UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended December 31, 1996
Commission file number 0-13775
KEYSTONE HERITAGE GROUP, INC.
(Registrant)
PENNSYLVANIA 23-2219740
(State of incorporation) (I.R.S. Employer
Identification No.)
555 WILLOW STREET, LEBANON, PENNSYLVANIA 17046
(Address of principal executive offices)
Registrant's telephone number, including area code: (717) 274-6800
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, $5.00 Par Value
(Title of Class)
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 and (2) has been subject to such filing
requirements for the past 90 days.
Yes __X__ No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
The aggregate market value of the registrant's voting stock held by its
non-affiliates on March 11, 1997 (based on the average bid and asked prices on
that date) was approximately $101,847,777. Reference is made to page 6 herein
for a statement of the assumptions upon which this calculation is based.
As of March 11, 1997, the registrant had 3,965,583 common shares of $5.00
Par Value outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of Parts I and II of this report are incorporated herein
by reference to the 1996 Keystone Heritage Group, Inc. Annual Report to
Stockholders; certain portions of Part III of this report are incorporated
herein by reference to the Keystone Heritage Group, Inc. definitive Proxy
Statement dated March 7, 1997.
<PAGE>
PART I
ITEM 1. BUSINESS
Keystone Heritage Group, Inc. (the "Company") is a bank holding company
organized in 1982 under the laws of Pennsylvania and registered under the
Federal Bank Holding Company Act of 1956, as amended. The Company's principal
subsidiary is Lebanon Valley National Bank (the "Bank"), which is the successor
to several banking institutions, the oldest of which was chartered in 1831. The
Bank engages in a general commercial and retail banking, mortgage banking and
trust business through its branch offices which are located in the five-county
market area of Lebanon, Lancaster, Dauphin, Schuylkill and Berks Counties. The
Bank is a member of the Federal Reserve System. Its deposits are insured by the
Bank Insurance Fund (BIF) of the Federal Deposit Insurance Corporation to the
extent provided by law.
At December 31, 1996, the Company had total consolidated assets of $616.3
million, total deposits of $526.8 million, total outstanding loans of $422.5
million, and stockholders' equity of $62.2 million. At December 31, 1995, the
Company had total assets of $577.8 million, total deposits of $487.9 million,
total outstanding loans of $390.6 million, and stockholders' equity of $58.9
million.
The Bank conducts general banking and trust business at its headquarters
office in Lebanon, Pennsylvania and through 21 other branches, eight of which
are located in Lebanon County, eight in Lancaster County, two in Dauphin County,
two in Berks County and one in Schuylkill County. The Bank offers a wide range
of loan and deposit products to individual and business customers. The Bank also
provides automated teller machine (ATM) access through sixteen automated teller
machines owned and operated by the Bank which are part of the MAC(R) shared
automated ATM network, and the PLUS(R) System ATM network. Two of the Bank's
ATM's are stand-alone facilities. The Bank offers a variety of fiduciary,
investment, advisory, employee benefit, corporate agency and custodian services
to its trust customers. At December 31, 1996, total trust assets having a book
value of $228.8 million were under management or administration by the Bank's
Trust Group.
On March 1, 1996, the Bank acquired the Business operations of Central
Mortgage Company, a Lancaster Pennsylvania mortgage origination company. As
consideration for this acquisition, the Company will pay the seller an amount
equal to one-tenth of one percent (.1%) of all mortgages closed and located in
Lancaster County during the next five years, up to a maximum of $50,000 per
year. This transaction was accounted for using purchase accounting. However, no
intangible assets were acquired as a result of this transaction.
Keystone Heritage Life Insurance Company is a wholly owned non-bank
subsidiary of the Company that reinsures credit life and accident and health
policies written on consumer loans generated by Lebanon Valley National Bank. At
December 31, 1996 this subsidiary had total assets of $1.2 million.
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Competition
The Bank is subject to intense competition from other commercial banks as
well as from savings and loan associations, credit unions, brokerage firms,
money market funds, consumer finance companies, insurance companies, and others
who offer consumer and commercial credit and investment services. Many of the
Bank's competitors have substantial resources and operations which are national
in scope.
The business of the Bank and the Company is not dependent upon any one
customer relationship, and the loss of any one customer would not have a
material impact upon the financial condition of either the Bank or the Company.
The Bank does not obtain any material portion of its deposits from a single
individual, one particular business, or from local, state or federal
governments. The majority of the Bank's lending activity, as well as its
deposits, are concentrated in southcentral Pennsylvania. There is no significant
risk attendant to foreign sources and application of funds. There is not
expected to be any material effect on the capital, expenditures, earnings, or
competitive position of the Bank due to compliance with any federal, state, or
local regulations or guidelines which have been adopted relating to the
protection of the environment.
Supervision and Regulation
The Company is a Pennsylvania bank holding company registered with the
Board of Governors of the Federal Reserve System ("Federal Reserve Board") under
the Bank Holding Company Act of 1956 and is required to comply with its
reporting and approval requirements. The Act requires that the Company obtain
approval of the Federal Reserve Board before it may acquire direct or indirect
ownership or control of more than 5% of the voting shares of any bank, or may
merge or consolidate with any other bank holding company. The Act also prohibits
the Company, with certain exceptions, from acquiring ownership or control of
more than 5% of the voting shares of another company engaged in non-banking
activities and from engaging in any business other than banking, unless the
Federal Reserve Board, by order or regulation, has determined such activities to
be so closely related to banking or to managing or controlling banks as to be a
proper incident thereto.
The Bank is a national bank, chartered under the National Banking Act, and
is subject to the primary supervision of, and is examined by, the Office of the
Comptroller of the Currency. The Bank is subject to provisions of the Federal
Reserve Act, which (among other things) restricts the ability of a bank to
extend credit to its parent holding company or to certain of the parent's
subsidiaries, or to invest in the Company's common stock or to take such stock
as collateral for loans to any borrower. The operations of the Bank are also
subject to regulation by the FDIC.
The Company is also subject to the monetary and credit policies of the
Federal Reserve System. The Federal Reserve System regulates the national supply
of bank credit through open market transactions in U.S. Government securities
and by controlling the discount rate charged for bank borrowings and the reserve
requirements on bank deposits.
Federal Law allows banks, beginning June 1, 1997, to expand across state
lines by acquiring existing banks or merging affiliated banks into a single
interstate bank, subject to the right of individual states to
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opt in early (as Pennsylvania has done) or to opt out entirely by June 1, 1997.
The same law allows banks to create de novo branches in another state if the law
of the other state permits (as Pennsylvania's now does). Finally, federal law
has permitted since September 1995 interstate ownership by bank holding
companies without regard to state laws limiting interstate ownership by bank
holding companies or imposing conditions such as reciprocity. Interstate banking
and branching authority is subject to regulatory approval and to certain
conditions and restrictions, such as capital adequacy, Community Reinvestment
Act compliance and deposit concentration. The Company does not currently have
any plans to expand its activities outside Pennsylvania.
Although this legislation may quicken the pace of consolidation within the
banking industry, the Company does not anticipate any immediate impact upon its
financial condition or its operations as a result of this new law.
Employees
As of December 31, 1996, the Company employed 294 full-time employees and
59 part-time employees.
ITEM 2. PROPERTIES
The Company and the Bank own their principal executive and administrative
offices which are located at 555 Willow Street, Lebanon, Pennsylvania, at which
address the Bank also owns and operates a branch banking facility and an "ATM".
The Bank also owns its data processing operations center located at 421 East
Penn Avenue, Cleona, Pennsylvania. A branch banking facility is also located at
this address. In addition, the Bank owns thirteen other branch banking
buildings. Six branch offices are leased under lease agreements which expire at
various dates through 2013. The Bank also leases the an office site located at
1476 Lititz Pike, P.O. Box 4097, Lancaster, Pennsylvania for the Bank's mortgage
banking operations. The above facilities are generally believed to be adequate
for the Company's current needs.
ITEM 3. LEGAL PROCEEDINGS
Note 16 of the "Notes to Consolidated Financial Statements" on page 25 of
the 1996 Keystone Heritage Group, Inc. Annual Report to Stockholders is
incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ADDITIONAL INFORMATION
The following information is furnished in Part I of this report pursuant to
Instruction 3 to Item 401 (b) of Regulation S-K.
EXECUTIVE OFFICERS OF THE COMPANY AND THE BANK
The following sets forth as of March 11, 1997 information concerning the
officers of the Company and the Bank and certain other officers of the Company
and its subsidiaries. Shown are the name, age, and position or office with the
Company and its subsidiaries held by each listed person, the date since that
position or office has been held, and principal occupation during the last five
years, if other than as an employee of the Company or its subsidiaries. No
family relationships exist between any of the officers or directors. Except as
noted below, all officers hold office at the pleasure of the Board of Directors
of the Company, and there are no arrangements or understandings between any such
officer and any other person which resulted in his selection as an officer. The
Company's Board of Directors has determined that the only executive officers of
the Company are Albert B. Murry, Kurt A. Phillips and Donald W. Lesher, Jr.
Executive Officers Age Position & Office During the Last Five Years
Albert B. Murry (1) 56 President and Chief Executive Officer of the
Company and the Bank. He has served as
President and Chief Executive Officer of the
Company since 1983, and as President and Chief
Executive Officer of the Bank since 1978. Mr.
Murry has been employed by the Bank since 1978.
Kurt A. Phillips(1) 40 Treasurer and Chief Financial Officer
(principal financial and accounting officer) of
the Company since 1984, Executive Vice
President of the Bank since 1994 and Chief
Financial Officer of the Bank since 1983. Mr.
Phillips has been employed by the Bank since
1978.
Donald W. Lesher, Jr. 52 Vice President of the Company and Chairman of
the Board of the Bank (non- compensated
positions) since July 1993. Mr. Lesher is
President of Lesher Mack Sales and Services,
Inc. and has been a director of the Company
since 1983.
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Other Officers
Calvin L. Cassel 41 Senior Vice President of the Bank's Operations
Group since 1984. Mr. Cassel began his
employment with the Bank in 1981.
Larry H. Eberly 54 Senior Vice President of the Bank's Trust
Department since 1984. Mr. Eberly has been
employed by the Bank since 1960.
Michael H. Firestine 46 Senior Vice President of the Bank's Agriculture
Banking Group since 1992. Mr. Firestine has
been employed by the Bank since 1976.
James I. Freidly, III 42 Senior Vice President of the Bank's Corporate
Banking Group since 1996. Mr. Freidly was
Credit Review Manager from 1992 to 1996.
Previously, Mr. Freidly was employed by
Hamilton Bank in its Business Banking Division.
Bradford J. Norris 30 Senior Vice President and President of Central
Mortgage since 1996. Mr. Norris was previously
employed by Principal Residential Mortgage,
Inc. as an Account Executive since 1995, by
Jefferson Savings and Loan Assoc. from 1994 to
1995 and by Freddie Mac from 1991 to 1994.
Timothy L. Sandoe 39 Senior Vice President of the Retail Credit
Group since 1992. Vice President of Credit
Administration from 1987 to 1992. Mr. Sandoe
has been employed by the Bank since 1983.
Ellen M. Whitmoyer 45 Senior Vice President of the Consumer Banking
Group since 1992. Mrs. Whitmoyer has been
employed by the Bank since 1984.
Donald D. Canull 33 Vice President and Comptroller of the Bank
since 1994. Mr. Canull has been employed by the
Bank since 1989.
Barry L. Ginder 48 Vice President and Chief Auditor of the Bank
since 1991. Mr. Ginder was previously employed
by Northeastern Bank as Vice President of
Finance, Comptroller and Treasurer.
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(1) The Bank has entered into agreements with Albert B. Murry and Kurt A.
Phillips pursuant to which they are employed as President and Chief
Executive Officer and Executive Vice President and Chief Financial Officer
of the Company and the Bank, respectively. These agreements provide for
Messrs. Murry and Phillips to be paid base salaries as determined by the
Compensation Committee of the Bank's Board of Directors, plus increases and
bonuses as are consistent with those made available to other officers of
the Bank. The Bank may terminate these agreements upon three years' notice
and 30 months notice, respectively, or the death or disability of Mr. Murry
or Mr. Phillips, respectively, or upon their conviction of a crime
involving moral turpitude, or upon being charged with a criminal offense
arising out of these employments.
Assumptions Used in Calculating Market Value of Common Stock
For the purposes of calculating the aggregate market value of the shares of
common stock of the Company held by non-affiliates, as shown on the cover page
of this report, it has been assumed that all the outstanding shares at December
31, 1996 were held by non-affiliates except for the shares held by directors and
executive officers of the Company or the Bank. However, this should not be
deemed to constitute an admission that all such directors and officers are, in
fact, affiliates of the Company, or that there are not other persons who may be
deemed to be affiliates of the Company. Further information concerning
shareholdings of officers, directors and principal stockholders is included
elsewhere herein and in the Company's definitive proxy statement previously
filed with the Securities and Exchange Commission.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
"Stockholders Information" on page 52 and Footnote 17 "Dividend
Restrictions" on page 25 of the 1996 Keystone Heritage Group, Inc. Annual Report
to Stockholders are incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
"Summary of Selected Financial Data" on page 33 of the 1996 Keystone
Heritage Group, Inc. Annual Report to Stockholders is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 34 through 51 of the 1996 Keystone Heritage Group, Inc.
Annual Report to Stockholders is incorporated herein by reference.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements appearing on pages 10 through 13 of
the 1996 Keystone Heritage Group, Inc. Annual Report to Stockholders, along with
the accompanying notes to consolidated financial statements on pages 14 through
31, and the Independent Auditors' Report on page 32 are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
The information called for by Item 10 "Directors and Executive Officers of
the Registrant" (other than the information concerning executive officers set
forth after Item 4 herein), Item 11 "Executive Compensation", Item 12 "Security
Ownership of Certain Beneficial Owners and Management" and Item 13 "Certain
Relationships and Related Transactions" is incorporated herein by reference to
the Company's definitive proxy statement for its Annual Meeting of Stockholders
scheduled to be held April 15, 1997, which definitive proxy statement has been
filed with the Securities and Exchange Commission on March 7, 1997, to which
this report relates.
7
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS:
The following consolidated financial statements of the Company are
incorporated herein by reference to the 1996 Keystone Heritage Group, Inc.
Annual Report to Stockholders.
Page Number
(in Annual
Report)
Consolidated Balance Sheets as of December 31, 1996 and 1995 10
Consolidated Statements of Income for the years ended
December 31, 1996, 1995 and 1994 11
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1996, 1995 and 1994 12
Consolidated Statements of Cash Flows
for the years ended December 31, 1996, 1995 and 1994 13
Notes to Consolidated Financial Statements 14 - 31
Independent Auditors' Report 32
(a) 2. FINANCIAL STATEMENT SCHEDULES:
All schedules applicable to the registrant are shown in the respective
financial statements or in the notes thereto.
(a) 3. EXHIBITS:
3.1 Articles of Incorporation of Keystone Heritage Group, Inc,
incorporated by reference to Exhibit 3.1 of Keystone Heritage Group,
Inc. 1995 Annual Report on Form 10-K.
3.2 By-laws of Keystone Heritage Group, Inc., as amended, incorporated by
reference to Exhibit 3.2 of Keystone Heritage Group, Inc. 1995 Annual
Report on Form 10-K.
4 Miscellaneous long term debt instruments and credit facility or line
of credit agreements of the Company, under each of which the
underlying authorized debt is equal to or less than 10% of the total
assets of the Company and its subsidiaries on a consolidated basis,
are not filed as exhibits to this report. The Company agrees to
furnish to the Commission, upon request, copies of any such
instruments.
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10.1 Employment agreement between Lebanon Valley National Bank and Albert
B. Murry, President and Chief Executive Officer, incorporated by
reference to Exhibit 10 of Part IV of Keystone Heritage Group, Inc.
1995 Annual Report on Form 10-K.
10.2 Employment agreement between Lebanon Valley National Bank and Kurt A.
Phillips, Executive Vice President and Chief Financial Officer,
incorporated by reference to Exhibit 10 of Part IV of Keystone
Heritage Group, Inc. 1995 Annual Report on Form 10-K.
10.3 1994 Stock Incentive Plan filed herewith.
10.4 1996 Independent Directors Stock Option Plan, incorporated by
reference to Exhibit 4 of the Keystone Heritage Group, Inc.
Registration Statement on Form S-8 filed on February 26, 1997.
13 1996 Keystone Heritage Group, Inc. Annual Report to Stockholders,
filed herewith. Such report, except for the portions thereof which are
expressly incorporated by reference into this Form 10-K, is furnished
solely for the information of the Commission and is not to be deemed
"filed" as part of the filing.
21 Subsidiaries of Keystone Heritage Group, Inc., incorporated by
reference to Exhibit 21 of Part IV of Keystone Heritage Group, Inc.
1995 Annual Report on Form 10-K.
23 Consent of Independent Auditors, filed herewith.
27 Financial Data Schedule, filed herewith.
(b) No reports on Form 8-K were filed during the three months ended December
31, 1996.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
KEYSTONE HERITAGE GROUP, INC.
(Registrant)
by /s/ Albert B. Murry
Albert B. Murry
President and Chief Executive Officer
March 11, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
Signature Title Date
/s/ Raymond M. Dorsch, Jr. Director March 11, 1997
- - ----------------------------
Raymond M. Dorsch, Jr.
/s/ Lance M. Frehafer Secretary and Director March 11, 1997
- - ----------------------------
Lance M. Frehafer
/s/ Harry J. Gensemer Director March 11, 1997
- - ----------------------------
Harry J. Gensemer
/s/ Charles V. Henry III Director March 11, 1997
- - ----------------------------
Charles V. Henry III
s/s Wendie DiMatteo Holsinger Director March 11, 1997
- - -----------------------------
Wendie DiMatteo Holsinger
/s/ Bruce A. Johnson Director March 11, 1997
- - -----------------------------
Bruce A. Johnson
/s/ Donald W. Lesher, Jr. Vice President March 11, 1997
- - ----------------------------- and Director
Donald W. Lesher, Jr.
/s/ Thomas I. Siegel Director March 11, 1997
- - -----------------------------
Thomas I. Siegel
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/s/ Brett H. Tennis Director March 11, 1997
- - -----------------------------
Brett H. Tennis
/s/ Mark Randolph Tice Director March 11, 1997
- - -----------------------------
Mark Randolph Tice
/s/ John E. Wengert Director March 11, 1997
- - -----------------------------
John E. Wengert
/s/ Earnest D. Williams, Jr. Director March 11, 1997
- - -----------------------------
Earnest D. Williams, Jr.
/s/ Albert B. Murry President and Director March 11, 1997
- - ----------------------------- (Principal Executive
Albert B. Murry Officer)
/s/ Kurt A. Phillips Treasurer (Principal March 11, 1997
- - ---------------------------- Financial and
Kurt A. Phillips Accounting Officer)
<PAGE>
EXHIBIT INDEX
3.1 Articles of Incorporation of Keystone Heritage Group,
Inc., incorporated by reference to Exhibit 3.1 of Keystone
Heritage Group, Inc. 1995 Annual Report on Form 10-K.
3.2 By-laws of Keystone Heritage Group, Inc., incorporated by
reference to Exhibit 3.2 of Keystone Heritage Group, Inc.
1995 Annual Report on Form 10-K.
4 Miscellaneous long-term debt instruments and line of credit
agreements of the Company, under each of which the underlying
authorized debt is equal to or less than 10% of the total
assets of the Company and its subsidiaries on a consolidated
basis, are not filed as exhibits of this report. The Company
agrees to furnish to the Commission, upon request, copies of
any such instruments.
10.1 Employment agreement between Lebanon Valley National Bank and
Albert B. Murry, President and Chief Executive Officer,
incorporated by reference to Exhibit 10 of Part IV of Keystone
Heritage Group, Inc. 1995 Annual Report on Form 10-K.
10.2 Employment agreement between Lebanon Valley National Bank and
Kurt A. Phillips, Executive Vice President and Chief Financial
Officer, incorporated by reference to Exhibit 10 of Part IV of
Keystone Heritage Group, Inc. 1995 Annual Report on Form 10-K.
10.3 1994 Stock Incentive Plan filed herewith.
10.4 1996 Independent Directors Stock Option Plan, incorporated
by reference to Exhibit 4 of the Keystone Heritage Group,
Inc. Registration Statement on Form S-8 filed on February
26, 1997.
13 1996 Keystone Heritage Group, Inc. Annual Report to
Stockholders, filed herewith. Such report, except for the
portions thereof which are expressly incorporated by reference
into this Form 10-K, are furnished solely for the information
of the Commission and is not to be deemed "filed" as part of
the filing.
21 Subsidiaries of Keystone Heritage Group, Inc., incorporated by
reference to Exhibit 21 of Part IV of Keystone Heritage Group,
Inc. 1995 Annual Report on Form 10-K.
23 Consent of Independent Auditors, filed herewith
27 Financial Data Schedule, filed herewith.
Copies of any exhibits will be furnished to any stockholder upon
written request directed to Secretary, Keystone Heritage Group, Inc.,
555 Willow Street, P. O. Box 1285, Lebanon, Pennsylvania 17042-1285.
EXHIBIT 10.3
KEYSTONE HERITAGE GROUP, INC.
1994 STOCK INCENTIVE PLAN
1. Purpose. The purpose of this Stock Incentive Plan (the "Plan") is to
advance the development, growth and financial condition of Keystone Heritage
Group, Inc. (the "Company") and each subsidiary thereof as defined in Section
424 of the Internal Revenue Code of 1986, as amended (the "Code"), by providing
incentives through participation in the appreciation of capital stock of the
Company so as to secure, retain and motivate personnel who may be responsible
for the operation and management of the affairs of the Company and any such
subsidiary now or hereafter existing ("Subsidiary").
2. Term. The Plan shall become effective as of the date it is adopted by
the Company's Board of Directors (the "Board"), so long as the Company's
stockholders duly approve the Plan within twelve (12) months either before or
after the date of the Board's adoption of the Plan. Any and all options and
rights awarded under the Plan ("Awards") before it is so approved by the
Company's stockholders shall be conditional upon and may not be exercised before
timely obtainment of such approval, and shall lapse upon the failure thereof. If
the Plan is so approved, it shall continue in effect until all Awards either
have lapsed or been exercised, satisfied or cancelled according to their terms
under the Plan.
3. Stock. The shares of stock that may be issued under the Plan shall not
exceed in the aggregate 120,000 shares of the Company's common stock, par value
$5.00 per share (the "Stock"), as may be adjusted pursuant to paragraph 18
hereof. Such shares of Stock may be either authorized and unissued shares of
Stock, or authorized shares of Stock issued by the Company and subsequently
reacquired by it as treasury stock. Under no circumstances shall any fractional
shares of Stock be issued or sold under the Plan or any Award. Except as may be
otherwise provided in the Plan, any Stock subject to an Award that for any
reason lapses or terminates prior to its exercise as to such Stock shall become
and again be available under the Plan. The Company shall reserve and keep
available, and shall duly apply for any requisite governmental authority to
issue or sell the number of shares of Stock needed to satisfy the requirements
of the Plan while in effect. The Company's failure to obtain any such
governmental authority deemed necessary by the Company's legal counsel for the
lawful issuance and sale of Stock under the Plan shall relieve the Company of
any duty, or liability for the failure to issue or sell such Stock as to which
such authority has not been obtained.
<PAGE>
4. Administration. The Plan shall be administered by a committee (the
"Committee") consisting of two (2) or more directors from the Board serving for
such terms as determined, selected and appointed by the Board. The Board shall
fill all vacancies occurring in the Committee's membership, and at any time and
for any reason may add additional members to the Committee or may remove members
from the Committee and appoint their successors. To serve on the Committee, a
person must be a director of the Company and during the year prior to commencing
service on the Committee, was not granted or awarded any Awards, allocations or
other options or rights of or with respect to Stock or any other capital stock
of the Company or its affiliates pursuant to the Plan or any other plan of the
Company or its affiliates which provides for discretionary grants or awards. A
majority of the Committee's membership shall constitute a quorum for the
transaction of all business of the Committee, and all decisions and actions
taken by the Committee shall be determined by a majority of the members of the
Committee attending a meeting at which a quorum of the Committee is present.
