNING............................. 4,620 5,043
------ ------
CASH AND CASH EQUIVALENTS, ENDING................................ $7,954 $4,469
====== ======
SUPPLEMENTARY DISCLOSURE:
Cash paid for interest..................................... $2,729 $2,726
Cash paid for income taxes................................. $ 47 $ 0
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
On September 25, 1997, the Company's Board of Directors declared a dividend
on the outstanding shares of its Senior and Series A Preferred stock for the
stockholders of record at September 25, 1997. The Senior Preferred third quarter
1997 dividend of $56,273 and Series A Preferred third quarter 1997 dividend of
$55,498, as well as two quarters of Series A accumulated dividends of $110,995,
have been included in other liabilities.
The accompanying notes are an integral part of the consolidated financial
statements.
9
<PAGE>
FIRST LEHIGH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1996
------ ------
(in thousands)
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................ $ 729 $ 462
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses ................................. 513 0
Provision for foreclosed asset losses ..................... 222 0
Depreciation .............................................. 51 41
Amortization and accretion ................................ 4 19
Net decrease in trading securities ........................ 46 212
Gain on sale of foreclosed assets held for sale ........... (56) (28)
Loss on sale of real estate and other investments ......... 0 3
Change in:
Other assets ............................................ 180 (177)
Other liabilities ....................................... 14 (167)
------ ------
NET CASH PROVIDED BY
OPERATING ACTIVITIES .................................. 1,703 365
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available-for-sale:
Proceeds from maturities ................................. 84 69
Net increase in loans and leases .......................... (194) (1,117)
Capital expenditures for premises and equipment ........... (1) (2)
Proceeds from sales of foreclosed assets .................. 965 765
Capitalized expenditures for foreclosed assets ............ (2) (36)
Proceeds from sales of real estate and other investments... 0 97
Proceeds from sales of other assets ....................... 109 14
------ ------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES .................................. 961 (210)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits ....................... 345 (810)
Net increase (decrease) in other borrowed funds ........... (50) 550
Payment on long-term debt ................................. (28) (28)
Dividend Payments ......................................... (222) 0
------ ------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES ..................................... 45 (288)
------ ------
</TABLE>
10
<PAGE>
<TABLE>
<S> <C> <C>
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS......................................... 2,709 (133)
CASH AND CASH EQUIVALENTS, BEGINNING............................. 5,245 4,602
------ ------
CASH AND CASH EQUIVALENTS, ENDING................................ $7,954 $4,469
====== ======
SUPPLEMENTARY DISCLOSURE:
Cash paid for interest..................................... $ 936 $ 932
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
On September 25, 1997, the Company's Board of Directors declared a dividend
on the outstanding shares of its Senior and Series A Preferred stock for the
stockholders of record at September 25, 1997. The Senior Preferred third quarter
1997 dividend of $56,273 and Series A Preferred third quarter 1997 dividend of
$55,498, as well as two quarters of Series A accumulated dividends of $110,995,
have been included in other liabilities.
The accompanying notes are an integral part of the consolidated financial
statements.
11
<PAGE>
FIRST LEHIGH CORPORATION
FORM 10-QSB
Part I - Financial Information (Cont'd)
Part 1. - Financial Statements (Cont'd)
Notes to Consolidated Financial Statements
1. SIGNIFICANT ACCOUNTING POLICIES:
FINANCIAL STATEMENT PRESENTATION:
The consolidated interim financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission with respect to Form 10-QSB. The
financial information included herein reflects all adjustments (consisting
solely of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair statement of results for the interim periods. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the disclosures made herein are adequate to make the
information not misleading. It is suggested that these interim financial
statements be read in conjunction with the financial statements and the notes
thereto included in the Company's Form 10-KSB for year-end December 31, 1996.
Interim statements are subject to possible adjustments in connection with
the annual audit of the Company's accounts for the full fiscal year 1997. In the
Company's opinion, all adjustments necessary in order to make the interim
financial statements not misleading have been included.
The results of operations for the interim periods presented are not
necessarily indicative of the results expected for the year ending December 31,
1997.
PRINCIPLES OF CONSOLIDATION
First Lehigh Corporation and its subsidiary First Lehigh Bank (the "Bank")
and the Bank's subsidiaries (Allentown Properties, Inc., Quakertown Properties,
Inc., Walnutport Properties, Inc., Walnutport Properties II, Inc., Pond Road
Properties, Inc. and Winchester Property Management Co.) (collectively, the
"Company") provide commercial banking services. The consolidated financial
statements include the accounts of the First Lehigh Corporation and its direct
and indirect subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
12
<PAGE>
INVESTMENT SECURITIES
Investments in debt and equity securities are classified in three
categories, held-to-maturity securities, trading securities, and
available-for-sale securities. Classification in these categories requires,
respectively, accounting for securities at amortized cost, accounting for
securities at fair value with unrealized gains and losses included in earnings,
and accounting for securities at fair value with unrealized gains and losses
excluded from earnings and reported in a separate component of shareholders'
investment.
LOANS
Interest on loans is accrued and credited to income based upon the
principal amount outstanding and using the interest method for amortizing
unearned income on certain installment loans.
The accrual of interest income is generally discontinued on loans past due
90 days or more or when there is a reasonable doubt as to the collection of
interest. The Company continues the accrual of interest on loans past due 90
days or more when they are well secured and in the process of collection. When
interest accruals are discontinued, uncollected interest credited to income is
reversed if the collectibility is not certain.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are carried at the lower of aggregate cost or
market.
LOAN FEES
Fees collected upon loan origination and certain direct costs of
originating loans are deferred and recognized as adjustments to income over the
contractual lives of the related loans as yield adjustments. Upon prepayment or
other disposition of the underlying loans before their contractual maturities,
any associated unamortized fees or costs are recognized. Prior to 1988, such
fees and costs were included in income when collected or paid.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate by
management to absorb potential losses in the loan portfolio. Management's
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, past loan loss experience, current economic conditions, volume,
growth and composition of the loan portfolio, and other relevant factors.
13
<PAGE>
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation
and amortization. The provision for depreciation and amortization is computed
generally using the straight-line method.
FORECLOSED ASSETS HELD FOR SALE
Foreclosed assets held for sale are carried at the lower of fair value
minus costs to sell or cost. The provision for foreclosed asset losses and the
costs of holding and maintaining the property are included in the statement of
income caption "Foreclosed asset expenses."
INCOME TAXES
At September 30, 1997 the Company has available approximately $3.350
million of net operating losses based on its filed tax returns through December
31, 1996, which begin to expire 2007 if not utilized. No tax benefit related to
the unused net operating loss carry forward has been recognized in these
financial statements except for the reduction of the provision for income taxes
due to the availability of the net operating losses.
EARNINGS AND CASH DIVIDENDS PER SHARE
Primary earnings per common share is based on the weighted average common
shares and common share equivalents outstanding during the period. Net income
applicable to common stock is reduced by current year dividends declared and
unpaid or in arrears on both the Senior and Series A preferred stock. The
calculation of fully diluted earnings per common share is based on the
conversion of the Series A preferred stock into common shares at the rate of .8
shares of common stock for each share of Series A preferred stock. The
conversion rate of Series A preferred stock changed from .8 to .72 in March
1996. However, the Board of Directors has approved an amendment that would
retain the .8 conversion rate until March 1999, subject to shareholder approval.
For purposes of this calculation the conversion rate of .8 was used. The Senior
preferred shares are common stock equivalents since their effective yield was
less than 66.6% of an average Aa corporate bond yield at the time of issuance.
STATEMENT OF CASH FLOWS
The Company transferred approximately $1.361 million from loans to
foreclosed assets held for sale during the nine months ended September 30, 1997.
14
<PAGE>
LONG TERM DEBT
The Company has a term note due June 1999 with an outstanding balance of
$190,284 at September 30, 1997. Principal payments of $9,100 plus interest, at
the lenders commercial rate plus 0.6%, are due monthly. The note is secured by
less than 10% of the shares of the Bank which are owned by the Company.
REGULATORY MATTERS
Regulatory Enforcement Actions to Which the Company and the Bank Are
Subject
The Company and the Bank are subject to and have consented to the following
regulatory orders and agreements: (i) effective February 28, 1996, the Company
and the Bank entered into an Administrative Order (the "Pennsylvania Order")
with the Pennsylvania Department of Banking (the "Department"), which replaced
an earlier order entered into in 1993; (ii) on April 29, 1996 the Bank entered
into a Memorandum of Understanding (the "Memorandum of Understanding") with the
FDIC, which has replaced two cease and desist orders dating from October 1987
and June 1992; and (iii) in January 1991, the Company consented to a written
agreement (the "Federal Reserve Agreement") with the Federal Reserve Bank and
the Department.
The following is a discussion of the material terms and provisions of the
Pennsylvania Order, the Memorandum of Understanding and the Federal Reserve
Agreement.
The Pennsylvania Order
Capital Requirements and Dividend Restrictions
Under the terms of the Pennsylvania Order, the Bank is required to
maintain, at all times, a minimum Tier I capital equal to or greater than 6.5%
of the Bank's adjusted total assets, plus a fully-funded loan loss reserve. The
Bank must provide the Pennsylvania Department of Banking with a quarterly report
detailing the maintenance of a 6.5% Tier I capital ratio and a "fully-funded
loan loss reserve". As of September 30, 1997, the Bank's Tier I capital ratio
was 12.05%. The Bank is required to maintain a formal program to review the
adequacy of the Bank's allowance for loan and lease losses. The Bank may not
declare or pay any cash dividend without the prior written approval of the
Department and the Regional Director of the FDIC.
