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, 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 September 30, 1999
Common Stock, 3,906,080 shares
par value $.83 per share
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INDEX
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
Page #
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets -
September 30, 1999 and December 31, 1998 . . . . . . . .. 3
Consolidated Statements of Income -
Three Months Ended September 30, 1999 and 1998 . . . . . 4
Consolidated Statements of Income -
Nine Months Ended September 30, 1999 and 1998 . . . . . . 5
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1999 and 1998 .. . . . . 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. . . . . . . . . . . . . . . . . . . 22
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . 22
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . 22
Item 4. Submission of Matters to a Vote of Security Holders. . 22
Item 5. Other Information. . . . . . . . . . . . . . . . . . . 22
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 22
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
2
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<TABLE>
Part I. Financial Information
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
September 30,December 31,
1999 1998
<S> <C> <C>
ASSETS
Cash and due from banks $ 21,867 $ 17,539
Federal funds sold 18,696 8,635
Cash and cash equivalents 40,563 26,174
Interest bearing deposits with other banks 28 59
Short-term investments 398 -
Investment securities:
Available-for-sale 160,817 143,202
Held-to-maturity (market value - $1,681 and $1,794, respectively) 1,673 1,759
162,490 144,961
Loans:
Commercial, financial and agricultural 45,783 43,803
Real estate-construction 4,195 5,429
Real estate-commercial mortgage 47,787 44,750
Real estate-residential mortgage 129,881 130,196
Consumer 66,389 65,162
294,035 289,340
Less: Allowance for loan losses (3,737) (3,405)
Net loans 290,298 285,935
Premises and equipment 7,126 7,236
Accrued interest receivable 3,325 2,938
Other assets 5,654 2,790
TOTAL ASSETS $ 509,882 $ 470,093
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest bearing $ 36,105 $ 33,827
Interest bearing 373,118 330,181
409,223 364,008
Borrowed Funds:
Short-term 13,352 15,651
Long-term 48,264 49,136
61,616 64,787
Accrued interest payable 3,575 2,453
Other liabilities 1,163 1,468
Dividends payable 470 433
TOTAL LIABILITIES 476,047 433,149
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: 1999-3,906,080 shares;
1998-3,940,375 shares 3,242 3,270
Surplus 18,599 19,144
Accumulated other comprehensive income (3,405) 1,204
Retained earnings 15,399 13,326
TOTAL SHAREHOLDERS' EQUITY 33,835 36,944
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 509,882 $ 470,093
Book value per share $ 8.66 $ 9.38
<FN>
See accompanying notes.
</FN>
</TABLE>
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<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
Consolidated Statements of Income
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
Three months ended
September 30,
1999 1998
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 6,093 $ 6,077
Interest on federal funds sold 274 164
Interest on short-term investments - -
Interest on investment securities:
Taxable 1,680 1,376
Tax-exempt 607 359
2,287 1,735
TOTAL INTEREST INCOME 8,654 7,976
INTEREST EXPENSE
Interest on deposits 3,737 3,522
Interest on borrowed funds 836 591
TOTAL INTEREST EXPENSE 4,573 4,113
NET INTEREST INCOME 4,081 3,863
PROVISION FOR LOAN LOSSES 150 210
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,931 3,653
NET SECURITIES GAINS 90 142
OTHER INCOME
Trust and investment services income 306 250
Services charges on deposit accounts 414 319
Other operating income 249 238
TOTAL OTHER INCOME 969 807
OTHER EXPENSE
Salaries 1,494 1,437
Employee benefits 287 251
Occupancy expense 245 232
Equipment expense 314 272
Marketing and advertising 96 104
Professional and service fees 317 242
Other operating expense 708 596
TOTAL OTHER EXPENSE 3,461 3,134
INCOME BEFORE INCOME TAXES 1,529 1,468
INCOME TAXES 329 379
NET INCOME $ 1,200 $ 1,089
PER SHARE DATA
Net income - basic and diluted $ 0.31 $ 0.28
Cash dividends declared $ 0.12 $ 0.11
<FN>
See accompanying notes.