The Committee shall be responsible for the management and operation of the
Plan and, subject to its provisions, shall have full, absolute and final power
and authority, exercisable in its sole discretion: to interpret and construe the
provisions of the Plan, adopt, revise and rescind rules and regulations relating
to the Plan and its administration, and decide all questions of fact arising in
the application thereof; to determine what, to whom, when and under what facts
and circumstances Awards shall be made, and the form, number, terms, conditions
and duration thereof, including but not limited to when exercisable, the number
of shares of Stock subject thereto, and Stock option purchase prices; to adopt,
revise and rescind procedural rules for the transaction of the Committee's
business, subject to any directives of the Board not inconsistent with the
provisions or intent of the Plan or applicable provisions of law; and to make
all other determinations and decisions, take all actions and do all things
necessary or appropriate in and for the administration of the Plan. The
Committee's determinations, decisions and actions under the Plan, including but
not limited to those described above, need not be uniform or consistent, but may
be different and selectively made and applied, even in similar circumstances and
among similarly situated persons. Unless contrary to the provisions of the Plan,
all decisions, determinations and actions made or taken by the Committee shall
be final and binding upon the Company and all interested persons, and their
heirs, personal and legal representatives, successors, assigns and
beneficiaries. No member of the Committee or of the Board shall be liable for
any decision, determination or action made or taken in good faith by such person
under or with respect to the Plan or its administration.
-2-
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5. Awards. Awards may be made under the Plan in the form of: (a) "Qualified
Options" to purchase Stock that are intended to qualify for certain tax
treatment as incentive stock options under Sections 421 and 422 of the Code, (b)
"Non-Qualified Options" to purchase Stock that are not intended to qualify under
Sections 421-424 of the Code, (c) Stock appreciation rights ("SARs"), or (d)
"Restricted Stock". More than one Award may be granted to an eligible person,
and the grant of any Award shall not prohibit the grant of any other Award,
either to the same person or otherwise, or impose any obligation upon the person
to whom granted to exercise the Award. All Awards and the terms and conditions
thereof shall be set forth in written agreements, in such form and content as
approved by the Committee from time to time, and shall be subject to the
provisions of the Plan whether or not contained in such agreements. Multiple
Awards for a particular person may be set forth in a single written agreement or
in multiple agreements, as determined by the Committee, but in all cases each
agreement for one or more Awards shall identify each of the Awards thereby
represented as a Qualified Option, Non-Qualified Option, SAR, or Restricted
Stock, as the case may be. Every Award made to a person (a "Recipient") shall be
exercisable during his or her lifetime only by the Recipient, and shall not be
salable, transferable or assignable by the Recipient except by his or her Will
or pursuant to applicable laws of descent and distribution.
6. Eligibility. Persons eligible to receive Awards shall be those key
officers and other management employees of the Company and each Subsidiary as
determined by the Committee. In no case, however, shall any current member of
the Committee be eligible to receive any Awards. A person's eligibility to
receive Awards shall not confer upon him or her any right to receive any Awards;
rather, the Committee shall have the sole authority, exercisable in its
discretion consistent with the provisions of the Plan, to select when, to whom
and under what facts and circumstances Awards will be made. Except as otherwise
provided, a person's eligibility to receive, or actual receipt of Awards under
the Plan shall not limit or affect his or her benefits under or eligibility to
participate in any other incentive or benefit plan or program of the Company or
its affiliates.
7. Qualified Options. In addition to other applicable provisions of the
Plan, all Qualified Options and Awards thereof shall be under and subject to the
following terms and conditions:
(a) No Qualified Option shall be awarded more than ten (10) years
after the date the Plan is adopted by the Board or the date the Plan is
approved by the Company's stockholders, whichever date is earlier;
(b) The time period during which any Qualified Option is exercisable,
as determined by the Committee, shall not commence before the expiration of
six (6) months or continue
-3-
<PAGE>
beyond the expiration of ten (10) years after the date such Option is
awarded;
(c) If the Recipient of a Qualified Option ceases to be employed by
the Company or any Subsidiary for any reason other than his or her death,
the Committee may permit the Recipient thereafter to exercise such Option
during its remaining term for a period of not more than three (3) months
after such cessation of employment to the extent that the Option was then
and remains exercisable, unless such employment cessation was due to the
Recipient's disability as defined in Section 22(e)(3) of the Code, in which
case such three (3) month period shall be twelve (12) months; if the
Recipient dies while employed by the Company or a Subsidiary, the Committee
may permit the Recipient's qualified personal representatives, or any
persons who acquire the Qualified Option pursuant to his or her Will or
laws of descent and distribution, thereafter to exercise such Option during
its remaining term for a period of not more than twelve (12) months after
the Recipient's death to the extent that the Option was then and remains
exercisable; the Committee may impose terms and conditions upon and for
said exercise of such Qualified Option after such cessation of the
Recipient's employment or his or her death;
(d) The purchase price of a share of Stock subject to any Qualified
Option, as determined by the Committee, shall not be less than the Stock's
fair market value at the time such Option is awarded, as determined under
paragraph 13 hereof, or less than the Stock's par value.
8. Non-Qualified Options. In addition to other applicable provisions of the
Plan, all Non-Qualified Options and Awards thereof shall be under and subject to
the following terms and conditions:
(a) The time period during which any Non-Qualified Option is
exercisable, as determined by the Committee, shall not commence before the
expiration of six (6) months or continue beyond the expiration of ten (10)
years after the date such Option is awarded;
(b) If a Recipient of a Non-Qualified Option, before its lapse or full
exercise, ceases to be eligible under the Plan, the Committee may permit
the Recipient thereafter to exercise such Option during its remaining term,
to the extent that the Option was then and remains exercisable, for such
time period and under such terms and conditions as may be prescribed by the
Committee;
-4-
<PAGE>
(c) The purchase price of a share of Stock subject to any
Non-Qualified Option, as determined by the Committee, shall not be less
than the Stock's fair market value.
9. Stock Appreciation Rights. In addition to other applicable provisions of
the Plan, all SARs and Awards thereof shall be under and subject to the
following terms and conditions:
(a) SARs may be granted either alone, or in connection with another
previously or contemporaneously granted Award (other than another SAR) so
as to operate in tandem therewith by having the exercise of one affect the
right to exercise the other, as and when the Committee may determine;
however, no SAR shall be awarded in connection with a Qualified Option more
than ten (10) years after the date the Plan is adopted by the Board or the
date the Plan is approved by the Company's stockholders, whichever date is
earlier;
(b) Each SAR shall entitle its Recipient to receive upon exercise of
the SAR all or a portion of the excess of (i) the fair market value at the
time of such exercise of a specified number of shares of Stock as
determined by the Committee, over (ii) a specified price as determined by
the Committee of such number of shares of Stock that, on a per share basis,
is not less than the Stock's fair market value at the time the SAR is
awarded;
(c) Upon exercise of any SAR, the Recipient shall be paid either in
cash or in Stock, or in any combination thereof, as the Committee shall
determine; if such payment is to be made in Stock, the number of shares
thereof to be issued pursuant to the exercise shall be determined by
dividing the amount payable upon exercise by the Stock's fair market value
at the time of exercise;
(d) The time period during which any SAR is exercisable, as determined
by the Committee, shall not commence before the expiration of six (6)
months or continue beyond the expiration of ten (10) years after the date
such SAR is awarded; however, no SAR connected with another Award shall be
exercisable beyond the last date that such other connected Award may be
exercised;
(e) If a Recipient of a SAR, before its lapse or full exercise, ceases
to be eligible under the Plan, the Committee may permit the Recipient
thereafter to exercise such SAR during its remaining term, to the extent
that the SAR was then and remains exercisable, for such time period and
under such terms and conditions as may be prescribed by the Committee;
-5-
<PAGE>
(f) No SAR shall be awarded in connection with any Qualified Option
unless the SAR (i) lapses no later than the expiration date of such
connected Option, (ii) is for not more than the difference between the
Stock purchase price under such connected Option and the Stock's fair
market value at the time the SAR is exercised, (iii) is transferable only
when and as such connected Option is transferable and under the same
conditions, (iv) may be exercised only when such connected Option may be
exercised, and (v) may be exercised only when the Stock's fair market value
exceeds the Stock purchase price under such connected Option.
10. Restricted Stock. In addition to other applicable provisions of the
Plan, all Restricted Stock and Awards thereof shall be under and subject to the
following terms and conditions:
(a) Restricted Stock shall consist of shares of Stock that may be
acquired by and issued to a Recipient at such time, for such or no purchase
price, and under and subject to such transfer, forfeiture and other
restrictions, conditions or terms as shall be determined by the Committee,
including but not limited to prohibitions against transfer, substantial
risks of forfeiture within the meaning of Section 83 of the Code, and
attainment of performance or other goals, objectives or standards, all for
or applicable to such time periods as determined by the Committee;
(b) Except as otherwise provided in the Plan or the Restricted Stock
Award, a Recipient of shares of Restricted Stock shall have all the rights
as does a holder of Stock, including without limitation the right to vote
such shares and receive dividends with respect thereto; however, during the
time period of any restrictions, conditions or terms applicable to such
Restricted Stock, the shares thereof and the right to vote the same and
receive dividends thereon shall not be sold, assigned, transferred,
exchanged, pledged, hypothecated, encumbered or otherwise disposed of
except as permitted by the Plan or the Restricted Stock Award;
(c) Each certificate issued for shares of Restricted Stock shall be
deposited with the Secretary of the Company, or the office thereof, and
shall bear a legend in substantially the following form and content:
This Certificate and the shares of Stock hereby represented are
subject to the provisions of the Company's Stock Incentive Plan and a
certain agreement entered into between the owner and the Company
pursuant to said Plan. The release of this Certificate and the shares
of Stock hereby represented from such provisions shall occur only as
provided by said Plan and agreement, a copy of which are on file in
the office of the
-6-
<PAGE>
Secretary of the Company.
Upon the lapse or satisfaction of the restrictions, conditions and
terms applicable to such Restricted Stock, a certificate for the
shares of Stock free thereof without such legend shall be issued to
the Recipient;
(d) If a Recipient's employment with the Company or a Subsidiary
ceases for any reason prior to the lapse of the restrictions, conditions or
terms applicable to his or her Restricted Stock, all of the Recipient's
Restricted Stock still subject to unexpired restrictions, conditions or
terms shall be forfeited absolutely by the Recipient to the Company without
payment or delivery of any consideration or other thing of value by the
Company or its affiliates, and thereupon and thereafter neither the
Recipient nor his or her heirs, personal or legal representatives,
successors, assigns, beneficiaries, or any claimants under the Recipient's
Last Will or laws of descent and distribution, shall have any rights or
claims to or interests in the forfeited Restricted Stock or any
certificates representing shares thereof, or claims against the Company or
its affiliates with respect thereto.
11. Exercise. Except as otherwise provided in the Plan, Awards may be
exercised in whole or in part by giving written notice thereof to the Secretary
of the Company, or his or her designee, identifying the Award being exercised,
the number of shares of Stock with respect thereto, and other information
pertinent to exercise of the Award. The purchase price of the shares of Stock
with respect to which an Award is exercised shall be paid with the written
notice of exercise, either in cash or in Stock at its then current fair market
value, or in any combination thereof, as the Committee shall determine. Funds
received by the Company from the exercise of any Award shall be used for its
general corporate purposes.
The number of shares of Stock subject to an Award shall be reduced by the
number of shares of Stock with respect to which the Recipient has exercised
rights under the Award. If a SAR is awarded in connection with another Award,
the number of shares of Stock that may be acquired by the Recipient under the
other connected Award shall be reduced by the number of shares of Stock with
respect to which the Recipient has exercised his or her SAR, and the number of
shares of Stock subject to the Recipient's SAR shall be reduced by the number of
shares of Stock acquired by the Recipient pursuant to the other connected Award.
The Committee may permit an acceleration of previously established exercise
terms of any Awards as, when, under such facts and circumstances, and subject to
such other or further requirements and conditions as the Committee may deem
necessary or
-7-
<PAGE>
appropriate. In addition: (a) if the Company or its stockholders execute an
agreement to dispose of all or substantially all of the Company's assets or
capital stock by means of sale, merger, consolidation, reorganization,
liquidation or otherwise, as a result of which the Company's stockholders as of
immediately before such transaction will not own at least fifty percent (50%) of
the total combined voting power of all classes of voting capital stock of the
surviving entity (be it the Company or otherwise) immediately after the
consummation of such transaction, thereupon any and all Awards immediately shall
become and remain exercisable with respect to the total number of shares of
Stock still subject thereto for the remainder of their respective terms until
the consummation of such transaction, or if not consummated, until the agreement
therefor expires or is terminated, in which case thereafter all Awards shall be
treated as if said agreement never had been executed; (b) if there is an actual,
attempted or threatened change in the ownership of at least twenty-five percent
(25%) of all classes of voting capital stock of the Company through the
acquisition of, or an offer to acquire such percentage of the Company's voting
capital stock by any person or entity, or persons or entities acting in concert
or as a group, and such acquisition or offer has not been duly approved by the
Board; or (c) if during any period of two (2) consecutive years, the individuals
who are the beginning of such period constituted the Board, cease for any reason
to constitute at least a majority of the Board, unless the election of each
director of the Board, who was not a director of the Board at the beginning of
such period, was approved by a vote of at least two-thirds of the directors then
still in office who were directors at the beginning of such period, thereupon
any and all Awards immediately shall become and remain exercisable with respect
to the total amount of shares of Stock still subject thereto for the remainder
of their respective terms, thereupon any and all Awards immediately shall become
and remain exercisable with respect to the total number of shares of Stock still
subject thereto for the remainder of their respective terms.
12. Withholding. Whenever the Company is about to issue or transfer Stock
pursuant to any Award, the Company may require the Recipient to remit to the
Company an amount sufficient to satisfy fully any federal, state and other
jurisdictions' income and other tax withholding requirements prior to the
delivery of any certificates for such shares of Stock. Whenever payments are to
be made in cash to any Recipient pursuant to his or her exercise of an Award,
such payments shall be made net after deduction of all amounts sufficient to
satisfy fully any federal, state and other jurisdictions' income and other tax
withholding requirements.
13. Value. Where used in the Plan, the "fair market value" of Stock or any
options or rights with respect thereto, including Awards, shall mean and be
determined by (a) the average of the highest and lowest reported sales prices
thereof on the principal established domestic securities exchange on which
listed, and if
-8-
<PAGE>
not listed, then (b) the average of the dealer "bid" and "ask" prices thereof on
the New York over-the-counter market as reported by the National Association of
Securities Dealers, Inc., in either case as of the specified or otherwise
required or relevant time, or if not traded as of such specified, required or
relevant time, then based upon such reported sales or "bid" and "ask" prices
before and/or after such time in accordance with pertinent provisions of and
principles under the Code and the regulations promulgated thereunder.
14. Amendment. To the extent permitted by applicable law, the Board may
amend, suspend, or terminate the Plan at any time; provided, however, that: (a)
no amendment may be adopted that permits an Award to be granted to any member of
the Committee; (b) with respect to qualified options, except as specified in
paragraph 18 hereof, no amendment may be adopted that will increase the number
of shares reserved for Awards under the Plan, change the option price, or change
the provisions required for compliance with Section 422 of the Code and
regulations issued thereunder; and (c) notwithstanding anything to the contrary
herein, no amendment may be adopted to increase the number of securities that
may be issued under the Plan, except as specified in paragraph 18 hereof,
materially increase the benefits accruing to recipients or materially modify the
requirements for eligibility to participate in the Plan, without the approval of
the stockholders of the Company, to the extent that stockholder approval is
required under Section 16 of the Securities Exchange Act of 1934, as amended,
and the regulations thereunder, as from time to time in effect. The amendment or
termination of this Plan shall not, without the consent of the Recipients, alter
or impair any rights or obligations under any Award previously granted
hereunder.
In addition and subject to the foregoing, the Committee may prescribe other
or additional terms, conditions and provisions with respect to the grant or
exercise of any or all Awards as the Committee may determine necessary or
appropriate for such Awards and the Stock subject thereto to qualify under and
comply with all applicable laws, rules and regulations, and changes therein,
including but not limited to the provisions of Sections 421 and 422 of the Code,
Section 16 of the Securities Exchange Act of 1934, as amended, and Rule 16b-3
promulgated by the Securities and Exchange Commission. Without limiting the
generality of the preceding sentence, each Qualified Option, and any SAR awarded
in connection therewith, shall be subject to such other and additional terms,
conditions and provisions as the Committee may deem necessary or appropriate in
order to qualify such Option, or connected Option and SAR, as an incentive stock
option under Section 422 of the Code, including but not limited to the following
provisions:
(i) the aggregate fair market value, at the time such Option is
awarded, of the Stock subject thereto and of any
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<PAGE>
Stock or other capital stock with respect to which incentive stock options
qualifying under Sections 421 and 422 of the Code are exercisable for the
first time by the Recipient during any calendar year under the Plan and any
other plans of the Company or its affiliates, shall not exceed $100,000.00;
and (ii) No Qualified Option, or any SAR in connection therewith, shall be
awarded to any person if at the time of such Award, such person owns Stock
possessing more than ten percent (10%) of the total combined voting power
of all classes of capital stock of the Company or its affiliates, unless at
the time such Option or SAR is awarded the Stock purchase price under such
Option is at least one hundred and ten percent (110%) of the fair market
value of the Stock subject to such Option and the Option (and any SAR
connected therewith) by its terms is not exercisable after the expiration
of five (5) years from the date it is awarded.
From time to time, the Committee may rescind, revise and add to any of
such terms, conditions and provisions as may be necessary or appropriate to
have any Awards be or remain qualified and in compliance with all
applicable laws, rules and regulations, and may delete, omit or waive any
of such terms, conditions or provisions that are no longer required by
reason of changes in applicable laws, rules or regulations.
15. Continued Employment. Nothing in the Plan or any Award shall confer
upon any Recipient or other persons any right to continue in the employment of,
or maintain any particular relationship with the Company or its affiliates, or
limit or affect any rights, powers or privileges that the Company or its
affiliates may have to supervise, discipline and terminate such Recipient or
other persons, and the employment and other relationships thereof. However, the
Committee may require as a condition of making and/or exercising any Award that
its Recipient agree to, and in fact provide services, either as an employee or
in another capacity, to or for the Company or any Subsidiary for such time
period following the date the Award is made and/or exercised as the Committee
may prescribe. The immediately preceding sentence shall not apply to any
Qualified Option to the extent such application would result in disqualification
of said Option as an incentive stock option under Sections 421 and 422 of the
Code.
16. General Restrictions. Each Award shall be subject to the requirement
and provision that if at any time the Committee determines it necessary or
desirable as a condition of or in consideration of making such Award, or the
purchase or issuance or Stock thereunder, (a) the listing, registration or
qualification of the Stock subject to the Award, or the Award itself, upon any
securities exchange or under any federal or state securities or other laws, (b)
the approval of any governmental authority, or (c) an agreement by the Recipient
with respect to disposition of any
-10-
<PAGE>
Stock (including without limitation that at the time of the Recipient's exercise
of the Award, any Stock thereby acquired is being and will be acquired solely
for investment purposes and without any intention to sell or distribute such
Stock), then such Award shall not be consummated in whole or in part unless such
listing, registration, qualification, approval or agreement shall have been
appropriately effected or obtained to the satisfaction of the Committee and
legal counsel for the Company.
17. Rights. Except as otherwise provided in the Plan, the Recipient of any
Award shall have no rights as a holder of the Stock subject thereto unless and
until one or more certificates for the shares of such Stock are issued and
delivered to the Recipient. No adjustments shall be made for dividends, either
ordinary or extraordinary, or any other distributions with respect to Stock,
whether made in cash, securities or other property, or any rights with respect
thereto, for which the record date is prior to the date that any certificates
for Stock subject to an Award are issued to the Recipient pursuant to his or her
exercise thereof. No Award, or the grant thereof, shall limit or affect the
right or power of the Company or its affiliates to adjust, reclassify,
recapitalize, reorganize or otherwise change its or their capital or business
structure, or to merge, consolidate, dissolve, liquidate or sell any or all of
its or their business, property or assets.
18. Adjustments. In the event of any change in the number of issued and
outstanding shares of Stock which results from a stock split, reverse stock
split, payment of a stock dividend or any other change in the capital structure
of the Company, the Committee shall proportionately adjust the maximum number of
shares subject to each outstanding Award, and (where appropriate) the purchase
price per share thereof (but not the total purchase price under the Award), so
that upon exercise or realization of such Award, the Recipient shall receive the
same number of shares he or she would have received had he or she been the
holder of all shares subject to his or her outstanding Award and immediately
before the effective date of such change in the number of issued and outstanding
shares of Stock. Such adjustments shall not, however, result in the issuance of
fractional shares. Any adjustments under this paragraph 18 shall be made by the
Committee, subject to approval by the Board. No adjustments shall be made that
would cause a Qualified Option to fail to continue to qualify as an incentive
stock option within the meaning of Section 422 of the Code.
In the event the Company is a party to any merger, consolidation or other
reorganization, any and all outstanding Awards shall apply and relate to the
securities to which a holder of Stock is entitled after such merger,
consolidation or other reorganization. Upon any liquidation or dissolution of
the Company, any and all outstanding Awards shall terminate upon consummation of
such liquidation or dissolution, but prior to such
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<PAGE>
consummation shall be exercisable to the extent that the same otherwise are
exercisable under the Plan.
19. Forfeiture. Notwithstanding anything to the contrary in this Plan, if
the Committee finds after full consideration of the facts presented on behalf of
the Company and the involved Recipient, that he or she has been engaged in
fraud, embezzlement, theft, commission of a felony, or dishonesty in the course
of his or her employment by the Company or any Subsidiary that has damaged it,
or that the Recipient has disclosed trade secrets of the Company or its
affiliates, the Recipient shall forfeit all rights under and to all unexercised
Awards, and all exercised Awards under which the Company has not yet delivered
payment or certificates for shares of Stock (as the case may be), all of which
Awards and rights shall be automatically cancelled. The decision of the
Committee as to the cause of the Recipient's discharge from employment with the
Company or any Subsidiary and the damage thereby suffered shall be final for
purposes of the Plan, but shall not affect the finality of the Recipient's
discharge by the Company or Subsidiary for any other purposes. The preceding
provisions of this paragraph shall not apply to any Qualified Option to the
extent such application would result in disqualification of said Option as an
incentive stock option under Sections 421 and 422 of the Code.
20. Indemnification. In and with respect to the administration of the Plan,
the Company shall indemnify each present and future member of the Committee
and/or of the Board, who shall be entitled without further action on his or her
part to indemnity from the Company for all damages, losses, judgments,
settlement amounts, punitive damages, excise taxes, fines, penalties, costs and
expenses (including without limitation attorneys' fees and disbursements)
incurred by such member in connection with any threatened, pending or completed
action, suit or other proceedings of any nature, whether civil, administrative,
investigative or criminal, whether formal or informal, and whether by or in the
right or name of the Company, any class of its security holders, or otherwise,
in which such member may be or have been involved, as a party or otherwise, by
reason of his or her being or having been a member of the Committee and/or of
the Board, whether or not he or she continues to be such a member. The
provisions, protection and benefits of this paragraph shall apply and exist to
the fullest extent permitted by applicable law to and for the benefit of all
present and future members of the Committee and/or of the Board, and their
respective heirs, personal and legal representatives, successors and assigns, in
addition to all other rights that they may have as a matter of law, by contract,
or otherwise, except (a) as may not be allowed by applicable law, (b) to the
extent there is entitlement to insurance proceeds under insurance coverage
provided by the Company on account of the same matter or proceeding for which
indemnification hereunder is claimed, or (c) to the extent there is entitlement
to
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<PAGE>
indemnification from the Company, other than under this paragraph, on account of
the same matter or proceeding for which indemnification hereunder is claimed.
21. Miscellaneous. Any reference contained in this Plan to a particular
section or provision of law, rule or regulation, including but not limited to
the Internal Revenue Code of 1986 and the Securities Exchange Act of 1934, both
as amended, shall include any subsequently enacted or promulgated section or
provision of law, rule or regulation, as the case may be, of similar import.
With respect to persons subject to Section 16 of the Securities Exchange Act of
1934, as amended, transactions under this Plan are intended to comply with all
applicable conditions of Rule 16b-3 or any successor rule that may be
promulgated by the Securities and Exchange Commission, and to the extent any
provision of this Plan or action by the Committee fails to so comply, it shall
be deemed null and void, to the extent permitted by applicable law and deemed
advisable by the Committee. Where used in this Plan: the plural shall include
the singular, and unless the context otherwise clearly requires, the singular
shall include the plural; and, the term "affiliates" shall mean each and every
Subsidiary and any parent of the Company. The captions of the numbered
paragraphs contained in this Plan are for convenience only, and shall not limit
or affect the meaning, interpretation or construction of any of the provisions
of the Plan.
