FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
( X )QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
( )TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-12524
Hanover Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2219814
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
33 Carlisle Street, Hanover, Pennsylvania 17331
(address of principal executive office and zip code)
(717) 637-2201
Registrant's Telephone Number, including area code
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (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
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
CLASS OUTSTANDING September 30, 1998
Common Stock, 3,939,282 shares
par value $.83 per share
1
<PAGE>
INDEX
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Page #
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets -
September 30, 1998, and December 31, 1997 . . . . . . . 3
Consolidated Statements of Income -
Three Months Ended September 30, 1998 and 1997 . . . . 4
Consolidated Statements of Income -
Nine Months Ended September 30, 1998 and 1997 . . . . 5
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and 1997 . . . . 6
Notes to Consolidated Financial Statements . . . . . . 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . 9
Part II. Other Information
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . 23
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . 23
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . 23
Item 4. Submission of Matters to a Vote of Security Holders. . 23
Item 5. Other Information. . . . . . . . . . . . . . . . . . . 23
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 23
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
2
<PAGE>
PART I. FINANCIAL INFORMATION
<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
September 30, December 31,
1998 1997
<S> <C> <C>
ASSETS
Cash and due from banks $ 18,244 $ 15,643
Federal funds sold 10,964 4,075
Cash and cash equivalents 29,208 19,718
Interest bearing deposits with other banks 17 23
Short-term investments - 1,596
Investment securities:
Available-for-sale 118,146 94,814
Held-to-maturity (market value -
$2,056 and 2,868, respectively) 2,014 2,827
120,160 97,641
Loans:
Commercial, financial and agricultural 42,771 35,254
Real estate-construction 4,633 5,666
Real estate-commercial mortgage 43,843 34,216
Real estate-residential mortgage 127,838 135,217
Consumer 64,939 67,122
284,024 277,475
Less: Allowance for loan losses (3,371) (2,908)
Net loans 280,653 274,567
Premises and equipment 7,293 7,016
Accrued interest receivable 2,778 2,644
Other assets 2,966 3,151
TOTAL ASSETS $ 443,075 $ 406,356
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 33,489 $ 28,383
Interest bearing 326,342 301,568
359,831 329,951
Borrowed Funds:
Short-term 13,289 12,433
Long-term 29,217 25,452
42,506 37,885
Accrued interest payable 2,983 2,334
Other liabilities 1,100 1,490
Dividends payable 433 382
TOTAL LIABILITIES 406,853 372,042
SHAREHOLDERS' EQUITY
Common Stock, $.83 par value; authorized, 9,000,000 shares;
issued and outstanding: 1998-3,939,282 shares;
1997-3,911,953 shares 3,270 3,257
Surplus 19,125 18,687
Accumulated other comprehensive income 1,255 1,652
Retained earnings 12,572 10,718
TOTAL SHAREHOLDERS' EQUITY 36,222 34,314
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 443,075 $ 406,356
Book value per share $ 9.20 $ 8.78
<FN>
See notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
Three months ended
September 30,
1998 1997
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 6,077 $ 5,764
Interest on federal funds sold 164 182
Interest on short-term investments - 47
Interest on investment securities:
Taxable 1,376 957
Tax-exempt 359 297
1,735 1,254
TOTAL INTEREST INCOME 7,976 7,247
INTEREST EXPENSE
Interest on deposits 3,522 3,217
Interest on borrowed funds 591 402
TOTAL INTEREST EXPENSE 4,113 3,619
NET INTEREST INCOME 3,863 3,628
PROVISION FOR LOAN LOSSES 210 180
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,653 3,448
NET SECURITIES GAINS 142 89
OTHER INCOME
Trust department income 228 178
Services charges on deposit accounts 319 291
Other operating income 260 205
TOTAL OTHER INCOME 807 674
OTHER EXPENSE
Salaries 1,437 1,314
Pensions and other employee benefits 251 229
Occupancy expense 232 236
Equipment expense 272 257
Marketing and advertising 104 128
FDIC Insurance 10 10
Other operating expense 828 721
TOTAL OTHER EXPENSE 3,134 2,895
Income before income taxes 1,468 1,316
INCOME TAXES 379 344
NET INCOME $ 1,089 $ 972
PER SHARE DATA
Net income - basic and diluted $ 0.28 $ 0.25
Cash dividends declared $ 0.11 $ 0.10
<FN>
See notes to consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
Nine months ended
September 30,
1998 1997
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 18,048 $ 16,845
Interest on federal funds sold 258 309
Interest on short-term investments 6 112
Interest on investment securities:
Taxable 3,932 2,611
Tax-exempt 1,013 894
4,945 3,505
TOTAL INTEREST INCOME 23,257 20,771
INTEREST EXPENSE
Interest on deposits 10,067 9,017
Interest on borrowed funds 1,711 1,080
TOTAL INTEREST EXPENSE 11,778 10,097
NET INTEREST INCOME 11,479 10,674
PROVISION FOR LOAN LOSSES 865 480
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 10,614 10,194
NET SECURITIES GAINS 874 283
OTHER INCOME
Trust department income 659 554
Services charges on deposit accounts 928 791
Other operating income 762 535
TOTAL OTHER INCOME 2,349 1,880
OTHER EXPENSE
Salaries 4,225 3,883
Pensions and other employee benefits 823 805
Occupancy expense 704 706
Equipment expense 812 746
Marketing and advertising 366 383
FDIC Insurance 30 28
Other operating expense 2,723 2,083
TOTAL OTHER EXPENSE 9,683 8,634
Income before income taxes 4,154 3,723
INCOME TAXES 1,091 959
NET INCOME $ 3,063 $ 2,764
PER SHARE DATA
Net income - basic and diluted $ 0.78 $ 0.70
Cash dividends declared $ 0.31 $ 0.28
<FN>
See notes to consolidated financial statements.