</FN>
</TABLE>
4
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<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
Consolidated Statements of Income
(Unaudited: in thousands of dollars, except per share data)
<CAPTION>
Nine months ended
September 30,
1999 1998
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $17,981 $18,048
Interest on federal funds sold 632 258
Interest on short-term investments 67 6
Interest on investment securities:
Taxable 4,717 3,932
Tax-exempt 1,661 1,013
6,378 4,945
TOTAL INTEREST INCOME 25,058 23,257
INTEREST EXPENSE
Interest on deposits 10,599 10,067
Interest on borrowed funds 2,493 1,711
TOTAL INTEREST EXPENSE 13,092 11,778
NET INTEREST INCOME 11,966 11,479
PROVISION FOR LOAN LOSSES 540 865
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 11,426 10,614
NET SECURITIES GAINS 251 874
OTHER INCOME
Trust and investment services income 882 714
Service charges on deposit accounts 1,200 928
Other operating income 862 707
TOTAL OTHER INCOME 2,944 2,349
OTHER EXPENSE
Salaries 4,287 4,225
Employee benefits 892 823
Occupancy expense 709 704
Equipment expense 917 812
Marketing and advertising 319 366
Professional and service fees 1,028 660
Other operating expense 2,120 2,093
TOTAL OTHER EXPENSE 10,272 9,683
Income before income taxes 4,349 4,154
INCOME TAXES 941 1,091
NET INCOME $ 3,408 $ 3,063
PER SHARE DATA
Net income - basic and diluted $ 0.87 $ 0.78
Cash dividends declared $ 0.34 $ 0.31
<FN>
See accompanying notes.
</FN>
</TABLE>
5
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<TABLE>
HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited: in thousands of dollars)
<CAPTION>
Nine months ended
September 30,
1999 1998
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,408 $ 3,063
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 540 865
Provision for depreciation and amortization 825 743
Securities gains (251) (874)
(Increase) decrease in net deferred tax assets 147 (32)
Increase in interest receivable (387) (134)
Increase in interest payable 1,122 649
(Increase) decrease in other assets (636) 185
Increase (decrease) in other liabilities (233) 179
Decrease in accrued taxes (72) (332)
Loans originated for sale (10,264) (11,795)
Proceeds from sale of loans originated for sale 11,598 11,739
NET CASH PROVIDED BY
OPERATING ACTIVITIES 5,797 4,256
INVESTING ACTIVITIES
Net increase in loans (6,237) (14,814)
Proceeds from sale of loans - 7,919
Proceeds from sale of avaliable-for-sale investment securities 28,277 10,617
Proceeds from maturities of investment securities 14,274 11,667
Purchases of investment securities (66,813) (44,531)
Proceeds from maturities of short-term investments 8,000 1,602
Purchases of short-term investments (8,367) -
Purchases of premises and equipment (715) (1,020)
NET CASH USED IN
INVESTING ACTIVITIES (31,581) (28,560)
FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts,
money market accounts, and savings accounts 25,506 17,836
Net increase in certificates of deposit and other time deposits 19,709 12,044
Net increase (decrease) in borrowed funds (3,171) 4,621
Cash dividends paid (1,298) (1,160)
- (8)
Proceeds from issuance of common stock 130 461
Repurchase and retirement of common stock (703) -
NET CASH PROVIDED BY
FINANCING ACTIVITIES 40,173 33,794
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 14,389 9,490
Cash and cash equivalents at beginning of year 26,174 19,718
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 40,563 $ 29,208
<FN>
See accompanying notes.
</FN>
</TABLE>
6
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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, 1999, and December 31, 1998,
the results of its operations for the three months and nine months
ended September 30, 1999 and 1998 and cash flows for the nine months
ended September 30, 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
3,917,974 during the quarter ended September 30, 1999 and 3,937,258
during the quarter ended September 30, 1998; 3,932,143 during the
nine months ended September 30, 1999; and 3,931,327 during the nine
months ended September 30, 1998. The effect of dilutive securities
for these periods was immaterial.
(5) The results of operations for the nine months ended September 30,
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 quarter and nine
months ended September 30, are as follows:
Quarter Nine months
Ended Ended
1999 1998 1999 1998
Net income $1,200 $1,089 $3,408 $3,063
Adjustment to net unrealized gains and losses
on securities available-for-sale, net of
tax effects and reclassification adjustment
for gains included in net income (783) (293) (4,609) (397)
Comprehensive Income $ 417 $ 796 $(1,201) $2,666
Accumulated other comprehensive income consists of the net unrealized
gain/loss on securities available-for-sale, net of tax effects.
