SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE EXCHANGE ACT
For the transition period from ____________ to ______________-
Commission file Number: 2-85306
Lake Ariel Bancorp, Inc.
(Exact name of small business issuer as specified in its charter)
Pennsylvania
(State or other jurisdiction of incorporation or organization)
23-2244948
(I.R.S. Employer Identification No.)
Post Office Box 67
Lake Ariel, Pennsylvania 18436
(Address of principal executive offices)
(Zip Code)
(717) 698-5695
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2)has been subject to such filing requirements for the past 90
days. Yes X No ____
State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date: 4,562,148 shares of
common stock, par value $.21 per share, as of March 31, 1998.
1
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LAKE ARIEL BANCORP, INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 1998
INDEX
Part I - Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997................................................... 3
Consolidated Statement of Income for the three
months ended March 31, 1998 and 1997.............................. 4
Consolidated Statement of Comprehensive Income for the three
months ended March 31, 1998 and 1997............................... 5
Consolidated Statement of Cash Flows for the three
months ended March 31, 1998 and 1997.............................. 6
Notes to Consolidated Financial Statements............................... 8
Item 2. Management's Discussion and Analysis or
Plan of Operations......................................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk........... 21
Part II - Other Information
Item 1. Legal Proceedings................................................ N/A
Item 2. Changes in Securities............................................ N/A
Item 3. Defaults Upon Senior Securities.................................. N/A
Item 4. Submission of Matters to a Vote of Security
Holders.................................................................. N/A
Item 5. Other Information................................................. 26
Item 6. Exhibits and Reports on Form 8-K.................................. 32
Signatures................................................................ 33
2
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LAKE ARIEL BANCORP, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
MARCH 31, DECEMBER 31,
1998 1997
(in thousands) (in thousands)
ASSETS
Cash and cash equivalents...........................$ 18,417 $ 17,109
Available-for-sale securities....................... 85,765 56,545
Held-to-maturity securities (fair value of $81,720
and $59,008, respectively).......................... 81,074 58,245
Loans and leases.................................... 214,132 216,465
Mortgage loans held for resale..................... 4,356 621
Less unearned income and loan fees........... (6,522) (6,741)
Less allowance for possible credit losses...... (2,236) (2,109)
Net loans and leases............... 209,730 208,236
Premises and equipment, net........................ 13,769 13,744
Accrued interest receivable.......................... 3,488 3,005
Foreclosed assets held for sale...................... 478 523
Life insurance cash surrender value................ 8,288 7,891
Other assets........................................ 4,967 2,775
----------- -----------
TOTAL ASSETS..................... $ 425,976 $ 368,073
========= =========
LIABILITIES
Deposits:
Noninterest-bearing............................ $ 40,370 $ 39,689
Interest-bearing:
Demand........................... 30,368 31,767
Savings.......................... 35,966 36,437
Time............................. 127,714 128,538
Time $100,000 and over........... 44,399 44,019
------------ -------------
Total Deposits.................... 278,817 280,450
Accrued interest payable............................ 3,095 2,975
Federal funds purchased............................. 9,300 --
Securities sold under agreements to repurchase... 100 200
Long-term debt...................................... 96,974 47,656
Other liabilities................................... 1,291 977
------------- -------------
Total Liabilities.................. 389,577 332,258
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock: Authorized 1,000,000 shares of
$1.25 par value each; no outstanding shares..... -- --
Common stock: Authorized, 10,000,000 shares of
$.21 par value each; issued and outstanding
4,562,148 shares in 1998 and 4,548,383 in 1997 958 956
Capital surplus.................................. 25,876 25,717
Retained earnings ............................... 9,794 9,135
Net unrealized gains (losses) on
available-for-sale securities................... (229) 7
---------------- ---------------
Total Stockholders' Equity...... 36,399 35,815
-------------- -------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY...... $ 425,976 $ 368,073
============= ============
The accompanying notes are an integral part of the consolidated financial
statements.
3
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LAKE ARIEL BANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1998 1997
(in thousands, except per share data)
INTEREST INCOME:
Loans and leases.......................... $ 4,529 $ 3,938
Investment securities:
Taxable................................. 2,032 1,428
Exempt from federal income taxes........ 415 377
Dividends.............................. 53 28
---------- ----------
Total investment securities income..... 2,500 1,833
--------- ---------
Deposits in bank............................ 4 4
Federal funds sold.......................... 35 45
---------- ----------
TOTAL INTEREST INCOME........... 7,068 5,820
-------- ---------
INTEREST EXPENSE:
Deposits...................................... 2,726 2,386
Long-term debt............................... 1,260 699
Federal funds purchased...................... 19 1
Short-term borrowings........................ 10 6
Securities sold under agreements to repurchase 1 4
--------- ------------
TOTAL INTEREST EXPENSE.............. 4,016 3,096
------- ----------
NET INTEREST INCOME.................. 3,052 2,724
PROVISION FOR POSSIBLE CREDIT LOSSES 200 125
------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR POSSIBLE CREDIT LOSSES.... 2,852 2,599
------- ----------
OTHER OPERATING INCOME:
Loan origination fees........................ -- 34
Customer service charges and fees........... 334 301
Mortgage servicing fees...................... 77 81
Investment security gains (losses), net 55 (8)
Gain (loss) on sale of loans, net............ 79 16
Gain (loss) on sale of assets................ 311 5
Other income................................... 312 226
-------- -----------
TOTAL OTHER OPERATING INCOME 1,168 655
------- -----------
OTHER OPERATING EXPENSES:
Salaries and benefits....................... 1,184 1,076
Occupancy expense........................... 369 354
Equipment expense........................... 288 220
Advertising................................. 76 35
Other expenses.............................. 699 584
--------- -----------
TOTAL OTHER OPERATING EXPENSES 2,616 2,269
-------- -----------
INCOME BEFORE PROVISION FOR INCOME TAXES 1,404 985
PROVISION FOR INCOME TAXES.... 325 255
--------- -----------
NET INCOME................................. $ 1,079 $ 730
========= ==========
Earnings per share-basic*: $ 0.24 $ 0.20
========= ==========
Earnings per share-diluted*: $ 0.23 $ 0.19
========= ==========
Dividends per share*: $ 0.09 $ 0.08
========= ==========
Fully diluted weighted average number
of shares outstanding*: 4,688 3,772
*Reflects adjustment for 5% stock dividend issued on October 1, 1997 and a
two-for-one stock split effective November 10, 1997. The accompanying notes are
an integral part of the consolidated financial statements.
4
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LAKE ARIEL BANCORP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1998 1997
(in thousands)
NET INCOME................................. $1,079 $ 730
Other comprehensive income (loss):
Unrealized holding gains on
available-for-sale securities
Losses arising during the period........ (303) (378)
Reclassification adjustment............. (55) 8
---------- --------
Other comprehensive income (loss)
before income taxes......................... (358) (370)
Income taxes related to other comprehensive income 122 126
--------- -------
Other comprehensive (loss),
net of income taxes........................ (236) (244)
--------- --------
COMPREHENSIVE INCOME........................ $ 843 $ 486
The accompanying notes are an integal part of the consolidated financial
statements.