</TABLE>
5
<PAGE>
<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
Nine months ended
September 30,
1998 1997
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 3,063 $ 2,764
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 865 480
Provision for depreciation and amortization 743 664
Securities gains (874) (283)
Increase in net deferred tax assets (32) (184)
Increase in interest receivable (134) (224)
Increase in interest payable 649 665
(Increase) decrease in other assets 185 (649)
Increase in other liabilities 179 14
Increase (decrease) in accrued taxes (332) 162
NET CASH PROVIDED BY
OPERATING ACTIVITIES 4,312 3,409
INVESTING ACTIVITIES:
Net increase in loans (26,609) (22,490)
Proceeds of loan sales 19,658 8,442
Proceeds from sale of
available-for-sale investment securities 10,617 7,566
Proceeds from maturities of investment securities 11,667 5,945
Purchases of investment securities (44,531) (32,013)
Proceeds from maturities of short-term investments 1,602 25,000
Purchases of short-term investments - (24,966)
Purchases of premises and equipment (1,020) (601)
NET CASH USED IN
INVESTING ACTIVITIES (28,616) (33,117)
FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts,
money market accounts, and savings accounts 17,836 20,865
Net increase in certificates of
deposit and other time deposits 12,044 5,163
Net increase in borrowed funds 4,621 12,501
Cash dividends paid (1,160) (1,066)
Cash paid in lieu of fractional shares (8) -
Proceeds from issuance of common stock 461 22
Repurchase and retirement of common stock - (647)
NET CASH PROVIDED BY
FINANCING ACTIVITIES 33,794 36,838
INCREASE IN CASH AND CASH EQUIVALENTS 9,490 7,130
Cash and cash equivalents at beginning of period 19,718 15,955
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 29,208 $ 23,085
<FN>
See notes to consolidated financial statements.
</TABLE>
6
<PAGE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Notes to Consolidated Financial Statements
(1) In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments which are of a normal
recurring nature necessary to present fairly Hanover Bancorp, Inc's.
financial position as of September 30, 1998, and December 31, 1997, the
results of its operations for the three months and nine months ended
September 30, 1998 and 1997 and cash flows for the nine months ended
September 30, 1998 and 1997.
(2) The information contained in this report is unaudited and is subject to
year-end adjustment and audit.
(3) These statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Corporation's
Annual Report on Form 10-K for the year ended December 31, 1997.
(4) Net income and cash dividends per share are based on the weighted
average number of shares outstanding which were 3,937,258 during the
quarter ended September 30, 1998; 3,914,055 during the quarter ended
September 30, 1997; 3,931,327 during the nine months ended September
30, 1998; and 3,936,891 during the nine months ended September 30,
1997. Weighted average shares and all per share data have been adjusted
to give retroactive effect to the 4 for 3 stock split declared April
17, 1998 and paid June 1, 1998.
(5) The results of operations for the nine months ended September 30, 1998,
are not necessarily indicative of the results that may be expected for
the year ended December 31, 1998.
(6) Management maintains the allowance for loan losses at a level
believed adequate to absorb potential losses in the portfolio.
Factors considered in evaluating the adequacy of the allowance
include potential specific losses, past loan loss experience, the
volume, growth and composition of the loan portfolio and the current
economic conditions and trends.
(7) Effective January 1, 1998, the Corporation adopted Financial Accounting
Standards Board (FASB) Statement No. 130, "Reporting Comprehensive
Income". FASB 130 establishes new rules for the reporting and display
of comprehensive income and its components; however, the adoption of
this statement had no impact on the Corporation's net income or
shareholders' equity. The statement requires unrealized gains or
losses on the Corporation's available-for-sale securities to be
included in other comprehensive income. Prior year financial statements
have been reclassified to conform to the requirements of FASB 130.
7
<PAGE>
Comprehensive income and its components for the three and nine months ended
September 30, are as follows:
<TABLE>
<CAPTION>
Three months Nine months
Ended Ended
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income $1,089 $ 972 $3,063 $2,764
Adjustment to net unrealized gains on
securities available-for-sale, net of
tax effects and reclassification
adjustment for gains included in
net income (293) 637 (397) 597
Comprehensive Income $ 796 $1,609 $2,666 $3,361
</TABLE>
Accumulated other comprehensive income consists of the net unrealized
gain on securities available-for-sale, net of tax effects.