7
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(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. In July 1999, FASB issued
Statement No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement
No. 133 - an amendment of FASB Statement No. 133". This standard
delayed the effective date for FASB 133 to fiscal years beginning
after June 15, 2000. 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.
*********
8
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HANOVER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations:
Hanover Bancorp, Inc. is a Pennsylvania business corporation that is a
one-bank holding company with headquarters in Hanover, Pennsylvania. Bank
of Hanover and Trust Company, the Corporation's wholly owned subsidiary,
was incorporated in 1835. Hanover Bancorp's income is derived primarily
from the operations of Bank of Hanover and Trust Company. HOVB Investment
Co., a wholly owned subsidiary of the Corporation, was incorporated in
Delaware during 1999. Its principal activity is the holding of and
investing in equity securities.
The following discussion and analysis sets forth results of operations
through the Third 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.
Third Quarter of 1999 Compared to Third Quarter of 1998:
Net income for the three months ended September 30, 1999, increased $111,000
or 10.2% from 1998 while earnings per share (EPS) increased $.03 or 10.7%
during the same period. Return on average core equity (all equity accounts
except accumulated other comprehensive income) improved from 12.52% in 1998
to 12.85% in 1999.
Net interest income on a fully taxable equivalent basis was $4.4 million for
the quarter ended September 30, 1999, an increase of $306,000 or 7.4 from
1998's level of $4.1 million. This increase was due to higher earning asset
levels of $57 million, which was driven by deposit and loan growth and
increased investment security activity. Net interest margin decreased 22
basis points from 3.95% in 1998 to 3.73% 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 third quarter of 1999 was $150,000
compared to $210,000 for 1998. The Corporation makes provisions as necessary
to maintain the allowance at a level adequate to absorb potential future
losses within the portfolio.
9
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Securities gains decreased from $142,000 during the three months ended
September 30, 1998 to $90,000 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 September 30, 1999 increased
$162,000 or 20.1% 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 increases in the second half
of 1998.
Total other expense during the third quarter of 1999 was $327,000 or 10.4%
higher than in 1998. This increase was principally due to professional and
service fees resulting from the contracting of PC help desk and network
administration functions, costs related to technology consulting, legal fees
and the contracting of certain investment services record keeping. The
increase in other operating expense reflects additional telecommunications
costs related to the Corporation's PC network and various operating losses.
The resulting efficiency ratio (the cost to generate one dollar of revenue)
for the three months ended September 30, 1999 was 64.41% compared to 64.03%
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 21.5% for the quarter
ended September 30, 1999 compared to 25.8% rate in 1998. The decrease from
period to period was a result of a higher level of tax free income during
1999.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30 1998:
Earnings for the nine months ended September 30, 1999 increased $345,000 or
11.3% and earnings per share (EPS) increased $.09 or 11.5% over the same
period in 1998. The return on average core equity (all equity accounts
except accumulated other comprehensive income) was 12.32% in 1999 versus
11.96% in 1998.
Net interest income on a fully taxable equivalent basis for the nine months
ended September 30, 1999 increased $788,000 or 6.5% from the same period in
1998. This increase was due to higher earning asset levels, driven by loan
and deposit growth and increased investment security activity. Net interest
margin decreased 31 basis points from 4.09% in 1998 to 3.78% in 1999. As
discussed previously, this decrease was due primarily to the deployment of
excess funding in the investment portfolio at relatively narrow spreads.
The provision for loan losses during the first nine months of 1999 decreased
$325,000 over the same period in 1998. The Corporation makes provisions as
necessary to maintain the allowance at a level adequate to absorb potential
future losses within the portfolio.
Securities gains decreased $623,000 during the period ended September 30,
1999 from the same period in 1998. This decrease was due to a decreased
level of gains realized from the Corporation's bank stock portfolio.
10
<PAGE>
Other income for the nine months ended September 30, 1999 increased $595,000
or 25.3% over 1998. The increase in trust and investment services income is
reflective of growth in assets under management. Service charges on deposit
accounts increased primarily due to higher overdraft fees, as discussed
previously. The increase in other operating income was largely related to
higher income realized from loan origination activity and a change in
classification of customer reimbursed loan origination fees.