- - - - - - -
END
- - - - - - -
-13-
FINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)
Years ended December 31
<TABLE>
<CAPTION>
Percent
1996 1995 Change
<S> <C> <C> <C>
INCOME STATEMENT
Net interest income $ 25,480 $ 24,163 5.5%
Net income 8,720 7,657 13.9%
PER SHARE DATA
Net income $ 2.15 $ 1.88 14.4%
Cash dividends .84 .705 19.1%
Book value 15.65 14.46 8.2%
YEAR END BALANCE SHEET
Loans $422,534 $390,631 8.2%
Total assets 616,307 577,777 6.7%
Total deposits 526,833 487,917 8.0%
Stockholders' equity 62,239 58,879 5.7%
FINANCIAL RATIOS
Return on average assets 1.50% 1.38%
Return on average stockholders' equity 14.36 13.85
</TABLE>
[GRAPHIC OMITTED - BAR CHART OF NET INCOME FOR 1996-1992]
The data points are as follows ($ in thousands):
1996 $8,720
1995 $7,657
1994 $6,767
1993 $5,042
1992 $5,105
[GRAPHIC OMITTED - BAR CHART OF EARNINGS PER SHARE FOR 1996-1992]
The data points are as follows:
1996 $2.15
1995 $1.88
1994 $1.67
1993 $1.24
1992 $1.26
[GRAPHIC OMITTED - BAR CHART OF RETURN ON AVERAGE EQUITY FOR 1996-1992]
The data points are as follows:
1996 14.36%
1995 13.85%
1994 13.29%
1993 10.57%
1992 11.32%
[GRAPHIC OMITTED - BAR CHART OF RETURN ON AVERAGE ASSETS FOR 1996-1992]
The data points are as follows:
1996 1.50%
1995 1.38%
1994 1.26%
1993 0.94%
1992 0.95%
1
<PAGE>
BUILDING FOR THE FUTURE
Keystone Heritage has a proud 165-year heritage of providing outstanding
services to customers throughout our expanding market place and through its
principal subsidiary, Lebanon Valley National Bank, has developed an effective
business strategy around its personal and business banking services. Substantial
investments in technology, combined with input from highly skilled
professionals, have produced a platform that well positions Keystone Heritage
for future growth and expansion. To build and maintain market leadership and
shareholder value, Keystone Heritage's strategy concentrates on three areas --
operational excellence, product innovation, and the development of solid
relationships with individual and business clients. Our business strategy also
includes helping to build stronger communities throughout our market place. By
wisely investing resources in sound programs and innovative partnerships,
Keystone Heritage strives to make a positive difference in the lives of those
who live in the communities we serve.
Your Company had a very successful and productive year in 1996 including
the posting of record net income of $8.7 million or $2.15 per share which
represents a 14.4 percent per share increase over 1995. Return on average
stockholders' equity was 14.36 percent and return on average assets was 1.50
percent. Measures instituted over the past few years to improve earnings
performance and the momentum achieved will benefit our stockholders, customers,
and employees as we meet the challenges of a changing banking environment.
Throughout the 1990s, your Company, like many small community bank holding
companies similar in asset size, enjoyed growth and success by competing in the
traditional "commercial bank" market place. Supplying credit and non-credit
services to a wide variety of companies and personal clients contributed to
positive bottom-line results. These results were achieved through conservative
management practices with emphasis on a strong credit process, a revitalized
business solicitation approach, and diligent expense management. We are
confident that existing and planned product lines and customer services that we
offer are competitive and that our delivery channels for providing these
products and services are both effective and sufficiently technologically
advanced to enable us to continue to expand our service delivery on a profitable
basis.
Changing technology, industry over-capacity, and changing demographics are
just a few of the challenges that face bank managers and boards of directors.
Through our annual strategic planning process, each of these subjects is
addressed in depth with the result being that there is a strong feeling that our
Company has the resources and creativity to continue to compete effectively by
providing customized, high-quality, technologically advanced financial services
throughout our existing market place.
We believe that contact with customers in bank branches remains an
important ingredient of a community bank's approach to doing business. However,
the Company has extensively utilized technological resources in providing and
delivering financial products and services to its customers. We are quite
pleased with "The Banking Connection", LVNB's 24-hour telephone audio
information system that allows customers to receive account information, apply
for consumer loans, and receive a wide variety of other
2
<PAGE>
[GRAPHIC OMITTED: PHOTOGRAPH OF ROSEVILLE ROAD OFFICE: 38 East Roseville Road,
Lancaster, opened September 30, 1996]
financial information. The Lebanon Valley National Bank MasterMoney(TM) check
card was introduced in July 1996. This card was issued initially to some 14,000
checking account customers and can be used as both an automated teller machine
("ATM") card and as a "check card" to make purchases at any merchant that
accepts MasterCard(R) via an electronic deduction to a customer's checking
account. We continue to evaluate how technological advances can improve our
product lines, streamline our operating procedures, and reduce operating costs.
The Company's approach to adopting technology has been to avoid the initial
overhead burden of market research and product development, however, we will
react rapidly to provide products and services that have been shown to provide
value to both customers and the Company.
In last year's Letter to Our Stockholders, I highlighted how an 18-month
project known internally as "Project LVNB" was being undertaken in an effort to
emphasize team work as the linchpin for expanding our asset base. A significant
commitment to concentrate on sales activity through a reorganization of our
banking units and our administrative support departments has enabled us to
develop a strong sales culture throughout our entire Company. An organizational
restructure has enabled us to segregate credit underwriting responsibilities of
the loan approval process from the sales and calling efforts of our
customer-contact personnel. By so doing, we have enabled our customer-contact
staff to spend considerably more of their time with existing and prospective
customers. Results of this restructure have been evident in the increased volume
of loans and
3
<PAGE>
BUILDING FOR THE FUTURE
deposits booked during the year. Although these sales efforts focus on meeting
with a customer at their place of business, the Company's marketing philosophy
also considers the presence of physical branch locations to be extremely
important. And, it was for this reason that Lebanon Valley National Bank opened
three branches in 1996. The "Roseville Road" office in Manheim Township opened
in September, the "Grandview Heights" office in the City of Lancaster opened in
October and the "Cocoa Avenue" office in Hershey opened in November. Lebanon
Valley National Bank has twenty-two branch offices located throughout its
five-county marketing area and plans to open an additional office on the western
side of the City of Lancaster in the first quarter of 1997 and an office in West
Hempfield Township, Lancaster County, in the second quarter of 1997. After these
two new offices are opened, Lebanon Valley National Bank will have ten offices
in Lancaster County. This should enable us to enhance our market share over the
next few years and more effectively utilize our marketing and advertising
expenditures.
There are many banking experts who claim that alternative technologically
oriented delivery methods are rapidly making physical branch banks obsolete. The
use of ATMs, telephone banking, electronic banking, and PC home banking continue
to gain favor with customers. However, market research continues to indicate
that physical presence remains an important consideration in a customer's
decision-making process as to which financial institution they choose to
maintain their banking relationship. We especially find this to be more
prevalent in the communities that encompass our market territory than would be
the case for banks whose markets constitute metropolitan areas.
While continuing to expand our physical branch locations, we recognize that
technology is possibly the most consistently discussed influence impacting the
future of financial institutions. The question is often raised as to what effect
technological advancements may have upon a company of our size and how this may
impact its ability to compete. We believe that our current competencies, with
respect to our use of technology, provide an adequate response to these
inquiries. We are quite proud of the level of technology that we currently use
for our internal processing. We are also quite satisfied with the strength and
variety of technologically advanced products that we are able to offer to our
customers. An important concept in remaining competent with respect to
technology is our potential to outsource certain functions or to partner with
other companies in order to provide such services. Through these avenues, we
remain confident that we will be able to provide the types of products and
services to customers that are necessary in order to achieve outstanding
performance as we approach the next millennium.
1996 was a year of strong loan growth... Commercial loans outstanding
increased by 12.0 percent throughout the year and reached $200.1 million at
year-end 1996 compared to $178.6 million at year-end 1995. Agriculture loans
grew 17.1 percent during the year with outstandings at year-end being $106.5
million compared to $91.0 million at year-end 1995. Lebanon Valley National Bank
is the second largest agriculture lending institution in Pennsylvania and the
fifty-third largest agriculture lender in the United States, as reported in the
November 1996 edition of Agri-Finance. The portfolio of agriculture loans
consists primarily of loans to family farming operations with a significant
portion of this business concentrated in dairy operations. The
4
<PAGE>
[GRAPHIC OMITTED: PHOTOGRAPH OF GRANDVIEW HEIGHTS OFFICE:
792 New Holland Avenue, Lancaster, opened October 21, 1996.]
Company continues to focus on development of its agriculture business and will
continue to look to this segment as an important component of the Company's loan
growth in future years. We are especially gratified that we can yet again say
that we have never had an agriculture loan charge-off in the many years in which
we have concentrated on agriculture lending. Our success as an active
agriculture lender can be attributed to the fact that we have highly
professional banking officers with agriculture backgrounds who are willing and
active participants in the farming community.
Consumer loans outstanding remained relatively unchanged throughout the
year. Unlike many financial institutions who lowered their credit standards in
order to build portfolios, our Company remained steadfast in its desire to
maintain a high quality credit portfolio and, as a result, consumer loan
charge-offs were well controlled during 1996 despite a record number of personal
bankruptcies that occurred throughout our nation. Net charge-offs of consumer
loans amounted to only $314,000. The credit quality of our commercial loan
portfolio, as expressed by net charge-offs, was even better as evidenced by the
net recovery in charged-off loans of $27,000 for the year. The ratio of net
charge-offs to average total loans outstanding for the year was only
seven-hundredth of one percent.
The Company has offered a proprietary MasterCard(R) credit card program
since 1981 and at year end had a portfolio of approximately $3.5 million of
credit card loans outstanding to
5
<PAGE>
BUILDING FOR THE FUTURE
approximately 5,400 cardholders. While this product continues to be profitable,
a handful of nationwide card issuers have been able to capture the vast majority
of the market and offer this product on terms that are more competitive than
those provided by community banks. Your Company is currently in negotiations to
sell its credit card portfolio to a major card issuer at a premium over book
value. This transaction is likely to occur in the second quarter 1997.
In early 1996, the Company purchased the Central Mortgage Company of
Lancaster. This acquisition strengthens our mortgage banking activities and
extends the Company's ability to offer mortgage products that are underwritten
by the Veterans Administration and Federal Housing Administration, both
government agencies. The results of this transaction are reflected in the 1996
performance of this company's mortgage banking operations that include ten
months of results generated from the former Central Mortgage client base. Total
income generated from the sale of newly originated residential mortgage loans
was $940,000 for 1996 compared to $209,000 for 1995. We anticipate using the
enhanced processing expertise and underwriting skills obtained through this
acquisition to further expand our mortgage banking performance in 1997.
Serving our communities...Lebanon Valley National Bank was proud to
continue its strong commitment to being a positive influence and an important
partner in the communities in which it conducts its business. One example of
this type of partnership was the Company's participation in the Maple Terrace
Housing Project in Lebanon. Maple Terrace opened for residency in July 1996 and
is a twenty-unit, low-income elderly housing project in which the Company played
a key role by participating as a 99 percent equity limited partner. The
commitment of the Company to the communities that it serves was further
confirmed by the "Outstanding" Community Reinvestment Act (CRA) rating it
received from its national bank regulators. This highest rating is awarded to
only a small percentage of banks and reflects the outstanding performance in
providing a wide variety of credit to all segments of the communities that we
serve. We also believe it is important for our employees to participate in
community activities as members of various civic groups or by serving on boards
of service organizations and by participating in charitable fund raising
efforts. Our Company also provides significant financial support to area
charitable and cultural groups in order to improve the quality of life for
residents living throughout the communities of southcentral Pennsylvania.
Rewarding our stockholders...In January 1996, the Board authorized the
payment of a four-for-three stock split to be paid to stockholders on February
9, 1996 which increased the number of shares outstanding to 4,071,683. The
quarterly cash dividend was increased by 11 percent to $.20 per share in the
first quarter and was again increased by 10 percent to $.22 per share in the
third quarter of 1996. On January 14, 1997, the Board of Directors approved
another increase in the quarterly cash dividend to $.25 per share. This most
recent dividend declaration will provide, on an annualized basis, a 19 percent
increase over the total cash dividends per share paid in 1996.
We were disappointed that despite record earnings and significant increases
to cash dividends, the market price of our shares closed the year at $23.00
which was virtually the same as the prior year-end closing price. At $23.00 per
6
<PAGE>
[GRAPHIC OMITTED: HERSHEY OFFICE: 1212 Cocoa Ave., Hershey,
opened November 25, 1996]
share, the price reflects a price/earnings ratio of 10.7 times 1996 earnings. We
are pleased that the Company's stock price increased 15.6 percent during January
to close at $26.58 per share on January 31, 1997.
On June 12, 1996, the Company announced its intention to repurchase up to 5
percent or 203,584 shares of its common stock. The Company was active in
reacquiring shares during the remainder of the year and by December 31 the
Company had acquired a total of 93,700 shares at an average price of $22.66 per
share.
I would like to recognize the outstanding performance of our management
team and staff whose efforts have made 1996 an outstanding success. Also, I
would like to take this opportunity to thank our stockholders for their ongoing
support. We remain confident that our present strategies and the skills of our
staff will serve us well as we approach the next millennium.
/s/ A.B. Murry
Albert B. Murry
President and Chief Executive Officer
February 18, 1997
7
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(December 31, 1996 and 1995)
(Dollars in thousands)
1996 1995
<S> <C> <C>
ASSETS
Cash and due from banks $ 22,832 $ 23,766
Interest bearing deposits with banks 181 246
Investment securities available for sale 62,596 65,799
Investment securities held to maturity (fair value of
$92,081 and $88,052 for 1996 and 1995, respectively) 91,652 86,885
Loans held for sale 6,019 378
Loans 422,534 390.631
Less: Allowance for loan losses (7,736) (8,025)
--------- ---------
Loans, net 414,798 382,606
Other real estate owned 695 913
Premises and equipment, net 8,132 7,933
Deferred tax asset, net 2,604 3,100
Accrued interest receivable 3,677 3,844
Other assets 3,121 2,307
--------- ---------
Total assets $ 616,307 $ 577,777
========= =========
LIABILITIES
Deposits:
Non-interest bearing demand $ 72,683 $ 65,530
Interest bearing demand 57,284 57,146
Savings 127,090 128,425
Time 269,776 236,816
--------- ---------
Total deposits 526,833 487,917
Short-term borrowings 12,478 8,640
Other borrowings 6,438 14,009
Accrued interest payable 5,184 5,284
Other liabilities 3,135 3,048
--------- ---------
Total liabilities 554,068 518,898
STOCKHOLDERS' EQUITY
Common stock, $5.00 par value;
Authorized 10,000,000 shares; Outstanding
4,071,683 shares at December 31, 1996 and
December 31, 1995, respectively 20,358 20,358
Capital surplus 22,078 22,078
Retained earnings 21,418 16,107
Treasury Stock, 93,700 shares for 1996 and
0 shares for 1995 (2,123) 0
Net unrealized gain on investment securities
available for sale, net of taxes 508 336
--------- ---------
Total stockholders' equity 62,239 58,879
--------- ---------
Total liabilities and stockholders' equity $ 616,307 $ 577,777
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
(Years Ended December 31, 1996, 1995 and 1994)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 36,725 $ 34,946 $ 30,822
Interest on money market investments 309 539 127
Interest and dividends on investment
securities available for sale:
Taxable investment securities 2,858 2,685 3,046
Equity investments 217 195 161
Interest and dividends on investment
securities held to maturity:
Taxable investment securities 4,335 4,419 2,897
Non-taxable investment securities 530 447 558
-------- -------- --------
Total interest income 44,974 43,231 37,611
INTEREST EXPENSE
Interest on deposits 18,490 17,836 13,277
Interest on short-term borrowings 486 466 562
Interest on other borrowings 518 766 608
-------- -------- --------
Total interest expense 19,494 19,068 14,447
-------- -------- --------
Net interest income 25,480 24,163 23,164
Provision for loan losses 0 0 300
-------- -------- --------
Net interest income after provision
for loan losses 25,480 24,163 22,864
OTHER OPERATING INCOME
Fees and other service charges 1,625 1,499 1,453
Service charges on deposits 1,331 1,292 1,209
Trust income 1,310 1,277 1,289
Net gain on sale of loans 940 209 290
Net realized gain (loss) on investment
securities available for sale 79 126 (29)
Gain on sale of other real estate owned, net 60 410 0
Other income 586 598 607
-------- -------- --------
Total other operating income 5,931 5,411 4,819
OTHER OPERATING EXPENSE
Salaries and employee benefits 10,040 9,770 8,834
Equipment expense 1,954 1,934 1,871
Occupancy expense, net 1,306 1,256 1,237
Professional services 826 913 653
Bank card processing expense 822 711 662
Pennsylvania shares tax 502 479 457
Deposit insurance expense 2 539 1,016
Other expense 3,360 2,787 2,903
-------- -------- --------
Total other operating expense 18,812 18,389 17,633
-------- -------- --------
Income before income taxes 12,599 11,185 10,050
Income taxes 3,879 3,528 3,283
-------- -------- --------
Net income $ 8,720 $ 7,657 $ 6,767
======== ======== ========
PER COMMON SHARE:
Net income $ 2.15 $ 1.88 $ 1.67
Cash dividends paid .84 .705 .633
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Years Ended December 31, 1996, 1995 and 1994)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss)
on
Investment
Securities
Available
Common Capital Retained Treasury for Sale,
Stock Surplus Earnings Stock Net of Taxes Total
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993 $ 12,185 $ 30,052 $ 7,121 $ 0 $ 468 $ 49,826
Net income 0 0 6,767 0 0 6,767
Cash dividends ($.633 per share) 0 0 (2,572) 0 0 (2,572)
Stock split (5 for 4) 3,046 (3,046) 0 0 0 0
Implementation of change in
accounting for marketable
debt and equity securities,
net of tax effect of ($982) 0 0 0 0 (1,919) (1,919)
-------- -------- -------- -------- -------- --------
Balance, December 31, 1994 $ 15,231 $ 27,006 $ 11,316 $ 0 ($ 1,451) $ 52,102
Net Income 0 0 7,657 0 0 7,657
Cash dividends ($.705 per share) 0 0 (2,866) 0 0 (2,866)
Stock issued under dividend
reinvestment plan 38 161 0 0 0 199
Stock split (4 for 3) 5,089 (5,089) 0 0 0 0
Change in net unrealized gain
(loss) on investment securities
available for sale, net of tax
effect of $909 0 0 0 0 1,787 1,787
-------- -------- -------- -------- -------- --------
Balance, December 31, 1995 $ 20,358 $ 22,078 $ 16,107 $ 0 $ 336 $ 58,879
Net income 0 0 8,720 0 0 8,720
Cash dividends ($.84 per share) 0 0 (3,409) 0 0 (3,409)
Treasury stock repurchase,
93,700 shares 0 0 0 (2,123) 0 (2,123)
Change in net unrealized gain
(loss) on investment securities
available for sale, net of tax
effect of $91 0 0 0 0 172 172
-------- -------- -------- -------- -------- --------
Balance, December 31, 1996 $ 20,358 $ 22,078 $ 21,418 ($ 2,123) $ 508 $ 62,239
======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Years Ended December 31, 1996, 1995 and 1994)
(Dollars in thousands)
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 8,720 $ 7,657 $ 6,767
Adjustments to Reconcile Net Income to Net Cash:
Provision for loan losses 0 0 300
Depreciation and amortization 1,414 1,463 1,355
Deferred income taxes 405 23 366
Decrease (increase) in accrued interest receivable 167 (659) (539)
(Decrease) increase in accrued interest payable (100) 2,216 468
Net gain on sale of loans (940) (209) (290)
Net realized (gains) losses on investment securities available for sale (79) (126) 29
Net realized gain on sale of other real estate owned (60) (410) 0
Other, net (621) 1,166 (730)
-------- -------- --------
Net cash provided by operating activities 8,906 11,121 7,726
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest bearing deposits with banks 65 (96) 74
Net decrease (increase) in federal funds sold 0 1,300 (800)
Maturities of investment securities held to maturity 31,667 65,006 23,917
Maturities of investment securities available for sale 29,088 10,179 44,636
Sales of investment securities available for sale 196 609 20,760
Funds invested in investment securities held to maturity (36,329) (79,394) (34,667)
Funds invested in investment securities available for sale (25,978) (18,143) (44,005)
Net increase in loans made to customers (34,871) (7,759) (22,606)
Originations of residential mortgage loans sold (40,710) (10,456) (12,433)
Proceeds from sale of residential mortgage loans 38,582 10,510 13,078
Net expenditures for premises and equipment (1,613) (1,306) (590)
Net cash provided from branch acquisition 0 0 4,815
Proceeds from sale of other real estate owned 412 1,481 2,436
-------- -------- --------
Net cash used by investing activities (39,491) (28,069) (5,385)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in customer deposits 38,916 19,177 7,250
Net increase (decrease) in short-term borrowings 3,838 (3,447) (2,310)
Net (decrease) increase in other borrowings (7,571) 4,083 (317)
Cash dividends paid (3,409) (2,866) (2,572)
Acquisition of treasury stock (2,123) 0 0
Proceeds from issuance of common stock 0 199 0
-------- -------- --------
Net cash provided by financing activities 29,651 17,146 2,051
-------- -------- --------
Net (Decrease) Increase in Cash and Due From Banks (934) 198 4,392
Cash and Due From Banks at Beginning of Period 23,766 23,568 19,176
-------- -------- --------
Cash and Due From Banks at End of Period $ 22,832 $ 23,766 $ 23,568
======== ======== ========
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 10,658 $ 10,310 $ 8,403
Income taxes paid 3,090 3,653 3,124
Non-cash investing and financing activities:
Transfers from loans to other real estate owned 134 163 356
Loan charge-offs 895 583 1,197
Branch acquisition (note 2):
Fair value of purchased loans 0 0 1,107
Fair value of purchased deposits 0 0 6,808
Fair value of purchased equipment 0 0 396
</TABLE>
See accompanying notes to consolidated financial statements.
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Keystone Heritage Group, Inc. (the
Company) and its subsidiaries conform to generally accepted accounting
principles and reporting practices within the banking industry. In preparing the
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual results could
differ significantly from those estimates. The material estimate that is
particularly susceptible to significant change in the near-term relates to the
determination of the allowance for loan losses.
BUSINESS
Keystone Heritage Group, Inc. is a bank holding company headquartered in
Lebanon, Pennsylvania which engages in a general commercial and retail banking,
mortgage banking and trust business through its banking subsidiary, Lebanon
Valley National Bank (the Bank). Keystone Heritage Life Insurance Company is a
non-bank subsidiary that reinsures credit life and accident and health policies
written on consumer loans generated by the Bank.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company and subsidiaries
include the accounts of the Company and its wholly-owned subsidiaries, Lebanon
Valley National Bank and Keystone Heritage Life Insurance Company. All
significant intercompany balances and transactions have been eliminated in the
consolidated financial statements. For purposes of comparability, certain prior
year amounts have been reclassified.
LOANS
Loans are generally carried at the principal amount outstanding, net of
undisbursed commitments and net of deferred loan fees. Interest income on loans
is accrued based on methods which approximate a constant yield when related to
the principal amounts outstanding. The accrual of interest on loans is
discontinued when they are past due 90 days as to either principal or interest,
or when, in management's opinion, the collectibility of principal or interest is
doubtful, except for certain consumer loans for which the period is 120 days.
Management may maintain the accrual status for a past-due loan in the event that
the loan is well secured and in the process of collection. When the accrual of
interest is discontinued, unpaid interest recognized during the current year is
reversed by a charge against interest income, and unpaid interest from the prior
year is reversed by a charge against the allowance for loan losses. Interest
payments received on non-accrual loans are recorded as reductions of principal
if management determines that the ultimate collectibility of principal or
interest is doubtful. Loans are generally returned to accrual status when the
collectibility of both principal and interest on a timely basis is reasonably
assured, all delinquent principal and interest is brought current and the loan
has been performing as contractually agreed upon for at least six months. Net
loan fees and costs associated with originating loans are deferred and amortized
using the effective interest method to interest income over the contractual life
of the related loan. The amortization of deferred fees and costs is discontinued
on non-accrual loans.
Generally, all non-accrual loans are deemed to be impaired. Management
considers a loan to be impaired when it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. In evaluating whether a loan is impaired, management considers not
only the amount that the Company expects to collect but also the timing of the
collection. Generally if payments are consistently made, but on a delayed basis
of not more than 90 days, a loan is not deemed to be impaired.
When a loan is considered to be impaired, the amount of impairment is
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or at the loan's market price or fair value
of the collateral if the loan is collateral dependent. The majority of loans
deemed to be impaired by management are collateral dependent. Loans are
evaluated individually for impairment. The Company excludes smaller balance,
homogeneous loans (primarily consumer and residential mortgage loans) from the
evaluation of impairment. Impairment losses are included in the allowance for
loan losses. Impaired loans are charged-off when management believes that the
ultimate collectibility of principal and interest of a loan is not likely.