(8) Financial Accounting Standards Board (FASB) Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
became effective for fiscal years ending after December 15, 1997.
This statement establishes standards for the reporting of financial
information from operating segments in annual and interim financial
statements. It requires that segment financial information be
reported on the basis used by management to evaluate the operating
performance of its business units. FASB 131 is not required to be
applied to interim financial statements in the initial year of its
application. As a disclosure requirement, FASB 131 will not have an
impact on the Corporation's financial condition or results of
operations.
(9) In June 1998, FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which is required to
be adopted in years beginning after June 15, 1999. Because the
Corporation does not currently use derivatives, management does not
anticipate that the adoption of the new statement will have a
significant effect on its earnings or financial position.
***********
8
<PAGE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations:
The consolidated operations of Hanover Bancorp Inc., (the "Corporation")
are derived primarily from the operations of its wholly-owned subsidiary,
the Bank of Hanover and Trust Company (the "Bank"). The following discussion
and analysis sets forth results of operations through the third quarter of 1998,
including basic performance trends. There are no known trends, events or
uncertainties that will have or are likely to have a material effect on the
Corporation's liquidity, capital resources or operations.
All forward looking information contained in this discussion and analysis is
based on management's current knowledge of factors affecting the Corporation's
business. Actual results may differ due to unforeseen events such as, but not
limited to, a significant downturn in the economic environment, changes in
interest rates, legislative changes or additional requirements mandated by the
numerous regulatory authorities. All such forward-looking statements are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995.
Third Quarter of 1998 Compared to Third Quarter of 1997:
Net income for the three months ended September 30, 1998, increased $117,000
or 12.0% from 1997 while earnings per share (EPS) increased $.03 or 12.0%
during the same period.
Net interest income on a fully taxable equivalent basis was $4.1 million for
the quarter ended September 30, 1998, an increase of $287,000 or 7.6% from
1997's level of $3.8 million. This increase was due to higher earning asset
levels, driven by loan and deposit growth and increased investment security
activity. Net interest margin decreased 22 basis points from 4.15% in 1997 to
3.93% in 1998. The Corporation has generated growth through the promotion of a
more costly indexed, variable rate money market deposit account and through
additional Federal Home Loan Bank of Pittsburgh borrowings. Much of these
funds have been deployed in investment securities at relatively narrow
spreads. Although these growth strategies have lowered the Corporation's
margin, as was anticipated by management, they have boosted earning asset
levels and net interest income which has positively impacted EPS and Return on
Equity (ROE).
The provision for loan losses during the third quarter of 1998 increased
$30,000 over the same period in 1997. This increase is reflective of the
growth in the loan portfolio, the increased levels of net charge-offs, and the
change in the composition of the loan portfolio.
9
<PAGE>
Securities gains increased from $89,000 during the three months ended
September 30, 1997 to $142,000 for the same period in 1998. This increase was
due to higher equity gains realized from the Corporation's bank stock
portfolio.
Other income for the three months ended September 30, 1998 increased $133,000
or 19.7% over the same period in 1997. The increase in trust department
income is reflective of growth in assets under management which increased by
approximately 22% from period to period. Service charges on deposit accounts
increased due to higher automated teller machine (ATM) related fees generated
through the implementation of noncustomer surcharging and a debit card product
in addition to higher overdraft fees. Other operating income was up primarily
as a result of increased income realized through mortgage loan sales which has
been spurred by the recent surge in refinancing activity.
Total other expense during the third quarter of 1998 was $239,000 or 8.3%
higher than in 1997. The increase in other operating expense and equipment
expense was primarily related to continued technology investments. The
increase in salary expense was affected by several temporary vacancies during
the prior year.
The level of tax-free income is the primary factor impacting the Corporation's
effective tax rate. The Corporation recognized an income tax provision which
resulted in an effective tax rate of 25.8% for the quarter ended September 30,
1998 compared to 26.1% rate in 1997.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September
30 1997:
Net income for the nine months ended September 30, 1998, increased $299,000 or
10.8% from the same period in 1997. EPS increased $.08 or 11.4% from 1997 to
1998 while ROE excluding the FASB 115 component (core equity) increased 32
basis points to 11.96% in 1998 from 11.64% in 1997.
Net interest income on a fully taxable equivalent basis for the nine months
ended September 30, 1998 increased $923,000 or 8.2% from the same period in
1997. This increase was due to higher earning asset levels, driven by loan and
deposit growth and increased investment security activity. Net interest
margin decreased 22 basis points from 4.29% in 1997 to 4.07% in 1998. This
decrease was due primarily to the Corporation's balance sheet growth
strategies discussed earlier.