Total other expense during the first nine months of 1999 was $10.3 million,
an increase of $589,000 or 6.1% from 1998. The previous year included the
recognition of a $252,000 loss related to the termination of the Bank's
pension plan. Excluding this non-recurring item, other expense increased
$841,000 or 8.9%. This increase was principally due to professional and
service fees resulting from the contracting of PC help desk and network
administration functions, costs related to technology consulting, the
contracting of certain investment services record keeping and increased
recruiting expenses. The increase in equipment expense principally reflects
depreciation on technology-related capital items. The increase in other
operating expense was in large part related to a change in classification of
customer reimbursed loan origination fees. The resulting efficiency ratio
(the cost to generate one dollar of revenue) for the nine months ended
September 30, 1999 was 64.82% compared to 65.20% in 1998.
The Corporation recognized an income tax provision which resulted in an
effective tax rate of 21.6% for the period ended September 30, 1999 down
from the 26.3% rate in 1998. The decrease was the result of a greater
proportion of tax free assets to earning assets in 1999 relative to 1998 as
well as additional state corporate income taxes incurred at the parent
company in the prior year.
Financial Condition
Continued strong growth in the Bank's deposit base enabled the Corporation to
surpass the milestone of $500 million during the second quarter of 1999.
Deposits are the most important funding source and the primary support for
the Corporation's growth. During the first nine months of 1999, total
deposits increased $45.2 million or 12.4%. This growth came in nearly all
categories of deposits but particularly in the demand and money market
categories and certificates of deposit (CDs). Overall, deposit growth was
positively impacted by the continued consolidation within the local
marketplace. Borrowed funds, the other primary funding source, decreased due
to a decline in repurchase agreements.
The Corporation uses these funding sources to support its lending and
investing activities. Net loans outstanding increased by $4.4 or 1.5% from
December 31, 1998 to September 30, 1999. The growth was principally the
result of increases in the commercial and consumer categories.
Investment securities increased $17.5 million or 12.1% through the first
nine months of 1999 while federal funds sold and other short-term
investments increased by $10.4 million during this period. The increase
federal funds sold and other short-term investments reflects the mismatch
between deposit and loan growth and management's expectation that loan
growth will utilize a portion of these funds over time.
11
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<TABLE>
Trends in Sources and Uses of Funds
(in thousands, except percentages)
<CAPTION>
September 30, December 31 Change
1999 1998 $ %
<S> <C> <C> <C> <C>
Funding Sources
Deposits $ 409,223 $ 364,008 $45,215 12.4%
Borrowed funds 61,616 64,787 (3,171) (4.9%)
Other liabilities 5,208 4,354 854 19.6%
Shareholders' equity 33,835 36,944 (3,109) (8.4%)
TOTAL SOURCES $ 509,882 $ 470,093 $39,789 8.5%
Funding Uses
Loans $ 290,298 $ 285,935 $ 4,363 1.5%
Investment securities 162,490 144,961 17,529 12.1%
Federal funds sold and short-term investments 19,122 8,694 10,428 119.9%
Other assets 37,972 30,503 7,469 24.5%
TOTAL USES $ 509,882 $ 470,093 $39,789 8.5%
</TABLE>
12
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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, 1999, total shareholders' equity was $33.8 million, a
decrease of $3.1 million from December 31, 1998. This change consisted of
an increase of $1.5 million in capital stock, surplus and undivided profits
(core equity) and a decrease of $4.6 million in accumulated other
comprehensive income (unrealized gains on AFS securities). The increase in
the core equity was primarily the result of earnings retained. This was
partially offset by the repurchase of the Corporation's common stock, as
discussed below. The decrease in accumulated other comprehensive income
resulted from the higher level of market interest rates which negatively
effects the market value of debt securities 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 capital management and supporting the
market for the Corporation's stock is the repurchase program approved April
18, 1997 by the Board of Directors. During 1999, 42,888 shares were
repurchased at a total cost of $703,000. As of September 30, 1999, 115,039
shares were still available for purchase under the program which originally
authorized 186,667 shares (adjusted for the stock split). 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 September 30, 1999, the Board of Directors declared
a cash dividend of $.12 per share payable November 1, 1999, an increase of
$.01 or 9.1% 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.
September 30, December 31,
1999 1998
Hanover Bancorp, Inc.