Interest income on impaired loans is generally recorded as payments are
collected.
LOANS HELD FOR SALE
Loans held for sale consist of mortgages and credit card loans which the
Company intends to sell. The mortgage loans and credit card loans are separately
carried at the lower of aggregate cost or estimated market values with
unrealized losses, if any, recognized through a provision included in other
income. Gains and losses on the sale of mortgage and credit card loans held for
sale are determined using the specific identification method. Residential
mortgage loans are committed to be sold without recourse at the date of
origination to a third-party with servicing released by the Company. These loans
committed for sale are funded by the Company for a short period of time until
settlement with the third-party. The Company intends to sell its credit card
portfolio, without recourse, to a third-party during 1997 and therefore these
loans have been classified as held for sale at December 31, 1996.
14
<PAGE>
INVESTMENT SECURITIES
The Company classifies its debt and marketable equity securities into one
of two categories; available for sale or held to maturity. Investment securities
available for sale are securities held for the purpose of maintaining a liquid
asset base and may be sold. Investment securities held to maturity are those
securities for which the Company has the ability and intent to hold the security
until maturity.
Investment securities available for sale are recorded at fair value.
Investment securities held to maturity are recorded at amortized cost, adjusted
for the amortization or accretion of premiums or discounts. Unrealized holding
gains and losses, net of the related tax effect, on investment securities
available for sale are excluded from earnings and are reported as a separate
component of stockholders' equity until realized.
A decline in the fair value of investment securities available for sale or
investment securities held to maturity below cost that is deemed other than
temporary is charged to earnings resulting in the establishment of a new cost
basis for the security.
Premiums and discounts are amortized or accreted over the life of the
related investment security held to maturity as an adjustment to yield using the
effective interest method. Dividend and interest income are recognized when
earned. Realized gains and losses from the sale of available for sale securities
are included in earnings and are determined using the specific identification
method.
Other securities include stock of the Federal Reserve Bank of Philadelphia
and stock of the Federal Home Loan Bank of Pittsburgh and are stated at cost.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed by the straight-line
method over the estimated useful lives of the assets. Maintenance and repairs
are charged to other operating expense as incurred. Gains or losses on
dispositions are reflected in current results of operations.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a reserve for estimated potential losses
in the loan portfolio. Losses occur primarily from the loan portfolio, but may
also be derived from commitments to extend credit and standby letters of credit.
Loan losses and recoveries on previously charged-off loans are charged or
credited directly to the allowance for loan losses. The allowance for loan
losses is an amount which, in management's judgement, is considered adequate to
absorb potential losses inherent in the loan portfolio. Management performs a
quarterly assessment of the loan portfolio to determine the appropriate level of
the allowance. The factors considered in this evaluation include, but are not
necessarily limited to, estimated loan losses identified through review of loans
by the Company's personnel; analysis of historical loss experience;
deterioration in loan concentrations or pledged collateral; trends in portfolio
volume and composition; trends in delinquencies and non-accruals and changes in
lending policies and general economic conditions. While management uses
available information to determine the appropriate level of allowance for loan
losses, future changes in the allowance may become necessary due to changes in
economic conditions and other factors. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the Bank's
allowance for loan losses. These agencies may recommend the Bank change the
level of the allowance based on their judgements of information available to
them at the time of their examination.
OTHER REAL ESTATE OWNED
Other real estate owned is valued at the lower of cost or fair value less
the cost to sell. These assets are written down to fair value at the date of
transfer to other real estate owned by a charge to the allowance for loan
losses. Subsequent to transfer, any further declines in fair value are recorded
through a valuation allowance. These properties are reviewed on a quarterly
basis and additional provisions are charged to other operating expense as
appropriate. Fair values are derived from independent appraisals at the time of
foreclosure. Subsequent appraisals are obtained as market conditions are deemed
by management to have significantly changed. Gains or losses on the sale or
disposition of other real estate owned are credited or charged to other
operating expense or against the valuation allowance. Costs of maintaining
foreclosed properties are expensed as incurred.
EMPLOYEE BENEFITS
Retirement plan costs for the Company's defined benefit plan are accounted
for in accordance with the requirements of Statement of Financial Accounting
Standards No. 87, "Employers' Accounting for Pensions". The projected unit
credit method is utilized for measuring net periodic pension cost over the
employee's service life. The Company funds the plan according to an actuarial
formula to provide for both current and future benefit payments, to the extent
that contributions are deductible under existing federal tax regulations.
The Company does not provide any other significant post-retirement or
post-employment benefits.
INCOME TAXES
Income taxes are accounted for utilizing the asset and liability method.
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
rates and laws that will be in effect when the differences are expected to
reverse. The Company files a consolidated federal income tax return.
TRUST ASSETS AND INCOME
Property held in a fiduciary or agency capacity for customers of the
Company's trust department is not included in the consolidated balance sheets
since such items are not assets of the Company or its subsidiaries. Trust income
is recognized on a cash basis which is not materially different than if it were
reported on an accrual basis.
INTEREST RATE CONTRACTS
The Bank has entered into interest rate swap contracts as part of its
asset-liability management activities. These contracts are entered into to
manage interest rate risk exposure.
Interest rate swap contracts generally involve the exchange of fixed and
floating-rate interest payment obligations without the exchange of the
underlying principal amounts. Entering into interest rate swap contracts
involves not only the risk of dealing with counterparties and their ability to
meet the terms of the contracts but also the interest rate risk associated with
unmatched positions. Notional principal amounts often are used to express the
volume of these transactions, but the amounts potentially subject to credit risk
are much smaller.
The interest income or interest expense differential from interest rate
swap contracts is recognized on the accrual basis as a component of interest
income or interest expense over the life of the contract. Interest income or
interest expense resulting from the cap and collar contracts is recognized on
the accrual basis when the national prime rate moves below or above a
predetermined interest rate level. Gains or losses from early termination of
interest rate swap contracts are deferred and amortized over the remaining term
of the underlying assets or liabilities.
EARNINGS PER SHARE
Earnings per common share are based on the weighted average number of
common shares outstanding during each year and dilutive common equivalent shares
using the treasury share method. Common equivalent shares consist entirely of
stock options. Retroactive effect is given for stock dividends and stock splits.
The resulting average number of shares used in computing primary earnings per
share in 1996, 1995 and 1994 was 4,053,490, 4,066,936 and 4,061,617,
respectively. The difference between primary and fully diluted earnings per
share is not significant.
NEW ACCOUNTING STANDARDS
On January 1, 1996 the Company adopted the provisions of Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121), which
requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. The implementation of SFAS 121 did not materially impact the
Company's financial condition or results of operation.
On January 1, 1996, the Company adopted the provisions of the Statement of
Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65" (SFAS 122). FASB Statement No.
65, "Accounting for Certain Mortgage Banking Activities," required separate
capitalization of purchased origination activities. SFAS 122 requires that
purchased and originated mortgage servicing rights be accounted for in the same
manner. Presently, the Company does not sell or securitize mortgage loans with
servicing rights retained. Accordingly, the Company has not been impacted by the
provisions of SFAS 122.
On January 1, 1996 the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), which establishes financial accounting and reporting
standards for stock-based employee compensation plans. As permitted under SFAS
123, the Company has elected not to adopt the fair value based method of
accounting for its stock-based compensation plans, but will continue to account
for such compensation under the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion 25) and,
accordingly, the impact of SFAS 123 on the Company's financial statements is not
material. The Company has complied with the disclosure requirements of SFAS 123
in note 14.
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125, "Accounting for and Servicing of
Financial Assets and Extinguishment of Liabilities" (SFAS 125). SFAS 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. Those standards are based
on consistent application of a financial-components approach that focuses on
control. Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. SFAS 125 provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. SFAS 125 is effective for transfers and
servicing of financial assets and extinguishment of liabilities occurring after
December 31, 1996, except for the provisions for secured borrowings and
collateral and for repurchase agreement, dollar-roll,
16
<PAGE>
securities lending, and similar transactions which have been delayed for one
year under Statement of Financial Accounting Standards No. 127, "Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125". The adoption of
SFAS 125 will not have a material effect on the Company's financial condition or
results of operations.
2. ACQUISITIONS
On March 1, 1996, the Bank acquired the business operations of Central
Mortgage Company, a Lancaster, Pennsylvania mortgage origination company. As
consideration for this acquisition, the Company will pay the seller an amount
equal to one-tenth of one percent (0.1%) of all mortgages closed and located in
Lancaster County during the next five years, up to a maximum of $50,000 a year.
This transaction was accounted for using purchase accounting. However, no
intangible assets were acquired as a result of this transaction.
On September 16, 1994, the Bank and Guaranty Bank, N.A. ("Guaranty")
completed a Purchase and Assumption Agreement (the "Agreement") for Guaranty's
New Holland branch. Pursuant to the Agreement, the Bank assumed $6,800,000 in
deposit liabilities and purchased $1,600,000 of assets consisting of home equity
and other personal loans, commercial loans, vault cash, and bank premises and
equipment. The Bank also assumed certain liabilities for contracts related to
the operation of the branch. This transaction was accounted for using purchase
accounting and resulted in the Company's recognition of intangible assets
amounting to $406,000 or 5.99 percent of deposits purchased.
3. CASH AND DUE FROM BANKS
Cash and due from banks consists of cash and cash items, balances due from
correspondent banks and balances maintained with the Federal Reserve Bank. The
Company is required to maintain average reserve balances with the Federal
Reserve Bank. The average amount of those required reserve balances was
$7,449,000 and $6,643,000 at December 31, 1996 and 1995, respectively, which
amounts were primarily covered by the Bank's vault cash.
4. INVESTMENT SECURITIES
A summary of the amortized cost and fair values of investment securities
available for sale and investment securities held to maturity at December 31,
1996 and 1995 is as follows:
Investment Securities Available for Sale: (Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury and government agencies $56,153 $ 40 $ 209 $55,984
Mortgage-backed securities 1,389 41 8 1,422
Equity securities 1,821 909 4 2,726
Other investment securities 2,464 0 0 2,464
------- ------- ------- -------
Total $61,827 $ 990 $ 221 $62,596
======= ======= ======= =======
</TABLE>
Investment Securities Held to Maturity: (Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury and government agencies $25,724 $ 298 $ 120 $25,902
States and political subdivisions 17,179 89 11 17,257
Mortgage-backed securities 48,749 387 214 48,922
------- ------- ------- -------
Total $91,652 $ 774 $ 345 $92,081
======= ======= ======= =======
</TABLE>
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investment Securities Available for Sale: (Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1995
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury and government agencies $59,829 $ 106 $ 117 $59,818
Mortgage-backed securities 1,851 55 10 1,896
Equity securities 1,648 475 3 2,120
Other securities 1,965 0 0 1,965
------- ------- ------- -------
Total $65,293 $ 636 $ 130 $65,799
======= ======= ======= =======
</TABLE>
Investment Securities Held to Maturity: (Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1995
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury and government agencies $37,802 $ 714 $ 157 $38,359
States and political subdivisions 12,394 105 14 12,485
Mortgage-backed securities 36,689 629 110 37,208
------- ------- ------- -------
Total $86,885 $ 1,448 $ 281 $88,052
======= ======= ======= =======
</TABLE>
Investment securities having a book value and a fair value of $54,493,000
and $54,752,000 respectively, at December 31, 1996 were pledged as required by
law to secure public and trust deposits, repurchase agreements, and other
borrowings.
A summary of proceeds from the sales of investment securities available for
sale, gross realized gains, and gross realized losses for each of the years in
the three-year period ended December 31, 1996 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Proceeds from sales $ 196,000 $ 609,000 $20,760,000
Gross unrealized gains 79,000 134,000 73,000
Gross unrealized losses 0 8,000 102,000
</TABLE>
The amortized cost and fair value of investment securities available for
sale and investment securities held to maturity at December 31, 1996, by
contractual maturity, are shown below. Expected maturities may differ from
contractual maturities because certain issuers have the right to call or prepay
obligations.
Investment Securities Available for Sale: (Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1996
Amortized Cost Fair Value
<S> <C> <C>
Due in one year or less $17,247 $17,209
Due after one year through five years 38,309 38,179
Due after five years through ten years 217 216
Due after ten years 380 380
Mortgage-backed securities 1,389 1,422
Equity securities 1,821 2,726
Other securities 2,464 2,464
------- -------
Total $61,827 $62,596
======= =======
</TABLE>
18
<PAGE>
Investment Securities Held to Maturity:(Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1996
Amortized Cost Fair Value
<S> <C> <C>
Due in one year or less $10,315 $10,202
Due after one year through five years 32,388 32,742
Due after five years through ten years 200 215
Mortgage-backed securities 48,749 48,922
------- -------
Total $91,652 $92,081
======= =======
</TABLE>
5. LOANS
The carrying amounts of loans at December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
1996 1995
<S> <C> <C>
Commercial $ 194,950 $ 170,872
Agriculture 106,513 90,971
Commercial real estate - construction 5,126 7,742
Real estate - residential mortgage 29,596 34,236
Consumer (net of unearned income of $1,812 and
$2,830 for 1996 and 1995, respectively) 87,003 87,560
Unamortized net loan fees (654) (750)
--------- ---------
Total, net $ 422,534 $ 390,631
========= =========
</TABLE>
Included within this loan portfolio are loans on which the Company has
ceased the accrual of interest. Such loans amounted to $973,000 and $741,000 at
December 31, 1996 and 1995, respectively. If interest income had been recognized
during 1996, 1995 and 1994 on non-accrual loans in accordance with their
original terms, interest income would have been affected as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
1996 1995 1994
<S> <C> <C> <C>
Interest income which would have been
recognized in accordance with original terms $ 66 $ 65 $ 133
Interest income recorded during the period 45 45 21
----- ----- -----
Net effect upon interest income ($ 21) ($ 20) ($112)
===== ===== =====
</TABLE>
The Company has determined that loans with a carrying value of $973,000 and
$1.2 million were deemed to be impaired at December 31, 1996 and 1995,
respectively. Of the $973,000 in loans classified as impaired for 1996, all the
loans were classified as non-accruing loans and approximately $528,000 are loans
for which there is no specific allowance for credit losses and approximately
$445,000 are loans which have an aggregate allowance for credit losses of
$100,000. For 1995, of the $1.2 million in loans classified as impaired,
approximately $1.1 million are loans for which there was no specifically
allocated allowance for credit losses and approximately $100,000 are loans which
have an aggregate allowance for credit losses of $100,000. The average balance
of loans classified as impaired amounted to $895,000 and $1.6 million for the
years ended December 31, 1996 and 1995, respectively. Interest income of
approximately $45,000 was recognized during each of the years ended December 31,
1996 and 1995 on loans classified as impaired loans.
Loans to officers and directors of the Company and its subsidiaries, and
corporations in which such officers or directors are beneficially interested as
stockholders, officers or directors, aggregated approximately $3,556,000 and
$2,853,000 at December 31, 1996 and 1995, respectively. These loans were made on
substantially the same basis, including interest rates and collateral, as those
prevailing for comparable transactions with other borrowers at the same time.
During 1996, approximately $795,000 of new loans were made, and repayments
approximated $92,000. At December 31, 1996 and 1995, none of these loans were
classified as non-accrual, past due, restructured, or potential problem loans.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31,
1996, 1995 and 1994 are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
1996 1995 1994
<S> <C> <C> <C>
Balance, beginning of year $ 8,025 $ 8,140 $ 8,486
Provision charged to operations 0 0 300
Loans charged-off (895) (583) (1,197)
Recoveries on loans charged-off 606 468 551
------- ------- -------
Balance, end of year $ 7,736 $ 8,025 $ 8,140
======= ======= =======
</TABLE>
7. VALUATION ALLOWANCE FOR OTHER REAL ESTATE OWNED
Other real estate owned totalled $695,000 and $913,000, each net of the
valuation allowance of $-0-, at December 31, 1996 and 1995, respectively.
Changes in the valuation allowance included $696,000 in losses and writedowns in
1994. There has been no activity in the valuation allowance since then.
8. PREMISES AND EQUIPMENT
Premises and equipment at December 31, 1996 and 1995 are summarized below:
(Dollars in thousands)
<TABLE>
<CAPTION>
Estimated
Useful
Lives 1996 1995
<S> <C> <C> <C>
Land - $ 1,495 $ 1,245
Premises 20 years 8,503 7,948
Furniture and equipment 2-7 years 8,787 8,070
Leasehold improvements 20 years 916 905
--------- -------- --------
Subtotal 19,701 18,168
Less: Accumulated depreciation and amortization (11,569) (10,235)
-------- --------
Total, net $ 8,132 $ 7,933
======== ========
</TABLE>
Depreciation and amortization amounted to $1,414,000, $1,463,000 and
$1,355,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
9. TIME DEPOSITS
Time deposits in excess of $100,000 amounted to $23,930,000 and $18,587,000
at December 31, 1996 and 1995, respectively. Interest expense of $1,055,000,
$1,112,000 and $753,000 was recognized on these deposits in 1996, 1995, and
1994, respectively.
At December 31, 1996, the scheduled maturities of time deposits are as
follows:
(Dollars in thousands)
1997 $ 202,217
1998 27,472
1999 14,528
2000 10,888
2001 7,259
2002 and thereafter 7,412
---------
Total time deposits $ 269,776
=========
20
<PAGE>
10. SHORT-TERM BORROWINGS
At December 31, 1996 and 1995, short-term borrowings consisted of the
following:
(Dollars in thousands)
<TABLE>
<CAPTION>
1996 1995
December Average Interest December Average Interest
31 Outstanding Expense 31 Outstanding Expense
<S> <C> <C> <C> <C> <C> <C>
Federal funds purchased $ 0 $ 604 $ 35 $ 0 $ 112 $ 7
Securities sold under
agreement to repurchase 12,478 11,128 451 8,640 11,397 459
------- ------- ------- ------- ------- -------
Total $12,478 $11,732 $ 486 $ 8,640 $11,509 $ 466
======= ======= ======= ======= ======= =======
</TABLE>
Federal funds purchased represent the Company's overnight borrowing
transactions. The weighted average interest rate on federal funds borrowing was
5.76 percent for 1996 and 5.92 percent for 1995.
Securities sold under agreement to repurchase range in maturity from one to
90 days. The weighted average interest rate was 4.05 percent during 1996 and
4.03 percent during 1995. The highest month-end outstanding balance was
$15,433,000 for 1996 and $14,720,000 for 1995. The weighted average rate at
December 31, 1996 and 1995 was 4.04 percent and 4.02 percent, respectively. The
securities that serve as collateral for the securities sold under agreement to
repurchase which had a book value of $20,131,000 and $15,071,000 at December 31,
1996 and 1995, respectively, are under the Company's control.
Unused federal funds lines of credit available to the Company for
short-term financing at December 31, 1996 totalled $108,000,000.
11. OTHER BORROWINGS
At December 31, 1996 and 1995, there were $6,075,000 and $13,570,000,
respectively, of advances outstanding from the Federal Home Loan Bank of
Pittsburgh (FHLB) with original maturities between one to five years. The FHLB
advances had a weighted average interest rate of 6.10 percent and 5.86 percent
at December 31, 1996 and 1995, respectively, and a range of interest rates from
5.67 percent to 6.48 percent. All FHLB advances are secured by the FHLB capital
stock owned by the Company and by certain investment securities having a fair
value of $6,147,000 and $13,616,000 at December 31, 1996 and 1995, respectively.
Obligations under capital leases were $363,000 and $439,000 at December 31,
1996 and 1995, respectively, and carried an imputed interest rate of 7.67
percent and 9.60 percent, respectively. Scheduled lease payments include payment
of imputed interest of $27,000, $26,000 and $24,000 for 1997, 1998 and 1999,
respectively. The costs of leasing a branch location and the equipment purchased
as a result of the mortgage banking acquisition totalling $341,000, net of
accumulated amortization of $48,000, at December 31, 1996, were recorded as
assets under the capital lease. In addition, computer hardware and software
systems which are fully depreciated amounting to $2,509,000 at December 31,
1996, were also recorded as assets under the capital lease.
The following is a summary of the maturities of FHLB advances and the
scheduled amortization of capital lease obligations as of December 31, 1996:
(Dollars in thousands)
<TABLE>
<CAPTION>
FHLB ADVANCES
WEIGHTED CAPITAL LEASE
AMOUNT AVERAGE RATE OBLIGATIONS
<S> <C> <C> <C>
1997 $3,428 5.96% $ 31
1998 0 0.00 33
1999 2,647 6.28 34
2000 0 0.00 36
2001 0 0.00 4
2002-2006 0 0.00 225
------ ---- ------
Total $6,075 6.10% $ 363
====== ==== ======
</TABLE>
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. FEDERAL INCOME TAXES
Federal income taxes included in the accompanying statements of income for
the years ended December 31, 1996, 1995 and 1994 are as follows:
(Dollars in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Current $3,474 $3,505 $2,917
Deferred 405 23 366
------ ------ ------
Total $3,879 $3,528 $3,283
====== ====== ======
</TABLE>
The following is a reconciliation between the applicable income tax expense
and the amount of income taxes which would have been provided at the Federal
statutory rate of 35 percent for the years ended December 31, 1996, 1995 and
1994.
(Dollars in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Federal tax expense at statutory rates $ 4,410 $ 3,915 $ 3,518
Increase (Reduction) in taxes resulting from:
Non-taxable investment security income (162) (139) (191)
Non-taxable loan income (193) (189) (145)
Low income housing tax credit (64) 0 0
Other, net (112) (59) 101
------- ------- -------
Total $ 3,879 $ 3,528 $ 3,283
======= ======= =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 and December 31, 1995 are presented below:
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
<S> <C> <C>
DEFERRED TAX ASSETS:
Allowance for loan losses $2,630 $2,729
Deferred compensation 359 348
Unamortized net loan fees 241 273
Non-accrual loan interest 32 35
Accrued pension expense 0 201
Gross unrealized loss on investment
securities available for sale 77 44
Other 46 56
------ ------
Total $3,385 $3,686
====== ======
DEFERRED TAX LIABILITIES:
Depreciation $ 174 $ 253
Gross unrealized gain on investment
securities available for sale 337 214
Discount accretion 153 81
Prepaid pension expense 76 0
Other 41 38
------ ------
Total $ 781 586
------ ------
Deferred tax asset, net $2,604 $3,100
====== ======
</TABLE>
The Company has determined that it is not required to establish a valuation
reserve for the deferred tax asset since it is more likely than not that the
deferred tax asset of $3,385,000 will be realized through carrybacks to taxable
income in prior years, through future reversals of existing temporary
differences, future taxable income and tax planning strategies. The Company
reviews the tax criteria related to the recognition of deferred tax assets on a
quarterly basis.
22
<PAGE>
13. STOCKHOLDERS' EQUITY
On June 12, 1996 the Company announced its intentions to repurchase up to 5
percent or 203,584 shares of its outstanding common stock. These shares, when
repurchased, will be available for reissuance through the Company's Dividend
Reinvestment or Stock Option Plans or for other general corporate purposes.
During 1996, the Company repurchased a total of 93,700 shares at an average
price of $22.66 per share.
The Board of Directors of the Company effected a 4 for 3 stock split during
January 1996 and a 5 for 4 stock split during 1994. All prior period per share
data has been restated to give effect for these stock splits. The weighted
average number of shares outstanding was 4,053,490 for 1996, 4,066,936 for 1995,
and 4,061,617 for 1994.
During the years ended December 31, 1996, 1995 and 1994, the Company
purchased 20,239, 7,605 and 11,618 shares of its common stock, respectively, for
delivery under its dividend reinvestment program. The Company issued 0, 7,549
and 0 shares of its common stock under its dividend reinvestment plan in 1996,
1995 and 1994, respectively.
14. STOCK OPTION PLAN
At December 31, 1996 the Company has two stock-based compensation plans,
both of which are fixed option plans, which are described below. The Company
applies APB Opinion 25 and related interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its fixed stock option
plans. Had compensation cost for the Company's two stock-based compensation
plans been determined on the fair value at the grant dates for awards under
those plans consistent with the method of SFAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
1996 1995
Net income As reported $8,720,000 $7,657,000
Pro forma 8,613,000 7,583,000
Net income per
common share As Reported $2.15 $1.88
Pro forma 2.12 1.86
Under the 1994 Stock Option Plan, the Company may grant options or stock
appreciation rights to officers and key employees of the Company and its
subsidiaries for up to 200,000 shares of common stock. Under the 1996
Independent Directors Stock Option Plan, the Company may grant options or stock
appreciation rights to non-employee directors of the Company and its
subsidiaries for up to 60,000 shares of common stock. Under both plans, the
exercise price of each option equals the fair market value of the Company's
common stock on the date of grant and an option's maximum term is 10 years.