5
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LAKE ARIEL BANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1998 1997
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................... $ 1,079 $ 730
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for possible credit losses...... 200 125
Depreciation, amortization and accretion.... 328 211
Deferred income taxes....................... (87) --
Investment security gains, net.............. (55) 8
(Gain) on sale of loans....................... (80) --
Loss on sale of foreclosed assets............ 26 --
(Gain) on sale of credit card portfolio..... (337) --
(Gain) on sale of equipment.................. -- (5)
(Increase) decrease in mortgage loans
held for resale............................ (3,735) (411)
(Increase) in accrued interest receivable.... (483) (515)
Increase (decrease) in accrued interest payable. 120 (68)
(Increase) decrease in other assets........... (1,732) 560
Increase (decrease) in other liabilities...... 314 333
-------- ----------
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES........................... (4,442) 968
CASH FLOWS FROM INVESTING ACTIVITIES
Held-to-maturity securities:
Proceeds from maturities and paydowns........ 4,401 1,186
Purchases .................................... (27,247) (32,527)
Available-for-sale securities:
Proceeds from maturities and paydowns........ 1,961 942
Proceeds from sales .......................... 10,815 --
Purchases ................................... (41,596) (2,000)
Increase of life insurance policies cash
surrender value (397) --
Increase in loans and leases.................. (1,317) (5,599)
Purchases of premises and equipment........... (1,318) (266)
Proceeds from sale of loans................... 3,383 --
Proceeds from sale of credit card portfolio... 355 5
Proceeds from sale of foreclosed assets....... 74 43
----------- ----------
NET CASH USED IN INVESTING ACTIVITIES... (50,886) (38,216)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits......... (1,633) 343
Increase in short-term borrowings........... 9,300 --
Decrease in securities sold under
agreements to repurchase................. (100) --
Proceeds from long-term debt................. 50,000 30,000
Principal payments on long-term debt......... (682) (356)
Proceeds from issuance of common stock....... 161 155
Cash dividends............................... (410) (300)
---------- ---------
NET CASH PROVIDED BY
FINANCING ACTIVITIES........................ 56,636 29,842
--------- --------
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INCREASE IN CASH AND CASH EQUIVALENTS....... 1,308 (7,406)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR.......................... 17,109 15,971
--------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR... $ 18,417 $ 8,565
======== ===========
CASH PAID DURING THE YEAR FOR:
Interest.................................... $ 4,016 $ 3,164
========= ===========
Income taxes................................. $ -- $ --
============ =========
The accompanying notes are an integral part of the consolidated financial
statements.
7
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LAKE ARIEL BANCORP, INC.
FORM 10-Q
Part I - Financial Information (Cont'd)
Item 1. Financial Statements (Cont'd)
Notes to Consolidated Financial Statements
The financial information as of December 31, 1997 is audited and for the interim
periods ended March 31, 1998 and 1997 included herein is unaudited; however,
such information reflects all adjustments consisting of only normal recurring
adjustments, which are, in the opinion of management, necessary to a fair
presentation of the results for the interim periods.
1. REPORTING AND ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accounting and financial reporting policies of Lake Ariel
Bancorp, Inc. and its subsidiary conform to generally accepted accounting
principles and to general practice within the banking industry. The consolidated
statements include the accounts of Lake Ariel Bancorp, Inc. and its wholly owned
subsidiary, LA Bank, N.A. (Bank) including its subsidiaries, LA Lease, Inc. and
Ariel Financial Services, Inc. (collectively, Company). All material
intercompany accounts and transactions have been eliminated in consolidation.
The accompanying interim financial statements are unaudited. In management's
opinion, the consolidated financial statements reflect a fair presentation of
the consolidated financial position of Lake Ariel Bancorp, Inc. and subsidiary,
and the results of its operations and its cash flows for the interim periods
presented, in conformity with generally accepted accounting principles.
2. CASH FLOWS
The Company considers amounts due from banks and federal funds
sold as cash equivalents. Generally, federal funds are sold for one-day periods.
From time to time, the Company swaps its residential mortgage
loans for participation certificates of a similar amount issued by the Federal
Home Loan Mortgage Corporation. These certificates do not involve the transfer
of cash for cash flow purposes. No mortgage loans were swapped for participation
certificates during the first three months of 1998 or 1997.
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<PAGE>
3. INVESTMENT SECURITIES
SFAS No. 115 requires the classification of securities as
held-to-maturity, available- for-sale or trading. Securities, other than
securities classified as available-for-sale, are carried at amortized cost if
management has the ability and intent to hold these securities to maturity.
Securities expected to be held for an indefinite period of time and not held
until maturity are classified as available-for-sale and are carried at estimated
fair value. Decisions to sell these securities are determined by the Company's
financial position, including but not limited to, liquidity, interest rate risk,
asset liability management strategies, regulatory requirements, tax
considerations or capital adequacy. Gains or losses on investment securities are
computed using the specific identification method.
The Company has no derivative financial instruments requiring disclosure
under SFAS No. 119.
4. RECLASSIFICATIONS
Certain prior years' amounts have been reclassified to conform to the 1998
reporting format.
5. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
There were no short-term borrowings at March 31, 1998.
Long-term debt at March 31, 1998 consisted of the following:
Unsecured note, payable in the amount
of $850.32 monthly, fixed interest rate
of 2.9%, maturing November, 2000...................$ 26
Unsecured notes, payable in the amount
of $31,200 semiannually, maturing
April 22, 1998..................................... 31
Borrowings with The Federal Home Loan Bank........... 96,917
Total..............................................$96,974
Annual maturities of the long-term debt are as follows:
$12,145 in 1998; $2,982 in 1999; $8,178 in 2000; $8,282 in 2001; $10,387 in
2002; $50,000 in 2003; $5,000 in
2005.
The borrowings with the Federal Home Loan Bank of Pittsburgh
(FHLB) require the Company to maintain collateral with a fair value in an amount
which approximates the total outstanding debt. In addition, the Company must
maintain its membership with the FHLB.
9
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LAKE ARIEL BANCORP, INC.
FORM 10-Q
Part I - Financial Information (Cont'd)
Item 2. Management's Discussion and Analysis or Plan of
Operations:
The consolidated financial review of Lake Ariel Bancorp, Inc. ("the Company")
provides a comparison of the performance of the Company for the periods ended
March 31, 1998 and 1997. The financial information presented should be reviewed
in conjunction with the consolidated financial statements and accompanying notes
appearing elsewhere in this annual report.
Background
The Company is a one bank holding company whose principal subsidiary is LA Bank,
N.A. The Company operates 17 full-service branch banking offices in its
principal market area in Lackawanna, Monroe, Pike and Wayne Counties. At March
31, 1998, the Company had 145 full-time equivalent employees.
NET INTEREST INCOME
Net income for the first three months of 1998 increased to
$1.1 million, an increase of $370,000 or 50.7% over 1997. Net income for the
first three months of 1997 was $730,000, an increase of $27,000 or 3.8% over
1996. On a per share basis, net income was $0.24 basic and $0.23 diluted in 1998
and $0.20 basic and $0.19 diluted in 1997. Weighted average shares outstanding -
diluted at March 31 1998 and 1997 were 4,687,000, and 3,772,000, respectively.
Earnings per share and weighted average shares outstanding reflect adjustment
for the 5% stock dividends paid on October 1, 1997 and 1996, and the two-for-one
stock split effective November 10, 1997.
The growth in net income during 1998 was attributable to the
improvement in net interest income, which increased to $3.1 million, an increase
of $400,000 or 14.8% over 1997, and which was coupled with an increase in other
operating income to $1.2 million, an increase of $600,000 or 200% over 1997. The
increase reflects a gain of $348,000 recognized on the sale of our credit card
portfolio. This increase more than offset the increase in other operating
expenses to $2.6 million, an increase of $400,000 or 18.2% over 1997. The
Company continued to focus its efforts toward retail banking services within its
market area with specific attention given to increasing market share.
10
<PAGE>
The growth in net income in 1997 was also attributable to the
improvement in net interest income, which increased to $2.7 million, an increase
of $300,000 or 12.5% over 1996 and which was also coupled with an increase in
other operating income to $600,000, an increase of $10,000 or 1.7% over 1996.
This increase more than offset the increase in other operating expenses to $2.2
million, an increase of $200,000 or 10.0% over 1996.
