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 March 31, 1999
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 March 31, 1999
Common Stock, 3,941,374 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 -
March 31,1999 and December 31, 1998 . . . . . . . . . . 3
Consolidated Statements of Income -
Three Months Ended March 31, 1999 and 1998 . . . . . . 4
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 1999 and 1998 . . . . . . 5
Notes to Consolidated Financial Statements . . . . . . . 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . 8
Part II. Other Information
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . 20
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . 20
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . 20
Item 4. Submission of Matters to a Vote of Security Holders. . 20
Item 5. Other Information. . . . . . . . . . . . . . . . . . . 20
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 20
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2
<PAGE>
Part I. Financial Information
<TABLE>
Consolidated Balance Sheets
(unaudited in thousands, except per share data)
<CAPTION>
March 31, December 31,
1999 1998
<S> <C> <C>
ASSETS
Cash and due from banks $ 17,415 $ 17,539
Federal funds sold 15,996 8,635
Cash and cash equivalents 33,411 26,174
Interest bearing deposits with other banks 1,177 59
Short-term investments 7,966 -
Investment securities:
Available-for-sale 139,408 143,202
Held-to-maturity (market value -$1,790 and $1,794, respectively) 1,755 1,759
141,163 144,961
Loans:
Commercial, financial and agricultural 42,348 43,803
Real estate-construction 4,459 5,429
Real estate-commercial mortgage 47,888 44,750
Real estate-residential mortgage 129,109 130,196
Consumer 66,369 65,162
290,173 289,340
Less: Allowance for loan losses (3,629) (3,405)
Net loans 286,544 285,935
Premises and equipment 7,150 7,236
Accrued interest receivable 2,934 2,938
Other assets 3,147 2,790
TOTAL ASSETS $483,492 $ 470,093
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest bearing $ 36,753 $ 33,827
Interest bearing 339,826 330,181
376,579 364,008
Borrowed Funds:
Short-term 15,721 15,651
Long-term 49,053 49,136
64,774 64,787
Accrued interest payable 3,123 2,453
Other liabilities 1,430 1,468
Dividends payable 434 433
TOTAL LIABILITIES 446,340 433,149
Shareholders' Equity
Preferred stock, $2.50 par value; authorized, 2,000,000 shares;
no shares issued or outstanding - -
Common Stock, $.83 par value; authorized, 9,000,000 shares;
issued and outstanding: 1999-3,941,374 shares;
1998-3,940,375 shares 3,271 3,270
Surplus 19,159 19,144
Accumulated other comprehensive income 766 1,204
Retained earnings 13,956 13,326
TOTAL SHAREHOLDERS' EQUITY 37,152 36,944
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $483,492 $ 470,093
Book value per share $ 9.43 $ 9.38
<FN>
See accompanying notes.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
Consolidated Statements of Income
(unaudited in thousands, except per share data)
<CAPTION>
Three months ended
March 31,
1999 1998
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 5,872 $ 5,897
Interest on federal funds sold 170 21
Interest on short-term investments 32 6
Interest on investment securities:
Taxable 1,499 1,245
Tax-exempt 485 308
1,984 1,553
TOTAL INTEREST INCOME 8,058 7,477
INTEREST EXPENSE
Interest on deposits 3,369 3,189
Interest on borrowed funds 830 543
TOTAL INTEREST EXPENSE 4,199 3,732
NET INTEREST INCOME 3,859 3,745
PROVISION FOR LOAN LOSSES 195 445
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,664 3,300
NET SECURITIES GAINS 76 348
OTHER INCOME
Trust and investment services income 286 235
Service charges on deposit accounts 379 296
Other operating income 350 197
TOTAL OTHER INCOME 1,015 728
OTHER EXPENSE
Salaries 1,385 1,382
Employee benefits 298 280
Occupancy expense 226 230
Equipment expense 298 272
Marketing and advertising 111 131
Professional and service fees 359 188
Other operating expense 711 611
TOTAL OTHER EXPENSE 3,388 3,094
Income before income taxes 1,367 1,282
INCOME TAXES 303 341
NET INCOME $ 1,064 $ 941
PER SHARE DATA
Net income - basic and diluted $ 0.27 $ 0.24
Cash dividends declared 0.11 0.10
<FN>
See accompanying notes.