Options vest immediately and are exercisable six months from the date of grant.
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1996 and 1995, respectively: dividend yield of
3.8 percent for each year; expected volatility of 28 percent and 24 percent;
risk-free interest rates of 5.56 percent and 6.60 percent; and expected lives of
7 years for 1996 and 1995.
A summary of the Company's two fixed stock option plans as of December 31,
1996, 1995 and 1994, and changes during the years ending on those dates is
presented below:
<TABLE>
<CAPTION>
FIXED STOCK OPTIONS:
1996 1995 1994
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 37,330 $ 21.61 18,665 $ 19.88 0 $ 0.00
Granted 29,800 21.75 18,665 23.34 18,665 19.88
Exercised 0 0.00 0 0.00 0 0.00
Forfeited 0 0.00 0 0.00 0 0.00
------ -------- ------ -------- ------ -------
Outstanding at end of year 67,130 $ 21.67 37,330 $ 21.61 18,665 $ 19.88
====== ======== ====== ======== ====== =======
Options exercisable at year-end 67,130 18,665 0
Weighted-average fair value of
options granted during the year $ 5.50 $ 6.08 $ 6.10
</TABLE>
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about fixed stock options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted-
average Weighted- Weighted-
Number remaining average Number average
Range of outstanding contractual exercise exercisable exercise
exercise prices at 12/31/96 life price at 12/31/96 price
<C> <C> <C> <C> <C> <C>
$19.88-$23.34 67,130 9 years $21.67 67,130 $21.67
</TABLE>
At December 31, 1996, there were 144,870 shares available for grant under
the 1994 Officer and Key Employee Stock Option Plan and there were 48,000 shares
available for grant under the 1996 Independent Director Stock Option Plan.
15. EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Company has a non-contributory pension plan covering substantially all
employees. Pension expense of $328,000, $287,000 and $271,000 was recognized for
1996, 1995 and 1994, respectively. The following presents the plan's funded
status (using a measurement date of October 1) and amounts recognized on the
Company's balance sheets:
(Dollars in thousands)
<TABLE>
<CAPTION>
October 1,
1996 1995 1994
<S> <C> <C> <C>
Actuarial present value of accumulated plan benefits:
Vested $ 4,659 $ 4,071 $ 3,322
Nonvested 119 117 100
------- ------- -------
Accumulated plan benefits 4,778 4,188 3,422
Effects of projected future compensation levels 2,232 2,065 1,820
------- ------- -------
Projected benefit obligation 7,010 6,253 5,242
Plan assets at fair value 6,725 5,740 5,006
------- ------- -------
Projected benefit obligation in excess of plan assets (285) (513) (236)
Amount contributed from 10-1-96 to 12-31-96 571 0 0
Unrecognized net transition asset (248) (298) (348)
Unrecognized prior service cost 15 16 102
Unrecognized net gain due to past experience from
different assumptions made 170 204 178
------- ------- -------
Prepaid (accrued) pension expense $ 223 ($ 591) ($ 304)
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31
1996 1995 1994
<S> <C> <C> <C>
The net pension expense included the following:
Service cost - benefits earned during the year $ 422 $ 350 $ 368
Interest cost on the projected benefit obligation 432 380 357
Net amortization and deferral 56 446 (536)
Return on plan assets (582) (889) 82
----- ----- -----
Net pension expense $ 328 $ 287 $ 271
===== ===== =====
</TABLE>
The discount rate used in determining the projected benefit obligation was
7.5 percent for 1996, 7.0 percent for 1995 and 7.5 percent for 1994. The
expected long-term return on plan assets and the projected increase in salary
levels were 8.0 percent and 5.0 percent, respectively, for 1996, 1995 and 1994.
Plan assets are primarily invested in money market funds, equity common
trust funds, and U.S. Treasury and agency securities.
24
<PAGE>
The Company also sponsors a defined contribution plan where each eligible
participant's contribution is 50 percent matched by the Company up to a maximum
of the first 3 percent of the participant's compensation and 25 percent matched
by the Company for the next 3 percent of the participant's compensation. For the
years ended December 31, 1996, 1995 and 1994, the expense to the Company to
provide these matching contributions totalled $100,000, $83,000 and $78,000,
respectively.
16. COMMITMENTS AND CONTINGENT LIABILITIES
Leases for five branch banking facilities and one mortgage banking
operations facility provide for minimum annual rentals of approximately $358,000
through 2001, $258,000 through 2004, $199,000 through 2008, $65,000 through
2009, $104,000 through 2011 and $62,000 through 2013. In addition, the Company
had operating lease arrangements for the use of various data processing
equipment which expired in 1996. Total rental expense included in operating
expense for 1996, 1995 and 1994 was $362,000, $287,000 and $361,000,
respectively.
In the normal course of business, the Company is subject to pending and
threatened legal actions and proceedings. Management does not believe the
outcome of these actions and proceedings will have a materially adverse effect
on the financial condition or results of operations of the Company.
17. DIVIDEND RESTRICTIONS
The Company's ability to pay dividends on its common stock is derived from
other dividends from the Bank and the Company's nonbanking subsidiary. The
ability of the Company's banking subsidiary to pay dividends is subject to
certain restrictions.
National banks are subject to various legal limitations on the amount of
dividends that may be paid to their stockholders. Under the provisions of 12
U.S.C. ss.56, a national bank may not pay a dividend in an amount greater than
its net profits then on hand after deducting therefrom its losses and bad debts.
For this purpose, "bad debts" are defined to generally include the principal
amount of loans which are in arrears with respect to payment of interest for six
months or more and "net profits" has been construed by the Comptroller of the
Currency to mean retained earnings plus that portion of a bank's capital surplus
which was transferred from retained earnings. The amount of bad debts to be
deducted is limited to such amount thereof as exceeds a bank's allowance for
loan and lease losses. Under the provisions of 12 U.S.C. ss.60, the approval of
the Comptroller of the Currency is required if the total of all dividends
declared by a national bank in any calendar year exceeds such bank's net profits
(as defined) for that year, combined with its net profits for the preceding two
calendar years, less any required transfers to surplus.
At December 31, 1996, under the most restrictive of these limitations, the
Bank could declare dividends in 1997 of approximately $7.8 million, combined
with an additional amount equal to its net profits for 1997 up to the date of
any dividend declaration. In determining whether, and to what extent, to pay
dividends, the Bank must also consider the effect of applicable risk-based
capital regulations and leverage limitations.
18. MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by the regulators that, if undertaken, could have a direct
material effect on the Company's Financial Statements. Under the capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank and the Company to maintain minimum amounts and ratios, as set
forth in the table below, of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). Management believes, as of December 31,
1996, that the Bank and the Company meet all capital adequacy requirements to
which they are subject.
As of December 31, 1996, the most recent notification from the Office of
the Comptroller of the Currency categorized the Bank as "Well Capitalized" under
the regulatory framework. To be categorized as "Well Capitalized", the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table below. There are no conditions or events since that
notification that management believes have changed the Bank's or the Company's
category.
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's actual capital amounts and ratios are presented in the table
below:
<TABLE>
<CAPTION>
To be well
capitalized
To be under
adequately regulatory
Actual capitalized guidelines
Amount Ratio Amount Ratio Amount Ratio
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996
Total Capital
(to Risk Weighted Assets) $67,264 14.43% *$37,291 *8.0% *$46,614 *10.0%
Tier 1 Capital
(to Risk Weighted Assets) $61,414 13.12% *$18,721 *4.0% *$28,082 *6.0%
Tier 1 Capital
(to Average Assets) $61,414 10.28% *$23,898 *4.0% *$29,873 *5.0%
As of December 31, 1995
Total Capital
(to Risk Weighted Assets) $63,540 14.93% *$34,041 *8.0% *$42,551 *10.0%
Tier 1 Capital
(to Risk Weighted Assets) $58,188 13.59% *$17,127 *4.0% *$25,691 *6.0%
Tier 1 Capital
(to Average Assets) $58,188 10.29% *$22,613 *4.0% *$28,267 *5.0%
<FN>
* Greater than or equal to
</FN>
</TABLE>
19. GEOGRAPHIC CONCENTRATIONS OF CREDIT AND OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS
The Company's loan portfolio consists of loans primarily to businesses and
individuals in its five-county market area of Lebanon, Lancaster, Schuylkill,
Dauphin, and Berks counties.
In the ordinary course of business, the Company enters into agreements with
customers, such as commitments to extend credit and standby letters of credit
which involve, to varying degrees, elements of credit and interest rate risk in
excess of the amounts presented in the balance sheet. The Company's exposure to
possible loss in the event of non-performance by the other party to the
financial instruments for commitments to extend credit and financial guarantees
written is represented by the contractual amount of those instruments. The
Company may not be obligated to advance funds if the customer's financial
condition deteriorates or if the customer fails to meet certain terms. The
Company applies the same credit standards in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments generally have fixed expiration dates or termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being used, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis, applying the same credit standards
used in the lending process, through periodic reassessments of the customer's
creditworthiness and through ongoing credit reviews. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on management's credit evaluation of the counterparty. Collateral held varies
but may include accounts receivable, inventory, property, plant and equipment,
and income-producing commercial properties.
Group concentrations of credit are considered to exist if a number of
counterparties are engaged in similar activities and have similar economic
characteristics that would cause their ability to meet contractual obligations
to be similarly affected by changes in economic or other conditions. At December
31, 1996, there were $106.5 million or 25.2 percent of the total loan portfolio
in loans to agriculture-related borrowers. These loans consist of loans for a
variety of purposes within the industry, primarily dairy farms, poultry farms,
agri-business and swine operations. These loans may be impacted by adverse
climate, economic conditions, or other factors not common to other industries.
The Company's exposure to possible loss in the event of non-performance by these
borrowers is represented by the contractual amount of those instruments. The
Company's policy is to require supporting collateral for these loans in the form
of agriculture real estate, livestock, and farm equipment.
Most of the Company's business activity is with customers located within
the Company's defined market area. Since a significant amount of the Company's
loans which are secured by real estate are located within this market area, a
substantial portion of the Company's debtors' ability to honor their contracts,
and increases and decreases in the market value of the real estate
collateralizing such loans, may be significantly affected by the level of
economic activity in this area.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance of a customer to a third-party. The majority of the
standby letters of credit consist of performance assurances made on behalf of
customers.
26
<PAGE>
The credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers, and the Company applies
the same credit standards used in the lending process.
The Company enters into various interest rate swap contracts in managing
its interest-rate risk. In these contracts, the Company agrees to exchange, at
specific intervals, the difference between fixed and floating rate interest
amounts calculated on an agreed-upon notional amount. The Company used interest
rate swap contracts to effectively convert portions of its floating rate loans
to a fixed basis. These interest rate swap transactions allowed the Company to
better match the funding source which is a portion of the Company's core deposit
base. The core deposit base, although subject to immediate withdrawal, displays
a longer term fixed character. At December 31, 1996, $70 million of such
"receive-fixed" swaps were in effect. In addition, the interest rate swap
contracts were entered into to protect the Company's interest rate risk in a
declining or stable interest rate environment. Specifically, these contracts
protect the Company's risk from negative movements in its prime rate based asset
portfolio which would not be perfectly matched by repricing liabilities.
The Company does not obtain collateral or other security to support
financial instruments subject to credit risk but monitors the credit standing of
counterparties. The counterparties of the aforementioned interest rate contracts
are commercial banks having a rating of A1 from Moody's Investor Service.
The table below summarizes by notional amounts the activity for
receive-fixed interest rate swap contracts in 1996 and 1995. The Company had no
deferred gains or losses relating to terminated interest rate swap contracts in
1996.
(Dollars in thousands) Contractual Amount
Balance at December 31, 1994 $10,000
Additions 30,000
Maturities 10,000
-------
Balance at December 31, 1995 30,000
Additions 40,000
Maturities 0
-------
Balance at December 31, 1996 $70,000
=======
The approximate annual maturities of interest rate swap contracts
outstanding as of December 31, 1996 were as follows:
(Dollars in thousands)
Contractual Pay Prime Weighted Average
Amount Rate Receive Rate (Fixed)
1997 $20,000 8.25% 8.70%
1998 40,000 8.25% 8.58%
1999 10,000 8.25% 8.76%
The following is the amount of financial instruments with off-balance sheet
risk not reflected in the consolidated balance sheets at December 31, 1996 and
December 31, 1995:
<TABLE>
<CAPTION>
(Dollars in thousands)
Contractual Amounts
December 31, December 31,
1996 1995
<S> <C> <C>
Financial instruments whose contractual amounts
represent credit risk:
Commitments to extend credit $93,811 $88,242
Standby letters of credit 7,335 8,862
Interest rate swaps, notional value 70,000 30,000
Interest rate cap/collar, notional value 0 10,000
Contractual amounts of off-balance sheet
financial instruments not constituting
credit risk:
Forward commitments to sell in secondary market 2,677 2,483
</TABLE>
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosure about Fair
Value of Financial Instruments" (SFAS 107) requires disclosure of the fair value
of financial instruments. The majority of the Company's assets and liabilities
are considered financial instruments. The Company uses various methods and
assumptions in estimating fair value disclosures for its financial instruments.
Many of the Company's financial instruments lack an available trading market and
require substantial estimation and present value calculations to determine their
current fair values. The following assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
CASH AND DUE FROM BANKS: The carrying amounts reported in the balance sheet
for cash and due from banks approximate those assets' fair values.
INTEREST BEARING DEPOSITS WITH BANKS: The fair value of interest bearing
deposits with banks is estimated to be the carrying value due to the short
maturities and negligible credit concerns.
INVESTMENT SECURITIES: Investment securities actively traded in a secondary
market have been valued using quoted available market prices.
LOANS HELD FOR SALE: The fair value of mortgage loans held for sale is
estimated using the current secondary market rates. The fair value of credit
card loans are carried at an amount that approximates fair value since the
Company's credit card loans are either variable or fixed rates that are
repriceable within 30 days notice to Cardholders.
LOANS: For variable-rate loans with no significant change in credit risk,
fair values are based on carrying values. The fair values for fixed-rate
commercial loans, commercial real estate-constructions loans, agriculture loans,
real estate-residential mortgage loans, and consumer loans are estimated using
discounted cash flow analyses, using interest rates currently being offered for
loans with similar terms to borrowers of similar credit quality. The fair value
of non-performing and classified loans is determined either through an
appropriate adjustment to the discount rate used in the discounted cash flow
analysis or from an estimation of the amount of expected recovery on individual
loans.
ACCRUED INTEREST RECEIVABLE: The fair value of accrued interest receivable
is estimated to be the current carrying value.
DEMAND AND SAVINGS DEPOSITS: Interest bearing demand deposits and savings
deposits are, by definition, payable on demand as of the balance sheet date. The
carrying amounts reported in the balance sheet for these deposits approximate
fair values.
TIME DEPOSITS, SHORT-TERM BORROWINGS AND OTHER BORROWINGS: Fair values for
fixed-rate time certificates of deposit are estimated using a discounted cash
flow calculation that applies a discount rate equal to the cost of replacing
these deposits to a schedule of aggregated monthly maturities on time deposits.
The carrying amounts of securities sold under agreements to repurchase
approximate their fair values due to their short maturity. The fair value of the
Company's FHLB advances and capital lease obligations are estimated using
discounted cash flow analyses, based upon the current incremental borrowing
rates for similar types of borrowing.
ACCRUED INTEREST PAYABLE: The fair value of accrued interest payable is
estimated to be the carrying value.
OFF-BALANCE-SHEET INSTRUMENTS: Fair values for the Company's loan
commitments and standby letters of credit are based on fees which have been
received but not recognized as of the balance sheet date. Fair values for
interest rate contracts are based on pricing models using current assumptions.
The fair value of forward commitments to sell in the secondary market is
estimated using the current secondary market rates.
LIMITATIONS: The fair values estimated are dependent upon subjective
assumptions and involve significant uncertainties resulting in estimates that
vary with changes in assumptions. Any sales of financial instruments may incur
potential tax and other expenses that would not be reflected in the fair values.
Any changes in assumptions or estimation methodologies may have a material
effect on the estimated fair values disclosed. The reasonable comparability
between financial institutions may not be likely due to the wide range of
permitted valuation methods. Also,the estimates do not reflect any additional
premium or discount that could result from the sale of the Company's entire
holdings of a particular instrument.
28
<PAGE>
At December 31, 1996 and 1995, the Company's estimated fair values of
financial instruments based on disclosed assumptions are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
December 31, 1996 December 31, 1995
Carrying Value Fair Value Carrying Value Fair Value
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and due from banks $ 22,832 $ 22,832 $ 23,766 $ 23,766
Interest bearing deposits with banks 181 181 246 246
Investment securities available for sale 62,596 62,596 65,799 65,799
Investment securities held to maturity 91,652 92,081 86,885 88,052
Loans held for sale 6,019 6,019 378 378
Loans:
Commercial 194,950 195,290 170,872 170,950
Agriculture 106,513 105,693 90,971 91,220
Commercial real estate - construction 5,126 5,135 7,742 7,746
Real estate - residential mortgage 29,596 29,775 34,236 36,629
Consumer (net of unearned income
of $2,830 and $5,088 for
1996 and 1995, respectively) 87,003 87,272 87,560 89,023
Unamortized net loan fees (654) 0 (750) 0
--------- --------- --------- ---------
Total loans, net 422,534 423,165 390,631 395,568
Accrued interest receivable 3,677 3,677 3,844 3,844
FINANCIAL LIABILITIES:
Deposits:
Non-interest bearing demand 72,683 72,683 65,530 65,530
Interest bearing demand 57,284 57,284 57,146 57,146
Savings 127,090 127,090 128,425 128,425
Time 269,776 271,826 236,816 240,785
--------- --------- --------- ---------
Total deposits 526,833 528,883 487,917 491,886
Short-term borrowings 12,478 12,478 8,640 8,640
OTHER BORROWINGS:
FHLB advances 6,075 6,147 13,570 13,616
Capital lease obligations 363 363 439 439
--------- --------- --------- ---------
Total other borrowings 6,438 6,510 14,009 14,055
Accrued interest payable 5,184 5,184 5,284 5,284
</TABLE>
<TABLE>
<CAPTION>
(Dollars in thousands)
December 31, 1996 December 31, 1995
OFF-BALANCE-SHEET INSTRUMENTS
Contractual Contractual
Amount Fair Value Amount Fair Value
<S> <C> <C> <C> <C>
Commitments to extend credit $ 93,811 $ 0 $ 88,242 $ 0
Standby letters of credit 7,335 12 8,862 10
Interest rate swaps, notional value 70,000 114 30,000 339
Interest rate collar contract, notional value 0 10,000
6% Floor 0 0
7% Ceiling 0 (13)
Forward commitments to
sell in the secondary market 2,677 0 2,483 0
</TABLE>
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
21. PARENT COMPANY STATEMENTS
The balance sheets, income statements, and statements of cash flows for
Keystone Heritage Group, Inc. (Parent only) are presented below:
(Dollars in thousands)
BALANCE SHEETS December 31,
1996 1995
Assets
Cash $ 3 $ 61
Investment securities held to maturity 65 0
Investment securities available for sale 2,687 2,121
Investment in subsidiaries 59,860 56,843
Other assets 20 19
------- -------
Total assets $62,635 $59,044
======= =======
Liabilities and Stockholders' Equity
Current liabilities $ 396 $ 165
Stockholders' equity 62,239 58,879
------- -------
Total liabilities and stockholders' equity $62,635 $59,044
======= =======
<TABLE>
<CAPTION>
INCOME STATEMENTS Years Ended December 31,
1996 1995 1994
<S> <C> <C> <C>
Interest and dividend income $ 84 $ 69 $ 47
Net realized gain on investment securities available for sale 77 129 58
Dividends from bank subsidiary 5,610 3,316 2,821
Expense 180 213 238
------ ------ ------
Income before undistributed income of subsidiaries 5,591 3,301 2,688
Undistributed income of subsidiaries 3,129 4,356 4,079
------ ------ ------
Net income $8,720 $7,657 $6,767
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS Years Ended December 31,
1996 1995 1994
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income $ 8,720 $ 7,657 $ 6,767
Equity in undistributed income of subsidiaries (3,129) (4,356) (4,079)
Other, net 4 (138) (260)
------- ------- -------
Net cash provided by operating activities 5,595 3,163 2,428
Cash Flows from Investing Activities:
Maturities and sales of investment securities available for sale 195 883 679
Funds invested in investment securities available for sale and held to maturity (316) (1,320) (638)
------- ------- -------
Net cash (used by) provided by investing activities (121) (437) 41
Cash Flows from Financing Activities:
Proceeds from issuance of common stock 0 199 0
Acquisition of treasury stock (2,123) 0 0
Cash dividends paid (3,409) (2,866) (2,572)
------- ------- -------
Net cash used by financing activities (5,532) (2,667) (2,572)
------- ------- -------
Net (decrease) increase in cash and cash equivalents (58) 59 (103)
Cash at beginning of period 61 2 105
------- ------- -------
Cash at end of period $ 3 $ 61 $ 2
======= ======= =======
</TABLE>
30
<PAGE>
22. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(Dollars in thousands, except per share data)
1996
First Second Third Fourth
Quarter Quarter Quarter Quarter
Interest income $10,852 $10,952 $11,418 $11,752
Interest expense 4,786 4,724 4,905 5,079
------- ------- ------- -------
Net interest income 6,066 6,228 6,513 6,673
Provision for loan losses 0 0 0 0
Other operating income 1,203 1,454 1,608 1,666
Other operating expense 4,475 4,681 4,821 4,835
------- ------- ------- -------
Income before income taxes 2,794 3,001 3,300 3,504
Income taxes 871 923 1,001 1,084
------- ------- ------- -------
Net income $ 1,923 $ 2,078 $ 2,299 $ 2,420
======= ======= ======= =======
Per common share:
Net income $ .47 $ .51 $ .57 $ .60
Cash dividends paid .20 .20 .22 .22
1995
First Second Third Fourth
Quarter Quarter Quarter Quarter
Interest income $10,292 $10,846 $11,035 $11,058
Interest expense 4,269 4,830 4,970 4,999
------- ------- ------- -------
Net interest income 6,023 6,016 6,065 6,059
Provision for loan losses 0 0 0 0
Other operating income 1,140 1,280 1,303 1,688
Other operating expense 4,620 4,585 4,590 4,594
------- ------- ------- -------
Income before income taxes 2,543 2,711 2,778 3,153
Income taxes 786 847 857 1,038
Net income $ 1,757 $ 1,864 $ 1,921 $ 2,115
======= ======= ======= =======
Per common share:
Net income $ .43 $ .46 $ .47 $ .52
Cash dividends paid .165 .18 .18 .18
31
<PAGE>
INDEPENDENT AUDITORS' REPORT
KPMG Peat Marwick LLP
Independent Auditors' Report
The Board of Directors
Keystone Heritage Group, Inc.:
We have audited the accompanying consolidated balance sheets of Keystone
Heritage Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Keystone Heritage
Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results
of operations and their cash flows for each of the years in the three-year
period ended December 31, 1996 in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
January 24, 1997
32
<PAGE>
SUMMARY OF SELECTED FINANCIAL DATA
(Dollars in thousands, except per share and nonfinancial data)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Total interest income $ 44,974 $ 43,231 $ 37,611 $ 37,583 $ 42,248
Total interest expense 19,494 19,068 14,447 15,697 20,532
----------- ----------- ----------- ----------- -----------
Net interest income 25,480 24,163 23,164 21,886 21,716
Provision for loan losses 0 0 300 2,400 3,600
Other operating income 5,931 5,411 4,819 5,084 4,366
Other operating expense 18,812 18,389 17,633 17,213 15,400
----------- ----------- ----------- ----------- -----------
Income before income taxes and
cumulative effect of change in
accounting for income taxes 12,599 11,185 10,050 7,357 7,082
Income taxes 3,879 3,528 3,283 2,115 1,977
----------- ----------- ----------- ----------- -----------
Income before cumulative effect of
change in accounting for income taxes 8,720 7,657 6,767 5,242 5,105
Cumulative effect of change
in accounting for income taxes 0 0 0 (200) 0
----------- ----------- ----------- ----------- -----------
Net income $ 8,720 $ 7,657 $ 6,767 $ 5,042 $ 5,105
=========== =========== =========== =========== ===========
COMMON STOCK DATA -- PER SHARE
Income before cumulative effect of
change in accounting for income taxes $ 2.15 $ 1.88 $ 1.67 $ 1.29 $ 1.26
Cumulative effect of change
in accounting for income taxes .00 .00 .00 (.05) .00
----------- ----------- ----------- ----------- -----------
Net income $ 2.15 $ 1.88 $ 1.67 $ 1.24 $ 1.26
=========== =========== =========== =========== ===========
Cash dividends paid $ .84 $ .705 $ .633 $ .624 $ .624
Book value $ 15.65 $ 14.46 $ 12.83 $ 12.27 $ 11.51
Weighted average number of
shares outstanding 4,053,490 4,066,936 4,061,617 4,058,868 4,044,545
AT YEAR END
Investment securities available for sale $ 62,596 $ 65,799 $ 55,664 $ 79,387 $ 3,579
Investment securities held to maturity 91,652 86,885 72,704 61,594 114,551
Loans held for sale 6,019 378 432 969 860
Loans 422,534 390,631 382,722 359,838 375,214
Allowance for loan losses 7,736 8,025 8,140 8,486 8,317
Total assets 616,307 577,777 548,194 533,774 540,038
Total deposits 526,833 487,917 468,740 454,700 464,031
Other borrowings 6,438 14,009 9,926 10,325 10,371
Stockholders' equity 62,239 58,879 52,102 49,826 46,556
Trust assets, at cost 228,800 210,328 205,860 189,495 177,575
RATIOS
Return on average assets 1.50% 1.38% 1.26% .94% .95%
Return on average stockholders' equity 14.36 13.85 13.29 10.57 11.32
Cash dividend payout ratio 39.09 37.43 38.01 50.21 49.42
Allowance for loan losses to total loans 1.83 2.05 2.12 2.35 2.21
Average stockholders' equity
to average assets 10.46 9.93 9.51 8.91 8.41
</TABLE>
Retroactive effect is given to per share data for stock splits and stock
dividends. Return on average assets and return on average stockholders' equity
for 1993 is after cumulative effect of change in accounting for income taxes.