Analysis of Net Interest Income
For the first three months of 1998, net interest income
(tax-equivalent basis) increased to $3.2 million, an increase of $300,000 or
10.3% over 1997 levels. Average loans and leases increased to $212.4 million, an
increase of $30.2 million or 16.0% over 1997. Average commercial loans grew to
$71.5 million, an increase of $15.3 million or 27.2% over 1997 levels. Interest
income on commercial loans increased to $1.6 million, an increase of $300,000 or
23.0% over 1997. This was due to increased volume through most of 1998. The
national prime rate as reported in a national publication published daily, an
index to which the majority of these loans were tied, was 8.50% at March 31,
1998 and 1997, respectively. Average real estate loans increased 17.4%, which
contributed to an 11.1% increase in interest income on real estate loans.
Average consumer loans, which included credit card receivables (in 1997) and
leases, decreased $400,000 or 10.8% over 1997, and resulted in a 1.7% decrease
in related interest income.
Net interest income (tax-equivalent basis) for the first three
months of 1997 increased to $2.9 million, an increase of $400,000 or 16.0% over
1996. This increase was due to the continued strong growth of earning assets,
which grew 26.1% over 1996 levels.
On average, investment securities in 1998 increased to $154.0
million, an increase of $41.2 million or 36.5% over 1997 levels. Investment
securities in 1997 increased to $112.8 million, an increase of $35.3 million or
45.5% over 1996 levels. Income earned on investment securities increased to $2.7
million, an increase of $700,000 or 35.0% over 1997. Income earned in 1997
increased to $2.0 million, an increase of $700,000 or 53.8% over 1996. As is
discussed under "Financial Condition," the asset/liability management and
investment strategies that were employed during 1998 and 1997 resulted in
increased holdings of investment securities and created an increase in
investment income. The mix of securities in the investment portfolio changed
slightly during 1998. Taxable securities, which represented 74.9% of the
investment portfolio in 1997, increased to 79.4% or $122.2 million in 1998. At
March 31, 1998, tax-exempt securities represented 20.6% of the portfolio
compared to 25.1% in 1997. In 1998, tax-exempt securities, for part of the year,
provided better after-tax investment returns than taxable issues in similar
maturity and quality ranges. Accordingly, average balances on state and
municipal securities at March 31, 1998 increased to $31.8 million, an increase
of $3.5 million or 12.4% over 1997.
Average interest-bearing deposits at March 31, 1998 increased
to $239.7 million, an increase of $18.9 million or 8.6% over 1997. As interest
rates continued constant through most of 1997 and 1998, more depositors sought
higher rate, longer-term deposits.
11
<PAGE>
Average savings and interest-bearing demand deposits at March
31, 1998 increased to $67.6 million, an increase of $2.2 million or 3.4% over
1997. As a percentage of total average interest-bearing deposits, savings and
interest-bearing demand deposits represented 28.2% in 1998 and 29.6% in 1997.
Due to the shift in the mix of deposits, the rates at which they were repricing
and the volume increase, interest expense on deposits for the three months ended
March 31, 1998 increased to $2.7 million, an increase of $300,000 or 12.5% over
1997. These results were reflected in the cost of funds on deposits which
increased 5.3% from 1997 through 1998, while volume increased 8.6%. There were
no brokered deposits within the Company's deposit base during 1998 or 1997.
Short-term borrowings, including federal funds purchased, and
securities sold under agreements to repurchase, averaged $1.6 million in 1998
and $375,000 in 1997.
Interest expense as a percent of earning assets increased by
20 basis points from 4.21% in 1997 to 4.41% in 1998 due to the volume increase
in interest bearing liabilities, the mix in the makeup of the interest-bearing
deposits, and the increase in the related interest rates paid.
The overall effect of the decrease in yield on investments and
loans and leases, increase in interest rates paid, the shift in mix of and
growth in deposit accounts and long-term debt and the growth in earning assets
produced a negative impact on net interest margin. The net interest margin
decreased by 43 basis points to 3.54% in 1998 from 3.97% in 1997.
The following tables provide an analysis of changes in net
interest income with regard to volume, rate and yields of interest-bearing
assets and liabilities based on average balances for each period. Components of
interest income and expenses are presented on a tax-equivalent basis using the
statutory federal income tax rate of 34.0% each year.
12
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<TABLE>
<CAPTION>
For Three Months Ended March 31,
1998 1997
----------------------------------- -----------------
Average Interest Average Interest
Balance Income/ Yield/ Balance Income/ Yield/
(1) Expense Rate (1) Expense Rate
--------- ------- ------ ---------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Earning assets:
Federal funds sold ....................... $ 2,591 35 5.48% $2,987 $ 45 6.11%
Deposits in Federal Home Loan Bank ....... 455 4 3.57 318 4 5.10
Investment securities:
U.S. government agencies ............ 117,630 2,032 7.01 81,967 1,428 7.07
State and municipal(2) .............. 31,796 629 8.02 28,350 571 8.17
Other securities .................... 4,616 53 4.66 2,523 28 4.50
----- -------- -------- -----
Total investment securities ..... 154,042 2,714 7.15 112,840 2,027 7.29
Loans and leases:
Commercial, financial and industrial 71,454 1,575 8.94 56,235 1,284 9.26
Real estate-construction and mortgage 104,518 2,035 7.90 89,024 1,764 8.04
Installment loans to individuals(3) .. 33,238 779 9.51 34,768 838 9.77
Lease financing(3) .................. 3,238 99 12.40 2,165 55 10.30
----- -------- -------- -----
Total loans and leases .......... 212,448 4,488 8.57 182,192 3,941 8.77
Total earning assets ..................... 369,536 7,241 7.95 298,337 6,017 8.18
Cash and due from banks .................. 9,611 8,506
Premises and equipment ................... 13,621 10,021
Other, less allowance for credit losses
and loan fees ....................... 12,400 5,989
-------- -----
Total assets ............................. $405,168 $322,853
======== =====
Liabilities and stockholders' equity:
Interest-bearing deposits:
Demand .............................. $ 30,874 $ 155 2.04% $ 27,742 $ 133 1.94%
Savings ............................. 36,674 181 2.00 37,621 188 2.03
Time ................................ 127,069 1,754 5.60 114,785 1,487 5.25
Time over $100,000 .................. 45,131 636 5.72 40,679 578 5.76
----- -------- -------- -----
Total interest-bearing deposits . 239,748 2,726 4.61 220,827 2,386 4.38
Short-term borrowings .................... 1,429 16 4.54 75 1 5.41
Securities sold under agreements
to repurchase ....................... 137 2 5.92 300 4 5.41
Long-term debt ........................... 83,877 1,272 6.15 44,949 705 6.36
----- -------- -------- -----
Total interest-bearing liabilities ....... 325,191 4,016 5.01 266,151 3,096 4.72
-------- -----
Demand - noninterest - bearing ........... 39,812 32,007
Other liabilities ........................ 4,273 3,387
-------- -----
Total liabilities ........................ 369,276 301,545
Stockholders' equity ..................... 35,892 21,308
-------- -----
Total liabilities and stockholders' equity $405,168 $322,853
======== =====
Net interest income ...................... $ 3,225 $ 2,921
======== =====
Net interest spread ...................... 2.94% 3.46%
======== =====
Net interest margin(4) ................... 3.54% 3.97%
======== =====
<FN>
- ------------------------------
(1) Average balances have been computed using daily balances. Nonaccrual loans
are included in loan balances.
(2) Interest and yield are presented on a tax-equivalent basis using a 34.0%
statutory tax rate.
(3) Installment loans and leases are presented net of unearned interest.
(4) Represents the difference between interest earned and interest paid, divided
by average total earning assets.