10
<PAGE>
The provision for loan losses during the period ended September 30, 1998
increased $385,000 over the same period in 1997. This increase was primarily
related to a special $250,000 provision taken in the first quarter to raise
the allowance to a level more comparable to industry standards. The higher
provision is also reflective of the growth in the loan portfolio and an
increased level of net charge-offs.
Securities gains increased $591,000 during the nine months ended September 30,
1998 from the same period in 1997. This increase was due to higher gains
realized from the Corporation's bank stock portfolio. Management views these
gains as deferred investment income as the return on these investments comes
primarily in the form long term market appreciation.
Other income for the nine months ended September 30, 1998 increased $469,000
or 24.9% over 1997. The increase in trust department income is reflective of
growth in assets under management. Service charges on deposit accounts
increased primarily due to higher ATM related fees and higher overdraft fees,
as discussed above. The increase in other operating income was largely related
to higher income realized through mortgage loan sale activity.
Total other expense during the period ended September 30, 1998 was $9.7
million, an increase of $1.0 million or 12.1% from 1997. As discussed, the
increase in other operating expense and equipment expense was due largely
continued technology investments. The increase in other operating expense was
also due to a loss of $252,000 related to the termination of the Corporation's
pension plan which had been frozen in 1996. The increase in salary expense was
affected by several temporary vacancies during the prior year while benefits
expense was positively impacted by lower healthcare costs. The resulting
efficiency ratio (the cost to generate one dollar of revenue), excluding the
nonrecurring pension termination loss, for the nine months ended September 30,
1998 was 65.20% compared to 66.05% in 1997.
The Corporation recognized an income tax provision which resulted in an
effective tax rate of 26.3% for the period ended September 30, 1998 up from
the 25.8% rate in 1997. The increase was the result of a lower proportion of
tax free assets to earning assets in 1998 relative to 1997 as well as
additional state corporate income taxes incurred at the parent company.
11
<PAGE>
<TABLE>
Trends in Sources and Uses of Funds
<CAPTION>
September 30, December 31, Change
1998 1997 $ %
<S> <C> <C> <C> <C>
Funding Sources
Deposits $ 359,831 $ 329,951 $ 29,880 9.1%
Borrowed funds 42,506 37,885 4,621 12.2%
Other liabilities 4,516 4,206 310 7.4%
Shareholders equity 36,222 34,314 1,908 5.6%
TOTAL SOURCES $ 443,075 $ 406,356 $ 36,719 9.0%
Funding Uses
Loans $ 280,653 $ 274,567 $ 6,086 2.2%
Investment securities 120,160 97,641 22,519 23.1%
Federal Funds Sold and other
short-term investments 10,981 5,694 5,287 92.9%
Other assets 31,281 28,454 2,827 9.9%
TOTAL USES $ 443,075 $ 406,356 $ 36,719 9.0%
</TABLE>
12
<PAGE>
Financial Condition
Deposits are the most important funding source and the primary support for the
Corporation's growth. During the first nine months of 1998, total deposits
increased $29.9 million or 9.1%. This growth came primarily from the demand
and money market categories and certificates of deposit (CDs). The increase in
money market deposits was reflective of the continued growth of the indexed,
variable rate account mentioned earlier. The increase in CDs was largely
related to one significant municipal deposit. Borrowed funds increased
primarily as a result of the additional usage of FHLB borrowings as discussed
above. In addition to being a source for funding specific investments, these
borrowings are used to manage the balance sheet and interest rate risk.
The Corporation uses funds primarily to support its lending activities. Net
loans outstanding increased by $6.1 million or 2.2% from December 31, 1997 to
September 30, 1998. This increase was net of residential mortgage loans sold
of $19.7 million. The growth was comprised primarily of increases in the
commercial categories offset by decreases in the residential mortgage and
consumer categories. The decrease in the residential mortgage category was a
result of the loan sales in addition to increased prepayment activity driven
by the current lower rate environment. The decrease in the consumer category
was due to lower dealer loan activity resulting from generally slower
automobile sales. Investment securities increased $22.5 million or 23.1%
through the first nine months of 1998 while federal funds sold and other
short-term investments increased by $5.3 million during this period. These
increases reflect the deployment of funding resulting from deposit growth
exceeding loan growth. In addition, the Corporation increased its investment
portfolio, with FHLB funding, in order to boost earning asset levels and net
interest income. To limit the interest rate risk exposure, most of this
activity was focused on intermediate term, fixed rate mortgage backed and tax
exempt municipal securities.
Capital Resources and Dividends
The Corporation has an ongoing strategic objective of maintaining a capital
base which supports the pursuit of profitable business opportunities, provides
resources to absorb the risks inherent in its activities and meets or exceeds
all regulatory requirements.
At September 30, 1998, total shareholders' equity was $36.2 million, an
increase of $1.9 million or 5.6% from December 31, 1997. This change
consisted of an increase of $2.3 million in capital stock, surplus and
undivided profits (core equity) and a decrease of $397,000 in accumulated
other comprehensive income (unrealized gains on AFS securities). The increase
in the core equity was primarily the result of earnings retained. The
decrease in unrealized gains resulted from lower valuations within the bank
stock portfolio.