Credit Limitations and Restrictions
The following credit limitations and restrictions were imposed under the
Pennsylvania Order: (i) the Bank may not grant, extend, renew, alter or
restructure any loan or other extension of credit without first obtaining and
analyzing all relevant credit information, as well as taking all necessary steps
to properly value and perfect its interests in collateral, where applicable;
(ii) the Bank may not extend, directly or, indirectly, any new or additional
credit (which for the purposes of the Pennsylvania Order, includes the granting
of renewals or extensions, or the capitalizing of accrued interest) to, or for
the benefit of, any borrower who is obligated in any manner to the Bank on any
15
<PAGE>
extension of credit, or portion thereof, which has been charged off the books of
the Bank, in whole or in part, or to any affiliate or related interest of, or
other person or entity associated with, any such borrower, as long as any
portion of such extension of credit, whether or not the portion was charged off,
remains uncollected. The provisions of clause (ii) above do not apply to the
advancement of funds by the Bank for the sole purpose of maintaining or
protecting the Bank's real estate collateral if the failure to extend such
credit would otherwise be substantially detrimental to the best interests of the
Bank; (iii) the Bank may not extend, directly or indirectly, any new or
additional credit to, or for the benefit of, any borrower who is obligated in
any manner to the Bank on any loan or other extension of credit that has been
adversely classified, in whole or in part, by the Department in the report of
examination dated as of June 30, 1995, or as a result of any subsequent
examination of the Bank by the Department or the FDIC, or to any affiliate or
related interest of, or other person or entity associated with any such borrower
("classified borrower"), as long as such loan or other extension of credit
remains classified or uncollected. This clause (iii) does not prohibit the Bank
from renewing all or any part of an extension of credit to a classified borrower
who is not subject to the prohibitions of clause (ii), after collection in cash
of interest due on the entire extension of credit. The prohibitions of clause
(iii) do not apply to any extension of credit to a classified borrower who is
not subject to the prohibitions of clause (ii) above, if the Bank's failure to
extend further credit to a classified borrower would be substantially
detrimental to the best interests of the Bank, which determination must be
evidenced in writing in the applicable loan files; and (iv) the Bank must comply
fully and at all times with the provisions of section 1415 of the Banking Code
of 1965, as amended, relating to loans to executive officers and directors.
Performance Objectives
The following performance objectives were also stated in the Pennsylvania
Order: (i) the Bank must reduce the level of nonaccrual loans to total gross
loans noted in the Report of Examination as of June 30, 1995, to no more than 7%
by August 26, 1996, and further reduce such ratio to no more than 4% by November
24, 1996 and 2% by February 22, 1997; and (ii) the Bank must reduce the level of
classified assets as of June 30, 1995, to no more than 100% of Tier I capital
and reserve for loan and lease losses by August 26, 1996, and further reduce
such ratio to 75% by November 24, 1996 and 50% by February 22, 1997. As of
September 30, 1997, the Bank's level of nonaccrual loans to gross loans was
0.105%, and the Bank's level of classified assets to Tier I capital and reserve
for loan and lease losses was 23.68%.
Reporting and Other Requirements
Other affirmative measures required to be taken by the Bank under the
Pennsylvania Order are as follows: (i) the Bank is required to submit quarterly
progress reports, no later than 30 days following the last day of each calendar
quarter; (ii) the Bank must comply with all state and federal laws that relate
to the operation of the Bank; (iii) the Bank must have and retain qualified
management, must notify the Secretary of Banking in writing of any resignations
and/or terminations of any members of its Board of Directors and/or any of its
senior executive officers and must obtain prior written approval from the
Department for any new Directors or senior executive officers; (iv) and the Bank
must maintain a written investment policy in a form and manner acceptable to the
Secretary of Banking, as determined at subsequent examinations or visitations.
16
<PAGE>
Status of Compliance with the Pennsylvania Order
The Company believes that it and the Bank are currently in compliance with
the Pennsylvania Order. The Pennsylvania Order required the Bank to reduce the
level of nonaccrual loans to total gross loans noted in the report of
examination as of June 30, 1995, to no more than 2% by February 22, 1997. As of
September 30, 1997, this ratio was 0.105%. Additionally, the Order requires the
Bank to reduce the level of classified assets as of June 30, 1995, to no more
than 50% of Tier I capital and the reserve for loan and lease losses by February
22, 1997, with further reductions thereafter. As of September 30, 1997, this
ratio was 23.68%. The Pennsylvania Order also contains a provision requiring the
Bank to maintain, at all times, a minimum Tier I capital equal to or greater
than 6.5% of the Bank's adjusted total assets, plus a fully-funded loan loss
reserve. As of September 30, 1997 this ratio was 12.05% and the Bank's loan loss
reserve was fully funded.
The Memorandum of Understanding
Capital Requirements and Dividend Restrictions
The Memorandum of Understanding requires the Bank maintain its Tier I
capital at an amount equal to or greater than 6.0% of the Bank's adjusted total
assets. During the term of the Memorandum of Understanding, the Bank may not
declare or pay dividends without the prior written approval of the FDIC, which
declarations and payments must be made in accordance with applicable laws and
regulations, and may be made only if after such payments the ratio of Tier I
capital to adjusted total assets will be not less than 6.0%.
Credit Limitations and Restrictions
Under the terms of the Memorandum of Understanding, the Bank is prohibited
from extending credit, either directly or indirectly to, or for the benefit of
any borrower who is obligated in any manner to the Bank on any extension of
credit, or portion thereof, which has been charged off the books of the Bank.
The Bank is also prohibited from extending credit to, or for the benefit of any
borrower who is obligated in any manner to the Bank on any extension of credit
that has been classified, in whole or in part, as a result of the examination of
the Bank as of June 30, 1995. These prohibitions will not apply if the Bank
determines that failure to extend further credit would be substantially
detrimental to the institution.
Reporting and Other Requirements
The Bank was required to charge-off assets classified as "Loss" or
"Doubtful" as of June 30, 1995 by May 9, 1996, and, within 30 days of receipt of
future FDIC Reports of Examination, charge-off assets classified "Loss" or
"Doubtful." The Bank was required to submit a Classified Asset Reduction Plan to
the FDIC by May 29, 1996. Also, the Bank was required (i) to adopt a method of
computing the balance of its allowance for loan and lease losses that gives
consideration to the volume and composition of the loan portfolio; (ii) to adopt
and implement a written earnings plan and (iii) revise, adopt and implement
written lending and investment policies in a form and manner acceptable to the
FDIC as determined at subsequent examinations. The Bank is required to review
the adequacy of the loan loss allowance quarterly and submit progress reports to
the Regional
17
<PAGE>
Director of the FDIC detailing the form, content, and manner of any actions
taken to secure compliance with the Memorandum of Understanding on a quarterly
basis.
Status of Compliance with the Memorandum of Understanding
The Bank is currently in compliance with the requirements of the Memorandum
of Understanding. As of September 30, 1997 the Bank's Tier I capital ratio was
12.05%, which is greater than the 6.0% ratio required by the Memorandum of
Understanding. The Bank has made necessary charge-offs and revised and adopted
its credit and investment policies. The earnings improvement plan required has
been prepared and submitted.
The Federal Reserve Agreement
Requirements and Dividend Restrictions
Under the Federal Reserve Agreement, the Company is subject to the
following requirements: (i) the Board of Directors of the Company was required
to establish a compliance committee consisting of three directors who were not
officers or principal shareholders of the Company, which would be responsible
for monitoring and coordinating the Company's adherence to the Federal Reserve
Agreement and submit quarterly progress reports to the Company's Board of
Directors; (ii) the Company is not permitted to declare or pay any dividends
without the prior written approval of the Federal Reserve Bank and the
Department; (iii) the Board of Directors of the Company was required to conduct
a review of the functions and performance of the officers of the Company and the
Bank and forward its written findings and conclusions along with a written
description of proposed management or operational changes; (iv) the Company was
required to submit a capital plan; (v) the Company is not permitted to redeem or
repurchase its outstanding preferred and common stock without 30 days prior
written notice to the Federal Reserve Bank and the Department; (vi) the Company
may not incur any additional debt without the written approval of the Federal
Reserve Bank and the Department; (vii) the Company was required to develop
written procedures to strengthen and maintain in a satisfactory manner its
records and audit functions; and (viii) the Company and the Bank are required to
submit quarterly reports to the Federal Reserve Bank and the Department.
Status of Compliance with the Federal Reserve Agreement
According to information received from the Federal Reserve Bank, the
Company believes that it is currently in substantial compliance with the Federal
Reserve Agreement. The Company received permission from the Federal Reserve Bank
to issue the shares of Senior Preferred Stock in lieu of accumulated dividends
on its outstanding shares of Senior Preferred Stock for the periods ending
December 31, 1994 and December 31, 1995. Also, the Company received permission
from the Federal Reserve Bank to pay cash dividends to its Senior Preferred
stockholders for the first, second and third quarters of 1997 and all dividends
in arrears amounting to $237,542. In addition, the Company received permission
from the Federal Reserve Bank to pay cash dividends to its Series A stockholders
for the second and third quarters of 1997 as well as four quarters of dividends
previously in arrears in the amount of $221,990.