</FN>
</TABLE>
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<PAGE>
1998 Compared to 1997(1)
Caused by Total
Volume Rate Variance
(In thousands)
Interest income:
Federal funds sold.............. $(6) $(4) $ (10)
Deposits in Federal Home Loan Bank 2 (2) 0
Investment securities.............. 708 (21) 687
Loans and leases.................. 632 (85) 547
------ ------ ------
Total interest income................. 1,336 (112) 1,224
----- ----- -----
Interest expense:
Demand and savings deposits...... 11 4 15
Time deposits..................... 228 97 325
Borrowed funds................... 605 (25) 580
------ ------ ------
Total interest expense................ 844 76 920
------ ------- ------
Net interest income....................$ 492 $(188) $ 304
====== ====== ======
- ------------------------------
(1) The portion of the total change attributable to both volume and rate changes
during the period has been allocated to the volume and rate components based
upon the absolute dollar amount of the change in each component prior to the
allocation.
Provision for Possible Credit Losses
The provision for possible credit losses for the three months
ended March 31, 1998 increased to $200,000, an increase of $75,000 or 60.0% over
1997. In 1998, the provision for possible credit losses was 270% of net
charge-offs, compared to 116% in 1997. The provision represented management's
assessment of the risks inherent in the loan and lease portfolio while providing
the amounts necessary to cover potential charge-offs.
Net charge-offs in 1998 decreased to $74,000, a decrease of
$34,000 or 31.5% over the same period in 1997. The net charge-offs in 1998 were
primarily attributed to the consumer installment loan portfolio.
Net charge-offs on commercial and industrial loans for 1998
were $0 compared to $10,000 or 9.3% of net charge-offs for 1997. Consumer and
credit card, lease financing, and real estate related debt accounted for 100.0%
in 1998 and 90.7% in 1997, of net charge-offs, respectively.
14
<PAGE>
Other Operating Income
Other operating income in the first three months of 1998
increased to $1.2 million, an increase of $500,000 or 71.4% over 1997. Mortgage
servicing fee income in 1998 decreased to $77,000, a decrease of $4,000 or 4.9%
over 1997. These fees were directly influenced by the volume of loans that were
sold in the secondary market. Gains or losses on sales of mortgage loans
occurred when the coupon rates on mortgage loans exceeded or fell short of the
yields required by the purchasers. The net gain of $79,000 recorded in 1998,
compared with the net gain of $16,000 in 1997, was indicative of the changes in
interest rates during the periods in which the sales occurred.
Fee income from service charges on demand deposits, item
processing, return items and other service fees in 1998 increased to $334,000,
an increase of $33,000 or 11.0%. These fees, which represented 28.6% of other
operating income, were influenced by both pricing changes and increases in the
number of consumer and business demand deposit accounts.
Net gains on available-for-sale securities represented
approximately 32.7% in 1998 and 0% in 1997 of other operating income,
respectively. The sales of these securities resulted from the Company's decision
to liquidate certain securities to capture market gains with the ability to
reinvest in bonds with similar risk and yield.
Included in other income are earnings on directors' and
officers' life insurance policies, credit card annual fees and merchant
discounts, safe deposit box rentals, rental income on excess office space in two
of the Company's branch offices, automated teller machine surcharge income,
commissions on check orders and other general service fees. Other income in 1998
increased to $312,000, an increase of $86,000 or 38.1% over 1997. Earnings on
directors' and officers' life insurance policies represented $70,000 of the
increase.
OTHER OPERATING EXPENSES
Other operating expenses in 1998 increased to $2.6 million, an
increase of $300,000 or 13.0% over 1997. Salaries and benefits, which were the
most significant of the noninterest expenses, increased in each of the years
reported. Salaries and benefits for 1998 increased to $1.2 million, an increase
of $100,000 or 9.1% over 1997. This increase was due to the additional staffing
needs in both new and existing branch and administrative offices, merit
increases and the added costs associated with health care insurance and other
benefits which were provided by the Company.
Equipment and occupancy expenses in 1998 increased to
$657,000, an increase of $83,000 or 14.5% over 1997. These increases were
primarily attributable to the growth in the number of branch offices, in
addition to overall increases in overhead expenses, maintenance costs and
equipment upgrades (including computer hardware and software) throughout the
branch network.
15
<PAGE>
FDIC insurance assessments decreased from $222,000 in 1995, to
$2,000 in 1996 and $0 in 1997. The decrease in the FDIC insurance assessment
reflected the decision by the FDIC in late 1995 to charge well-capitalized banks
a $1,000 semi-annual membership fee without any deposit-based insurance premium,
then reducing this amount to zero in 1997 and beyond.
Other expenses in 1998 increased to $699,000, an increase of
$115,000 or 19.7% over 1997. Included in these expenses were such costs as legal
fees, professional and audit, state shares' tax, directors' fees and other
general operating expenses.
INCOME TAXES
The provision for income taxes for the three months ended March 31, 1998 was
$325,000, an increase of 27.5% or $70,000 in 1998. The effective tax rate for
1998 and 1997 was 23.1% and 25.9%, respectively.
FINANCIAL CONDITION
March 31, 1998 Compared to December 31, 1997
The Company's total assets increased to $426.0 million at
March 31, 1998, an increase of $57.9 million or 15.7% from $368.1 million at
December 31, 1997. The increase in assets was primarily attributable to a $1.5
million growth in net loans and a $52.0 million purchase of investment
securities.
The amortized cost of investment securities, including
held-to-maturity (HTM) and available-for-sale (AFS), increased to $161.9 million
at March 31, 1998, an increase of $50.1 million or 44.8% from $111.8 million at
December 31, 1997. The continued attention given to management's asset/liability
and investment strategies resulted in an increase in net interest income while
controlling interest rate risk. By again utilizing structured borrowings with
the FHLB, the Company was able to purchase both taxable and tax-exempt
investments that provided a favorable spread between the interest rate on
deposits and borrowings versus the yield on invested funds. During the first
quarter of 1998, the Company purchased $50.0 million of securities with funds
borrowed from the FHLB. The strategy that was employed provided a favorable
spread between the rates on invested and borrowed funds. At March 31, 1998,
gross unrealized gains in the HTM investments were $762,000 while gross
unrealized losses amounted to $116,000.
The following table presents the maturity distribution and
weighted average yield of the securities portfolio of the Company at March 31,
1998. Weighted average yields on tax-exempt obligations have been computed on a
taxable equivalent basis.
16
<PAGE>
<TABLE>
<CAPTION>
Available for Sale March 31, 1998
After 1 Year But After 5 Years But After 10 Years
Within 1 Year Within 5 Years Within 10 Years or no maturity Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Amortized cost:
U.S. government agencies and
corporations ................. $5,875 6.8% $18,350 7.0% $13,426 7.0% $27,040 6.9% 64,691 6.9%
Obligations of state and
political subdivisions ....... 200 8.1 605 7.2 9,660 6.8 5,695 7.4 16,160 6.9
Equity securities ................. - - - - - - 5,262 4.0 5,262 4.0
--------- ------- --- ------- ---
Total securities available for sale $6,075 6.9% $18,955 7.0% $23,086 6.9% $37,997 6.5% $86,113 6.8%
</TABLE>
<TABLE>
<CAPTION>
Held to Maturity March 31, 1998
After 1 Year But After 5 Years But After 10 Years
Within 1 Year Within 5 Years Within 10 Years or no maturity Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Amortized cost:
U.S. government agencies and
corporations ............... $5,974 7.5% $12,985 7.3% $19,364 7.3% $17,656 6.9% $55,979 7.2%
Obligations of state and
political subdivisions ..... -- -- 1,185 6.6% 10,866 7.0% 13,044 7.7% 25,095 7.3
Total securities held to maturity $5,974 7.5% $14,170 7.3% $30,230 7.2% $30,700 7.2% $81,074 7.2%
</TABLE>
Total net loans increased to $209.7 million at March 31, 1998,
an increase of $1.5 million or 1.0% from $208.2 million at December 31, 1997.