13
<PAGE>
On April 17, 1998, the Board of Directors declared a 4-for-3 stock split which
was paid June 1, 1998 to shareholders of record May 1, 1998. The primary
objective of this split was to enhance liquidity and improve marketability by
increasing the number of shares outstanding, while maintaining the strong
market climate for Hanover Bancorp stock. Another tool available to management
for supporting the market for the Corporation's stock is the repurchase
program approved April 18, 1997 by the Board of Directors. As of September 30,
1998, 148,347 shares were still available for purchase under the program. This
program and the prior program have benefited the Corporation in terms of
improved EPS and ROE, two performance factors key to driving shareholder
value.
During the quarter ended September 30, 1998, the Board of Directors declared a
cash dividend of $.11 per share payable November 1, 1998, an increase of $.01
or 10.0% per share from a year ago. The Corporation relies on net income
rather than retained earnings for the payment of dividends to shareholders.
The dividend rate is determined by the Board of Directors after considering
the level of internal capital growth necessary to maintain an appropriate
ratio of equity to assets and the projected level of earnings. Management
anticipates that the internal growth rate of equity is more than adequate to
support the Corporation's asset growth.
As can be seen by the following tables, the Corporation and the Bank remain
well capitalized as defined by the regulatory authorities.
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
<S> <C> <C>
Hanover Bancorp, Inc.
Tier 1 capital to risk-adjusted assets 12.26% 12.47%
Total capital to risk-adjusted assets 13.44% 13.58%
Leverage ratio 8.07% 8.19%
Bank of Hanover and Trust Company
Tier 1 capital to risk-adjusted assets 10.81% 10.82%
Total capital to risk-adjusted assets 12.01% 11.93%
Leverage ratio 7.07% 7.09%
</TABLE>
14
<PAGE>
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") created a framework for supervisory actions in an effort to
reduce the risks of possible long-term losses to the deposit insurance
funds. It established five levels of capital at which insured depository
institutions will be "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized". In 1992, the regulators adopted regulations to
implement the requirements of FDICIA. Under the regulations, the required
minimum capital ratios for each category of institutions are, with certain
exceptions, as follows:
Tier I
Total Capital Capital to
to Risk-Adjusted Risk-Adjusted
Assets Assets Leverage
Well capitalized 10% or above and 6% or above and 5% or above
Adequately
capitalized 8% or above and 4% or above and 4% or above
Undercapitali zed Under 8% or under 4% or under 4%
Significantly
Undercapitalized Under 6% or under 3% or under 3%
Critically
undercapitalized 2% or under
The appropriate federal bank regulatory agency has authority to downgrade
an institution's capital designation by one category if it determines that
an institution is in an unsafe or unsound condition or is engaging in
unsafe or unsound practices.
FDICIA provides for increased supervision for banks not rated in one of the
highest categories under the "CAMELS" composite bank rating system.
Undercapitalized institutions are required to submit capital restoration
plans to the appropriate federal banking regulator and are subject to
restrictions on operations, including prohibitions on branching, engaging
in new activities, paying management fees, making capital distributions
such as dividends, and growing without regulatory approval.
The Bank has been deemed "well capitalized".
15
<PAGE>
Asset Quality and Allowance for Loan Losses:
The following table illustrates the Corporation's nonperforming asset position
as of September 30, 1998 compared to its position at December 31, 1997.
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
<S> <C> <C>
Non-accrual loans $ 649 $ 331
Accruing loans past due 90 days or more 31 174
Restructured loans 177 221
Other real estate and other
repossessed assets 97 236
Total non-performing assets $ 954 $ 962
Non-accrual loans by category
Commercial, financial and agricultural $ 105 $ -
Real estate-construction - -
Real estate-mortgage 534 331
Consumer 10 -
$ 649 $ 331
Past due loans by category
Commercial, financial and agricultural $ 4 $ -
Real estate-construction - -
Real estate-mortgage 25 153
Consumer 2 21
$ 31 $ 174
Restructured loans by category
Commercial, financial and agricultural $ - $ -
Real estate-construction - -
Real estate-mortgage 177 221
Consumer - -
$ 177 $ 221
</TABLE>
16
<PAGE>
Nonperforming assets were .34% of total loans at September 30, 1998 compared
to .35% at December 31, 1997. In addition, potential problem loans at
September 30, 1998, as determined by the Corporation's internal review
process, were $1.8 million in comparison to $2.8 million at December 31, 1997.
Of these amounts, $484,000 and $470,000 were considered impaired under FASB
114 for September 30, 1998 and December 31, 1997, respectively. Loans
considered impaired under FASB 114 represent those potential problem loans
which management feels are probable (as opposed to possible) to result in
future noncompliance in addition to the Corporation's applicable nonaccrual
loans and restructured loans.