18
<PAGE>
FIRST LEHIGH CORPORATION
FORM 10-QSB
Part I - Financial Information (Cont'd)
Item 2. - Management's Discussion and Analysis or Plan of Operations:
The consolidated financial review of the Company is intended to compare the
performance of the Company for the periods ended September 30, 1997 and 1996.
The review of the information presented should be read in conjunction with the
consolidated financial statements and the accompanying notes.
OVERVIEW
The Company's total assets were $113.56 million at September 30, 1997, an
increase of $3.28 million from December 30, 1996. The increase in net assets was
primarily the result of an increase in cash funded in part by an increase in the
Bank's deposit base.
The Company reported net income of $2.685 million, or $0.81 per share for
the nine months ended September 30, 1997 as compared to $2.738 million, or $0.85
per share for the same period in 1996. The majority of the net income was
attributable to trading security gains in 1997, while the litigation Settlement
was the primary source in 1996.
During 1997, the Bank continued its program to dispose of foreclosed assets
and reduce its nonperforming and/or classified assets, which resulted in a net
decrease of $2.40 million. The proceeds from these activities were invested in
performing assets contributing to an increase in the Bank's net interest income.
In January 1996, the Bank instituted a new consumer loan program, pursuant
to which it signed agreements with several auto dealers to originate their
dealer paper. The Bank incurred unanticipated losses during the third quarter of
1997, when the Bank charged off $244,000 of consumer loans and provided an
additional provision of $513,000 for loan losses, of which the provision for the
auto loan segment was $232,000. Furthermore, the Bank's management concluded
after reviewing the detail analysis of the indirect paper portfolio that its net
yield before these losses was comparable to other consumer loan portfolios with
lesser degree of risk. Therefore, effective August 1997, the Bank discontinued
this auto dealer program. The Bank has added two additional employees within its
credit and collection department to continually monitor and work this segment of
this loan portfolio to provide against future losses.
On October 30, 1997, the Bank will finalize the sale of the deposits of the
Quakertown branch to The Quakertown National Bank, the sole subsidiary of QNB
Corporation. The Company had filed a report on Form 8-K on July 3, 1997 to
report under Item 5 that the Bank had entered into this Branch Purchase
Agreement with The Quakertown National Bank.
19
<PAGE>
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1997 TO
NINE MONTHS ENDED SEPTEMBER 30, 1996
NET INCOME
Net income for the first nine months of 1997 was $2.685 million compared to
$2.738 million for the same period in 1996, a decline of $53,000, or 1.94%. Net
interest income increased $245,000, primarily attributable to higher interest
income and fees earned on loans while interest costs remain static between
periods. The provision for loan losses amounted to $603,000 for the first three
quarters of 1997 as compared to $667,000 credit recorded for the same period in
1996, primarily the result of a large recovery recorded during the second
quarter of 1996. Other income increased $783,000 during the nine months ended
September 30, 1997 as compared to the same period in 1996 due to two significant
items. During May 1996, the Company recorded $1,539,000 as other income
resulting from a litigation settlement (the "Settlement") with respect to a
large impaired loan. This nonrecurring Settlement amount was mitigated in the
first three quarters of 1997 by an increase in the gains recognized on the
trading securities of $2,148,000 as compared to the same period in 1996. Other
expenses declined $189,000 during the first nine months of 1997 as compared to
the same period in 1996, mostly as the result of decreased legal expenses
pertaining to FDIC litigation involving the Company's Chairman and CEO and the
Bank's former president.
The profit performance for financial institutions is measured by the Return
on Average Assets ("ROA") and the Return on Average Equity ("ROE"). On an
annualized basis the Company's ROA was 3.20% in 1997 as compared to 3.41% in
1996. The ROE was 27.25% for the first three quarters of 1997 compared to 33.20%
in 1996.
NET INTEREST INCOME
Net interest income is the difference between interest income and fees on
earning assets and interest expense on deposits and borrowed funds. The
principal components of earning assets are loans and investment securities. The
primary sources used to fund these assets were deposits, borrowed funds, and
capital.
During the first nine months of 1997, interest and fee income on loans
increased $226,000, or 5.36%, over the same period in 1996, mostly due to
increased average loan balance of $5.86 million, or 10.0%. The average loan
balance has continually grown since the Bank instituted a consumer loan program
initiative which was directed to the local auto dealers and their credit-worthy
customers during the period of January 1996 to July 1997. The Bank has
continually monitored the performance of the auto segment of its consumer loan
program and believes that the additional direct and indirect costs associated
with this segment has produced a marginal return. Therefore, effective August
1997, the Bank has discontinued its indirect auto loan program. The yield on
loans decreased 40 basis points to 9.20% during the nine months ended September
30, 1997 as compared to the same period in 1996. The decrease in the interest
yield is attributable to management's evaluation of certain loans and the
related accrued interest which it determined that collection is uncertain and,
therefore, reversed $112,000 of interest income in 1997. In 1996, the opposite
occurred in which
20
<PAGE>
$85,000 of previously discontinued accrued interest was collected ($58,000
directly attributable to the Settlement) producing a higher yield on the average
loan balance.
Interest expense on deposits was static at approximately $2.7 million for
the first nine months of 1997 and 1996. The average balance of time deposits
increased $2.35 million in 1997 over the same period in 1996. The majority of
the increase is attributable to two certificates of deposit promotions aimed at
attracting new deposits. The first promotion occurred in October 1996, while the
second occurred in the second and third quarters of 1997 and coincided with the
opening of its new Pond Road Branch office. The increase in the average deposits
was mitigated by a decrease in interest paid on savings deposits and time
deposits of 10 and 5 basis points, respectively, during 1997 as compared to
1996. The decrease in the time deposits interest rates was mostly attributable
to 1995 two-year certificates repricing at lower rates in 1997.
For the first nine months of 1997, the average yield on interest-earning
assets decreased 15 basis points, while the cost of interest-bearing liabilities
declined 5 basis points, resulting in a net decrease in the interest rate spread
of 10 basis points. The net yield on interest-earning assets increased 7 basis
points during the first nine months of 1997 mostly due to an increase in net
interest income of $245,000 as discussed above.
21
<PAGE>
Distribution of Interest-Earning Assets and Interest-Bearing Liabilities:
Interest Rates and Interest Differential
The following tables set forth, for the periods indicated, information
regarding: (a) the average balances of asset and liability categories; (b) the
total dollar amount of interest income from interest from interest-earning
assets (including mortgage loan origination fees representing yield adjustments)
and the resulting average yields; (c) the total dollar amount of interest
expense on interest-bearing liabilities and resulting average costs; (d) net
interest income; (e) interest rate spread; (f) net interest margin on
interest-earning assets; and (g) the ratio of average interest-earning assets
to average interest-bearing liabilities. Average balances are based on daily
balances.
<TABLE>
<CAPTION>
For the Nine Months ended September 30,
(in thousands)
------------------------------------------------------------------------------
1997 1996
------------------------------------ -------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans (1) $64,409 $4,442 9.20% $58,550 $4,216 9.60%
Investment securities 30,504 1,401 6.12% 31,124 1,404 6.01%
Overnight funds 2,598 108 5.54% 1,955 78 5.33%
------- ------ ------ ------- ------ ------
Total interest-earning assets $97,511 $5,951 8.14% $91,629 $5,698 8.29%
======= ------ ------ ======= ------ ------
INTEREST-BEARING
LIABILITIES:
Saving deposits $36,062 $ 724 2.68% $36,276 $ 754 2.78%
Time deposits 50,384 1,977 5.25% 48,037 1,906 5.30%
Other borrowed funds 338 15 5.85% 926 41 5.82%
Long-term debt 231 16 9.13% 340 23 8.89%
------- ------ ------ ------- ------ ------
Total interest-bearing liabilities $87,015 $2,732 4.20% $85,579 $2,724 4.25%
======= ------ ------ ======= ------ ------
NET INTEREST INCOME $3,219 $2,974
====== ======
INTEREST RATE SPREAD 3.94% 4.04%
====== ======
NET INTEREST MARGIN
ON INTEREST-EARNING
ASSETS (2) 4.40% 4.33%
====== ======
RATIO OF AVERAGE INTEREST-
EARNING ASSETS TO
AVERAGE INTEREST-BEARING
LIABILITIES 112.06% 107.07%
====== ======
</TABLE>
- ----------
(1) For the purpose of these computations, nonaccrual loans are not included in
the daily average loan amounts outstanding.
(2) Net interest income divided by average interest-earning assets.
22
<PAGE>
<TABLE>
<CAPTION>
For the Nine Months ended September 30,
(in thousands)
------------------------------------------------------------------------------
1996 1995
------------------------------------ -------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans (1) $58,550 $4,216 9.60% $52,922 $3,825 9.64%
Investment securities 31,124 1,404 6.01% 30,235 1,301 5.74%
Overnight funds 1,955 78 5.33% 2,355 104 5.89%
------- ------ ------ ------- ------ ------
Total interest-earning assets $91,629 $5,698 8.29% $85,512 $5,230 8.16%
======= ------ ------ ======= ------ ------
INTEREST-BEARING
LIABILITIES:
Saving deposits $36,276 $ 754 2.78% $36,002 $ 820 3.05%
Time deposits 48,037 1,906 5.30% 46,376 1,754 5.06%
Other borrowed funds 926 41 5.82% 840 42 6.59%
Long-term debt 340 23 8.89% 450 32 9.38%
------- ------ ------ ------- ------ ------
Total interest-bearing liabilities $85,579 $2,724 4.25% $83,668 $2,648 4.23%
======= ------ ------ ======= ------ ------
NET INTEREST INCOME $2,974 $2,582
====== ======
INTEREST RATE SPREAD 4.04% 3.93%
====== ======
NET INTEREST MARGIN
ON INTEREST-EARNING
ASSETS (2) 4.33% 4.03%
====== ======
RATIO OF AVERAGE INTEREST-
EARNING ASSETS TO
AVERAGE INTEREST-BEARING
LIABILITIES 107.07% 102.20%
====== ======
</TABLE>
- ----------
(1) For the purpose of these computations, nonaccrual loans are not included in
the daily average loan amounts outstanding.