The increase in net loans was directly related to the growth in commercial loans
and residential mortgages, reduced by the $3.4 million of mortgage loans sold
during the first three months of 1998 and the sale of our $2.2 million credit
card portfolio. Residential mortgage loans, which included real estate
construction loans, increased to $106.4 million at March 31, 1998, an increase
of $3.4 million or 3.3% from $103.0 million at December 31, 1997.
Consumer loans and leases, net of unearned discounts,
decreased to $34.3 million at March 31, 1998, a decrease of $4.3 million or
11.1% from $38.6 million at December 31, 1997. Commercial loans increased to
$71.2 million at March 31, 1998, an increase of $1.7 million or 2.5% from $69.5
million at December 31, 1997. Commercial loans consisted of loans made to small
businesses within the Company's market area and were generally secured by real
estate and other assets of the borrowers.
Life insurance cash surrender value increased to $8.3 million
at March 31, 1998, an increase of $400,000 or 5.1% from $7.9 million at December
31, 1997. The increase represents an investment in 1997 in various life
insurance policies to fund both a non-qualified supplemental retirement plan
(SERP) and an officer group term life insurance replacement plan on the
executive officers and certain other officers of the Company.
17
<PAGE>
Total deposits increased to $278.8 million at March 31, 1998,
a decrease of $1.7 million or 0.6% from $280.5 million at March 31, 1997.
Noninterest-bearing demand deposits increased to $40.4 million at March 31,
1998, an increase of $700,000 or 1.8% from $39.7 million at March 31, 1997. In
the aggregate, savings and interest-bearing demand deposits decreased to $66.3
million at March 31, 1998, a decrease of $11.9 million or 2.8% from $68.2
million at March 31, 1997. As a percentage of total deposits, savings and
interest-bearing demand deposits represented 23.8% in 1998, compared to 24.3% in
1997. Savings deposits decreased to $30.4 million at March 31, 1998, a decrease
of $1.4 million or 4.4% from $31.8 million at March 31, 1997. This decrease is
because certificates of deposit offered a competitive alternative for customers.
Time deposits, which include certificates of deposit in denominations of
$100,000 or more, decreased to $172.1 million at March 31, 1998, a decrease of
$500,000 or 0.3% from $172.6 million at March 31, 1997. As a percentage of total
deposits, these deposits remained constant at 62.0% in both 1998 and in 1997.
Approximately $16.9 million of these deposits are from public funds of school
districts and local governments located within the Company's market area.
Included in interest-bearing deposits are certificates of deposit in amounts of
$100,000 or more. There are no brokered deposits included in certificates of
deposit of $100,000 or more.
NONPERFORMING ASSETS
Nonperforming assets included nonperforming loans and
foreclosed assets held for sale. Nonperforming loans consisted of loans where
the principal and/or interest was 90 days or more past due and loans that had
been placed on nonaccrual status. When loans were placed on nonaccrual status,
income from the current period was reversed from current earnings and interest
from prior periods was charged to the allowance for possible credit losses.
Consumer loans were charged-off when principal or interest was 120 days or more
delinquent, or were placed on nonaccrual status if a sufficient amount of
collateral existed. The following table shows information concerning loan
delinquency and other nonperforming assets of the Company at March 31, 1998 and
December 31, 1997:
1998 1997
---- ----
(in thousands)
Loans past due 90 days or more $1,603 $1,453
Impaired loans in nonaccrual status 1,008 411
Other nonaccrual loans 263 123
-------- -------
Total nonperforming loans 2,874 1,987
Foreclosed assets held for sale 477 523
-------- --------
Total nonperforming assets $ 3,351 $ 2,510
======= =======
Nonperforming loans as a
percentage of loans 1.36% .94%
Nonperforming assets as a
percentage of assets .79% .68%
18
<PAGE>
Nonperforming loans increased 44.6% from year-end 1997.
Nonaccrual loans increased $737,000 or 138% from year-end 1997. Commercial loans
accounted for 79% of all nonaccruals, followed by real estate loans at 21%.
Within the $1.3 million of total nonaccrual loans, 96% were secured by
mortgages, primarily first liens, against residential or commercial properties.
Loans past due 90 days or more increased $150,000 from 1997 year-end levels.
These loans included $462,000 in real estate mortgages, $218,000 in consumer
credit, $847,000 in commercial loans and $76,000 in leasing. These loans were
reviewed by management at its quarterly loan review meetings regarding
collection efforts.
Legal proceedings on the nonaccrual loans are ongoing,
routine, and are reviewed by management on a continuing basis. No material
losses are expected as a result of these proceedings.
Foreclosed assets held for sale were $477,000 at March 31,
1998 compared to $523,000 at year-end 1997. The decrease was a result of sales
during the first three months of 1998 without any substantial additions. The
Company does not expect any material losses on the sales of these properties
based on current appraised values exceeding book values. See "Factors That May
Affect Future Results" for factors that could affect sales prices of foreclosed
assets.
POTENTIAL PROBLEM LOANS
At March 31, 1998, the Company had approximately $1.7 million
of potential problem loans not included in the nonperforming loan
classification. Known information about possible credit problems related to
these borrowers caused management to have serious doubts as to the ability of
such borrowers to comply with present loan repayment terms and may result in
future classification of such loans as nonperforming. These potential problem
loans were taken into consideration by management when determining the adequacy
of the allowance for possible credit losses at March 31, 1998. See "Factors That
May Affect Future Results" for further discussion.
ALLOWANCE FOR POSSIBLE CREDIT LOSSES
The Company determined the provision for possible credit
losses through a quarterly review of the loan portfolio. Factors such as
declining economic trends; the volume of nonperforming loans; concentrations of
credit risk; adverse situations that may affect the borrower's ability to repay;
prior loss experience within the various categories of the portfolio; and
current economic conditions were considered when reviewing the risks in the
portfolio. Larger exposures were analyzed individually. Over the past several
years, the Company implemented more stringent underwriting standards in
commercial lending as this category of loans continues to grow. While management
believed the allowance for possible credit losses was adequate, future additions
to the allowance may be necessary based on changes in economic conditions. The
adequacy of the allowance for possible credit losses was reviewed
19
<PAGE>
quarterly by a loan review committee comprised of members of the Board of
Directors and senior management of the Company. The full Board of Directors
reviewed the relevant ratios with respect to the allowance after the loan review
committee made its recommendations. At March 31, 1998, the allowance for
possible credit losses was 1.05% of loans compared to 1.00% at December 31,
1997. For further discussion on factors that could influence the allowance for
possible credit losses, see "Factors That May Affect Future Results."
Changes in the allowance for possible credit losses at March 31, 1998 and
December 31, 1997 were as follows:
1998 1997
(dollars in thousands)
Balance at beginning of period $2,109 $1,830
Charge-offs:
Real estate-construction - -
Real estate-mortgage 12 103
Commercial and industrial 3 106
Consumer installment 74 363
Lease financing - 11
--------- --------
Total 89 583
-------- --------
Recoveries:
Real estate-construction - -
Real estate-mortgage - -
Commercial and industrial 3 42
Consumer installment 13 40
Lease financing - -
--------- -
Total 16 82
-------- ---------
Net charge-offs 73 501
-------- --------
Provision for possible credit losses 200 780
-------- --------
Balance at end of period $ 2,236 $ 2,109
======= =======
Ratio of net charge-offs during period to
average loans outstanding during period 0.01% 0.26%
======== ========
The Company's management is unable to determine in what loan
category future charge-offs and recoveries may occur. The following schedule
sets forth the allocation of the allowance for possible credit losses among
various categories. At March 31, 1998, approximately 61% of the allowance for
possible credit losses is allocated to general risk to protect the Company
against potential yet undetermined losses. The allocation is based upon
historical experience. The entire allowance for possible credit losses is
available to absorb future loan losses in any loan category.