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this discussion is to further detail the financial condition
and results of operations of Keystone Heritage Group, Inc. (the Company). This
discussion should be read in conjunction with the financial statements appearing
elsewhere in this report. Earnings per common share are based upon the weighted
average number of shares outstanding and have been adjusted for a 4-for-3 stock
split which was effected in January 1996 and a 5-for-4 stock split which was
effected in October 1994. All prior period per share data has been restated to
give effect for these stock splits.
The Company is a bank holding company headquartered in Lebanon,
Pennsylvania which engages in a general commercial and retail banking, mortgage
banking and trust business through its banking subsidiary, Lebanon Valley
National Bank (the Bank). Keystone Heritage Life Insurance Company is a non-bank
subsidiary that reinsures credit life and accident and health policies written
on consumer loans generated by the Bank.
SUMMARY OF OPERATIONS
In 1996, the Company recorded the highest net income ever reported by the
Company for a calendar year. Net income of $8.7 million or $2.15 per share for
1996 represents an increase of 13.9 percent compared to the $7.7 million or
$1.88 per share reported for 1995. The Company's return on average stockholders'
equity for 1996 was 14.36 percent and the return on average assets was 1.50
percent compared with 13.85 percent and 1.38 percent, respectively, for 1995.
NET INTEREST INCOME
Net interest income is the primary source of operating income for the
Company. Net interest income is the difference between interest earned on loans
and investments and interest paid on deposits and other funding sources. The
factors that influence net interest income include changes in interest rates and
changes in asset and liability balances. The net interest margin is calculated
by dividing tax equivalent net interest income by average earning assets and
represents the Company's net yield on its earning assets.
[GRAPHIC OMITTED - BAR CHART SHOWING NET INTEREST INCOME FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $21,716
1993 $21,886
1994 $23,164
1995 $24,163
1996 $25,480
For purposes of this discussion, interest income and the average yield
earned on loans and investments are presented on a taxable equivalent basis.
This provides a basis for comparison of tax-exempt loans and investments with
taxable loans and investments by giving effect to interest earned on tax-exempt
loans and investments by an amount equivalent to the federal income taxes which
would have been paid if the interest earned on those assets were taxable at the
statutory tax rate of 35 percent.
[GRAPHIC OMITTED - BAR CHART SHOWING NET INTEREST MARGIN (FTE) FOR 1992-1996]
The data points are as follows:
1992 4.45%
1993 4.48%
1994 4.69%
1995 4.66%
1996 4.73%
Net interest income for the year ended December 31, 1996 was $26.1 million,
a $1,4 million or 5.8 percent increase over 1995. Net interest income for 1994
was $23.7 million.
For 1996 compared to 1995, an increase of $1.6 million in net interest
income was associated with volume changes in earning assets and interest bearing
liabilities, and a decrease of $210 thousand was associated with changes in
interest rates earned or paid on earning assets and interest bearing
liabilities.
The volume component of the increase in net interest income was a result of
a combination of an increase in average earning assets of $21.7 million for 1996
over 1995 and a change in the mix of earning assets and a change in mix in
interest bearing liabilities. The change in mix associated with the increase in
earning assets provided $2.1 million of additional interest income over 1995. An
increase in interest bearing liabilities outstanding of $11.6 million added $482
thousand of additional interest expense compared to 1995. The increase in
earning assets resulted from a $27.1 million increase in average loans
outstanding which was somewhat offset by a decrease in average money market
investments of $3.5 million and a decrease of $1.9 million in average
investments outstanding. The increase in interest bearing liabilities resulted
primarily from an increase in average time deposits of $7.8 million and a $7.3
million increase in average savings deposits from 1995. The increase in time and
savings deposits was partially offset by a $3.7 million reduction in average
other borrowings and average interest bearing demand deposits from 1995. The
increase in average interest bearing deposit volumes resulted in an additional
$648 thousand in interest expense as compared to 1995. Another component of
funding the earning asset growth was the growth in non-interest bearing demand
deposits of $6.0 million and a $5.4 million growth in average stockholders'
equity.
Although the net interest margin actually increased from 1995 to
34
<PAGE>
TABLE 1
AVERAGE BALANCE SHEETS, RATES, AND INTEREST INCOME AND EXPENSE
<TABLE>
<CAPTION>
(Dollars in thousands)
1996 1995 1994
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Loans $409,049 $ 37,066 9.06% $381,939 $ 35,225 9.22% $371,467 $ 31,046 8.36%
Money market investments:
Interest bearing deposits with banks 379 23 6.02 2,864 165 5.76 265 12 4.53
Federal funds sold 5,368 286 5.33 6,407 374 5.83 2,608 115 4.41
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total money market investments 5,747 309 5.38 9,271 539 5.82 2,873 127 4.42
Investment securities available for
sale and held to maturity:
Taxable investment securities
available for sale 56,231 3,075 5.47 56,577 2,881 5.09 66,283 3,207 4.84
Taxable investment securities
held to maturity 68,308 4,334 6.34 71,911 4,417 6.14 51,931 2,898 5.58
Non-taxable investment
securities held to maturity 12,195 816 6.69 10,105 688 6.81 12,360 857 6.94
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total investment securities 136,734 8,225 6.02 138,593 7,986 5.75 130,574 6,962 5.33
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total earning assets 551,530 $ 45,600 8.27% 529,803 $ 43,750 8.26% 504,914 $ 38,135 7.55%
-------- -------- ---- -------- -------- ---- -------- -------- ----
Other assets 28,926 26,990 30,234
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total assets $580,456 $556,793 $535,148
======== ======== ==== ======== ======== ==== ======== ======== ====
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing deposits:
Demand $ 54,683 $ 709 1.30% $ 55,523 $ 798 1.44% $ 64,198 $ 927 1.44%
Savings 129,267 4,061 3.14 121,995 3,663 3.00 132,984 3,269 2.46
Time 244,465 13,720 5.61 236,662 13,375 5.65 199,774 9,081 4.55
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total interest bearing deposits 428,415 18,490 4.32 414,180 17,836 4.31 396,956 13,277 3.34
Short-term borrowings 11,732 486 4.14 11,509 466 4.05 17,023 562 3.30
Other borrowings 8,763 518 5.91 11,636 766 6.58 10,259 608 5.93
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total interest bearing liabilities 448,910 $ 19,494 4.34% 437,325 $ 19,068 4.36% 424,238 $ 14,447 3.41%
-------- -------- ---- -------- -------- ---- -------- -------- ----
Non-interest bearing demand deposits 63,088 57,076 54,929
Other liabilities 7,720 7,092 5,071
Stockholders' equity 60,738 55,300 50,910
-------- -------- ---- -------- -------- ---- -------- -------- ----
Total liabilities and
stockholders' equity $580,456 $556,793 $535,148
-------- -------- ---- -------- -------- ---- -------- -------- ----
Net interest income $ 26,106 $ 24,682 $ 23,688
======== ======== ==== ======== ======== ==== ======== ======== ====
NET YIELD ON EARNING ASSETS
Total yield on earning assets 8.27% 8.26% 7.55%
Rate on supporting liabilities 3.54% 3.60% 2.86%
-------- -------- ---- -------- -------- ---- -------- -------- ----
Net interest margin 4.73% 4.66% 4.69%
======== ======== ==== ======== ======== ==== ======== ======== ====
</TABLE>
Interest and average interest rates are presented on a fully taxable equivalent
basis, using an effective tax rate of 35 percent. For purposes of calculating
loan yields, average loan balances include non-accrual loans.
Loan fees of $754,000, $501,000 and $434,000 for the years 1996, 1995, and 1994,
respectively, are included in interest income.
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
1996 from 4.66 percent to 4.73 percent, the rate component of net interest
income resulted in a decrease of $210 thousand in net interest income. This was
primarily due to lower yields on average loans. The yield on average loans
decreased by 16 basis points which had the effect of reducing the rate component
of interest income on loans by $602 thousand compared to 1995. This was
partially offset by a 27 basis point increase in the yield on investment
securities which added $359 thousand in additional interest income compared to
1995. In conjunction with the aforementioned factors, an increase in
non-interest bearing demand deposits of $6.0 million resulted in a 7 basis point
increase in the average net interest margin to 4.73 percent. A major component
of the Company's asset liability management policies is to try to minimize the
interest rate risk exposure caused by changing interest rate environments. The
Company utilizes interest rate swap contracts in an attempt to manage this
interest rate risk. At December 31, 1996 the Company had a notional value of $70
million in interest rate contracts, described in more detail in the
asset-liability management section of this report. These contracts had the
effect of increasing interest income by $164 thousand in 1996, decreasing
interest income by $255 thousand in 1995 and increasing interest income by $2
thousand in 1994. These interest rate contracts are in place to protect the Bank
against falling interest rates, which according to interest rate simulations
produced for managing the Bank's interest rate risk exposure, shows the greatest
risk to be in the falling rate environments. Should the national prime rate
remain constant at 8.25 percent or with a decline in the prime rate in future
periods, these contracts would add to interest income in future periods. This
will somewhat offset the reduction in income received from variable rate loan
products.
For 1995 as compared to 1994, an increase of $404 thousand was associated
with volume changes in earning assets and interest bearing liabilities, and $590
thousand was associated with changes in interest rates earned or paid on earning
assets and interest bearing liabilities.
The rate component of the increase in net interest income resulted from an
increase in the yield on earning assets of 71 basis points which added an
additional $4.0 million of interest income compared to 1994. This was partially
offset by a 95 basis point increase in the cost of interest bearing liabilities
which added $3.4 million in additional interest expense compared to 1994. A
large contributor to the rate associated increase in interest income was due to
the $10.5 million increase in average loans outstanding, which have a higher
yielding return as compared to the investment portfolio. An increase in the
average prime rate of 180 basis points from 1994 was a major contributor to the
higher yields on earning assets. In addition, due to the increase in interest
rates, depositors shifted from transaction accounts to higher yielding time
deposits. This resulted in the cost of time deposit accounts increasing 110
basis points from 1994. The net effect of the increase in rate on earning assets
and cost of interest bearing liabilities resulted in a 24 basis point decrease
in the net interest rate spread. The decrease in the net interest rate spread of
24 basis points was partially offset by the increase in non-interest bearing
demand deposits of $2.1 million resulting in a 3 basis point decline in the
average net interest margin to 4.66 percent.
The volume component of the increase in net interest income was a result of
an increase in average earning assets of $24.9 million for 1995 over 1994, which
provided $1.7 million of additional interest income over 1994. An increase in
interest bearing liabilities outstanding of $13.1 million added $1.3 million of
additional interest expense compared to 1994. The increase in earning assets
resulted from a $10.5 million increase in average loans outstanding and a $8.0
million increase in average investments outstanding and a $6.4 million increase
in average money market investments. The increase in interest bearing
liabilities resulted primarily from an increase in average time deposits of
$36.9 million from 1994. The increase in time deposits was partially offset by a
$19.7 million reduction in average interest bearing demand and savings deposits
from 1994. The increase in average interest bearing deposit volumes resulted in
an additional $1.5 million in interest expense as compared to 1994.
A comparative statement of average balances of interest earning assets and
interest bearing liabilities, interest income and interest expense, and interest
rates for the years ended December 31, 1996, 1995, and 1994 is presented in
Table 1. A presentation of the changes in net interest income for 1996 compared
to 1995, and 1995 compared to 1994, is given in Table 2. This analysis indicates
the changes in interest income and interest expense caused by the volume and
rate components of interest earning assets and interest bearing liabilities.
OTHER OPERATING INCOME
Other operating income for 1996 was $5.9 million, a $520 thousand or 9.6 percent
increase from 1995. Other operating income for 1995 was $5.4 million, compared
to $4.8 million for 1994.
[GRAPHIC OMITTED - BAR CHART OF OTHER OPERATING INCOME FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $4,366
1993 $5,084
1994 $4,819
1995 $5,411
1996 $5,931
Other operating income increased from 1995 as primarily as a result of an
increase in the amount of income recognized from the sale of residential
mortgage loans of $731 thousand. In 1996 the Company sold a total of $36.0
million of mortgage loans in the secondary market compared to $10.5 million in
1995. On March 1, 1996 the Company acquired the business operations of Central
Mortgage Company, a Lancaster, Pennsylvania mortgage origination
36
<PAGE>
TABLE 2
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
<TABLE>
<CAPTION>
(Taxable equivalent, dollars in thousands)
1996 Compared to 1995 1995 Compared to 1994
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
Volume Rate Net Volume Rate Net
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans $ 2,443 ($ 602) $ 1,841 $ 894 $ 3,285 $ 4,179
Money market investments:
Interest bearing deposits with banks (149) 7 (142) 150 3 153
Federal funds sold (58) (30) (88) 211 48 259
------- ------- ------- ------- ------- -------
Total money market investments (207) (23) (230) 361 51 412
------- ------- ------- ------- ------- -------
Investment securities available for sale and held to maturity
Taxable investment securities available for sale (32) 226 194 (646) 320 (326)
Taxable investment securities held to maturity (228) 145 (83) 1,210 309 1,519
Non-taxable investment securities held to maturity 140 (12) 128 (153) (16) (169)
------- ------- ------- ------- ------- -------
Total investment securities (120) 359 239 411 613 1,024
------- ------- ------- ------- ------- -------
Total interest income $ 2,116 ($ 266) $ 1,850 $ 1,666 $ 3,949 $ 5,615
======= ======= ======= ======= ======= =======
INTEREST EXPENSE:
Interest bearing deposits:
Demand ($ 12) ($ 77) ($ 89) ($ 125) ($ 4) ($ 129)
Savings 224 174 398 (235) 629 394
Time 436 (91) 345 1,853 2,441 4,294
------- ------- ------- ------- ------- -------
Total interest bearing deposits 648 6 654 1,493 3,066 4,559
Short-term borrowings 10 10 20 (318) 222 (96)
Other borrowings (176) (72) (248) 87 71 158
------- ------- ------- ------- ------- -------
Total interest expense 482 (56) 426 1,262 3,359 4,621
------- ------- ------- ------- ------- -------
Net interest income $ 1,634 ($ 210) $ 1,424 $ 404 $ 590 $ 994
======= ======= ======= ======= ======= =======
</TABLE>
Interest is presented on a taxable equivalent basis, using an effective tax rate
of 35 percent.
Note: The change in interest due to both rate and volume has been allocated to
the volume and rate changes in proportion to the absolute dollar amounts of each
change.
TABLE 3
OTHER OPERATING INCOME
<TABLE>
<CAPTION>
(Dollars in thousands) Years Ended December 31,
1996 1995 1994
<S> <C> <C> <C>
Fees and other service charges $ 1,625 $ 1,499 $ 1,453
Service charges on deposits 1,331 1,292 1,209
Trust income 1,310 1,277 1,289
Net gain on sale of loans 940 209 290
Reinsurance subsidiary premium income 402 384 382
Net realized gain (loss) on investment securities available for sale 79 126 (29)
Gain on sale of other real estate owned 60 410 0
Other income 184 214 225
------- ------- -------
Total other operating income $ 5,931 $ 5,411 $ 4,819
======= ======= =======
</TABLE>
37
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
company. The aforementioned increase in other operating income was
somewhat offset by a lower amount of gains recognized from the sale of other
real estate owned as compared to 1995. In 1995, a $410 thousand gain recognized
on the sale of a property classified as other real estate owned was recognized.
As shown on Table 15, Non-performing Assets, the amount of properties classified
as other real estate owned has decreased significantly over the five past
consecutive years. This increase in asset quality should have the effect of
reducing the amount of income recognized from these one time sales in future
periods.
In addition, fees and other service charges increased by $126 thousand or
8.4 percent from 1995. In 1996, the Company introduced a new direct debit card
product. This product, called "Master Money(TM)" allows customers to use their
ATM card at both MAC and MasterCard(R) locations. Fees associated with this card
as well as other fees associated with the Company's ATM and credit card products
resulted in the increase in this category.
Other operating income increased from 1994 to 1995 as a result of a $410
thousand gain recognized on the sale of a property classified as other real
estate owned that was sold during 1995. In addition, net realized gains recorded
on the sale of investment securities available for sale amounted to $126
thousand for 1995 compared to net realized losses of $29 thousand for 1994.
Income from service charges on deposit accounts increased by $83 thousand
or 6.9 percent for 1995 as compared to 1994. Income from service charges on
deposit accounts was $1.3 million and $1.2 million for 1995 and 1994,
respectively.
A summary of the components of other operating income is provided in Table
3.
OTHER OPERATING EXPENSE
Other operating expense for 1996 was $18.8 million, a $423 thousand or 2.3
percent increase over 1995. Other operating expense for 1994 was $17.6 million.
The largest component of the Company's other operating expense is salaries
and employee benefits, which increased by 2.8 percent from $9.8 million in 1995
to $10.0 million in 1996. Salaries and employee benefits expense for 1994
totalled $8.8 million. The increase was due to the net effect of three primary
factors. First, a 4 percent merit increase was applied on January 1, 1996 to
base salaries in effect as of that date. Second, salaries and employee benefits
increased as a result of staffing additions which resulted from the Central
Mortgage acquisition and due to the addition of three full service branch
locations during 1996. Third, these factors were somewhat offset by a 3 percent
reduction in staffing positions (excluding Central Mortgage and the new branch
additions), which were realized through attrition.
The Company does not provide any significant post-retirement or
post-employment benefits.
Federal Deposit Insurance Company (FDIC) deposit insurance premiums for
1996 were $2 thousand which represents a $537 thousand decrease from 1995. This
was attributable to a decrease in the assessment rate charged by the FDIC which
occurred in May 1995. The assessment rate charged to the Company on deposit
accounts decreased significantly from the 23 cents per $100 of deposits charged
during the first quarter of 1995 to a rate of 4 cents per $100 of deposits for
during May 1995. This reduction in premium resulted in a refund of a portion of
the FDIC insurance assessments that were previously paid by the Company in 1995.
This refund amounted to $290 thousand. The rate paid by the Company is the
lowest assessment rate charged to "Well Capitalized" institutions. During 1996,
the Company paid the minimum rate assessed by the FDIC of $2 thousand. During
the latter part of 1996, Congress agreed on a legislative package to stabilize
the savings and loan (S&L) industry's deposit insurance fund (SAIF). The
legislation required the S&L industry to recapitalize its deposit fund with a
one-time assessment. Previous proposals required the bank insurance fund (BIF)
to contribute a substantial amount to help recapitalize SAIF. Under the current
legislation, banks are required to pay an annual rate of 1.29 cents for every
$100 of domestic deposits from 1997 through 1999 and pay 2.43 cents per $100 of
domestic deposits for the years 2000 through 2017. The amount of FDIC insurance
to be paid under this new legislation will not materially impact the financial
statements or the results of operations for the Company in future periods.
Increases in several categories such as in occupancy, equipment and several
other categories were a result of the acquisition of Central Mortgage and the
addition of the Bank's twentieth, twenty-first and twenty-second branch sites.
The increase in loan administration and workout expense is a direct result of
the increase in loan volumes and an increase in calling efforts.
[GRAPHIC OMITTED - BAR CHART OF OTHER OPERATING EXPENSE FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $15,400
1993 $17,213
1994 $17,633
1995 $18,389
1996 $18,812
Other operating expense increased by $756 thousand or 4.3 percent from 1994
to 1995. The major changed from 1994 to 1995 occurred in salaries and employee
benefits, professional services and FDIC deposit insurance.
Increases in salaries and employee benefits for 1995 over 1994 resulted
from the recognition of $616 thousand related to employee bonuses recorded
during 1995. In addition, a 4 percent merit increase was applied on January 1,
1995 to base salaries in effect as of that date. These increases were somewhat
offset by a reduction in the full time equivalent staff by 3 percent from 1994
to 1995. Expenses related to professional services increased by $260 thousand
from 1994 to 1995. Increases in legal, advisory and consult-
38
<PAGE>
TABLE 4
OTHER OPERATING EXPENSE
(Dollars in thousands) Years ended December 31,
1996 1995 1994
Salaries and employee benefits $10,040 $ 9,770 $ 8,834
Equipment expense 1,954 1,934 1,871
Occupancy expense, net 1,306 1,256 1,237
Professional services 826 913 653
Bank card processing expense 822 711 662
Marketing and advertising 565 404 423
Pennsylvania shares tax 502 479 457
Reinsurance subsidiary expense 426 315 332
Stationery and supplies 375 328 304
Postage 349 305 293
Telephone 344 287 229
Loan administration and workout expense 123 73 150
Expense of other real estate owned, net 60 79 91
Deposit insurance expense 2 539 1,016
Other 1,118 996 1,081
------- ------- -------
Total other operating expense $18,812 $18,389 $17,633
======= ======= =======
TABLE 5
INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
(Dollars in thousands) December 31, 1996
0 - 30 Days 31 - 90 Days 91 - 180 Days 181 - 365 Days 1 - 5 Years Over 5 Years
<S> <C> <C> <C> <C> <C> <C>
RATE SENSITIVE ASSETS:
Money market investments $ 181 $ 0 $ 0 $ 0 $ 0 $ 0
Investment securities available
for sale and investment securities
held to maturity 13,989 9,745 9,319 21,820 90,851 8,524
Loans held for sale 6,019 0 0 0 0 0
Loans 160,716 14,875 19,193 28,116 142,960 56,674
--------- --------- --------- --------- --------- ---------
Total $ 180.905 $ 24,620 $ 28,512 $ 49,936 $ 233,811 $ 65,198
========= ========= ========= ========= ========= =========
RATE SENSITIVE LIABILITIES:
Deposits $ 85,684 $ 89,279 $ 65,099 $ 76,723 $ 184,876 $ 25,172
Short-term borrowings 12,478 0 0 0 0 0
Other borrowings 2 5 8 3,444 2,754 225
--------- --------- --------- --------- --------- ---------
Total $ 98,164 $ 89,284 $ 65,107 $ 80,167 $ 187,630 $ 25,397
========= ========= ========= ========= ========= =========
Cumulative interest sensitivity gap $ 82,741 $ 18.077 ($ 18,518) ($ 48,749) ($ 2,568) $ 37,233
Cumulative interest sensitivity
ratio before effects of interest
rate swap contracts 1.84 1.10 .93 .85 1.00 1.07
Cumulative interest sensitivity
ratio after effects of interest
rate swap contracts 1.13 .72 .65 .70 1.00 1.07
</TABLE>
39
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
ing fees were the primary reason for the increase. A reduction in FDIC insurance
from 1994 to 1995 of $477 thousand somewhat offset the aforementioned increases.
A summary of the components of other operating expense is provided in Table
4.
FEDERAL INCOME TAXES
The federal income tax provision for 1996 was $3.9 million compared to $3.5
million for 1995 and $3.3 million for 1994. Income before income taxes for 1996
was $12.6 million compared to $11.2 million for 1995 and was $10.1 million for
1994. A reconciliation of reported income taxes to the amount of income tax
which would have been provided at the federal statutory tax rate is provided in
Note 12 of the Notes to Consolidated Financial Statements.
The Company's effective tax rate for 1996, 1995 and 1994 was 31 percent, 32
percent and 33 percent, respectively.