Transactions in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
Period ended Period ended
September 30, September 30,
1998 1997
<S> <C> <C>
Balance at beginning of period $2,908 $2,403
Recoveries on loans 157 115
Provision charged to operations 865 480
Loans charged-off (559) (382)
Balance at end of period $3,371 $2,616
</TABLE>
The Corporation remains committed to making provisions in order to maintain a
strong allowance relative to its level of specific potential losses and to its
growing overall loan portfolio. A total provision of $865,000 was made during
the first nine months of 1998 compared to $480,000 during the prior year. This
increase was primarily related to a special $250,000 provision taken in the
first quarter to raise the allowance to a level more comparable to industry
standards. The higher provision is also reflective of the growth in the loan
portfolio and an increased level of net charge-offs. Net charge-offs for
period ended September 30, 1998 were $402,000 compared to $267,000 for the
same period in 1997. The resulting allowance for loan losses at September 30,
1998 was $3.4 million in comparison to $2.9 million at December 31, 1997.
This allowance approximated 1.19% of total loans and 353% of nonperforming
assets at September 30, 1998 versus 1.05% and 302% at year end 1997.
Management feels that the allowance for loan losses is adequate to cover
potential losses within the overall portfolio.
Liquidity
Liquidity is the ability to meet funding requirements of customers' deposit
withdrawals or credit needs at a reasonable cost. The Corporation's
Asset/Liability Management Committee (ALCO) has established policies and
procedures to control its liquidity position and to provide for potential
future needs. The Corporation's liquidity position is enhanced by a
relatively stable funding base. The ratio of deposits (excluding CDs over
$100,000) to total assets was 76.4% at September 30, 1998, while CDs over
$100,000 and other borrowed funds to total assets was 14.4%. To manage its
liquidity needs, the Corporation looks to a number of sources on both sides of
its balance sheet.
17
<PAGE>
On the asset side of the balance sheet, the Corporation relies on federal
funds sold, short-term investments, maturities in the investment portfolio,
principal repayments on outstanding loans and amortizing investment securities
and sales of loans in the secondary markets. At September 30, 1998, the
balance of the federal funds sold account was $11.0 million, while a total of
$6.4 million of the Corporation's investment portfolio was scheduled to mature
in one year or less. Additionally, an average of $8.5 million in loan
principal repayments and $848,000 in mortgage-backed and asset-backed
securities repayments were received by the Corporation during each month of
the first nine months of 1998. Also during this period, the Corporation sold
$19.7 million of loans in the secondary markets.
The Corporation maintains borrowing agreements with several correspondent
banks and the Discount Window at the Federal Reserve Bank of Philadelphia.
In addition it has access to the FHLB for permanent funding needs.
Through these relationships, the Corporation has available short-term
credit of approximately $10.0 million and permanent funding of
approximately $80.0 million.
Market Risk
In January 1997, the Securities and Exchange Commission (SEC) issued new
disclosure rules related to derivatives and exposures to market risk from
derivative financial instruments, other financial instruments and certain
derivative commodity instruments. These rules became effective for the
Corporation's December 31, 1997 financial statements. Market risk includes
interest rate risk, foreign currency exchange rate risk, commodity price
risk and equity price risk. The new disclosure rules have two parts:
quantitative and qualitative market risk disclosures outside the financial
statements and accounting policy disclosures about derivatives in the notes
to the financial statements. As further discussed within, the
Corporation's primary market risk is interest rate risk from its financial
assets and liabilities. Derivatives are not presently utilized and thus
the expanded policy disclosures are not applicable.
Interest rate risk is the exposure to fluctuations in the Corporation's
current and future net interest income from movements in interest rates.
This exposure results from differences between the amounts of interest
earning assets and interest bearing liabilities that reprice within a
specified time period.
The primary objective of the Corporation's asset/liability management
process is to maximize current and future net interest income within
acceptable levels of interest rate risk while satisfying liquidity and
capital requirements. Management recognizes that a certain amount of
interest rate risk is inherent and appropriate yet is not essential to the
Corporation's profitability. Thus the goal of interest rate risk
management is to strike a balance between risk and reward such that net
interest income is maximized while risk is maintained at a tolerable level.
18
<PAGE>
The Corporation uses "gap" and simulation analysis for measuring interest
rate risk. These methods allow management to regularly monitor both the
direction and magnitude of the Corporation's risk exposure. The
Corporation primarily uses the securities portfolio and FHLB advances to
manage its interest rate risk position. Additionally, pricing, promotion
and product development activities are directed in an effort to emphasize
the term or repricing characteristics that best meet current interest rate
risk objectives. At present, off-balance sheet instruments are not used
by the Corporation.
Gap analysis assigns each interest earning asset and interest bearing
liability to a time frame reflecting its next repricing or maturity date.