20
<PAGE>
March 31, December 31,
1998 1997
Percent Percent
of Loans of Loans
in Each in Each
Category Category
Amount to Loans(1) Amount to Loans(1)
(Dollars in thousands)
Allocation of allowance for
possible credit losses:
Real Estate...................... $329 49% $ 278 49%
Commercial and industrial.. 903 33 868 33
Consumer installment........ 388 17 465 19
Lease financing............... 74 1 68 1
Unallocated.................... 542 - 430 -
------- ------- ------- -
Total...................... $2,236 100% $2,109 100%
====== ==== ====== ====
(1) Loans, net of unearned income.
Interest Rate Risk Management
The following discussion contains certain forward-looking
statements (as defined in the Private Securities Litigation Reform Act of 1995).
These forward-looking statements may involve significant risks and uncertainties
that are described under the caption "Factors That May Affect Future Results."
Interest rate risk management involves managing the extent to
which interest-sensitive assets and interest-sensitive liabilities are matched.
Interest rate sensitivity is the relationship between market interest rates and
earnings volatility due to the repricing characteristics of assets and
liabilities. The Company's net interest income is affected by changes in the
level of market interest rates. In order to maintain consistent earnings
performance, the Company seeks to manage, to the extent possible, the repricing
characteristics of its assets and liabilities.
Asset/Liability Management. One major objective of the Company
when managing the rate sensitivity of its assets and liabilities is to stabilize
net interest income. The management of and authority to assume interest rate
risk is the responsibility of the Company's Asset/Liability Committee ("ALCO"),
which is comprised of senior management and Board members. ALCO meets quarterly
to monitor the ratio of interest sensitive assets to interest sensitive
liabilities. The process to review interest rate risk management is a regular
part of management of the Company. Consistent policies and practices of
measuring and reporting interest rate risk exposure, particularly regarding the
treatment of noncontractual assets and liabilities, are in effect. In addition,
there is an annual process to review the interest rate risk policy with the
Board of Directors which includes limits on the impact to earnings from shifts
in interest rates.
21
<PAGE>
Interest Rate Risk Measurement. Interest rate risk is
monitored through the use of three complementary measures: static gap analysis,
earnings at risk simulation and economic value at risk simulation. While each of
the interest rate risk measurements has limitations, taken together they
represent a reasonably comprehensive view of the magnitude of interest rate risk
in the Company and the distribution of risk along the yield curve, the level of
risk through time, and the amount of exposure to changes in certain interest
rate relationships.
Static Gap. The ratio between assets and liabilities repricing
in specific time intervals is referred to as an interest rate sensitivity gap.
Interest rate sensitivity gaps can be managed to take advantage of the slope of
the yield curve as well as forecasted changes in the level of interest rate
changes.
To manage this interest rate sensitivity gap position, an
asset/liability model called "static gap analysis" is used to monitor the
difference in the volume of the Company's interest sensitive assets and
liabilities that mature or reprice within given periods. A positive gap (asset
sensitive) indicates that more assets reprice during a given period compared to
liabilities, while a negative gap (liability sensitive) has the opposite effect.
The Company employs computerized net interest income simulation modeling to
assist in quantifying interest rate risk exposure. This process measures and
quantifies the impact on net interest income through varying interest rate
changes and balance sheet compositions. The use of this model assists the ALCO
to gauge the effects of the interest rate changes on interest sensitive assets
and liabilities in order to determine what impact these rate changes will have
upon the net interest spread.
At March 31, 1998, LA Bank maintained a one year cumulative
gap of negative $29.5 million or 6.94% of total assets. The effect of this gap
position provided a negative mismatch of assets and liabilities which can expose
LA Bank to interest rate risk during a period of rising interest rates.
<TABLE>
<CAPTION>
Interest Sensitivity Gap at March 31, 1998
3 months 3 through 1 through Over
or less 12 months 3 years 3 years Total
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents ......... $18,417 $ -- $ -- $ -- $18,417
Investment securities(1)(2) ....... 17,746 32,194 22,812 94,088 166,840
Loans(2) .......................... 47,028 42,521 60,930 60,321 210,800
Fixed and other assets ............ -- -- -- 29,671 29,671
------- --------- -------- -------- --------
Total assets ...................... $83,191 $74,715 $83,742 $184,080 $425,728
======= ========= ======== ======== ========
Non interest-bearing transaction deposits(3) $10,102 $ -- $10,102 $20,202 $40,406
Interest-bearing transaction deposits(3) -- 6,032 19,907 42,429 68,368
Time .............................. 30,796 70,085 13,539 11,261 125,681
Time over $100,000 ................ 17,246 20,590 6,562 -- 44,398
Short-term borrowings ............. 9,547 10,446 1,114 436 21,543
Long-term debt .................... 10,652 1,951 10,210 62,016 84,829
Other liabilities ................. -- -- -- 4,104 4,104
------- --------- -------- -------- --------
Total Liabilities ........ $78,343 $109,104 $61,434 $176,847 $425,728
======= ========= ======== ======== ========
Interest sensitivity gap .......... $4,848 $(34,389) $22,308 $7,233
========= ======== ======== ========
Cumulative gap .................... $4,848 $(29,541) $(7,233) $0
========= ======== ======== ========
Cumulative gap to total assets .... 1.14% (6.94)% (1.70)% 0.00%
- -----------------------------
</TABLE>
22
<PAGE>
(1) Gross of unrealized gains/losses on available for sale securities.
(2) Investments and loans are included in the earlier of the period in which
interest rates were next scheduled to adjust or the period in which they are
due. In addition, loans were included in the periods in which they are scheduled
to be repaid based on scheduled amortization. For amortizing loans and
mortgage-backed securities, annual prepayment rates are assumed reflecting
historical experience as well as management's knowledge and experience of its
loan products.
(3) LA Bank's demand and savings accounts were generally subject to immediate
withdrawal. However, management considers a certain amount of such accounts to
be core accounts having significantly longer effective maturities based on the
retention experiences of such deposits in changing interest rate environments.
The effective maturities presented are the FDICIA 305 recommended maturity
distribution limits for nonmaturing deposits.
Upon reviewing the current interest sensitivity scenario,
decreasing interest rates could positively effect net income because the Company
is liability sensitive. In a rising interest rate environment, net income could
be negatively affected because more liabilities than assets will reprice during
a given period.
Certain shortcomings are inherent in the method of analysis
presented in the above table. Although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
to changes in market interest rates. The interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In the event of a change in
interest rates, prepayment and early withdrawal levels may deviate significantly
from those assumed in calculating the table. The ability of many borrowers to
service their adjustable-rate debt may decrease in the event of an interest rate
increase.
Earnings at Risk and Economic Value at Risk Simulations. The
Company recognizes that more sophisticated tools exist for measuring the
interest rate risk in the balance sheet beyond static gap analysis. Although it
will continue to measure its static gap position, the Company utilizes
additional modeling for identifying and measuring the interest rate risk in the
overall balance sheet. The ALCO is responsible for focusing on "earnings at
risk" and "economic value at risk", and how both relate to the risk-based
capital position when analyzing the interest rate risk.
Earnings at Risk. Earnings at risk simulation measures the
change in net interest income and net income should interest rates rise and
fall. The simulation recognizes that not all assets and liabilities reprice one
for one with market rates (e.g., savings rate). The ALCO looks at "earnings at
risk" to determine income changes from a base case scenario under an increase
and decrease of 200 basis points in interest rates simulation model.
Economic Value at Risk. Earnings at risk simulation measures
the short-term risk in the balance sheet. Economic value (or portfolio equity)
at risk measures the long-term risk by finding the net present value of the
future cashflows from the Company's existing assets and liabilities. The ALCO
examines this ratio quarterly utilizing an increase and decrease of 200 basis
points in interest rates simulation model. The ALCO recognizes that, in some
instances, this ratio may contradict the "earnings at risk" ratio.