</FN>
</TABLE>
4
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows
(unaudited in thousands)
<CAPTION>
Three months ended
March 31,
1999 1998
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 1,064 $ 941
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 195 445
Provision for depreciation and amortization 272 243
Securities gains (76) (348)
(Increase) decrease in net deferred tax assets 147 (32)
Decrease in interest receivable 4 3
Increase in interest payable 670 371
Increase in other assets (278) (94)
Increase (decrease) in other liabilities (301) 200
Increase in accrued taxes 263 230
Loans originated for sale (4,359) (6,175)
Proceeds from sale of loans originated for sale 5,102 4,542
NET CASH PROVIDED BY
OPERATING ACTIVITIES 2,703 326
INVESTING ACTIVITIES
Net increase in loans (1,548) (2,309)
Proceeds from sale of loans - -
Proceeds from sale of avaliable-for-sale investment securities 26,699 603
Proceeds from maturities of investment securities 5,418 5,111
Purchases of investment securities (28,907) (17,208)
Proceeds from maturities of short-term investments - 1,600
Purchases of short-term investments (9,084) (26)
Purchases of premises and equipment (186) (551)
NET CASH USED IN
INVESTING ACTIVITIES (7,608) (12,780)
FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts,
money market accounts, and savings accounts 7,481 9,752
Net increase (decrease) in certificates of deposit and other time deposits 5,090 (1,079)
Net increase (decrease) in borrowed funds (13) 4,611
Cash dividends paid (433) (382)
Cash paid in lieu of fractional shares - -
Proceeds from issuance of common stock 17 343
Repurchase and retirement of common stock - -
NET CASH PROVIDED BY
FINANCING ACTIVITIES 12,142 13,245
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,237 791
Cash and cash equivalents at beginning of year 26,174 19,718
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 33,411 $ 20,509
<FN>
See accompanying notes.
</FN>
</TABLE>
5
<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 March 31, 1999, and December 31, 1998, the
results of its operations for the three months ended March 31, 1999 and
1998 and cash flows for the three months ended March 31, 1999 and 1998.
(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, 1998.
(4) Net income (basic and diluted) and cash dividends per share are based
on the weighted average number of shares outstanding which were
3,941,336 during the quarter ended March 31, 1999 and 3,921,747 during
the quarter ended March 31, 1998. The effective dilutive securities
for these periods are immaterial.
(5) The results of operations for the three months ended March 31, 1999,
are not necessarily indicative of the results that may be expected for
the year ended December 31, 1999.
(6) Management maintains the allowance for loan losses at a level
believed adequate to absorb potential future 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) Comprehensive income and its components for the three months ended
March 31, are as follows:
<TABLE>
<CAPTION>
Three months ended
1999 1998
<S> <C> <C>
Net income $ 1,064 $ 941
Adjustment to net unrealized gains on
securities available-for-sale, net of
tax effects and reclassification adjustment
for gains included in net income (438) (179)
Comprehensive Income $ 626 $ 762
</TABLE>
Accumulated other comprehensive income consists of the net unrealized
gain on securities available-for-sale, net of tax effects.
6
<PAGE>
(8) In June 1998, FASB issued Statement No 133, "Accounting for
Derivative Instruments and Hedging Activities". This statement
requires the recognition of derivative instruments as assets or
liabilities, measured at fair value. This standard is effective for
fiscal years beginning after June 15, 1999. The Corporation is not
currently involved in any transactions which fall under the
definitions of this standard, therefore it is not expected to have an
impact on its' liquidity, capital resources or results of
operations.
In October 1998, FASB issued Statement No. 134, " Accounting for
Mortgage Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise".
This statement amends FASB Statement No. 65, "Accounting for Certain
Mortgage Banking Activities" to require that after the
securitization of mortgage loans, the classification of the resulting
mortgage-backed securities be based on the ability and intent to sell
or hold the securities. This standard was effective on January 1,
1999. The Corporation is not currently involved in any transactions
which fall under the definitions of this standard, therefore it has
not had an impact on the Corporation's liquidity, capital resources
or results of operations.
***********
7
<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 first quarter of 1999,
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.
First Quarter of 1999 Compared to First Quarter of 1998:
Net income for the three months ended March 31, 1999, increased $123,000 or
13.1% from 1998 while earnings per share (EPS) increased $.03 or 12.5% during
the same period. Return on average core equity (all equity accounts except
accumulated other comprehensive income) improved from 11.30% in 1998 to 11.73%
in 1999.