ASSET-LIABILITY MANAGEMENT
Interest rate sensitivity is a function of the repricing characteristics of
the Company's assets and liabilities. Each asset and liability reprices either
at maturity or during the life of the instrument. Interest rate sensitivity
measures the difference between the volume of assets and liabilities that are
subject to repricing at a future period of time. These differences are known as
interest sensitivity gaps.
The principal objectives of asset-liability management are to manage the
funding and investment strategies necessary to maintain an appropriate balance
of the sensitivity between assets and liabilities to potential movements in
interest rates and to provide adequate liquidity while enhancing profitability
through returns from managed levels of interest rate risk. The Company actively
manages the interest rate sensitivity of its assets and liabilities. Several
techniques are used for measuring interest rate sensitivity. The traditional
maturity "gap" analysis, which reflects the volume difference between interest
rate sensitive assets and liabilities during a given time period, is reviewed
regularly by management. An interest rate risk simulation model is also used to
assess the level of interest rate risk inherent in the Company's assets and
liabilities under various interest rate scenarios. The Company recognizes the
importance of managing both assets and liabilities simultaneously for the
purpose of reducing interest rate risk, providing liquidity, and enhancing the
market value of the Company.
Managing interest rate sensitivity is an inexact science. The repricing
intervals between assets and liabilities change on a daily basis. Contractual
maturities are not always the same as actual maturities as a result of
prepayments prior to scheduled maturities. Additionally, demand deposits, NOW
accounts, and money market fund accounts may be withdrawn upon demand, and
savings deposits may be withdrawn upon a very short period of notice. However,
for asset-liability management purposes, the Company considers a portion of each
of these types of deposits to be "core" amounts which may be considered to have
various maturities.
The Company manages its interest rate sensitivity by changing mix and
repricing characteristics of its assets and liabilities through its investment
securities portfolio, its loan and deposit terms, and through the use of
off-balance sheet derivatives, primarily interest rate swap contracts. These
interest rate swap contracts will have the effect of decreasing net interest
income in a rising rate environment and increasing net interest income in a
decreasing rate environment.
The Company's use of these interest rate swap contracts is closely
monitored by the Company's Board of Directors and is closely controlled as to
levels of exposure. At December 31, 1996 the Company had seven interest rate
agreements outstanding having a total notional amount of $70 million. These
agreements consisted of interest rate swap agreements each with a notional
amount of $10 million.
The Company has entered into interest rate swap contracts as part of its
asset-liability management activities. These contracts are used primarily for
the purpose of managing interest rate risk in order to minimize mismatches in
the Bank's interest rate sensitivity and interest rate risk positions.
Interest rate swap contracts generally involve the exchange of fixed and
floating-rate interest payment obligations without the exchange of the
underlying principal amounts. Entering into interest rate swap contracts
involves not only the risk of dealing with counterparties and their ability to
meet the terms of the contracts but also the interest rate risk associated with
unmatched positions should the counterparties fail to perform. Notional
principal amounts often are used to express the volume of these transactions.
The interest income or interest expense differential from interest rate
swap contracts is recognized on the accrual basis as a component of interest
income or interest expense over the life of the contract. Gains or losses from
early termination of interest rate swap contracts are deferred and amortized
over the remaining term of the underlying assets or liabilities. The Company is
not exposed to credit risk in terms of the notional amounts of these contracts,
however, the receipt of payments representing the interest differential is based
on the creditworthiness of the counterparty to each contract.
The Company does not obtain collateral or other security to support
financial instruments subject to credit risk but monitors the credit standing of
counterparties. The counterparties of the aforementioned interest rate contracts
are commercial banks having a rating of A1 from Moody's Investor Service.
The Company's cumulative static gap position for various time intervals is
shown in Table 5. The maturity distribution and weighted average yields of
investment securities is presented in Table 6. The maturity distribution and
interest sensitivity characteristics of the Company's loan portfolio is shown in
Table 7. The maturity distribution of time deposits of $100 thousand or more is
shown in Table 8. The data in these tables indicates that the Company is
liability sensitive up to one year, however, as a result of liability prices
changing at a different speed than asset pricing, the Company's simulations of
earnings indicate that net interest income up to one year will be positively
affected by increases in general levels of interest rates and negatively
effected by a level rate or falling rate environment. The effects of the
interest rate swap contracts are indicated on Table 5. These contracts were
entered into to minimize the negative
40
<PAGE>
TABLE 6
MATURITY DISTRIBUTION OF INVESTMENT SECURITIES
<TABLE>
<CAPTION>
(Dollars in thousands) December 31, 1996
Over One But Over Five But
Within One Year Within Five Years Within Ten Years Over Ten Years Total
Amort- Amort- Amort- Amort- Amort-
ized Fair ized Fair ized Fair ized Fair ized Fair
Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT
SECURITIES
AVAILABLE FOR SALE:
U.S. Treasury and
government agencies $17,247 $17,209 6.32% $38,309 $38,179 6.11% $217 $216 5.88% $380 $380 7.27% $56,153 $55,984 6.18%
Mortgage-backed
securities 1,389 1,422 7.87
Equity securities 1,821 2,726 5.75
Other investment
securities 2,464 2,464 6.18
------- ------- ---- ------- ------- ---- ---- ---- ---- ---- ---- ---- ------- ------- ----
Total $61,827 $62,596 6.21%
======= ======= ==== ======= ======= ==== ==== ==== ==== ==== ==== ==== ======= ======= ====
</TABLE>
(Dollars in thousands) December 31, 1996
<TABLE>
<CAPTION>
Over One But Over Five But
Within One Year Within Five Years Within Ten Years Over Ten Years Total
Amort- Amort- Amort- Amort- Amort-
ized Fair ized Fair ized Fair ized Fair ized Fair
Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT
SECURITIES
HELD TO MATURITY:
U.S. Treasury and
government agencies $6,855 $6,736 4.36% $18,869 $19,166 6.57% $ 0 $ 0 .00% $ 0 $ 0 .00% $25,724 $25,902 5.98%
States and political
subdivisions 3,460 3,466 6.20 13,519 13,576 7.03 200 215 9.59 0 0 .00 17,179 17,257 6.89
------ ------ ---- ------- ------- ---- --- --- --- --- --- --- ------- ------- ----
$10,315 $10,202 4.98% $32,388 $32,742 6.76% $200 $215 9.59% $ 0 $ 0 .00% 42,903 43,159 6.35
Mortgage-backed
securities 48,749 48,922 6.46
------ ------ ---- ------- ------- ---- --- --- --- --- --- --- ------- ------- ----
Total $91,652 $92,081 6.41%
====== ====== ==== ======= ======= ==== === === === === === === ======= ======= ====
</TABLE>
The effective rate used to determine taxable-equivalent yields was 35%.
41
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
effects that the Bank will realize in falling rate environments (e.g. reduction
in prime based rates).
LIQUIDITY
In managing liquidity, the Company attempts to meet the demand for funds,
such as deposit withdrawals, net loan demand and other funding needs of the
Company. Liquidity may normally be obtained either through the maturity or sale
of assets or the issuance of liabilities at costs which accomplish the Company's
objectives.
The Company actively monitors its liquidity position and has a contingency
plan to provide adequate liquidity under various scenarios. The Company's
primary source of funds is its retail deposit base supported by its branch
network of 22 locations. Retail repurchase agreements entered into with certain
corporate customers are also a source of funds for the Company. The investment
portfolio is also used by the Company as a primary source of liquidity. Although
not a primary source of liquidity, loans held for sale are considered to be very
liquid. The liquidity of the Company is considered to be strong as a result of
the reliability of the Company's deposit gathering sources and of the maturity
structure of the investment portfolio in addition to the availability of funds
to the Company through established federal funds lines of credit, amounting to
$108 million, with other commercial banks and with the Federal Home Loan Bank of
Pittsburgh. During each of the past five years, the Company has been a net
seller of federal funds.
FUNDING
The primary source of funds for the Company is customer deposits. Customer
deposits increased approximately $38.9 million from December 31, 1995 to
December 31, 1996. The balance of securities sold under repurchase agreement at
December 31, 1996 and 1995 was $12.5 million and $8.6 million, respectively.
[GRAPHIC OMITTED - BAR CHART OF TOTAL DEPOSITS FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $464,031
1993 $454,700
1994 $468,740
1995 $487,917
1996 $526,833
Another source of funding for the Company is borrowing from the Federal
Home Loan Bank of Pittsburgh (FHLB). The average balance of FHLB borrowings was
$8.4 million during 1996 and $10.9 million during 1995. The funds borrowed from
the FHLB are secured by the FHLB stock owned by the Company and by certain of
its investment securities. Total borrowings from the FHLB at December 31, 1996
and 1995 totalled $6.1 million and $13.6 million, respectively, and ranged in
original maturity from one to five years.
Time deposits of $100 thousand or more increased by $5.3 million from
December 31, 1995 to December 31, 1996 and decreased $2.0 million from December
31, 1994 to December 31, 1995. The Company considers its "core deposits" to be
all deposits except "jumbo time deposits" which are certificates of deposit of
$100 thousand or more. These "jumbo deposits" are priced competitively by the
Company based on short and intermediate-term funding needs. In addition to the
"core deposit" base, the Company may choose to utilize the maturities in its
liquid investment portfolio, jumbo certificates of deposit or Federal Home Loan
Bank of Pittsburgh advances or a combination of the three to provide a source of
funds for future loan growth should the necessity arise.
With respect to average balances, earning assets grew by $21.7 million from
1995. This was comprised of growth in average loans of $27.1 million which was
slightly offset by decreases in average investment securities and average money
market investments of $5.4 million. The increase in average earning assets was
funded by increases in average interest bearing deposits, average non-interest
bearing deposits and average stockholders' equity of $14.2 million, $6.0 million
and $5.4 million respectively. The aforementioned increases in average funding
sources was somewhat offset by a $2.7 million decrease in average short-term and
other borrowings. The average balances and average interest rates applicable to
the major classifications of deposits and short-term borrowings for the years
ended December 31, 1996, 1995 and 1994 are presented in Table 9 and Table 10.
Reference is also made to the Consolidated Statements of Cash Flows for the
years ended December 31, 1996, 1995 and 1994 which appear elsewhere in this
report.
INVESTMENTS
The Company's investment portfolio is classified as either "held to
maturity" or "available for sale". Investment securities that are classified as
held to maturity are carried at amortized cost. Investment securities classified
as available for sale are carried at fair value with the unrealized holding
gains or losses, net of taxes, reported as a separate component of stockholders'
equity.
The Company has both the ability and the intent to hold the investment
securities designated as held to maturity until maturity. A total of $61.8
million and $65.3 million of investment securities, having a fair value of $62.6
million and $65.8 million were designated as available for sale by the Company
as of December 31, 1996 and 1995, respectively. A total of $91.7 million and
$86.9 million of investment securities having a fair value of $92.1 million and
$88.1 million, were designated as held to maturity by the Company as of December
31, 1996 and 1995, respectively.
As permitted by the Financial Accounting Standards Board, during 1995, the
Company had a "one-time" opportunity to transfer investment securities from the
held to maturity to the available for sale portfolio. The Company chose not to
transfer any of its investments during this "one-time" opportunity. This was
based primarily on the Company's strong liquidity position and the short average
42
<PAGE>
TABLE 7
MATURITIES AND INTEREST SENSITIVITY OF LOANS
<TABLE>
<CAPTION>
December 31, 1996 (Dollars in thousands)
One Year One through
or Less Five years Over Five Years Total
<S> <C> <C> <C> <C>
Commercial $ 47,668 $ 123,105 $ 24,177 $ 194,950
Agriculture 25,063 47,090 34,360 106,513
Commercial real estate - construction 1,253 3,237 636 5,126
Real estate - residential mortgage 3,359 8,576 17,661 29,596
Consumer, net of unearned income 43,674 41,610 1,719 87,003
--------- --------- --------- ---------
Total loans $ 121,017 $ 223,618 $ 78,553 423,188
Unamortized net loan fees (654)
--------- --------- --------- ---------
Total loans, net $ 422,534
========= ========= ========= =========
Loans with predetermined interest rates $ 75,413 $ 143,614 $ 56,674 $ 275,701
Loans with floating interest rates 45,604 80,004 21,879 147,487
--------- --------- --------- ---------
Total loans $ 121,017 $ 223,618 $ 78,553 423,188
Unamortized net loan fees (654)
--------- --------- --------- ---------
Total loans, net $ 422,534
--------- --------- --------- ---------
</TABLE>
TABLE 8
MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
1996 1995 1994
<S> <C> <C> <C>
Three months or less $ 6,308 $ 6,435 $10,174
Over three through six months 4,249 2,512 4,175
Over six through twelve months 9,765 3,309 2,521
Over twelve months 3,608 6,331 3,700
------- ------- -------
Total $23,930 $18,587 $20,570
======= ======= =======
</TABLE>
TABLE 9
DEPOSITS BY MAJOR CLASSIFICATION
<TABLE>
<CAPTION>
(Dollars in thousands) Years ended December 31,
1996 1995 1994
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing demand deposits $ 63,088 0.00% $ 57,076 0.00% $ 54,929 0.00%
Interest bearing demand deposits 54,683 1.30 55,523 1.44 64,198 1.44
Savings deposits 129,267 3.14 121,995 3.00 132,984 2.46
Time deposits 244,465 5.61 236,662 5.65 199,774 4.55
-------- ---- -------- ---- -------- ----
Total deposits $491,503 3.76% $471,256 3.78% $451,885 2.94%
======== ==== ======== ==== ======== ====
</TABLE>
43
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
life of the investment portfolio. The Company does not purchase securities for
the purpose of trading. Investment securities which are classified as available
for sale are done so for the purpose of providing additional insurance that
adequate levels of liquidity are available.
The composition of the Company's total investment portfolio, including
investment securities available for sale and investment securities held to
maturity, at December 31, 1996 was approximately 53.3 percent U. S. Treasury and
agency securities, 32.7 percent mortgage-backed securities, 11.2 percent state
and political subdivisions obligations, with the balance consisting of various
equity and other securities. A summary of the book value of investment
securities at December 31 of each of the past five years is provided in Table
11. The portfolio is structured to provide a maximum return on investment while
providing a consistent source of liquidity and meeting strict interest and
credit risk standards.
The net unrealized gain on investment securities available for sale at
December 31, 1996 was $769 thousand or $508 thousand, net of taxes, which
consisted of gross unrealized gains of $990 thousand and gross unrealized losses
of $221 thousand. The net unrealized gains on investment securities available
for sale at December 31, 1995 was $506 thousand or $336 thousand, net of taxes,
which consisted of gross unrealized gains of $636 thousand and gross unrealized
losses of $130 thousand. The increase in net unrealized gains on securities
available for sale resulted from a slight decrease in interest rates during
1996, which increased the value of the securities held by the Company.
A total of $196 thousand of investment securities available for sale were
sold during 1996 at a net realized gain of $79 thousand.
The net unrealized gain on investment securities held to maturity at
December 31, 1996 was $429 thousand which consisted of gross unrealized gains of
$774 thousand and gross unrealized losses of $345 thousand. The net unrealized
gains at December 31, 1995 was $1.2 million which consisted of gross unrealized
gains of $1.5 million and gross unrealized losses of $281 thousand. The decline
in market values for the held to maturity portfolio was the result of maturities
of held to maturity investments which had a higher net unrealized gain as
compared to the held to maturity investments which were purchased during the
year.
LOANS
The Company classifies its loans as either portfolio loans or loans held
for sale. The Company's loan portfolio consists primarily of loans to
individuals, farmers, and small and medium-sized businesses which operate within
the Company's trade area, which consists of Lebanon, Lancaster, Schuylkill,
Dauphin, and Berks counties in Pennsylvania. The Company maintains certain fixed
rate residential mortgage loans which are held for sale in the secondary market.
In addition to these loans, the Company also classified its credit card
portfolio as held for sale at December 31, 1996. The Company emphasizes strict
underwriting standards in managing its portfolio growth, support staff is
provided to lending personnel to assist in making credit decisions and adherence
to credit standards is monitored by the Company's senior credit management. The
loan portfolio is reviewed periodically by loan review officers to determine
adherence to established credit standards and procedures.
The Company's loans
outstanding at December 31, 1996 totalled $422.5 million, a $31.9 million
increase from December 31, 1995. The increase in loans outstanding was a
combination of an increase in commercial loan and commercial real
estate-construction loan balances from December 31, 1995 to December 31, 1996 of
$21.5 million or 12.0 percent, together with an increase of $15.5 million or
17.1 percent in agriculture loans and a decrease of $4.6 million or 13.6 percent
in real estate-residential mortgage loans over the same period.
[GRAPHIC OMITTED - BAR CHART OF LOANS FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $375,214
1993 $359,838
1994 $382,722
1995 $390,631
1996 $422,534
Commercial loans at December 31, 1996 totalled $195.0 million. The
Company's commercial loan business is transacted primarily with small and
medium-sized companies with known local management and financial stability.
Commercial real estate-construction loans at December 31, 1996 totalled $5.1
million or 1.2 percent of total loans compared to $7.7 million or 2.0 percent of
total loans at December 31, 1995.
Real estate-residential mortgage loans are loans secured by liens on
residential properties (other than home equity loans). At December 31, 1996
there were $29.6 million or 7.0 percent of total loans outstanding secured by
real estate-residential mortgages, compared to $34.2 million or 8.8 percent of
total loans at December 31, 1995. The outstanding balance for this type of loan
has decreased over the past several years due to a significant level of
refinancing by the Bank's existing loan customers and a significant portion of
the mortgages which the Company originated or refinanced are committed to be
sold at the date of origination and are sold to a third-party within a short
period of time after settlement. During 1996 the Company originated $40.7
million and sold a total of $38.6 million of mortgages to third-parties,
compared with originations and third-party sales of $10.5 million in 1995.
Consumer loans include credit card loans, personal lines of credit,
installment and home equity loans to individual borrowers. These loans include
both secured and unsecured loans to individuals and are generally for various
purposes such as automobile financing, home improvements and recreational and
educational purposes. As mentioned above, the Company has classified its entire
credit card loan portfolio as held for sale at December 31,
44
<PAGE>
TABLE 10
SHORT-TERM BORROWINGS
<TABLE>
<CAPTION>
(Dollars in thousands) Years ended December 31,
1996 1995 1994
December Average Average December Average Average December Average Average
31 Balance Rate 31 Balance Rate 31 Balance Rate
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Federal funds purchased $ 0 $ 604 5.79% $ 0 $ 112 5.92% $ 0 $ 569 4.04%
Securities sold under agreements
to repurchase 12,478 11,128 4.05 8,640 11,397 4.03 12,087 16,454 3.28
------- ------- ---- ------- ------- ---- ------- ------- ----
Total short-term borrowings $12,478 $11,732 4.14% $ 8,640 $11,509 4.05% $12,087 $17,023 3.30%
======= ======= ==== ======= ======= ==== ======= ======= ====
</TABLE>
The highest month end outstanding balance was $15,433,000, $14,720,000 and
$19,102,000 for 1996, 1995 and 1994, respectively. The weighted average rate
paid on December 31, 1996 was 4.04 percent and was 4.02 percent on December 31,
1995 and 1994.
TABLE 11
INVESTMENT SECURITIES - BOOK VALUE
<TABLE>
<CAPTION>
INVESTMENT SECURITIES AVAILABLE FOR SALE:
(Dollars in thousands) December 31,
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
U.S. Treasury and government agencies $ 56,153 $ 59,829 $ 50,071 $ 69,050 462
Mortgage-backed securities 1,389 1,851 2,420 7,225 0
Equity securities 1,821 1,648 1,252 1,165 766
Other investment securities 2,464 1,965 1,921 1,947 2,351
-------- -------- -------- -------- --------
Total $ 61,827 $ 65,293 $ 55,664 $ 79,387 $ 3,579
======== ======== ======== ======== ========
INVESTMENT SECURITIES HELD TO MATURITY:
(Dollars in thousands) December 31,
1996 1995 1994 1993 1992
U.S. Treasury and government agencies $ 25,724 $ 37,802 $ 36,837 $ 25,119 $ 83,625
States and political subdivisions 17,179 12,394 11,424 13,717 14,203
Mortgage-backed securities 48,749 36,689 24,443 23,118 16,723
-------- -------- -------- -------- --------
Total $ 91,652 $ 86,885 $ 72,704 $ 61,954 $114,551
======== ======== ======== ======== ========
</TABLE>
TABLE 12
LOAN PORTFOLIO
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Commercial $ 194,950 $ 170,872 $ 158,343 $ 157,003 $ 177,270
Agriculture 106,513 90,971 86,687 79,081 75,461
Commercial real estate - construction 5,126 7,742 9,063 9,612 11,338
Real estate - residential mortgage 29,596 34,236 37,426 41,496 52,894
Consumer, net of unearned income 87,003 87,560 92,069 73,530 59,400
Unamortized net loan fees (654) (750) (866) (884) (1,149)
--------- --------- --------- --------- ---------
Total, net $ 422,534 $ 390,631 $ 382,722 $ 359,838 $ 375,214
========= ========= ========= ========= =========
</TABLE>
45
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
1996 as it is management's intent to sell this portion of the loan portfolio in
1997. The Company continued its emphasis on marketing its direct consumer
installment loan products to consumers during 1996 which resulted in a $4.7
million or 11.3 percent increase in installment loans. Home equity and other
personal lines of credit balances increased by $1.3 million or 9.6 percent from
December 31, 1995 to December 31, 1996. This was offset by decreases in dealer
installment loans of $5.0 million or 17.5 percent and the reclassification of
$3.5 million of credit card loans to loans held for sale at December 31, 1996.
The Company did not classify its credit card loan portfolio as held for sale at
December 31, 1995. A distribution of the Company's loan portfolio according to
major loan classifications is shown in Table 12.
Group concentrations of credit are considered to exist if a number of
counterparties are engaged in similar activities and have similar economic
characteristics that would cause their ability to meet contractual obligations
to be similarly affected by changes in economic or other conditions. At December
31, 1996 there were $106.5 million, or 25.2 percent of the total loan portfolio,
in loans outstanding to agriculture-related borrowers. These loans are for a
variety of purposes within the industry, primarily dairy farms, poultry farms,
agri-business and swine operations. Dairy farms comprised 54.3 percent of such
loans at December 31, 1996, swine operations comprised 12.8 percent, poultry
farms comprised 12.0 percent, loans to agriculture-related businesses were 8.5
percent and beef operations comprised 8.3 percent of this portfolio. These loans
may be similarly impacted by adverse climate, economic conditions, or other
factors not common to other industries. The Company's exposure to possible loss
in the event of nonperformance by these borrowers is represented by the
contractual amount of these loans. The Company's policy is to require supporting
collateral for these loans in the form of agriculture real estate, livestock,
and farm equipment. At December 31, 1996 there were no agriculture-related
borrowings which were included in non-performing loans in Table 15 or which are
considered as potential problem loans.
Most of the Company's business activity is with customers located within
the Company's defined market area. Since the majority of the Company's real
estate loans are located within this area, a substantial portion of the
Company's debtors' ability to honor their contracts, and increases and decreases
in the market value of the real estate collateralizing such loans, may be
significantly affected by the level of economic activity in this area.
The Company had no loans outstanding to foreign countries and no loans
which may be classified as highly leveraged transactions at December 31, 1996.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
There was no provision for loan losses charged to operations in 1996 or in
1995. The provision for loan losses for 1994 was $300 thousand. The Company
performs a credit quality review of its loan portfolio on a quarterly basis and
through this review determined that the level of the allowance for loan losses
was adequate as of December 31, 1996 and no provision was needed for 1996 due to
the continued improvement of credit quality of the loan portfolio. Total
non-performing loans were $973 thousand at December 31, 1996 compared to $741
thousand and $1.3 million at December 31, 1995 and 1994, respectively. Net
charge-offs for 1996 were $289 thousand or .07 percent of average loans
outstanding compared with $115 thousand or .03 percent of average loans
outstanding for 1995 and $646 thousand or .17 percent of average loans
outstanding for 1994. Charge-offs related to commercial loans increased by $312
thousand to $523 thousand during 1996 which related primarily to a single
commercial customer. An increase in recoveries on loans previously charged-off
was also recognized on commercial real estate-construction loans of $138
thousand. This was due to a recovery of a commercial real estate-construction
loan which was previously charged-off. A summary of charge-offs and recoveries
of loans is presented in Table 13.
The allowance for loan losses at December 31, 1996 was $7.7 million or 1.83
percent of total loans outstanding compared to $8.0 million or 2.05 percent of
total loans outstanding at December 31, 1995. The allowance for loan losses is a
reserve for estimated loan losses and other loan-related charges. The allowance
for loan losses is an amount determined by management's evaluation of the loan
portfolio, historical loss experience, the level of non-performing and
delinquent loans, assessment of economic conditions, and the quality of any
concentrations within the portfolio. Loan losses arise primarily from the loan
portfolio but could also be derived from other sources, including commitments to
extend credit and standby letters of credit. Actual loan losses, net of
recoveries, are deducted from the allowance for loan losses. While management
uses available information to determine the appropriate level of the allowance
for loan losses, the allowance may be affected in the future based upon changes
in economic conditions and other factors. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may recommend the Bank
change the level of the allowance based on their judgements of information
available to them at the time of their examination.