(2) Net interest income divided by average interest-earning assets.
23
<PAGE>
Analysis of the Effect of Volume and Rate Changes in Interest Income and
Interest Expense:
The following table presents the extent to which net interest income
changed due to changes in interest rates and changes in volume of
interest-earning assets and interest-bearing liabilities during the periods
indicated. Information provided in each category with respect to changes
attributable to changes in volume (changes in volume multiplied by prior rate),
changes attributable to changes in rates (changes in rate multiplied by prior
volume) and the net change. The change in interest income and interest expense
attributable to the combined impact of both volume and rate has been allocated
proportionately to the changes due to volume and the changes due to rate.
<TABLE>
<CAPTION>
For the Nine Months Ended For the Nine Months Ended
September 30, 1997 vs. September 30, 1996 vs.
1996 Increase (Decrease) 1995 Increase (Decrease)
Due to Due to
----------------------------- -----------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans $ 423 $(197) $ 226 $ 415 $ (24) $ 391
Investment securities (14) 11 (3) 37 66 103
Overnight funds 27 3 30 (16) (10) (26)
----- ----- ----- ----- ----- -----
Total interest-earning assets $ 436 $(183) $ 253 $ 436 $ 32 $ 468
----- ----- ----- ----- ----- -----
INTEREST-BEARING LIABILITIES:
Savings deposits $ (6) $ (24) $ (30) $ 16 $ (82) (66)
Time deposits 96 (25) 71 31 121 152
Other borrowed funds (26) 0 (26) 6 (7) (1)
Long-term debt (8) 1 (7) (7) (2) (9)
----- ----- ----- ----- ----- -----
Total interest-bearing liabilities $ 56 $ (48) $ 8 $ 46 $ 30 $ 76
----- ----- ----- ----- ----- -----
CHANGE IN NET INTEREST INCOME $ 380 $(135) $ 245 $ 390 $ 2 $ 392
===== ===== ===== ===== ===== =====
</TABLE>
24
<PAGE>
OTHER INCOME
Total other income, excluding securities gains and the Settlement amount,
increased $157,000 for the nine months ended September 30, 1997, as compared to
the same period in 1996, primarily the result of $130,000 additional gains on
the sale of certain real estate parcels previously acquired by the Company. The
Company continues to experience an increase in its gains on investment
securities. The strong stock market growth over the recent years has resulted in
significant net gains in its trading securities. During the nine months ending
September 30, 1997, the gains on investment securities increased $2.165 million
as compared to the same period in 1996. The Company continually manages its
investment portfolio with the intention of ensuring a maximum rate of return but
at the same time managing risk associated with its entire investment portfolio.
Throughout 1997, management has evaluated its investment position, particularly
its equity securities, and has sold those securities which represented
significant appreciation. Of the $2.990 million of trading securities gains
during the first nine months of 1997, $2.169 million represented realized gains
on equity securities. The Company's trading securities are carried at fair value
and consist principally of common stock of bank holding companies. Management
continues to closely monitor its investment portfolio to position the portfolio
against future fluctuations in the stock market. A downturn in the overall
market could result in future trading securities losses.
During the first half of 1996, the Company recorded $1,539,000 from the
Settlement of an impaired loan which had been in protracted litigation.
OTHER EXPENSES
Other expenses declined $189,000, or 5.04%, during the first three quarters
of 1997 as compared to the same period in 1996. Salaries and employees benefits
increased $188,000, or 19.71% in 1997 due to additional employees being hired
for the new Pond Road branch and two employees added to the credit and
collection department. Occupancy expenses decreased $77,000, or 19.35%, the
result of a reduction in rent expense for the administrative offices of the
Company and the Bank. Other expenses declined $252,000, or 15.59%, during the
first nine months of 1997 as compared to the same period in 1996, mostly due to
decreased legal and professional fees of $414,000. Through September 1996, the
Company incurred $414,000 of legal and professional fees attributable to
litigation brought by the FDIC against the Company's Chairman and CEO and the
Bank's former president. As discussed in the legal proceedings section, the
hearings in this matter are closed and the involved parties are awaiting the
decision by the administrative law judge on December 23, 1997. Since the
majority of casework was performed in 1996, the Company incurred minimal
expenses attributable to this litigation in 1997. Also in 1997, amortization
expense was reduced by $64,000 since certain assets previously acquired in an
earlier branch purchase became fully amortized in 1996. The above decreases were
mitigated by increases in 1997 in computer service fees of $51,000 due to
outsourcing of certain keypunch processes and increased advertising fees of
$69,000 incurred for an advertising campaign aimed at promoting the Bank within
the local community.
25
<PAGE>
PROVISION FOR LOAN LOSSES
The allowance for loan losses was $1.571 million at September 30, 1997,
compared to $1.624 million at December 31, 1996. The allowance equaled 2.34% of
loans at September 30, 1997, as compared to 2.46% at December 31, 1996. The
decline in this percentage is attributable to recent growth in the loan
portfolio.
The adequacy of the allowance for loan losses is measured monthly by an
adequacy test. The adequacy test includes an evaluation of all loans which have
been classified (other loans especially mentioned, substandard, doubtful, loss)
by internal loan review, regulatory examination, monitoring of delinquency and
other pertinent factors. Allocations are determined by an in depth review of
each individual credit based on its potential future loss. The value of tangible
collateral and/or guarantees is determined as well as the borrower's ability and
willingness to repay. This value, as measured against the loan balance, is used
in determining the allowance allocation for collateral-dependent loans.
Additionally, the Bank considers the suggested guidelines of its regulatory
agencies when completing the analysis of the institution's allowance for loan
losses. The guidelines suggest the utilization of minimum percentages of 15%,
50%, and 100% for use in determining general allowances for loans classified as
substandard, doubtful and loss, respectively. These requirements are a
measurement only and do not constitute a specific allowance placed against any
specifically identified loan. Total loans outstanding, net of substandard,
doubtful, and loss are given an estimated allowance requirement to absorb future
losses. These loans are performing loans, well secured, or loans secured by
cash, cash equivalents or marketable securities. Although it would appear that
little or no allowance allocations would apply to these loans, allowances need
to be made for the historical charge-offs and the human error element in the
perfection of the Bank's interest and other issues unforeseen to management.
Additionally, the Bank conducts an annual review of all credits in excess of
$100,000 or more, which demonstrates any recent delinquency characteristics or
other weaknesses, to assure the adequacy of the allowance and provision for loan
losses.
At monthly meetings, the Credit Administration Committee is presented with
the adequacy test of the allowance for loan losses that contains information
relative to both specific credits and the total portfolio in general. The
information is used to determine the adjustment needed for the allowance to be
properly stated. In establishing the adjustment required, management considers a
variety of factors, including, but not limited to, general economic factors and
potential losses from significant borrowers. The Bank continues to strengthen
its underwriting process and internal loan review process by implementing
stringent analytical standards in the loan approval and review procedures.
At September 30, 1997, the amount charged to operating expense for the
provision for loan losses was $603,000 as compared to a credit provision for
loan losses of $667,000 in 1996. The increase in the 1997 provision was based on
management's evaluation of the loan portfolio as outlined above and also above
average losses incurred within the auto segment of the installment loan
portfolio. In August 1997, management discontinued the loan program to local
auto dealers to reduce the Bank's exposure for additional losses. The credit
provision in 1996 was mostly due to a significant recovery as part of the
Settlement which occurred in the second quarter of 1996.
26
<PAGE>
The following table sets forth a reconciliation of the allowance for loan
losses and illustrates the charge-offs and recoveries by major loan category for
the period ended September 30, 1997 (in thousands):
Beginning Balance, January 1, 1997.................. $1,624
------
Charge-offs:
Commercial, financial and agricultural........... 15
Real estate - construction....................... 37
Real estate - mortgage........................... 259
Installment loans to individuals................. 453
Lease financing.................................. --
------
Total charge-offs................................... 764
------
Recoveries:
Commercial, financial and agricultural........... 18
Real estate - construction....................... --
Real estate - mortgage........................... 24
Installment loans to individuals................. 33
Lease financing.................................. 33
------
Total recoveries.................................... 108
------
Net charge-offs..................................... 656
------
Provision for loan losses........................... 603
------
Ending Balance, September 30, 1997.................. $1,571
======
Ratio of net charge-offs to
average loans outstanding........................ 0.99%
FINANCIAL CONDITION
At September 30, 1997, the Company's total assets were $113.6 million,
representing an increase of $3.28 million from December 31, 1996, mostly
attributable to an increase in deposits of $2.365 million. As of September 30,
1997, the Company's available cash balance was $3.33 million higher than the
balance at December 31, 1996 because of anticipated funding requirements for
assumptions of deposits of its Quakertown branch by The Quakertown National
Bank.