Net interest income on a fully taxable equivalent basis was $4.1 million for
the quarter ended March 31, 1999, an increase of $205,000 or 5.2% from 1998's
level of $3.9 million. This increase was due to higher earning asset levels of
$64.0 million, which was driven by deposit and loan growth and increased
investment security activity. Net interest margin decreased 41 basis points
from 4.17% in 1998 to 3.76% in 1999. Since deposit growth outpaced loan growth
during this period, much of the excess funding was deployed in the investment
portfolio. The Corporation also utilized Federal Home Loan Bank of Pittsburgh
(FHLB) borrowings to fund additional investment security activity. As a
result, this growth generated narrower spreads which lowered the margin.
The provision for loan losses during the first quarter of 1999 was $195,000
compared to $445,000 for 1998. The Corporation makes provisions as necessary
to maintain the allowance at level adequate to absorb potential future
losses within the portfolio.
8
<PAGE>
Securities gains decreased from $348,000 during the three months ended March
31, 1998 to $76,000 for the same period in 1999. This decrease was due to
lower equity gains realized from the Corporation's bank stock portfolio.
Other income for the three months ended March 31, 1999 increased $287,000 or
39.4% over the same period in 1998. The increase in trust and investment
services income is reflective of growth in assets under management. Service
charges on deposit accounts increased primarily as a result of higher
overdraft fees related to fee changes. Other operating income was up as a
result of increased income realized through mortgage loan sales in addition to
increased loan fee income.
Total other expense during the first quarter of 1999 was $294,000 or 9.5%
higher than in 1998. The increase in professional and service fees was due to
the contracting of PC help desk and network administration functions, costs
related to technology consulting and increased recruiting expenses. The
increase in other operating expense was primarily related to continued
technology enhancements. Salary expense was affected by a lower level of FTEs
within the technology group due to the contracting of the functions mentioned
above. The resulting efficiency ratio (the cost to generate one dollar of
revenue) for the three months ended March 31, 1999 was 65.67% compared to
66.29% a year ago.
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 22.2% for the quarter
ended March 31, 1999 compared to 26.6% rate in 1998. The decrease from period
to period was a result of a higher level of tax free assets during 1999.
Financial Condition
Deposits are the most important funding source and the primary support for the
Corporation's growth. During the first three months of 1999, total deposits
increased $12.6 million or 3.5%. This growth came primarily from the demand
and money market categories and certificates of deposit (CDs). Overall,
deposit growth was positively impacted by an early year promotion program and
the continued consolidation within the local marketplace. Borrowed funds, the
other primary funding source, remained fairly constant during the first
quarter of 1999.
The Corporation uses funds to support its lending and investing activities.
Net loans outstanding increased by $609,000 or .2% from December 31, 1998 to
March 31, 1999. The growth was comprised of increases in the commercial and
consumer categories offset by decreases in the residential mortgage
categories. The decrease in the residential mortgage category was a result of
the increased prepayment activity driven by the lower rate environment.
Investment securities decreased $3.8 million or 2.6% through the first three
months of 1999 while federal funds sold and other short-term investments
increased by $16.4 million during this period. The decrease in investment
securities resulted from continued high prepayment activity. The increase
federal funds sold and other short-term investments reflects the current
mismatch between deposit and loan growth and management's expectation that
this trend is only temporary.
9
<PAGE>
<TABLE>
Trends in Sources and Uses of Funds
(in thousands, except percentages)
<CAPTION>
March 31, December 31, Change
1999 1998 $ %
<S>
Funding Sources <C> <C> <C> <C>
Deposits $376,579 $ 364,008 $12,571 3.5%
Borrowed funds 64,774 64,787 (13) (0.0%)
Other liabilities 4,987 4,354 633 14.5%
Shareholders' equity 37,152 36,944 208 0.6%
TOTAL SOURCES $483,492 $ 470,093 $13,399 2.9%
Funding Uses
Loans $286,544 $ 285,935 $ 609 0.2%
Investment securities 141,163 144,961 (3,798) (2.6%)
Federal funds sold and short-term investments 25,139 8,694 16,445 189.2%
Other assets 30,646 30,503 143 0.5%
TOTAL USES $483,492 $ 470,093 $13,399 2.9%
</TABLE>
10
<PAGE>
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 March 31, 1999, total shareholders' equity
was $37.2 million, an increase of $208,000 or .6% from December 31, 1998.