23
<PAGE>
The following table illustrates the simulated impact of 200
basis points upward or downward movement in interest rates on net interest
income, net income, and the change in economic value (portfolio equity). This
analysis assumed that interest-earning asset and interest-bearing liability
levels at March 31, 1998 remained constant. The impact of the rate movements was
developed by simulating the effect of rates changing over a twelve-month period
from the March 31, 1998 levels.
Rates +200 Rates -200
Earnings at risk:
Percent change in:
Net Interest Income (3.51)% (4.41)%
Net Income (6.30) (8.18)
Economic value at risk:
Percent change in:
Economic value of equity (46.88)% 1.69%
Economic value of equity as a
percent of book assets .15% (4.06)%
Economic value has the most meaning when viewed within the
context of risk-based capital. Therefore, the economic value may change beyond
the Company's policy guideline for a short period of time as long as the
risk-based capital ratio (after adjusting for the excess equity exposure) is
greater than 10%.
CAPITAL
The adequacy of the Company's capital is reviewed on an
ongoing basis with regard to size, composition and quality of the Company's
resources. An adequate capital base is important for continued growth and
expansion in addition to providing an added protection against unexpected
losses.
An important indicator in the banking industry is the leverage
ratio, defined as the ratio of common stockholders' equity less intangible
assets, to average quarterly assets less intangible assets. The leverage ratio
at March 31, 1998 was 8.92% compared to 10.26% at December 31, 1997. This
decrease is the direct result of the increase in average assets in 1998 caused
by the borrowings from the FHLB which were invested in investment grade
securities, in addition to the increase in stockholders' equity as a result of
the public stock offering in 1997. For 1998 and 1997, the ratios were well above
minimum regulatory guidelines.
As required by the federal banking regulatory authorities,
guidelines have been adopted to measure capital adequacy. Under the guidelines,
certain minimum ratios are required for core capital and total capital as a
percentage of risk-weighted assets and other off-balance sheet instruments. For
the Company, Tier I capital consists of common stockholders' equity less
intangible assets, and Tier II capital includes the allowable portion of the
allowance for possible loan losses, currently limited to 1.25% of risk-weighted
assets.
24
<PAGE>
By regulatory guidelines, neither Tier I nor Tier II capital reflect the
adjustment of SFAS No. 115, which requires adjustment in financial statements
prepared in accordance with generally accepted accounting principles by
including as a separate component of equity, the amount of net unrealized
holding gains or losses on debt and equity securities that are deemed to be
available-for-sale.
At March 31, 1998
(Dollars in thousands)
Primary capital.. ........................ $36,627
Intangible assets. ....................... 538
---------
Tier I capital..... .................... 36,089
Tier II capital.............................. 2,162
---------
Total risk-based capital.................. $38,251
=======
Total risk-weighted assets................ $231,470
Tier I ratio................................ ... 15.59%
Risk-based capital ratio....................... 16.53%
Tier I leverage ratio.......................... 8.92%
Regulatory guidelines require that core capital and total
risk-based capital must be at least 4.0% and 8.0%, respectively.
LIQUIDITY AND FUNDS MANAGEMENT
Liquidity management is to ensure that adequate funds will be
available to meet anticipated and unanticipated deposit withdrawals, debt
servicing payments, investment commitments, commercial and consumer loan demand
and ongoing operating expenses. Funding sources include principal repayments on
loans and investments, sales of assets, growth in core deposits, short- and
long-term borrowings and repurchase agreements. Regular loan payments are a
dependable source of funds, while the sale of loans and investment securities,
deposit flows, and loan prepayments are significantly influenced by general
economic conditions and level of interest rates.
At March 31, 1998, the Company maintained $18.4 million in
cash and cash equivalents (including Federal funds sold) in the form of cash and
due from banks (after reserve requirements). In addition, the Company had $4.4
million of mortgage loans held for resale and $85.8 million in AFS securities.
This combined total of $108.6 million represented 25.5% of total assets at March
31, 1998. The Company believes that its liquidity is adequate.
The Company considers its primary source of liquidity to be
its core deposit base. This funding source has grown steadily over the years and
consists of deposits from customers throughout the branch network. The Company
will continue to promote the acquisition of deposits through its branch offices.
At March 31, 1998 , approximately 65.5% of the Company's assets were funded by
core deposits acquired within its market area. An additional 8.5% of the assets
were funded by the Company's equity. These two components provide a substantial
and stable source of funds.
25
<PAGE>
Net cash used by operating activities was $4.4 million for the
three months ended March 31, 1998, as compared to net cash provided by operating
activities of $1.0 million for the comparable period in 1997. This $5.4 million
decrease is primarily related to a net $4.1 million increase in the change in
mortgage loans held for resale. Net cash used in investing activities increased
$12.7 million for the year ended March 31, 1998, from $38.2 million to $50.9
million, which was primarily attributable to purchases of investment securities.
Net cash provided by financing activities increased $26.8 million from 1997. A
net increase in FHLB borrowings of $50.0 million was used to fund investment
purchases.
FUTURE OUTLOOK
The national prime lending rate fell to 8.5% at December 31,
1995, falling again to 8.25% in February 1996, where it remained at December 31,
1996. In March 1997, the national prime lending rate increased to its current
level of 8.5%. Management and the Board of Directors do not have the ability to
determine if another rate increase will occur; however, the Company believes it
is very well prepared to meet the challenges and effects of a rising interest
rate environment. Management's belief is that a significant impact on earnings
depends on its ability to react to changes in interest rates. Through its ALCO,
the Company continually monitors interest rate sensitivity of its earning assets
and interest-bearing liabilities to minimize any adverse effects on future
earnings. The Company's commitment to remaining a community-based organization
is strong and the intention is to recognize steady growth in its consumer,
mortgage and commercial loan portfolios while obtaining and maintaining a strong
core deposit base.
The banking and financial services industries are constantly
changing. The Company is not aware of any pending pronouncements that would have
a material impact on the results of operations.
Beginning September 1995, bank holding companies are permitted
to acquire banks in other states without regard to state law. In addition, banks
can merge with other banks in another state beginning in September 1997.
Predictions are that consolidation will continue to occur as the banking
industry strives for greater cost efficiencies and market share. Management
believes that such consolidation may enhance its competitive position as a
community bank.
A normal examination of LA Bank by the Office of the
Comptroller of the Currency ("OCC") in 1997 resulted in no significant findings
and no impact is anticipated on current or future operations.
26
<PAGE>
The FDIC Board of Directors voted on November 26, 1996, to
retain the existing BIF assessment schedule of 0 to 27 basis points (annual
rates) for the first semiannual period of 1997, and to collect an assessment
against BIF - assessable deposits to be paid to the Financing Corporation
("FICO"). In addition, the Board eliminated the $2,000 minimum annual assessment
and authorized the refund of the fourth-quarter minimum assessment of $500 paid
by certain BIF-insured institutions on September 30, 1996. LA Bank's current and
future FDIC BIF assessment is expected to be $0; however, the FICO assessment
for 1998 is expected to be approximately $35,000.
In 1996, LA Bank acquired the real estate and deposit customer
lists of the Milford (Pike County) and Mountainhome (Monroe County) branches of
PNC Bank. These branches opened in December 1996. The amortization of the
customer lists was $100,000 for 1997 and is expected to be $100,000 in 1998.
The OCC granted approval to establish new branches as follows:
Location Date Approved
Wal-Mart, Honesdale 12/29/97
Taylor 3/16/98
Tannersville 4/9/98
In addition, the Company opened two new branches during 1998.
On March 18, 1998, a branch opened in the Wal-Mart Supercenter in Dickson City
and the Lackawaxen branch opened on April 2, 1998.
Management is hopeful that the newest additional banking
offices will continue to expand the Company's deposit base by attracting new
depositors, while providing quality service to both new and existing customers.
The initial costs associated with the branch openings, such as salaries and
benefits, advertising, overhead expenses and marketing, will have a negative
impact on the Company's earnings until the growth in deposits reaches a level to
offset these expenses.