Loans
Net loans increased $1.17 million, from $64.374 million at December 31,
1996 to $65.547 million at September 30, 1997.
The majority of the increase in loans remains within the consumer loan
portfolio in particular auto loans. As mentioned earlier, the Bank discontinued
indirect dealer program in August 1997. The change in the composition of loans
at September 30, 1997 as compared to December 31, 1996 is as follows: Real
estate construction loans declined $58,000, or 1.18%; Residential real estate
loans decreased $1.248 million, or 4.84%; Commercial real estate loans decreased
$896,000, or 4.52%; Commercial loans increased $74,000, or 2.02%; and Consumer
loans increased $3.248 million, or 27.60%.
27
<PAGE>
The following table sets forth the maturity and repricing schedule of
the loan portfolio at September 30, 1997 (in thousands):
After one After
Within but within five
One year five years years Total
-------- ---------- ------- -------
Maturity Schedule:
Commercial ................ $ 1,715 $ 1,133 $ 765 $ 3,613
Real estate-construction... 3,866 693 148 4,707
Real estate-mortgage ...... 8,232 22,341 10,939 41,512
Consumer, net ............. 925 12,791 1,209 14,925
Nonaccrual loans .......... -- -- -- 2,361
------- ------- ------- -------
Total ........................ $14,738 $36,958 $13,061 $67,118
======= ======= ======= =======
Repricing Schedule(1):
Fixed rate loans .......... $14,700 $31,787 $ 3,638 $50,125
Floating rate loans ....... 13,657 670 305 14,632
Nonaccrual loans .......... -- -- -- 2,361
------- ------- ------- -------
Total ........................ $28,357 $32,457 $ 3,943 $67,118
======= ======= ======= =======
- ----------
(1) Data for repricing schedule by loan categories is not available.
Investment Securities
The primary objectives of the Company's investment strategy are to provide
and maintain a level of liquidity, to generate a favorable return on investments
without incurring undue interest rate and credit risk and to promote the
Company's lending activities.
The largest sector of the investment portfolio remains securities of U.S.
Government agencies and corporations which total $21.68 million (amortized
costs) at September 30, 1997, or 75.02% of total investment securities. Included
in the above are $2.865 million mortgage-backed products, mostly consisting of
collateralized mortgage obligations ("CMO") and real estate mortgage investment
conduits ("REMIC"). Twice a year, stress tests are conducted on these CMOs and
REMICs, all of which were passed as of September 30, 1997.
At the present time, the Company does not engage in the use of derivatives
investment products as a means to hedge the risks in its investment, loan or
deposit portfolios.
Deposits and Other Borrowed Funds
The Company continues to offer a variety of deposit accounts with a range
of interest rates and term options. The deposits consist primarily of checking,
savings, super now, money market and certificates of deposit. Fluctuation within
its deposit base are influenced by competition, economic conditions and changes
in current rates. Total deposits at September 30, 1997 increased
28
<PAGE>
$2.365 million from $95.939 million at December 31, 1996 to $98.304 million.
Noninterest-bearing deposits increased $467,000 and interest-bearing deposits
increased $1.90 million. Savings, club and interest-bearing demand deposits
increased $775,000, of which $546,000 consisted of increases in Christmas club
accounts which will mature in October 1997. Time deposits increased $1.122
million, primarily as the result of a special promotion offered during June and
July 1997 when the Bank opened its new Pond Road branch. As a percentage of
total deposits, savings, club accounts and interest-bearing demand deposits
represented 36.75% at September 30, 1997 as compared to 36.85% at December 31,
1996. There were no brokered deposits within the Company's deposit base at
September 30, 1997.
There were no borrowed funds at September 30, 1997 as compared to $1.20
million at December 31, 1996. At December 31, 1996, the Company utilized
borrowings in the form of repurchase agreement to fund a portion of the Bank's
asset growth, in particular its installment loan portfolio. As a result of $1.5
million securities which were called by their issuers during 1997, the Company
was able to repay this short-term borrowing.
The following table sets forth maturities of time deposits of $100,000 or
more at September 30, 1997 and December 31, 1996.
September 30, December 31,
1997 1996
------------- ------------
(in thousands)
Three months or less...................... $2,150 $2,800
Over three months through
twelve months...................... 3,255 3,412
Over one year through
five years......................... 2,119 1,640
Over five years........................... 0 0
------ ------
TOTAL.................................. $7,524 $7,852
====== ======
NONPERFORMING ASSETS
Nonperforming assets include nonperforming loans and foreclosed assets held
for sale. Nonperforming loans consist of impaired and other loans where the
principal, interest, or both, is 90 or more days past due and loans that have
been placed on nonaccrual. When loans are placed on nonaccrual status, income
from the current period is reversed from current earnings and interest from
prior periods is charged to the allowance for loan losses. Similarly, consumer
loans are considered nonaccrual if the collateral is insufficient to recover the
principal or are charged-off if deemed to be uncollectible. Foreclosed assets
consist of assets acquired through foreclosure or real estate acquired by
acceptance of a deed in lieu of foreclosure.
29
<PAGE>
The following table represents nonperforming assets of the Company at
September 30, 1997 and December 31, 1996.
September 30, December 31,
1997 1996
------------- ------------
(in thousands)
Impaired loans ................................... $2,361 $2,052
Other loans past due 90 days or more ............. 277 609
------ ------
Total nonperforming loans .................... 2,638 2,661
Foreclosed assets held for sale .................. 4,025 4,850
------ ------
Total nonperforming assets ................... $6,663 $7,511
====== ======
Nonperforming loans as a percentage
of loans (net of unearned interest) .......... 3.93% 4.03%
Nonperforming assets as a percentage of assets ... 5.87% 6.81%
Loans past due 90 days or more decreased $332,000 from $609,000 at December
31, 1996 to $277,000 at September 30, 1997. This decrease primarily resulted
from the reclassification of several of these loans to the impaired loan
category. Due to increased delinquencies in the installment loan portfolio
during the beginning of the third quarter 1997, management has allocated
additional personnel for collection efforts and will continue to monitor
collection department's needs and performance in the future. All delinquent
loans are reviewed by management on a weekly basis with regard to legal
proceedings and collection efforts. Of the delinquent loans, 84.12% are secured
by real estate, 14.80% are loans to consumers and 1.08% are to commercial
borrowers.
Impaired loans increased $309,000, or 15.06%, at September 30, 1997
compared to December 31, 1996. During the first nine months of 1997, the overall
increase has the result of various changes within the impaired loan portfolio.
First, based on management's evaluation of the loan portfolio, $2.624 million of
loans were internally classified and moved to the impaired category. Mitigating
this increase was the transfer of $1.361 million of impaired loans to foreclosed
assets, $559,000 of loans were restored to accrual status, $239,000 were charged
off to the provision for loan losses and $156,000 of payments were received
against outstanding balances. The majority of the impaired loans are beyond the
point of restructure. These are loans that have been in litigation and/or
foreclosure and can be resolved through liquidation. Management believes that
the transfer from impaired loans to foreclosed assets continues to be an
improving trend that will continue for the next several quarters as the
litigation and/or foreclosure actions move toward completion. Management has
continued to market and sell off its foreclosed asset portfolio. The proceeds
from the sale of foreclosed assets for 1997 amounted to $2.120 million as
compared to $1.105 million for the same period in 1996. Real estate loans
represent $2.151 million of impaired loans and loans to consumer and commercial
borrowers represent $90,000 and $120,000, respectively.
30
<PAGE>
The following table sets forth the total of commercial and investment
properties at September 30, 1997, all of which are currently in litigation
and/or foreclosure.
Commercial/Investment Properties:
Impaired and over 90 days............................ $1,412,924
Foreclosed assets held for sale...................... 968,358
----------
Total............................................... $2,381,282
==========
The following table sets forth the total of residential properties to be
foreclosed upon and liquidated at September 30, 1997, including properties
currently owned that are listed for sale. All litigation and foreclosure
proceedings in the nonaccrual and over 90-day category are being actively
pursued.
Residential:
Impaired and over 90 days............................. $ 417,326
Foreclosed assets held for sale....................... 873,571
----------
Total................................................. $1,290,897
==========
The following table sets forth the total of land developments and building
lots to be foreclosed upon and liquidated at September 30, 1997, including land
developments and building lots currently owned and listed for sale. All
litigation and foreclosure proceedings in the nonaccrual and over 90-day
category are being actively pursued.
Land Development/Building Lots:
Impaired and over 90 days............................. $ 26,333
Foreclosed assets held for sale....................... 1,098,932
----------
Total................................................. $1,125,265
==========
The following table sets forth the total of loans in litigation that are
not secured by real estate at September 30, 1997.
Secured by Other Than Real Estate:
Impaired and over 90 days............................. $ 464,646
==========
The following table sets forth the total of assets that are listed as
nonperforming, but which are under agreements that provide a yield at or in
excess of current market rates at September 30, 1997.
Performing/Nonperforming Assets:
Impaired and over 90 days............................. $ 317,123
==========
The following table sets forth the total of assets that are under agreement
or are being paid off with the settlement dates to take place in the fourth
quarter of 1997.
Assets Under Agreement or Payoffs:
Foreclosed assets held for sale....................... $1,084,297
==========
31
<PAGE>
At September 30, 1997, there were no loans, other than those classified as
nonperforming loans, where known information about borrowers' possible credit
problems causes management to have serious doubts as to their ability to comply
with the current loan repayment terms.