Tier 1 capital to risk-adjusted assets 11.64% 12.02%
Total capital to risk-adjusted assets 12.83% 13.16%
Leverage ratio 7.53% 8.04%
Bank of Hanover and Trust Company
Tier 1 capital to risk-adjusted assets 9.65% 10.43%
Total capital to risk-adjusted assets 10.86% 11.60%
Leverage ratio 6.19% 6.93%
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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
Undercapitalized 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".
14
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<TABLE>
Asset Quality and Allowance for Loan Losses:
The following table illustrates the Corporation's nonperforming asset position
as of September 30, 1999 compared to its position at December 31, 1998 (in thousands).
<CAPTION>
September 30,December 31,
1999 1998
<S> <C> <C>
Non-accrual loans $ 387 $ 517
Accruing loans past due 90 days or more 205 425
Restructured loans - -
Other real estate and other
repossessed assets 150 81
Total non-performing assets $ 742 $ 1,023
Non-accrual loans by category
Commercial, financial and agricultural $ 122 $ 81
Real estate-construction 80 -
Real estate-mortgage 185 426
Consumer - 10
$ 387 $ 517
Past due loans by category
Commercial, financial and agricultural $ 65 $ 153
Real estate-construction - -
Real estate-mortgage 123 204
Consumer 17 68
$ 205 $ 425
Restructured loans by category
Commercial, financial and agricultural $ - $ -
Real estate-construction - -
Real estate-mortgage - -
Consumer - -
$ - $ -
</TABLE>
15
<PAGE>
Nonperforming assets were .25% of total loans at September 30, 1999 compared
to .35% at December 31, 1998. In addition, potential problem loans at
September 30, 1999, as determined by the Corporation's internal review
process, were $2.0 million, an increase of $.8 million from December 31,
1998. Of these amounts, $306,000 and $379,000 were considered impaired
under FASB 114 for September 30, 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:
Period ended
September 30,
1999 1998
Balance at beginning of period $3,405 $2,908
Recoveries on loans 268 157
Provision charged to operations 540 865
Loans charged-off (476) (559)
Balance at end of period $3,737 $3,371
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 $540,000 was made
during the first nine months of 1999 compared to $865,000 during the prior
year. Net charge-offs for the period ended September 30, 1999 were $208,000
compared to net charge-offs of $402,000 for the same period in 1998. The
resulting allowance for loan losses at September 30, 1999 was $3.7 million
in comparison to $3.4 million at September 30, 1998. This allowance
approximated 1.27% of total loans and 504% of nonperforming assets at
September 30, 1999 versus 1.19% and 353% at September 30, 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 74.5% at September 30, 1999, while CDs over
$100,000 and other borrowed funds to total assets was 17.9%. To manage its
liquidity needs, the Corporation looks to a number of sources on both sides
of its balance sheet.
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,
1999, the balance of the federal funds sold was $18.7 million while a total
of $16.0 million of the Corporation's investment portfolio was scheduled to
16
<PAGE>
mature in one year or less. Additionally, an average of $10.5 million in
loan principal repayments and $.9 million in mortgage-backed and
asset-backed securities repayments were received by the Corporation during
each month of the first nine 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 $58.2 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.
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
17
<PAGE>
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 September 30, 1999 of
negative $24.6 million or 4.82% 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 more liability sensitive gap position from
December 31, 1998 to September 30, 1999 was largely the result of extending
maturities in the investment portfolio and maturing 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 September 30, 1999, the
Corporation would expect net interest income to decrease over the next
twelve months by 4.7% assuming an immediate upward shift in market interest
rates of 200 basis points, and to increase by 2.0% 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 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. Consistent with
the gap analysis, the change to a more liability sensitive position from
December 31, 1998 to September 30, 1999 is due to extended maturities in
the investment portfolio, increased certificate of deposit maturities
within one year, and the FHLB convertible advances explained above.
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 miscalculation 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,
18
<PAGE>
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 adopted a policy and strategic
project plan using guidelines established by the Federal Financial
Institutions Examination Council (FFIEC). The Corporation completed all
mission-critical aspects of the Year 2000 project plan and had
substantially all necessary system changes implemented in advance of the
regulatory deadline of June 30, 1999. A corporate-wide Year 2000 task
force actively addresses Year 2000 readiness. Senior Management and the
Board of Directors closely monitor the Year 2000 project using a progress
report and internal audits. On a regular basis, bank examiners from the
Federal Deposit Insurance Corporation (FDIC) have evaluated readiness for
the Year 2000 to confirm that guidelines are met.