The allocation of the allowance for loan losses among the major loan
classifications and the percentage of total loans represented by such
classifications are shown in Table 14 as of December 31 of each of the past five
years. Allocations are determined primarily from an analysis of historical
charge-offs and past-due trends, and current economic conditions as they affect
loans. In addition, although Table 14 shows specific allocations for the
allowance for loan losses, the total valuation allowance is established and is
available for the entire loan portfolio based upon economic conditions, loan
loss experience, concentrations, portfolio trends, credit policies and
procedures, and quality trends in the portfolio. With the growth in the
Company's loan portfolio, the allowance allocated for each type of loan
increased slightly during 1996. The unallocated portion of the allowance for
loan losses decreased by $563 thousand which resulted from increasing the
reserve allocated to each of the loan types and not having a provision for loan
losses charged to operating results in 1996.
46
<PAGE>
TABLE 13
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
(Dollars in thousands) Years ended December 31,
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Balance, beginning of period $8,025 $8,140 $8,486 $8,317 $6,888
LOANS CHARGED-OFF:
Commercial 523 211 874 2,478 2,479
Agriculture 0 0 0 0 0
Commercial real estate - construction 4 0 0 5 349
Real estate - residential mortgage 2 0 0 0 0
Consumer 366 372 323 110 245
------ ------ ------ ------ ------
Total loans charged-off 895 583 1,197 2,593 3,073
RECOVERIES ON LOANS PREVIOUSLY CHARGED-OFF:
Commercial 372 384 459 274 427
Agriculture 0 0 0 0 0
Commercial real estate - construction 182 44 67 39 324
Real estate - residential mortgage 0 0 0 0 0
Consumer 52 40 25 49 151
------ ------ ------ ------ ------
Total recoveries 606 468 551 362 902
------ ------ ------ ------ ------
Net charge-offs 289 115 646 2,231 2,171
Current period's provision for loan losses 0 0 300 2,400 3,600
------ ------ ------ ------ ------
Balance, end of period $7,736 $8,025 $8,140 $8,486 $8,317
====== ====== ====== ====== ======
Ratio of net charge-offs during the period to average
loans outstanding during the period .07% .03% .17% .61% .58%
</TABLE>
TABLE 14
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
(Dollars in thousands)
Balance at December 31, applicable to:
1996 1995 1994 1993 1992
Category Category Category Category Category
as a as a as a as a as a
Percent Percent Percent Percent Percent
of of of of of
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $ 782 46.1% $ 691 43.7% $1,911 41.1% $6,199 43.4% $6,796 47.0%
Agriculture 363 25.2 309 23.2 294 22.6 798 21.9 747 20.0
Commercial real estate -
construction 63 1.2 31 2.0 331 2.4 382 2.7 489 3.0
Real estate -
residential mortgage 0 7.0 0 8.8 0 9.9 0 11.7 0 14.0
Consumer 738 20.5 641 22.3 587 24.0 184 20.3 232 16.0
Unallocated 5,790 -- 6,353 -- 5,017(1) -- 923 -- 53 --
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total $7,736 100.0% $8,025 100.0% $8,140 100.0% $8,486 100.0% $8,317 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
<FN>
(1) The increase in the unallocated reserve is primarily due to a change in the
Bank's allocation methodology to adopt a process recommended by the Bank's
primary regulator, the Office of the Comptroller of the Currency. Data is
not readily available to restate 1993 and 1992.
</FN>
</TABLE>
47
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
NON-PERFORMING ASSETS
Loans, other than consumer loans not secured by residential real estate,
are generally classified as non-accrual or charged to the allowance for loan
losses at the time they reach 90 days past due as to principal or interest, or
earlier if when, in management's opinion, the collectibility of principal or
interest is doubtful. An exception to placing such loans on non-accrual status
or from charging-off such loans may be made if management determines that the
principal and interest of such a loan is well secured and in the process of
collection. Other real estate owned includes assets acquired through
foreclosure.
[GRAPHIC OMITTED - BAR CHART OF NON-PERFORMING ASSETS FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $10,853
1993 $10,272
1994 $3,315
1995 $1,654
1996 $1,668
Total non-performing assets at December 31, 1996 were $1.7 million or .39
percent of loans plus other real estate owned, compared to $1.7 million or .42
percent of loans plus other real estate owned at December 31, 1995. Non-accrual
loans at December 31, 1996 increased by $232 thousand from December 31, 1995 and
totalled $973 thousand at December 31, 1996. Other real estate owned decreased
from $913 thousand, net of the valuation allowance, at December 31, 1995, to
$695 thousand, net of the valuation allowance, at December 31, 1996. At December
31, 1996, the Company also had $624 thousand in loans that were more than 90
days past due as to interest and principal but were still classified as
accruing.
Potential problem loans are loans which are included as performing loans,
but for which possible credit problems cause management to have serious doubts
as to the ability of such borrower to comply with present loan repayment terms
and which may eventually result in classification as non-performing assets. At
December 31, 1996 there were no loans which were considered as potential problem
loans which were not included as non-performing assets as presented in Table 15
or included with the amount of impaired loans discussed below.
Loans for which the accrual of interest has been ceased amounted to $973
thousand at December 31, 1996 and $741 thousand at December 31, 1995,
respectively. Interest income of $66 thousand, $65 thousand, and $133 thousand
for 1996, 1995 and 1994, respectively, would have been recognized on these loans
had they been in accordance with their original terms. Interest income of $45
thousand, $45 thousand, and $21 thousand was recognized on these loans during
1996, 1995 and 1994, respectively.
The Company adopted the provisions of Statement of Financial Accounting
Standard No. 114, "Accounting by Creditors for Impairment of a Loan" (SFAS 114),
as amended by Statement of Financial Accounting Standards No. 118, "Accounting
by Creditors for Impairment of a Loan-Income Recognition and Disclosure" on
January 1, 1995. The Company has determined that loans with a carrying value of
$973 thousand and $1.2 million were deemed to be impaired under SFAS 114 at
December 31, 1996 and 1995, respectively. At December 31, 1996 the loans
classified as impaired were all on non-accrual status and included in Table 15.
The $1.2 million considered to be impaired at December 31, 1995 is comprised of
loans with a balance of $741 thousand which are classified as non-accruing loans
and $459 thousand of loans which have not been classified as non-performing, and
accordingly, were not included in Table 15.
At December 31, 1996, of the $973 thousand in loans classified as impaired,
approximately $528 thousand are loans for which there is no specifically
allocated allowance for credit losses and approximately $445 thousand are loans
which have an aggregate allowance for credit losses of $100 thousand. The $100
thousand specific reserve is included in the $7.7 million allowance for loan
losses. The average balance of loans classified as impaired amounted to $895
thousand for 1996. Interest income of approximately $45 thousand was recognized
during 1996 on loans classified as impaired loans. For 1995, of the $1.2 million
in loans classified as impaired, approximately $1.1 million are loans for which
there is no specifically allocated allowance for credit losses and approximately
$100 thousand are loans which have an aggregate allowance for credit losses of
$100 thousand. The $100 thousand specific reserve is included in the $8.0
million allowance for loan losses. The average balance of loans classified as
impaired amounted to $1.6 million for 1995. Interest income of approximately $45
thousand was recognized during 1995 on loans classified as impaired loans.
CAPITAL RESOURCES
The Company's stockholders' equity at December 31, 1996 was $62.2 million,
a 5.7 percent increase over the $58.9 million at December 31, 1995. The increase
in stockholders' equity resulted primarily from net income of $8.7 million which
was offset by cash dividend payments to stockholders of $3.4 million and the
acquisition of treasury stock which amounted to $2.1 million. In addition, the
change in net unrealized gains on investment securities available for sale was
$172 thousand, net of taxes, for the year ended December 31, 1996.
On June 12, 1996 the Company announced its intentions to repurchase up to 5
percent or 203,584 shares of its outstanding common stock. These shares, when
repurchased, will be available for reissuance through the Company's Dividend
Reinvestment or Stock Option Plans or for other general corporate purposes.
During 1996, the Company repurchased a total of 93,700 shares at an average
price of $22.66 per share.
The Board of Directors of the Company effected a 4 for 3 stock split during
January 1996 and a 5 for 4 stock split during 1994. All
48
<PAGE>
TABLE 15
NON-PERFORMING ASSETS
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
NON-PERFORMING LOANS:
Loans not accruing interest $ 973 $ 741 $ 1,346 $ 6,347 $ 3,285
Troubled debt restructuring 0 0 0 0 2,389
-------- -------- -------- -------- --------
Total non-performing loans 973 741 1,346 6,347 5,674
OTHER REAL ESTATE OWNED:
Other real estate owned 695 913 1,969 4,621 5,253
Less: Valuation allowance 0 0 0 (696) (74)
-------- -------- -------- -------- --------
Other real estate owned, net 695 913 1,969 3,925 5,179
-------- -------- -------- -------- --------
Total non-performing assets $ 1,668 $ 1,654 $ 3,315 $ 10,272 $ 10,853
======== ======== ======== ======== ========
Past due 90 days or more as to
interest or principal and still accruing $ 624 $ 793 $ 647 $ 46 $ 481
Non-performing loans as a percent of
total loans outstanding .23% .19% .35% 1.76% 1.51%
Non-performing assets as a percent of
total loans outstanding plus other real
estate owned .39% .42% .86% 2.82% 2.85%
Non-performing assets as a percent of
total assets .27% .29% 60% 1.92% 2.01%
</TABLE>
TABLE 16
RISK-BASED CAPITAL RATIOS
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
1996 1995
<S> <C> <C>
Tier 1 Capital:
Stockholders' equity, excluding net unrealized gain on investment
securities available for sale, net of taxes, and intangible assets $ 61,414 $ 58,188
Tier 2 Capital:
Allowance for loan losses allowable in Tier 2 capital 5,850 5,352
-------- --------
Total Capital $ 67,264 $ 63,540
======== ========
Total risk-weighted assets $466,140 $425,511
======== ========
Tier 1 risk-based capital ratio 13.12% 13.59%
Total risk-based capital ratio 14.43% 14.93%
Leverage ratio 10.28% 10.29%
</TABLE>
49
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
prior period per share data has been restated to give effect for these stock
splits. The weighted average number of shares outstanding was 4,053,940 for
1996, 4,066,936 for 1995, and 4,061,617 for 1994.
The Company's capital adequacy and dividend policy are closely monitored by
management and are reviewed regularly by the Board of Directors of the Company.
The Company intends to provide an adequate return to its stockholders while
retaining a sufficient capital base to provide for future growth and to comply
with regulatory standards.
[GRAPHIC OMITTED - BAR CHART OF STOCKHOLDERS' EQUITY FOR 1992-1996]
The data points are as follows ($ in thousands):
1992 $46,556
1993 $49,826
1994 $52,102
1995 $58,879
1996 $62,239
Banking regulators' risk-based capital guidelines address the capital
adequacy of banking organizations. These guidelines include a definition of
capital and a framework for calculating risk-weighted assets by assigning assets
and off-balance sheet items to broad risk categories, as well as minimum ratios
to be maintained by banking organizations. The risk-based capital ratios are
calculated by dividing qualifying capital by risk-weighted assets.
Under the risk-based capital guidelines, Total Capital is defined as the
sum of core or "Tier 1" Capital and "Tier 2" Capital. As the guidelines apply to
the Company, Tier 1 Capital is total stockholders' equity excluding the effects
of net unrealized gain (loss) on investment securities available for sale, net
of taxes, and intangible assets and Tier 2 Capital includes a portion of the
allowance for loan losses. The rules require that banking organizations must
have ratios of 4.00 percent and 8.00 percent for Tier 1 and Total Capital,
respectively. At December 31, 1996 the Company's Tier 1 and Total Capital ratios
were 13.12 percent and 14.43 percent, respectively. Tier 1 and Total Capital
ratios were 13.59 percent and 14.93 percent respectively, in 1995. Total
risk-weighted assets increased by 9.5 percent. In addition to the risk-based
capital ratio, a bank is also required to maintain a "Leverage ratio" of Tier 1
capital to average total assets of 3 percent or higher. At December 31, 1996 and
1995, the Company's Leverage ratio was 10.28 percent and 10.29 percent,
respectively.
The banking regulators have also established regulations which classify a
bank's capital position as 1) well capitalized; 2) adequately capitalized; 3)
undercapitalized; 4) significantly undercapitalized; and 5) critically
undercapitalized. The degree of oversight and restriction by a bank's regulators
is tied to its capital position. An institution which is classified as
undercapitalized, significantly undercapitalized or critically undercapitalized
is subject to additional operating restrictions and increased regulatory
oversight. A bank is considered to be "well capitalized" if it has a ratio of
Total Capital to risk-weighted assets of 10.00 percent or higher; a ratio of
Tier 1 Capital to risk-weighted assets of 6.00 percent or higher; a Leverage
ratio (Tier 1 Capital to average total assets) of 5.00 percent or higher; and is
not under a regulatory capital order or directive. At December 31, 1996 the Bank
was considered to be "well capitalized".
The Company's risk-based capital and weighted risk assets at December 31,
1996 and 1995 are shown in Table 16.
EFFECTS OF INFLATION
The majority of assets and liabilities of a financial institution, such as
the Company, are monetary in nature and, therefore, differ from those of
commercial and industrial companies. Fluctuations in interest rates and the
efforts of the Federal Reserve Board to regulate money and credit conditions
have a greater effect on the Company's profitability than do the effects of
higher costs for goods and services. Through its asset-liability management
process, the Company seeks to manage the effect of changing interest rates and
inflationary trends.
SUPERVISION AND REGULATION
During the latter part of 1996, Congress agreed on a legislative package to
stabilize the Savings and Loan (S&L) industry's deposit insurance fund (SAIF).
The legislation required the S&L industry to recapitalize its deposit fund with
a one-time assessment. Previous proposals required the bank insurance fund (BIF)
to contribute a substantial amount to help recapitalize SAIF. Under the current
legislation, banks are required to pay an annual rate of 1.29 cents for every
$100 of domestic deposits from 1997 through 1999 and pay 2.43 cents per $100 of
domestic deposits for the years 2000 through 2017. The amount of FDIC insurance
to be paid under this new legislation will not materially impact the financial
statements or the results of operations for the Company in future periods.
The Bank is a national bank, chartered under the National Bank Act, and is
subject to the primary supervision of, and is examined by, the Comptroller of
the Currency. As a member of the Federal Reserve system, the Bank is subject to
provisions of the Federal Reserve Act, which restricts the ability of a bank to
extend credit to its parent holding company or to certain of the parent's
subsidiaries, or to invest in the Company's common stock or to take such stock
as collateral for loans to any borrower. The operations of the Bank are also
subject to regulation by the FDIC.
NEW ACCOUNTING STANDARDS
On January 1, 1996 the Company adopted the provisions of Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121), which
requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows esti-
50
<PAGE>
mated to be generated by those assets are less than the assets' carrying amount.
The implementation of SFAS 121 did not materially impact the Company's financial
condition or results of operation.
On January 1, 1996, the Company adopted the provisions of the Statement of
Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65" (SFAS 122). FASB Statement No.
65, "Accounting for Certain Mortgage Banking Activities", required separate
capitalization of purchased origination activities. SFAS 122 requires that
purchased and originated mortgage servicing rights be accounted for in the same
manner. Presently, the Company does not sell or securitize mortgage loans with
servicing rights retained. Accordingly, the Company has not been impacted by the
provisions of SFAS 122.
On January 1, 1996 the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), which establishes financial accounting and reporting
standards for stock-based employee compensation plans. As permitted under SFAS
123, the Company has elected not to adopt the fair value based method of
accounting for its stock-based compensation plans, but will continue to account
for such compensation under the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and, accordingly, the
impact of SFAS 123 on the Company's financial statements is not material. The
Company has complied with the disclosure requirements of SFAS 123 in note 14.
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125, "Accounting for and Servicing of
Financial Assets and Extinguishment of Liabilities" (SFAS 125). SFAS 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. Those standards are based
on consistent application of a financial-components approach that focuses on
control. Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. SFAS 125 provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. SFAS 125 is effective for transfers and
servicing of financial assets and extinguishment of liabilities occurring after
December 31, 1996, except for the provisions for secured borrowings and
collateral and for repurchase agreement, dollar-roll, securities lending, and
similar transactions which have been delayed for one year under Statement of
Financial Accounting Standards No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB Statement No. 125." The adoption of SFAS 125 will not
have a material effect on the financial condition or the results of operations
of the Company.
51
<PAGE>
STOCKHOLDERS INFORMATION
PRICE RANGE OF KEYSTONE HERITAGE GROUP, INC. COMMON STOCK
The following summary sets forth the range of high and low sales prices for the
common stock of Keystone Heritage Group, Inc. as well as cash dividends per
share, for the periods indicated. Per share data is restated to give effect for
the 4-for-3 stock split effective January 1996.
Cash
Year Quarter High Low Dividends
1996 Fourth $23.63 $21.88 $.22
Third 23.00 21.75 .22
Second 23.88 20.13 .20
First 26.13 22.50 .20
1995 Fourth $23.91 $22.50 $.18
Third 22.69 19.04 .18
Second 19.79 17.21 .18
First 20.25 17.63 .165
DIVIDEND RESTRICTIONS
Certain information concerning restrictions of the payment of dividends by
the Company is set forth in Footnote 17 of the Notes to Consolidated Financial
Statements appearing elsewhere in this Annual Report.
TRANSFER AGENT
Registrar and Transfer Company
10 Commerce Street
Cranford, NJ 07016
Telephone (800) 368-5948
COMMON STOCK
Keystone Heritage Group, Inc.'s common stock is traded nationally on the
American Stock Exchange under the ticker symbol "KHG". At February 10, 1997, the
Company had approximately 1,350 stockholders.
DIVIDEND REINVESTMENT AND STOCK PURCHASE
Stockholders of Keystone Heritage Group, Inc. may acquire additional shares
of common stock by reinvesting their cash dividends under the Dividend
Reinvestment Plan. Voluntary cash payments may also be made under this Plan. The
minimum voluntary cash payment must be at least $10 but not more than $2,000
during each quarter. Voluntary cash contributions must be received by Registrar
and Transfer Company within 30 days prior to the cash dividend payable date. The
quarterly cash dividend payable dates are usually on the 10th of February, May,
August and November, or the first business day before the 10th, should the 10th
fall on a weekend or federal holiday. If you have questions about the Plan,
contact Stockholder Relations, Lebanon Valley National Bank, 555 Willow Street,
P.O. Box 1285, Lebanon, Pennsylvania 17042 (Telephone 717-274-6844).
DIRECT DEPOSIT
Cash dividends on Keystone Heritage Group, Inc. common stock may be
deposited directly into any deposit account at Lebanon Valley National Bank. The
deposit is made on the dividend payment date and a confirmation of payment is
sent to you when the dividend is deposited into your account. For additional
information about Direct Deposit of cash dividends, contact Stockholder
Relations, Lebanon Valley National Bank, 555 Willow Street, P. O. Box 1285,
Lebanon, Pennsylvania 17042 (Telephone 717-274-6844).
FORM 10-K
A copy of Keystone Heritage Group, Inc.'s Annual Report on Form 10-K, as
filed with the Securities and Exchange Commission, will be provided to
stockholders without charge upon written request to:
Secretary
Keystone Heritage Group, Inc.
555 Willow Street
P. O. Box 1285
Lebanon, Pennsylvania 17042
ANNUAL MEETING
The Annual Meeting of the Stockholders of Keystone Heritage Group, Inc.
will be held at 10:00 A.M. on Tuesday, April 15, 1997 at the Quality Inn Lebanon
Valley, 625 Quentin Road, Lebanon, Pennsylvania.
52
<PAGE>
KEYSTONE HERITAGE GROUP, INC.
OFFICERS
ALBERT B. MURRY
President and Chief Executive Officer
DONALD W. LESHER, JR.
Vice President
LANCE M. FREHAFER
Secretary
KURT A. PHILLIPS
Treasurer
BOARD OF DIRECTORS
RAYMOND M. DORSCH, JR.
Vice President for Medical Affairs
Good Samaritan Hospital
LANCE M. FREHAFER
Secretary
Lebanon Valley National Bank
HARRY J. GENSEMER
President
J. Wilson Barto Sons, Inc.
CHARLES V. HENRY III
Senior Partner
Henry & Beaver
WENDI DIMATTEO HOLSINGER
Chief Executive Officer
ASK Foods, Inc.
BRUCE A. JOHNSON
Owner
Gallery 444, Ltd.
DONALD W. LESHER, JR.
Chairman of the Board
Lebanon Valley National Bank
President
Lesher Mack Sales and Service, Inc.
ALBERT B. MURRY
President and Chief Executive Officer
Lebanon Valley National Bank
THOMAS I. SIEGEL
President
Stanilla and Siegel, CPA's
BRETT H. TENNIS
Partner
Walz, Deihm, Geisenberger, Bucklen & Tennis, CPA's
MARK RANDOLPH TICE
President
APR Supply Co.
JOHN E. WENGERT
President
Wengert's Dairy, Inc.
E.D. WILLIAMS, JR.
Wengert's Dairy, Inc.
E.D. WILLIAMS, JR.
Private Investor
Honorary Directors
Harry Z. Gensemer, Jr.
Norman J. Rothermel
Elvin H. Spitler
Harlan R. Wengert
LEBANON VALLEY NATIONAL BANK
SENIOR OFFICERS
DONALD W. LESHER, JR.
Chairman of the Board
ALBERT B. MURRY
President and Chief Executive Officer
KURT A. PHILLIPS
Executive Vice President and Chief Financial Officer
CALVIN L. CASSEL, JR.
Senior Vice President Operations Group
LARRY H. EBERLY
Senior Vice President Trust Services
MICHAEL H. FIRESTINE
Senior Vice President Agriculture Banking
JAMES I. FREIDLY, III
Senior Vice President Credit Administration
BRADFORD J. NORRIS
Senior Vice President and President of Central Mortgage
TIMOTHY L. SANDOE
Senior Vice President Community Banking
ELLEN M. WHITMOYER
Senior Vice President Marketing
DONALD D. CANULL
Vice President and Comptroller
BARRY L. GINDER
Vice President and Chief Auditor
DARLENE F. WOODY
Director, Human Resources
Independent Auditors' Consent
The Board of Directors
Keystone Heritage Group, Inc.
We consent to incorporation by reference in the registration statement (No.
2-99022) on Form S-3 and the registration statements (Nos. 333-22397 and
33-88234) on Form S-8 of Keystone Heritage Group, Inc. of our report dated
January 24, 1997, relating to the consolidated balance sheets of Keystone
Heritage Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the years in the three year period ended December 31, 1996, which
report appears in the December 31, 1996 annual report on Form 10-K of Keystone
Heritage Group, Inc.
/s/ KPMG Peat Marwick LLP
March 28, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000715366
<NAME> KEYSTONE HERITAGE GROUP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 22,832
<INT-BEARING-DEPOSITS> 181
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 62,596
<INVESTMENTS-CARRYING> 91,652
<INVESTMENTS-MARKET> 92,081
<LOANS> 422,534
<ALLOWANCE> 7,736
<TOTAL-ASSETS> 616,307
<DEPOSITS> 526,833
<SHORT-TERM> 12,478
<LIABILITIES-OTHER> 8,319
<LONG-TERM> 6,438
20,358
0
<COMMON> 0
<OTHER-SE> 41,881
<TOTAL-LIABILITIES-AND-EQUITY> 616,307
<INTEREST-LOAN> 36,725
<INTEREST-INVEST> 7,940
<INTEREST-OTHER> 309
<INTEREST-TOTAL> 44,974
<INTEREST-DEPOSIT> 18,490
<INTEREST-EXPENSE> 19,494
<INTEREST-INCOME-NET> 25,480
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 79
<EXPENSE-OTHER> 18,812
<INCOME-PRETAX> 12,599
<INCOME-PRE-EXTRAORDINARY> 12,599
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,720
<EPS-PRIMARY> 2.15
<EPS-DILUTED> 2.15
<YIELD-ACTUAL> 4.73
<LOANS-NON> 973
<LOANS-PAST> 624
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 8,025
<CHARGE-OFFS> 895
<RECOVERIES> 606
<ALLOWANCE-CLOSE> 7,736
<ALLOWANCE-DOMESTIC> 7,736
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 5,790
</TABLE>