YEAR 2000 COMPLIANCE; MANAGEMENT INFORMATION SYSTEMS
The Board of Directors has established a Year 2000 compliance
committee to address the risks of the critical internal bank systems that are
affected by date sensitive applications, as well as external systems provided by
third parties. A comprehensive plan was developed detailing the sequence of
events and actions to be taken as the Year 2000 approaches.
27
<PAGE>
The Company has conducted a comprehensive review of its
computer systems that could be affected by the "Year 2000" issue and does not
believe the amounts to be expended over the next two years will have a material
impact on its earnings or financial position. It is anticipated that any
modifications to existing hardware and software will be completed by December
31, 1998, thus leaving the year 1999 for systems testing. However, no assurance
can be made that the systems of others that the Company relies upon will be
converted on a timely basis, or that their failure to be compliant would not
have an adverse effect on the Company.
In October 1997, the Company purchased and installed an
upgrade to its current systems to improve efficiencies of operations and
position itself for future growth. The cost of the new system was approximately
$775,000. Preconversion testing demonstrated that the new hardware and software
are Year 2000 compliant.
FACTORS THAT MAY AFFECT FUTURE RESULTS
General
Banking is affected, directly and indirectly, by local,
domestic and international economic and political conditions, and by government
monetary and fiscal policies. Conditions such as inflation, recession,
unemployment, volatile interest rates, tight money supply, real estate values,
international conflicts and other factors beyond the control of the Company may
adversely affect the future results of operations of the Company. Management
does not expect any one particular factor to affect results of operations. A
downward trend in several areas, however, including real estate, construction
and consumer spending, could have an adverse impact on the Company's ability to
maintain or increase profitability. Therefore, there is no assurance that the
Company will be able to continue its current rate of profitability and growth.
See "Allowance For Possible Credit Losses."
Interest Rates
The Company's earnings depend, to a large extent, upon net
interest income, which is primarily influenced by the relationship between its
cost of funds (deposits and borrowings) and the yield on its interest-earning
assets (loans and investments). This relationship, known as the net interest
spread, is subject to fluctuate and is affected by regulatory, economic and
competitive factors which influence interest rates, the volume, rate and mix of
interest-earning assets and interest-bearing liabilities, and the level of
nonperforming assets. As part of its interest rate risk management strategy,
management seeks to control its exposure to interest rate changes by managing
the maturity and repricing characteristics of interest-earning assets and
interest-bearing liabilities. Through its asset/liability committee, the Company
continually monitors interest rate sensitivity of its earning assets and
interest-bearing liabilities to minimize any adverse effects on future earnings.
28
<PAGE>
As of March 31, 1998, total interest-earning assets maturing
or repricing within one year were less than total interest-bearing liabilities
maturing or repricing in the same period by $29.5 million, representing a
cumulative one-year interest rate sensitivity gap as a percentage of total
assets of negative 6.94%. This condition suggests that the yield on the
Company's interest-earning assets should adjust to changes in market interest
rates at a slower rate than the cost of the Company's interest-bearing
liabilities. Consequently, the Company's net interest income could decrease
during periods of rising interest rates. See "Interest Rate Risk Management."
Adequacy of Allowance for Possible Credit Losses
In originating loans, there is a likelihood that some credit losses will
occur. This risk of loss varies with, among other things, general economic
conditions, the type of loan being made, the creditworthiness and debt servicing
capacity of the borrower over the term of the loan and, in the case of a
collateralized loan, the value and marketability of the collateral securing the
loan. Management maintains an allowance for possible credit losses based on,
among other things, historical loan loss experience, known inherent risks in the
loan portfolio, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral and an evaluation of
current economic conditions. Management believes that the allowance for possible
credit losses is adequate. There can be no assurance that nonperforming loans
will not increase in the future.
Effects of Inflation
The majority of assets and liabilities of a financial
institution are monetary in nature. Therefore, a financial institution differs
greatly from most commercial and industrial companies that have significant
investments in fixed assets or inventories. Management believes that the most
significant impact of inflation on financial results is the Company's ability to
react to changes in interest rates. As discussed previously, management attempts
to maintain an essentially balanced position between rate sensitive assets and
liabilities over a one year time horizon in order to protect net interest income
from being affected by wide interest rate fluctuations.
NEW FINANCIAL ACCOUNTING STANDARDS
Mortgage Servicing Rights
In 1995, the FASB issued SFAS No. 122, "Accounting for
Mortgage Servicing Rights," which amends Statement No. 65, "Accounting for
Certain Mortgage Banking Activities." The Statement applies to all mortgage
banking activities in which a mortgage loan is originated or purchased and then
sold or securitized with the right to service the loan retained by the seller.
The total cost of the mortgage loans is allocated between the mortgage servicing
rights and the mortgage loans based on their relative fair values. The mortgage
servicing rights are capitalized as assets and amortized over the period of
estimated net servicing income. Additionally, they are subject to an impairment
analysis based on their fair
29
<PAGE>
value in future periods. The Statement was effective for transactions in which
mortgage loans are sold or securitized beginning January 1, 1996. The impact on
the Company's financial position and results of operations will be dependent
upon the future volume of mortgage loans sold with servicing rights retained. In
1997 and 1998, the impact was immaterial.
Stock-Based Compensation
In 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." This standard provides the Company with a choice of
how to account for the issuance of stock options and other stock grants. The
Statement encourages companies to account for stock options at their fair value
and recognize the expense as compensation over the service period, but also
permits companies to follow existing accounting rules under Accounting
Principles Board ("APB") Opinion No. 25. Companies electing to follow APB
Opinion No. 25 rules will be required to disclose pro forma net income and
earnings per share information as if the new fair value approach had been
adopted. The Company is continuing to follow existing accounting rules under APB
Opinion No. 25 for options granted, with pro forma disclosure in the footnotes
to the consolidated financial statements.
Earnings Per Share and Capital Structure
In 1997, the FASB issued Statement No.128, "Earnings Per Share" and
Statement No. 129, "Disclosure of Information about Capital Structure." Both
Statements are effective for periods ending after December 15, 1997. Statement
No. 128 is designed to simplify the computation of earnings per share and will
require disclosure of "basic earnings per share" and, if applicable, "diluted
earnings per share." Statement No. 128 requires restatement of all prior period
earnings per share data when adopted. The adoption of Statement No. 129 had no
impact on the Company.
Reporting Comprehensive Income
In June 1997, the FASB issued Statement No. 130, "Reporting
Comprehensive Income." This Statement establishes standards for the reporting
and display of comprehensive income and its components in a full set of
general-purpose financial statements. Statement No. 130 requires that all items
that are required to be recognized as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. This Statement does not require a specific format
for that financial statement, but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. Statement No. 130 is effective for fiscal years beginning after
December 15, 1997. The impact of this Statement on the Company is to require
additional disclosures in the Company's financial statements.
30
<PAGE>
Operating Segment Disclosure
In June 1997, the FASB issued Statement No. 131, "Disclosures
About Segments of an Enterprise and Related Information." Statement No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Statement No. 131 is effective for periods beginning after December
15, 1997. The impact, if any, of this Statement on the Company is to require
additional disclosures in the Company's financial statements.
31
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by item 601 of Regulation S-K
Exhibit Number Description of Exhibit
2 None
3(i) None
3(ii) None
4 None
10 None
11 None
15 None
18 None
19 None
22 None
23 None
24 None
27 Financial Data Schedule
99 None
(b) Reports on Form 8-K
32
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LAKE ARIEL BANCORP, INC.
Date May 5, 1998
By ________________________________
John G. Martines
CHIEF EXECUTIVE OFFICER
- --------------------------------
Joseph J. Earyes, CPA
VICE PRESIDENT and
TREASURER
33
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<NAME> LAKE ARIEL BANCORP, INC.
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<PERIOD-START> JAN-1-1998
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