This change consisted of an increase of $646,000 in capital stock, surplus and
undivided profits (core equity) and a decrease of $438,000 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 the higher level of market interest
rates and lower valuations within the bank stock portfolio.
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 March 31,
1999, 148,347 shares were still available for purchase under the program. This
program and a 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 March 31, 1999, the Board of Directors declared a
cash dividend of $.11 per share payable May 1, 1999, 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>
March 31, December 31,
1999 1998
<S> <S> <S>
Hanover Bancorp, Inc.
Tier 1 capital to risk-adjusted assets 11.83% 12.02%
Total capital to risk-adjusted assets 13.03% 13.16%
Leverage ratio 7.79% 8.04%
Bank of Hanover and Trust Company
Tier 1 capital to risk-adjusted assets 9.93% 10.43%
Total capital to risk-adjusted assets 11.15% 11.60%
Leverage ratio 6.49% 6.93%
</TABLE>
11
<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:
<TABLE>
<CAPTION>
Tier I
Total Capital Capital to
to Risk-Adjusted Risk-Adjusted
Assets Assets Leverage
<S> <C> <C> <C>
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
Undercapitalized Under 8% or under 4% or under 4%
Significantly
Undercapitalized Under 6% or under 3% or under 3%
Critically
undercapitalized 2% or under
</TABLE>
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".
12
<PAGE>
Asset Quality and Allowance for Loan Losses:
The following table illustrates the Corporation's nonperforming asset position
as of March 31, 1999 compared to its position at December 31, 1998.
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
<S> <C> <C>
Non-accrual loans $ 843 $ 517
Accruing loans past due 90 days or more 162 425
Restructured loans - -
Other real estate and other
repossessed assets 94 81
Total non-performing assets $ 1,099 $ 1,023
Non-accrual loans by category
Commercial, financial and agricultural $ 72 $ 81
Real estate-construction - -
Real estate-mortgage 746 426
Consumer 25 10
$ 843 $ 517
Past due loans by category
Commercial, financial and agricultural $ 48 $ 153
Real estate-construction 80 -
Real estate-mortgage 25 204
Consumer 9 68
$ 162 $ 425
</TABLE>
13
<PAGE>
Nonperforming assets were .38% of total loans at March 31, 1999 compared to
.35% at December 31, 1998. In addition, potential problem loans at March 31,
1999, as determined by the Corporation's internal review process, were $1.2
million, the same level for December 31, 1998. Of these amounts, $353,000 and
$379,000 were considered impaired under FASB 114 for March 31, 1999 and
December 31, 1998, 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
March 31,
1999 1998
<S> <C> <C>
Balance at beginning of period $3,405 $2,908
Recoveries on loans 165 49
Provision charged to operations 195 445
Loans charged-off (136) (213)
Balance at end of period $3,629 $3,189
</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 $195,000 was made during
the first three months of 1999 compared to $445,000 during the prior year. Net
recoveries for the period ended March 31, 1999 were $29,000 compared to net
charge-offs of $164,000 for the same period in 1998. The Corporation
experienced net recoveries in 1999 due to a large recovery on one commercial
loan. The resulting allowance for loan losses at March 31, 1999 was $3.6
million in comparison to $3.4 million at December 31, 1998. This allowance
approximated 1.25% of total loans and 330% of nonperforming assets at March
31, 1999 versus 1.18% and 333% at year end 1998. Management feels that the
allowance for loan losses is adequate to cover potential future 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 74.3% at March 31, 1999, while CDs over $100,000
and other borrowed funds to total assets was 17.0%. To manage its liquidity
needs, the Corporation looks to a number of sources on both sides of its
balance sheet.
14
<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 March 31, 1999, the balance
of the federal funds sold and short-term investments accounts were $16.0
million and $8.0 million, respectively, while a total of $8.8 million of the
Corporation's investment portfolio was scheduled to mature in one year or
less. Additionally, an average of $8.8 million in loan principal repayments
and $1.1 million in mortgage-backed and asset-backed securities repayments
were received by the Corporation during each month of the first three months
of 1999.
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 $65.6 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 maintain a balance between risk and reward such that net
interest income is maximized while risk is maintained at a tolerable level.