Incorporated into this process are the trends in prepayments on loan
balances and mortgage-backed securities. The difference between total
interest-sensitive assets and liabilities at each time frame represents the
interest sensitivity gap for that interval. A positive gap generally
indicates that rising interest rates during a particular interval will
increase net interest income, since more assets will reprice than
liabilities. The opposite is true for a negative gap position. As can be
seen in the accompanying table, the Corporation had a cumulative gap within
one year at September 30, 1998 of positive $17.2 million and a rate
sensitivity ratio of positive 3.87%, in comparison to a positive gap of
$6.3 million and a rate sensitivity ratio of positive 1.55% at December 31,
1997. The change from year-end is primarily due to increased prepayment
activity driven by the current lower rate environment.
Simulation analysis prospectively evaluates the effect of upward and
downward changes in interest rates on net interest income. This process is
largely dependent on the underlying assumptions. Key assumptions in the
model include maturity and repricing characteristics of the financial
assets and liabilities, prepayments on amortizing assets, other imbedded
options, nonmaturity deposit sensitivity and loan and deposit growth and
pricing. These assumptions are inherently uncertain due to the timing,
magnitude and frequency of rate changes and changes in market conditions
and management strategies, among other factors. In addition, the
Corporation has not yet developed alternative prepayment or balance sheet
growth assumptions for the various rate scenarios. Therefore the model
cannot precisely estimate net interest income or predict the impact of
higher or lower interest rates on net interest income. However, the model
is useful in that it helps to quantify interest rate risk and it provides a
relative gauge of the Corporation's interest rate risk position.
Based on the results of the simulation model as of December 31, 1997, the
Corporation would expect net interest income to decrease over the next
twelve months by 3.1% assuming an immediate upward shift in market interest
rates of 200 basis points, and to increase by .9% if rates shifted downward
in the same manner. The more pronounced change in the upward scenario is
primarily due to the Corporation's holdings of convertible FHLB borrowings
These borrowings contain features which allow the FHLB to convert them
from fixed rate to variable rate after a specified time period. The model
assumes that in the upward scenario the FHLB would exercise these options
as soon as they become available. The conversion feature of these advances
cannot be reflected in the gap analysis which is a key factor explaining
why the gap show a more asset sensitive position. Management does not
believe this risk position has changed significantly since year-end.
19
<PAGE>
<TABLE>
HANOVER BANCORP INC. CONSOLIDATED GAP ANALYSIS
<CAPTION>
0-30 31-90 91-365
DAYS DAYS DAYS
(In thousands of dollars)
<S> <C> <C> <C>
September 30, 1998
Interest Earning Assets $ 74,896 $ 23,193 $ 81,186
Interest Bearing Liabilities $ 88,728 $ 22,839 $ 50,550
Rate Sensitivity GAP:
Periodic Gap $ (13,832) $ 354 $ 30,636
Cumulative Gap $ (13,832) $ (13,478) $ 17,158
Rate Sensitivity Ratio
Periodic Gap (3.12%) 0.08% 6.91%
Cumulative Gap (3.12%) (3.04%) 3.87%
December 31, 1997
Rate Sensitivity GAP:
Periodic Gap $ (9,391) $ (264) $ 15,948
Cumulative Gap $ (9,391) $ (9,655) $ 6,293
Rate Sensitivity Ratio
Periodic Gap (2.31%) (0.06%) 3.92%
Cumulative Gap (2.31%) (2.38%) 1.55%
</TABLE>
20
<PAGE>
IMPACT OF YEAR 2000
Many older computer programs were designed using two digits rather than
four to define the year. This date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could
cause a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to
process transactions, send invoices, or engage in similar normal
business activities. This situation, known by many as the Year 2000
(Y2K) issue, applies not only to the systems utilized by the Corporation
but also to the systems utilized by customers, creditors, vendors and
suppliers of the Corporation.
The Corporation has completed its assessment and has developed a project
plan to address year 2000 issues. The plan continues progressing through
the over one hundred steps with required completion dates. The year 2000
readiness of all software, hardware and systems is being assessed with
non-compliant items being upgraded or replaced as necessary. Testing is
being done to ensure that these systems will function correctly in the
year 2000 and beyond. Contingency plans are being developed in the event
of unexpected year 2000 problems. The project plan includes steps for
evaluating the year 2000 readiness of the Corporation's more significant
customer relationships. Evaluations are being made regarding the Year
2000 readiness of the Corporation's vendors and service providers. A
corporate-wide task force meets monthly to assess progress with this
plan and to discuss upcoming steps. The Corporation's Board of Directors
and regulatory authorities are closely monitoring this process. The
Corporation intends to have this year 2000 project plan completed and
have all necessary system changes implemented by June 30, 1999.
The cost of becoming year 2000 compliant has been insignificant to date
and management believes that the costs to complete the remaining steps
will not have a material impact on future results of operations.
Failure of the Corporation or third parties to correct year 2000 issues
could cause disruption of operations resulting in increased operating
costs and other adverse effects. In addition, to the extent customers'
financial positions are weakened as a result of year 2000 issues, credit
quality could be affected. It is not possible to predict with certainty
all of the adverse effects that may result from a failure of the
Corporation or third parties to become fully year 2000 compliant or
whether such effects could have a material impact on the Corporation.