For 1997, management has set a goal to dispose of $4.50 million of
classified assets. The disposition plan as originally drafted in 1996 and as
adjusted for 1997 was initiated to comply with the Administrative Order of the
Department, the Written Agreement of the Federal Reserve Bank and several
previous orders which have been replaced by the Memorandum of Understanding. As
outlined earlier, management continues to market these classified assets in an
effort to meet its goal for 1997. As of September 30, 1997, the gross reduction
in classified assets was approximately $3.68 million; however, the net reduction
was $2.40 million. Although the Bank is behind in its goal for the overall
reduction of classified assets for 1997, it remains in compliance at September
30, 1997 with the regulatory requirements pertaining to classified assets as
discussed in the "Regulatory Matters" in part I of this Form 10-QSB.
LIQUIDITY AND FUNDS MANAGEMENT
Liquidity management is intended to ensure that adequate funds will be
available to meet anticipated and unanticipated deposit withdrawals, debt
servicing payments, investment commitments, commercial and consumer loan demand
and ongoing operating expenses. Funding sources include principal repayments on
loans and investments, sales of assets, growth in core deposits, short and
long-term borrowings and repurchase agreements. While regular loan payments are
a predictable source of funds, the sale of loans and investment securities,
deposit flows, and loan prepayments are significantly influenced by general
economic conditions and level of interest rates and competition. The Company
manages its balance sheet to prove adequate liquidity based on various economic,
interest rate and competitive assumptions and in light of profitability
measures.
At September 30, 1997, the Company maintained $7.954 million in cash and
cash equivalents in the form of cash and due from banks (after reserve
requirements). In addition, the Company had $20.415 million in securities
available-for-sale representing 17.98% of total assets at September 30, 1997.
The Company considers its primary source of liquidity to be its core
deposit base and continues to promote the acquisition of deposits through its
branch offices. At September 30, 1997, approximately 79.94% of the Company's
assets were funded by core deposits acquired within its market area. An
additional 12.46% of the assets were funded by the Company's equity. These two
components provide a substantial and stable source of funds.
32
<PAGE>
The Company paid the following cash dividends to its Preferred stockholders
during 1997. There were no dividends paid to its common stockholders in 1997.
Class of Stock Date Paid Current Arrears Total
-------------- --------- ------- ------- -----
Senior Preferred May 12, 1997 $56,273 $237,542 $293,815
August 12, 1997 56,272 -- 56,272
(1) November 1997 56,272 -- 56,272
Series A Preferred August 12, 1997 $55,498 $110,995 $166,493
(1) November 1997 55,498 110,995 166,493
- ----------
(1) On September 25, 1997, the Company's Board of Directors declared the
dividends outlined above to the stockholders of record as of September 25,
1997. It is expected these dividends will be paid in November 1997.
For the Series A Preferred stockholders, after payments of the above
dividends, $1,054,457 remains in arrears at September 30, 1997.
The Bank is subject to certain restrictions under Pennsylvania law relating
to the declaration and payment of dividends. Dividends may be declared and paid
only out of accumulated net earnings (undivided profits). Where surplus is less
than 50% of the amount of the Bank's capital (defined as par value multiplied by
the number of shares outstanding), no dividend may be paid or declared without
the prior approval of the Department until surplus is equal to 50% of the total
amount of capital. Where surplus is equal to or greater than 50% but less than
100% of capital, until such time as surplus equals capital, the Bank must
transfer at least 10% of its net earnings to surplus prior to the declaration of
a dividend. The Department has the power to issue orders prohibiting the payment
of dividends where such payment is deemed to be an unsafe or unsound banking
practice. The Company's ability to pay dividends is also impacted by regulatory
orders and agreements.
For the nine months ended September 30, 1997, cash and cash equivalents
increased $3.334 million as compared to a $574,000 decrease for the same period
in 1996. The increase in cash and cash equivalents for the nine-month period
ended September 30, 1997 was primarily generated by operations. At September 30,
1997, the Company has elected to maintain a liquid cash position in anticipation
of the funding requirements for assumptions of deposits of the Quakertown branch
by The Quakertown National Bank on October 30, 1997. Changes in cash are
measured by changes in three major classifications of cash flow known as
operating, investing and financing activities.
Cash flows from operating activities increased $1.639 million for the nine
month ended September 30, 1997, principally as the result of net income from
operations adjusted for noncash items.
Cash flows from investing activities increased $6.928 million for the nine
months ended September 30, 1997 as compared to the same period in 1996. During
May 1996, approximately $4
33
<PAGE>
million of proceeds from the Settlement were utilized to purchase investment
securities. For the first nine months of 1997, net cash expenditures for loans
decreased $3.842 million as the Company discontinued its auto dealer loan
program in August 1997 and as the Company received several large commercial
repayments during the first quarter of 1997. Furthermore, proceeds from sale of
foreclosed assets and real estate and other investments increased $575,000 for
the nine months ended September 30, 1997 as compared to the same period in 1996,
a further indication of management's intention to continue to liquidate the
Company's nonperforming assets.
Cash flows provided by financing activities decreased $4.659 million for
the first nine months of 1997, mostly due to repayment of the repurchase
agreement and a reduction in deposits as compared to the same period in 1996. In
1996, the Company utilized both an increase in deposits and a repurchase
agreement to fund its loan growth. However, a major portion of the loan growth
for the nine months ended September 30, 1997 was funded solely by an increase in
deposits. Several large agency bonds included in the investment portfolio were
prematurely called, management utilized these funds to repay the outstanding
repurchase agreement.
INTEREST RATE SENSITIVITY
Interest rate sensitivity management involves the matching of maturity and
repricing dates of interest-earning assets and interest-bearing liabilities to
help insure the Company's earnings against extreme fluctuations in interest
rates.
The effect of interest rate changes on the Company's assets and liabilities
may be analyzed by monitoring the Company's interest rate sensitivity gap
("GAP"). An asset or liability is said to be interest-rate sensitive within a
specific time period if it will mature or reprice within a given time period.
The interest rate sensitivity GAP is defined as the difference between
interest-earning assets and interest-bearing liabilities maturing or repricing
within a given time period. A positive GAP (asset sensitive) indicates that more
assets reprice during a given period compared to liabilities, while a negative
GAP (liability sensitive) has the opposite effect.
The Company's principal financial objective is to achieve long-term
profitability while managing its exposure to fluctuations in interest rates.
This is accomplished through the measurement of the relationship between
interest rate sensitive assets and interest rate sensitive liabilities. The goal
of maintaining a reasonable balance between interest rate sensitive assets and
interest rate sensitive liabilities is accomplished through the Company's
asset/liability management program.
At September 30, 1997 the Company maintained a one-year cumulative GAP of
negative $2.96 million, or 2.92% of total interest-earning assets which have
been adjusted for the depreciation on securities available-for-sale. The effect
of this GAP position provides a negative mismatch of assets and liabilities
which exposes the Company to interest rate risk during a period of rising
interest rates. A significant item contributing to the short-term negative gap
is $17.164 million of interest-bearing demand and savings deposits which do not
have contractual maturities and are not as rate sensitive as time deposits.
However, the ability to reprice still exists, and, therefore, they have been
included in the shortest repricing time frame.
34
<PAGE>
The following table sets forth the Company's interest sensitivity GAP
position at September 30, 1997:
<TABLE>
<CAPTION>
September 30, 1997
------------------------------------------------------------------------------
6
Months
6 Months to 1 1 to 2 2 to 5 Over 5
or less Year Years Years Years Total
-------- ------- -------- ------- ------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities (1) $ 13,021 $ 547 $ 1,246 $ 4,598 $17,203 $ 36,615
Loans (2) ................. 21,564 6,793 10,597 21,860 3,942 64,756
-------- ------- -------- ------- ------- --------
TOTAL .................... $ 34,585 $ 7,340 $ 11,843 $26,458 $21,145 $101,371
-------- ------- -------- ------- ------- --------
Interest-bearing
liabilities:
Demand-interest bearing ... $ 15,014 $ -- $ -- $ -- $ -- $ 15,014
Savings and clubs (3) ..... 1,436 714 1,427 4,281 13,252 21,110
Time ...................... 19,524 8,011 17,602 6,488 -- 51,625
Long-term debt ............ 190 -- -- -- -- 190
-------- ------- -------- ------- ------- --------
TOTAL .................... $ 36,164 $ 8,725 $ 19,029 $10,769 $13,252 $ 87,939
-------- ------- -------- ------- ------- --------
GAP ........................ $( 1,579) $(1,385) $( 7,186) $15,689 $ 7,893 $ 13,432
-------- ------- -------- ------- ------- --------
Cumulative GAP ............. $( 1,579) $(2,964) $(10,150) $ 5,539 $13,432 $ 13,432
======== ======= ======== ======= ======= ========
</TABLE>
- ----------
(1) Includes average pay downs based on the stress test for collateralized
mortgage obligation securities, equity securities categorized as trading
securities and $5.427 million investment in overnight funds.
(2) Includes estimated scheduled maturities of the fixed rate loans ignoring
any potential rollover at maturity. Excludes nonaccrual loans of $2.361
million.
(3) Assumes that 7% of the savings deposits are repriceable each year based on
the previous five years' historical activity.