15
<PAGE>
The Corporation uses gap and simulation analyses 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. The
Corporation had a cumulative gap within one year at March 31, 1999 of
negative $2.2 million or .46% of total assets. At December 31, 1998, the
Corporation had a positive gap of $19.5 million or 4.15% of total assets.
This shift to a fairly neutral gap from December 31, 1998 to March 31, 1999
was largely the result of extending maturities in the investment portfolio
and a block of certificates of deposit falling within the one year time
frame.
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 over time.
Based on the results of the simulation model as of March 31, 1999, the
Corporation would expect net interest income to decrease over the next
twelve months by 1.2% assuming an immediate upward shift in market interest
rates of 200 basis points, and to decrease by 1.4% if rates shifted
downward in the same manner. At December 31, 1998, net interest income was
expected to decrease by .9% in the upward scenario and to decrease by 1.5%
in the downward scenario. The simulation results are largely affected by
the Corporation's holdings of approximately $43 million 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. This explains why
16
<PAGE>
both the up and down scenarios are showing similar results (i.e. in the up
scenario, the additional income realized due to the asset sensitivity is
offset by the repricing advances). Consistent with the gap analysis, the
change to a more negative position from December 31, 1998 to March 31, 1999
is due to extended maturities in the investment portfolio and increased
certificate of deposit maturities within one year.
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.
To address Year 2000 issues, the Corporation has adopted a policy and
strategic project plan using guidelines established by the Federal
Financial Institutions Examination Council (FFIEC). A corporate-wide Year
2000 task force meets regularly to discuss upcoming projects and assess
progress. Senior Management and the Board of Directors are closely
monitoring the Year 2000 project using a monthly progress report and
internal audits. On a regular basis, bank examiners from the Federal
Deposit Insurance Corporation (FDIC) evaluate readiness for the Year 2000
to confirm that guidelines are being met. The Corporation intends to
complete the Year 2000 project plan and have substantially all necessary
system changes implemented in advance of the deadline established by
regulatory authorities of June 30, 1999.
The Corporation's current focus is on testing and contingency planning.
The Corporation has inventoried and assessed all software, hardware and
systems for Year 2000 readiness. Any non-compliant items are being upgraded
or replaced. Testing is being done to ensure that all mission-critical
systems will function correctly in the year 2000 and beyond, properly
handling all date-sensitive data. The rigorous testing procedures encompass
the ATM network, telephone banking system, core processing system, internal
PC network, internal and external interfaces and mission-critical software.
The vendor of the core processing system has tested all 13 critical dates
outlined in FFIEC guidance. The Corporation is testing each critical date
based upon assessed exposure to date sensitivities. Doing so will ensure
that vendor test results are repeatable within the Corporation's specific
system parameters. The Corporation's internal auditor is reviewing test
results from all hardware, software and systems. The Corporation intends to
have all testing completed by June 30, 1999.
To minimize customer inconvenience and facilitate a "business as usual"
environment, the Corporation is developing contingency plans in the event
of unexpected Year 2000 problems. The Corporation has updated its disaster
recovery plan and assigned corporate-wide team leaders. This plan
encompasses contingencies for mission-critical mainframe and PC-based
17
<PAGE>
applications, third-party relationships and environmental systems. A Year
2000 contingency plan was also developed. This plan addresses aspects
outside of the locus of control such as telecommunications, electric
companies and other utility companies. The procedures in the disaster
recovery and Year 2000 contingency plans will be reassessed for
thoroughness and validity on a quarterly basis.
Utilizing information from written vendor surveys, Internet sites and
internal testing, the Corporation has assessed the year 2000 readiness of
vendors and service providers. Those being assessed include application
software vendors, automated clearinghouses, electronic payment systems
(Federal Reserve), equipment, telecommunication and utility companies. The
FDIC is also monitoring the readiness of the Corporation's ATM and core
processing system providers. The Corporation has determined that all
infrastructure components are Year 2000 compliant, including ATM machines,
safe deposit boxes, vaults, security systems, office equipment, lighting
and heating and cooling systems. Using a written survey and contacts with
loan officers, the Corporation is assessing the Year 2000 readiness of
customers holding significant commercial loans. The Corporation has
established Year 2000 compliance as a factor in its credit decisions and
loan documentation.