The Corporation inventoried and assessed all software, hardware and systems
for Year 2000 readiness. Any non-compliant items were upgraded or
replaced. Testing ensured that all mission-critical systems would function
correctly in the year 2000 and beyond, properly handling all
date-sensitive data. The rigorous testing procedures encompassed 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 tested all 13 critical dates
outlined in FFIEC guidance. The Corporation tested each critical date based
upon assessed exposure to date sensitivities. Doing so ensured that vendor
test results were repeatable within the Corporation's specific system
parameters. The Corporation's internal auditor reviewed test results from
all hardware, software and systems. The Corporation completed
mission-critical testing by June 30, 1999.
To minimize customer inconvenience and facilitate a "business as usual"
environment, the Corporation developed 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
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 are reassessed for thoroughness
and validity on a regular 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 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 has assessed 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.
19
<PAGE>
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, statement messages, posters and informational handouts. 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 Corporation informed all customers
about the Presidential Y2K hot line in statements during August 1999.
The cost of becoming Year 2000 compliant has been insignificant to date and
management believes that the remaining costs 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.
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
The Financial Institutions Modernization Act was recently enacted by
Congress. This law will dramatically change the financial services
industry by eliminating the barriers between commercial banking, insurance
and securities. These barriers have existed since the enactment of the
Glass-Steagall Act during the height of the Great Depression. Management
is analyzing the effect of the aforementioned law on the liquidity, capital
resources, and results of operations of the Corporation. The law may have
20
<PAGE>
a substantial long-term impact by changing the business environment in
which the Corporation operates.
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, although 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.
21
<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 - Exhibit 27. Financial Data Schedule
(b) Reports on Form 8-K -
On September 28, 1999 the Corporation filed a Form 8-K
disclosing the following information:
Item 5. Other Events - On August 23, 1999, HOVB Investment Co., a
wholly owned subsidiary of Registrant, was incorporated in Delaware.
Its principal activity is the holding of and investing in equity
securities. The subsidiary was capitalized with the transfer of the
Hanover Bancorp, Inc. equity securities portfolio with a book value
of $6,665,703 and $150,000 in cash.
22
<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: 11/15/99 /s/ Bradley Scovill
J. Bradley Scovill
President and
Chief Executive Officer
(Principal Executive Officer)
Date: 11/15/99 /s/ Thomas J. Paholsky
Thomas J. Paholsky
Treasurer
(Principal Accounting and
Financial Officer)
23
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-END> Sep-30-1999
<CASH> 21,867
<INT-BEARING-DEPOSITS> 28
<FED-FUNDS-SOLD> 18,696
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 160,817
<INVESTMENTS-CARRYING> 1,673
<INVESTMENTS-MARKET> 1,681
<LOANS> 294,035
<ALLOWANCE> 3,737
<TOTAL-ASSETS> 509,882
<DEPOSITS> 409,223
<SHORT-TERM> 13,352
<LIABILITIES-OTHER> 5,208
<LONG-TERM> 48,264
0
0
<COMMON> 3,242
<OTHER-SE> 30,593
<TOTAL-LIABILITIES-AND-EQUITY> 509,882
<INTEREST-LOAN> 17,981
<INTEREST-INVEST> 6,378
<INTEREST-OTHER> 699
<INTEREST-TOTAL> 25,058
<INTEREST-DEPOSIT> 10,599
<INTEREST-EXPENSE> 13,092
<INTEREST-INCOME-NET> 11,966
<LOAN-LOSSES> 540
<SECURITIES-GAINS> 251
<EXPENSE-OTHER> 10,272
<INCOME-PRETAX> 4,349
<INCOME-PRE-EXTRAORDINARY> 3,408
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,408
<EPS-BASIC> 0.87
<EPS-DILUTED> 0.87
<YIELD-ACTUAL> 3.78
<LOANS-NON> 387
<LOANS-PAST> 205
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,400
<ALLOWANCE-OPEN> 3,405
<CHARGE-OFFS> 476
<RECOVERIES> 268
<ALLOWANCE-CLOSE> 3,737
<ALLOWANCE-DOMESTIC> 3,737
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