The costs of the project and the date on which the Corporation
believes it will complete the Year 2000 modifications are based on
management's best estimates, which were derived utilizing numerous
assumptions of future events, including the continued availability
of certain resources and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results
could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this
area, the ability to locate and correct all relevant computer
codes, and similar uncertainties.
21
<PAGE>
REGULATORY ISSUES
Congress is currently considering legislative reform centered on repealing
the Glass-Steagall Act which prohibits commercial banks from engaging in
the securities industry. The holding company structure would be regulated
by the Federal Reserve Board, and its subsidiaries would be supervised by
the applicable regulator based on their respective functions.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restrictions
on, the business of the Corporation and the Bank. It cannot be predicted
whether such legislation will be adopted or, if adopted, how such
legislation would affect the business of the Corporation and the Bank. As
a consequence of the extensive regulation of commercial banking activities
in the United States, the Corporation's and the Bank's business is
particularly susceptible to being affected by federal legislation and
regulations that may increase the cost of doing business. Except as
specifically described above, management believes that the effect of the
provisions of the aforementioned legislation on the liquidity, capital
resources, and results of operations of the Corporation will be immaterial.
Further, the business of the Corporation is also affected by the state of
the financial services industry in general. As a result of legal and
industry changes, management expects that the industry will continue to
experience consolidations and mergers as the financial services industry
strives for greater cost efficiencies and market share. Management believes
that such consolidations and mergers may enhance its competitive position
as a community bank.
Management is not aware of any other current specific recommendations by
regulatory authorities or proposed legislation, which if they were
implemented, would have a material adverse effect upon the liquidity,
capital resources or results of operations. However, the general cost of
compliance with numerous and multiple federal and state laws and
regulations does have, and in the future may have, a negative impact on the
Corporation's results of operations.
During the first quarter of 1998 the Pennsylvania State Department of
Banking completed a routine examination of the Bank including an assessment
of asset quality. During 1997 the FDIC completed a similar examination of
the Bank.
22
<PAGE>
PART II. OTHER INFORMATION
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Item 1. Legal Proceedings
In the opinion of the management of the Corporation and the Bank, there are no
proceedings pending to which the Corporation and/or Bank is a party or to
which their property is subject, which, if determined adversely to the
Corporation or Bank, would be material in relation to the Corporation's and
the Bank's undivided profits or financial condition. There are no proceedings
pending other than ordinary routine litigation incident to the business of the
Corporation or the Bank. In addition, no material proceedings are pending or
are known to be threatened or contemplated against the Corporation or the Bank
by government authorities.
Item 2. Changes in Securities - None.
Item 3. Defaults Upon Senior Securities - None.
Item 4. Submission of Matters to a Vote of Security Holders - None.
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - None.
(b) Reports on Form 8-K - None
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANOVER BANCORP, INC.
Date: November 13, 1998 /s/ Bradley Scovill
J. Bradley Scovill
President and
Chief Executive Officer
(Principal Executive Officer)
Date: November 13, 1998 /s/ Thomas J. Paholsky
Thomas J. Paholsky
Treasurer
(Principal Accounting and
Financial Officer)
24
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-END> Sep-30-1998
<CASH> 18,244
<INT-BEARING-DEPOSITS> 17
<FED-FUNDS-SOLD> 10,964
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 118,146
<INVESTMENTS-CARRYING> 2,014
<INVESTMENTS-MARKET> 2,056
<LOANS> 284,024
<ALLOWANCE> 3,371
<TOTAL-ASSETS> 443,075
<DEPOSITS> 359,831
<SHORT-TERM> 13,289
<LIABILITIES-OTHER> 4,516
<LONG-TERM> 29,217
0
0
<COMMON> 3,270
<OTHER-SE> 32,952
<TOTAL-LIABILITIES-AND-EQUITY> 443,075
<INTEREST-LOAN> 18,048
<INTEREST-INVEST> 4,945
<INTEREST-OTHER> 264
<INTEREST-TOTAL> 23,257
<INTEREST-DEPOSIT> 10,067
<INTEREST-EXPENSE> 11,778
<INTEREST-INCOME-NET> 11,479
<LOAN-LOSSES> 865
<SECURITIES-GAINS> 874
<EXPENSE-OTHER> 9,683
<INCOME-PRETAX> 4,154
<INCOME-PRE-EXTRAORDINARY> 3,063
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,063
<EPS-PRIMARY> 0.78
<EPS-DILUTED> 0.78
<YIELD-ACTUAL> 0
<LOANS-NON> 649
<LOANS-PAST> 31
<LOANS-TROUBLED> 177
<LOANS-PROBLEM> 1,800
<ALLOWANCE-OPEN> 2,908
<CHARGE-OFFS> 559
<RECOVERIES> 157
<ALLOWANCE-CLOSE> 3,371
<ALLOWANCE-DOMESTIC> 3,371
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