A central component of the Year 2000 project is customer and shareholder
awareness of the issue and the steps taken by the Corporation. All branches
and the Teleservices area have been educated on the Year 2000 issue.
Customer concerns are being addressed using statement brochures, lobby
brochures and posters. To facilitate shareholder awareness, a brochure
describing the Corporation's Year 2000 effort was included in the fourth
quarter 1998 report. As a public service, the Corporation informed business
customers about the Small Business Administration Year 2000 hot line in
commercial statements from December 1998 through January 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.
18
<PAGE>
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.
On October 19, 1998, Congress enacted the Year 2000 Information and
Readiness Disclosure Act (the "Act"). The purpose of the Act is (1) to
promote the free disclosure and exchange of information related to Year
2000 readiness; (2) to assist in effectively and rapidly responding to Year
2000 problems; and (3) to establish uniform legal principles in connection
with the disclosure and exchange of information related to Year 2000
readiness. In accordance with the Act, all Bank of Hanover communications
regarding Year 2000 readiness efforts are designated as Year 2000 Readiness
Disclosures.
REGULATORY ISSUES
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. Congress has proposed
"modernization" of the financial services industry. This proposed
modernization will have the effect of deregulating and expanding the
business activities of financial institutions. These additional activities
may include broader insurance powers, securities underwriting activities
and equity investments by commercial banks. 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. 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 not be material. 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.
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 believes 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.
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.
19
<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
(a) An annual meeting of shareholders was held April 27, 1999.
(b)-(c) One matter was voted upon, as follows:
Four directors were elected, as below:
Votes Votes
Term Cast Cast Votes
Expires "For" "Against" "Abstained"
Re-elected
Michael D. Bross 2002 3,934,334 882 6,159
Thomas M. Bross, Jr. 2002 3,933,246 1,970 6,159
Earl F. Noel, Jr. 2002 3,935,216 0 6,159
J. Bradley Scovill 2002 3,930,654 4,562 6,159
Directors whose term continued after meeting
Term
Expires
Terrence L. Hormel 2000
Charles W. Test 2000
S. Eisenhart, Jr. 2000
Bertram F. Elsner 2001
J. Daniel Frock 2001
Gordon A Haaland, Ph.D. 2001
Stewart E. Hartman, Jr. 2001
20
<PAGE>
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - Exhibit 27. Financial Data Schedule
(b) Reports on Form 8-K - None
21
<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: May 14, 1999 /s/ Bradley Scovill
J. Bradley Scovill
President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 14, 1999 /s/ Thomas J. Paholsky
Thomas J. Paholsky
Treasurer
(Principal Accounting and
Financial Officer)
22
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-END> Mar-31-1999
<CASH> 17,415
<INT-BEARING-DEPOSITS> 1,177
<FED-FUNDS-SOLD> 15,996
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 139,408
<INVESTMENTS-CARRYING> 1,755
<INVESTMENTS-MARKET> 1,790
<LOANS> 290,173
<ALLOWANCE> 3,629
<TOTAL-ASSETS> 483,492
<DEPOSITS> 376,579
<SHORT-TERM> 15,721
<LIABILITIES-OTHER> 4,987
<LONG-TERM> 49,053
0
0
<COMMON> 3,271
<OTHER-SE> 33,881
<TOTAL-LIABILITIES-AND-EQUITY> 483,492
<INTEREST-LOAN> 5,872
<INTEREST-INVEST> 1,984
<INTEREST-OTHER> 202
<INTEREST-TOTAL> 8,058
<INTEREST-DEPOSIT> 3,369
<INTEREST-EXPENSE> 4,199
<INTEREST-INCOME-NET> 3,859
<LOAN-LOSSES> 195
<SECURITIES-GAINS> 76
<EXPENSE-OTHER> 3,388
<INCOME-PRETAX> 1,367
<INCOME-PRE-EXTRAORDINARY> 1,064
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,064
<EPS-PRIMARY> 0.27
<EPS-DILUTED> 0.27
<YIELD-ACTUAL> 3.76
<LOANS-NON> 843
<LOANS-PAST> 162
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,200
<ALLOWANCE-OPEN> 3,405
<CHARGE-OFFS> 136
<RECOVERIES> 165
<ALLOWANCE-CLOSE> 3,629
<ALLOWANCE-DOMESTIC> 3,629
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