35
<PAGE>
CAPITAL
The adequacy of the Company's capital is reviewed on an ongoing basis with
reference to size, composition and quality of the Company's resources. An
adequate capital base is important for continued growth and expansion in
addition to providing an added protection against unexpected losses.
As required by the federal banking regulatory authorities, new guidelines
have been adopted to measure capital adequacy. Under the guidelines, certain
minimum ratios are required for core capital and total capital as a percentage
of risk-weighted assets and other off balance sheet instruments. For the
Company, Tier I capital consists of shareholders' equity less intangible assets,
and Tier II capital includes the allowable portion of the allowance for loan
losses, currently limited to 1.25% of risk-weighted assets.
The following table sets forth the capital ratios of the Bank as of
September 30, 1997 and 1996.
September 30,
Regulatory -----------------
Requirements 1997 1996
------------ ---- ----
Leverage ratio:
Tier I (core capital) ratio.............. 4.0%* 12.05% 10.88%
Risk-based capital ratios:
Tier I capital/risk-weighted............. 4.0% 16.99% 15.14%
Tier I and Tier II capital/
risk-weighted assets................... 8.0% 18.25% 16.40%
- ----------
* The Pennsylvania Department of banking requires the Bank to maintain a
minimum Tier I leverage capital ratio of at least 6.5% under the terms of
the Administrative Order.
DEPOSIT INSURANCE FUNDS ACT OF 1996
The Deposit Insurance Funds Act of 1996 (the "Act") was enacted on
September 29, 1996. The Act changes payment terms for the Bank's payments into
the Bank Insurance Fund ("BIF") of the FDIC.
Beginning in 1997, BIF assessments will be used for the first time to help
pay off the $780 million annual interest payments on $8 billion in "FICO" bonds
issued in the 1980s as part of the federal government's savings and loan
bailout. The law provides that BIF assessments must be set at a rate equal to
one-fifth of the Savings Institution Insurance Fund ("SAIF") rates for 1997,
1998 and 1999. After 1999, all FDIC-insured institutions will pay the same
risk-adjusted rates.
The Bank estimates that its annual cost for FDIC insurance coverage will
increase less than $15,000 based on September 30, 1997 deposit levels and based
on available rate information. However, the FDIC may increase the projected
rates at anytime.
36
<PAGE>
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1997
TO THE THREE MONTHS ENDED SEPTEMBER 30, 1996
ANALYSIS OF OPERATIONS
Net income for three months ended September 30, 1997 was $729,000 as
compared to $462,000 for the same period in 1996, an increase of $267,000, or
57.8%. This increase was primarily attributable to increase in trading
securities gains of $902,000, offset in part by an increase in loan loss
provision of $513,000.
Net interest income before the provision for loan losses was approximately
the same, $1.05 million, for both the quarter ended September 30, 1997 and 1996.
During the three months ended September 30, 1997, the provision for loan losses
increased $503,000 based on management's evaluation of the loan portfolio and
delinquencies in the commercial and installment loan portfolios. In August 1997,
management discontinued its auto dealer loan program which was the source of the
increase in the delinquencies. Other income increased $925,000 during the third
quarter 1997 as compared to the same period in 1996, primarily attributable to
$902,000 of increased gains on its trading portfolio. Other expenses increased
$138,000 for the three months ended September 30, 1997 as compared to the same
period in 1996. Foreclosed asset expenses increased $180,000 primarily the
result of an increased provision to write down these assets to reflect changes
in the market place as well as allow management to aggressively market and
dispose of these nonperforming assets. Salary expense increased $103,000 due to
additional employees in the new Pond Road branch office and additional employees
in the credit and collection department. Other expenses decreased $241,000
mostly due to decreased legal costs in 1997 associated with the ongoing
litigation involving the Company Chairman and CEO and the Banks former
president. The decrease is mostly due to completion of the hearing phase of the
litigation as both parties are awaiting the judge's decision.
Overall, there was an increase of $2.842 million in net cash for the third
quarter of 1997 as compared to the third quarter of 1996, primarily attributable
to operating income adjusted for noncash items. The Company has elected to
maintain a liquid cash position at September 30, 1997 in anticipation of funding
requirements for the assumptions of deposit of the Quakertown branch by The
Quakertown National Bank. Net cash provided from investing activities increased
$1.171 million as the result of decreased loan originations of $923,000 due to
discontinuation of the auto dealer loan program. Net cash provided by financing
activities increased $333,000 in 1997 as compared to 1996, primarily
attributable to increased deposits of $1.155 million due to the opening of a new
branch office mitigated by repayment of other borrowings funds of $600,000 and
the payment of cash dividends of $222,000.
37
<PAGE>
FIRST LEHIGH CORPORATION
FORM 10-QSB
Part II - Other Information
Item 1. - Legal Proceedings
On June 23, 1995, the Federal Deposit Insurance Corporation (the "FDIC")
issued a Notice of Intention to Prohibit from Further Participation and a Notice
of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of Law,
Order to Pay and Notice of Hearing (collectively, the "Notices") against James
L. Leuthe, Chairman of the Board and Chief Executive Officer of the Company, and
against Harold R. Marvin, Jr., formerly the President of the Company and of the
Company's banking subsidiary, First Lehigh Bank (the "Bank"). Mr. Marvin
resigned as President and as director of both the Company and the Bank in 1993.
The FDIC and Mr. Marvin have reached and consummated a settlement in this
matter. The settlement does not assess any monetary damages or penalties against
Mr. Marvin and prohibits Mr. Marvin from participating in any manner in the
conduct of the affairs of any financial institution or organization.
The Notices initiated administrative proceedings in which the FDIC, as a
result of transactions occurring prior to February 1992, is seeking to prohibit
Mr. Leuthe from further participation in the conduct of the affairs of any bank
insured by the FDIC or any other federally insured depository institution,
without the prior approval of the FDIC and the appropriate federal financial
institution regulatory agency. The allegations of the FDIC are substantially the
same as those which formed the basis of the Stipulation of Settlement with and
Administrative Order of the Pennsylvania Department of Banking, which the
Company and the Bank entered into in March, 1993. The Notices also seek to
impose civil monetary penalties of $500,000 against Mr. Leuthe. Neither the
Company nor the Bank is a party to these proceedings. Mr. Leuthe has denied
wrongdoing and is defending these actions.
From a procedural standpoint, the hearings in this matter are closed.
Counsel for the parties have submitted memoranda of law and proposed findings of
fact/conclusions of law. The administrative law judge was initially expected to
issue a recommended decision by on or before September 8, 1997; however, that
date was recently pushed back to December 23, 1997. Either party which disputes
that recommended decision when it is eventually issued has 30 days thereafter to
file Exceptions. Those Exceptions are then heard by the full FDIC Board of
Directors, who will likely not render a decision for at least 60 to 90 days
following the filing of any such Exceptions. Either party which disputes the
eventual decision of the FDIC Board has thirty (30) days to appeal to the Third
Circuit Court of Appeals.
Under both the Company's and the Bank's Bylaws, the Company and the Bank
are required to indemnify Messrs. Leuthe and Marvin in connection with the
administrative proceedings brought against them by reason of the fact that they
are or were Officers and Directors of the Bank. However, Mr. Leuthe and/or Mr.
Marvin are required to reimburse the Company and/or the Bank for all expenses
incurred or advanced by the Company or the Bank in connection with such events
if a court ultimately determines that the alleged actions or omissions of Mr.
Leuthe and/or Mr. Marvin constituted willful misconduct or recklessness. While
it is difficult to determine the amount
38
<PAGE>
of indemnification in this case, the Company believes at this time that the
amount will not materially and adversely affect the Company's financial
condition.
The Company carries Director's and Officer's Liability Insurance coverage
and is in the process of submitting a claim for reimbursement of its expenses in
connection with these proceedings. The Company's insurance carrier has indicated
that it may dispute coverage relating to this matter on the basis that the
insurance carrier did not receive timely notice of the proceedings. The Company
disputes the insurance carrier's position.
39
<PAGE>
Item 6. - Exhibits and Reports on Form 8-K.
(a) Exhibits.
The following exhibits are filed with this Form 10-QSB:
Exhibit No. Description
----------- -----------
3.1 Articles of Incorporation of the Company, as amended
(incorporated by reference to Exhibit 3.1 to the
Company's Form SB-2 Registration Statement No.
33-71712).
3.2 Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Form SB-2 Registration
Statement No. 33-71712).
10.1 Branch Purchase Agreement between First Lehigh Bank and
the Quakertown National Bank dated as of June 20, 1997
(incorporated by reference to Exhibit 2.1 to the
Company's Form 8-K report dated June 20, 1997 and filed
with the Commission on July 3, 1997).
11.1 Statement re: Computation of Per Share Earnings.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
None.
40
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
FIRST LEHIGH CORPORATION
Date: November 7, 1997 By: /s/ James L. Leuthe
--------------------------------
James L. Leuthe, Chairman
of the Board and Chief
Executive Officer
Date: November 7, 1997 By: /s/ Kashmira K. Lodaya
--------------------------------
Kashmira K. Lodaya, Treasurer
(principal financial and
accounting officer)
41
<PAGE>
FIRST LEHIGH CORPORATION
FORM 10-QSB
EXHIBIT INDEX
Exhibit No. Description of Exhibit Page No.
- ----------- ---------------------- --------
3.1 Articles of Incorporation of the Company, as amended
(incorporated by reference to Exhibit 3.1 to the
Company's Form SB-2 Registration Statement No. 33-71712).
3.2 Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Form SB-2 Registration
Statement No. 33-71712).
10.1 Branch Purchase Agreement between First Lehigh Bank and
the Quakertown National Bank dated as of June 20, 1997
(incorporated by reference to Exhibit 2.1 to the
Company's Form 8-K report dated June 20, 1997 and
filed with the Commission on July 3, 1997).
11.1 Statement re: Computation of Per Share Earnings. 43-46
27 Financial Data Schedule. 47-48
42
FIRST LEHIGH CORPORATION AND SUBSIDIARY
COMPUTATION OF EARNINGS PER SHARE EXHIBIT 11.1
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 Page 1 of 2
SEPTEMBER SEPTEMBER
PRIMARY EARNINGS PER SHARE: 30, 1997 30, 1996
--------- ---------
NET INCOME 2,685,277 2,737,943
LESS DIVIDENDS PAID OR IN ARREARS (4):
SERIES A (166,493) (166,493)
SENIOR PREFERRED (168,818) (159,169)
--------- ---------
ADJUSTED NET INCOME 2,349,966 2,412,281
--------- ---------
COMMON STOCK EQUIVALENT SHARES
OUTSTANDING: 2,900,363 2,848,902
--------- ---------
PRIMARY EARNINGS PER SHARE 0.81 0.85
========= =========
COMPUTATION OF COMMON STOCK
EQUIVALENT SHARES:
COMMON STOCK 2,000,000 2,000,000
SENIOR PREFERRED STOCK 900,363 848,902
--------- ---------
TOTAL 2,900,363 2,848,902
========= =========
FULLY DILUTED EARNINGS SEPTEMBER SEPTEMBER
PER SHARE: 30, 1997 30, 1996
--------- ---------
NET INCOME 2,685,277 2,737,943
LESS DIVIDENDS PAID OR IN ARREARS (4):
SERIES A (166,493) (166,493)
SENIOR PREFERRED (168,818) (159,169)
---------- ----------
ADJUSTED NET INCOME 2,349,966 2,412,281
---------- ----------
FULLY DILUTED COMMON STOCK
EQUIVALENT SHARES OUTSTANDING: 3,466,893 3,414,502
---------- ----------
FULLY DILUTED EARNINGS PER SHARE 0.68 0.71
========== ==========
COMPUTATION OF FULLY DILUTED
COMMON STOCK EQUIVALENTS:
SHARES OUTSTANDING 2,000,000 2,000,000
INCLUSION OF SERIES A SHARES
AT CONVERSION RATE (1) 545,600 545,600
INCLUSION OF SENIOR PREFERRED
SHARES (2) 900,363 848,902
INCLUSION OF STOCK OPTIONS (3) 20,930 20,000
--------- ---------
TOTAL 3,466,893 3,414,502
========= =========
<PAGE>
Page 2 of 2
(1) ASSUMES THE CONVERSION OF THE SERIES A PREFERRED STOCK INTO COMMON SHARES
AT THE RATE OF .8 SHARES OF COMMON STOCK FOR EACH SHARE OF SERIES A
PREFERRED STOCK. THE CONVERSION RATE OF SERIES A PREFERRED STOCK CHANGED
FROM .8 to .72 IN MARCH 1996. HOWEVER, THE BOARD OF DIRECTORS HAS APPROVED
AN AMENDMENT THAT WOULD RETAIN THE .8 CONVERSION RATE UNTIL MARCH 1999,
SUBJECT TO SHAREHOLDER APPROVAL. FOR PURPOSES OF THIS CALCULATION THE
CONVERSION RATE OF .8 WAS USED.
(2) ASSUMES CONVERSION OF SENIOR PREFERRED SHARES INTO COMMON STOCK AT FULL
VALUE SINCE THE BASE VALUE APPROXIMATES MARKET VALUE. THE SENIOR PREFERRED
SHARES ARE COMMON STOCK EQUIVALENTS SINCE ITS EFFECTIVE YIELD WAS LESS THAN
66.6% OF AN AVERAGE Aa CORPORATE BOND YIELD AT THE TIME OF ISSUANCE.
(3) ASSUMES CONVERSION OF THE STOCK OPTIONS INTO COMMON SHARES USING TREASURY
STOCK METHOD OF COMPUTATION.
(4) OF THE $166,493 OF SERIES A PREFERRED STOCK DIVIDENDS INCLUDED IN THE
CALCULATION, $55,498 WAS PAID IN AUGUST 1997, $55,498 WILL BE PAID IN
NOVEMBER 1997, WITH THE BALANCE OF $55,497 REMAINING IN ARREARS.
OF THE $168,818 OF SENIOR PREFERRED STOCK DIVIDENDS INCLUDED IN THE
CALCULATION, $56,273 WAS PAID IN MAY 1997, $56,272 WAS PAID IN AUGUST
1997, WHILE THE THIRD QUARTER AMOUNT OF $56,273 WILL BE PAID IN
NOVEMBER 1997.
44
<PAGE>
FIRST LEHIGH CORPORATION AND SUBSIDIARY
COMPUTATION OF EARNINGS PER SHARE EXHIBIT 11.1
THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 Page 1 of 2
SEPTEMBER SEPTEMBER
PRIMARY EARNINGS PER SHARE: 30, 1997 30, 1996
--------- --------
NET INCOME 729,147 461,570
LESS DIVIDENDS PAID OR IN ARREARS (4):
SERIES A (55,498) (55,498)
SENIOR PREFERRED (56,273) (53,056)
---------- ----------
ADJUSTED NET INCOME 617,376 353,016
---------- ----------
COMMON STOCK EQUIVALENT SHARES
OUTSTANDING: 2,900,363 2,848,902
---------- ----------
PRIMARY EARNINGS PER SHARE 0.21 0.12
========== ==========
COMPUTATION OF COMMON STOCK
EQUIVALENT SHARES:
COMMON STOCK 2,000,000 2,000,000
SENIOR PREFERRED STOCK 900,363 848,902
---------- ----------
TOTAL 2,900,363 2,848,902
========== ==========
FULLY DILUTED EARNINGS SEPTEMBER SEPTEMBER
PER SHARE: 30, 1997 30, 1996
--------- ---------
NET INCOME 729,147 461,570
LESS DIVIDENDS PAID OR IN ARREARS (4):
SERIES A (55,498) (55,498)
SENIOR PREFERRED (56,273) (53,056)
---------- ----------
ADJUSTED NET INCOME 617,376 353,016
---------- ----------
FULLY DILUTED COMMON STOCK
EQUIVALENT SHARES OUTSTANDING: 3,466,893 3,414,502
---------- ----------
FULLY DILUTED EARNINGS PER SHARE 0.18 0.10
========== ==========
COMPUTATION OF FULLY DILUTED
COMMON STOCK EQUIVALENTS:
SHARES OUTSTANDING 2,000,000 2,000,000
INCLUSION OF SERIES A SHARES
AT CONVERSION RATE (1) 545,600 545,600
INCLUSION OF SENIOR PREFERRED
SHARES (2) 900,363 848,902
INCLUSION OF STOCK OPTIONS (3) 20,930 20,000
--------- ---------
TOTAL 3,466,893 3,414,502
========= =========
<PAGE>
Page 2 of 2
(1) ASSUMES THE CONVERSION OF THE SERIES A PREFERRED STOCK INTO COMMON SHARES
AT THE RATE OF .8 SHARES OF COMMON STOCK FOR EACH SHARE OF SERIES A
PREFERRED STOCK. THE CONVERSION RATE OF SERIES A PREFERRED STOCK CHANGED
FROM .8 to .72 IN MARCH 1996. HOWEVER, THE BOARD OF DIRECTORS HAS APPROVED
AN AMENDMENT THAT WOULD RETAIN THE .8 CONVERSION RATE UNTIL MARCH 1999,
SUBJECT TO SHAREHOLDER APPROVAL. FOR PURPOSES OF THIS CALCULATION THE
CONVERSION RATE OF .8 WAS USED.
(2) ASSUMES CONVERSION OF SENIOR PREFERRED SHARES INTO COMMON STOCK AT FULL
VALUE SINCE THE BASE VALUE APPROXIMATES MARKET VALUE. THE SENIOR PREFERRED
SHARES ARE COMMON STOCK EQUIVALENTS SINCE ITS EFFECTIVE YIELD WAS LESS THAN
66.6% OF AN AVERAGE Aa CORPORATE BOND YIELD AT THE TIME OF ISSUANCE.
(3) ASSUMES CONVERSION OF THE STOCK OPTIONS INTO COMMON SHARES USING TREASURY
STOCK METHOD OF COMPUTATION.
(4) BOTH DIVIDENDS ON THE SERIES A AND SENIOR PREFERRED STOCK HAVE BEEN
DECLARED AND WILL BE PAID IN NOVEMBER 1997 TO THE STOCKHOLDERS OF RECORD ON
SEPTEMBER 25, 1997.
<PAGE>
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<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
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<DEPOSITS> 98,304
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<LIABILITIES-OTHER> 917
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0
16
<COMMON> 20
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<NET-INCOME> 2,685
<EPS-PRIMARY> 0.81
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<YIELD-ACTUAL> 4.40
<LOANS-NON> 2,361
<LOANS-PAST> 277
<LOANS-TROUBLED> 77
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<ALLOWANCE-CLOSE> 1,571
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<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,088
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