UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-17455
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COMM BANCORP, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2242292
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)
521 MAIN STREET, FOREST CITY, PA 18421
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(Address of principal executive offices) (Zip Code)
(717) 785-3181
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve 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 [ ] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 2,207,022 AT
OCTOBER 21, 1998.
Page 1 of 54
COMM BANCORP, INC.
FORM 10-Q
SEPTEMBER 30, 1998
CONTENTS PAGE NO.
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PART I. FINANCIAL INFORMATION:
Item 1: Financial Statements.
Consolidated Statements of Income and Comprehensive Income -
for the Three Months and Nine Months Ended September 30,
1998 and 1997.............................................. 3
Consolidated Balance Sheets - September 30, 1998, and
December 31, 1997.......................................... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 1998............... 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997.......................... 6
Notes to Consolidated Financial Statements.................. 7
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 8
Item 3: Quantitative and Qualitative Disclosures About Market
Risk.................................................. *
PART II. OTHER INFORMATION:
Item 1: Legal Proceedings...................................... 53
Item 2: Changes in Securities and Use of Proceeds.............. 53
Item 3: Defaults Upon Senior Securities........................ 53
Item 4: Submission of Matters to a Vote of Security Holders.... 53
Item 5: Other Information...................................... 53
Item 6: Exhibits and Reports on Form 8-K....................... 53
SIGNATURES..................................................... 54
* Not Applicable
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
--------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans:
Taxable.......................................................... $5,183 $5,005 $15,387 $14,746
Tax-exempt....................................................... 100 123 299 364
Interest and dividends on investment securities available-for-sale:
Taxable.......................................................... 880 820 2,500 2,410
Tax-exempt....................................................... 506 507 1,537 1,545
Dividends........................................................ 39 32 113 96
Interest on federal funds sold..................................... 184 101 468 249
------ ------ ------- -------
Total interest income.......................................... 6,892 6,588 20,304 19,410
------ ------ ------- -------
INTEREST EXPENSE:
Interest on deposits............................................... 3,540 3,536 10,423 10,487
Interest on short-term borrowings.................................. 7 1
Interest on long-term debt......................................... 1 3 2
------ ------ ------- -------
Total interest expense......................................... 3,541 3,536 10,433 10,490
------ ------ ------- -------
Net interest income............................................ 3,351 3,052 9,871 8,920
Provision for loan losses.......................................... 105 105 315 255
------ ------ ------- -------
Net interest income after provision for loan losses............ 3,246 2,947 9,556 8,665
------ ------ ------- -------
NONINTEREST INCOME:
Service charges, fees and commissions.............................. 380 358 1,109 1,120
Litigation recovery................................................ 250
Net gains on sale of loans......................................... 4 4
Net gains on sale of investment securities......................... 235 235
------ ------ ------- -------
Total noninterest income....................................... 619 358 1,348 1,370
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NONINTEREST EXPENSE:
Salaries and employee benefits expense............................. 1,105 998 3,308 3,020
Net occupancy and equipment expense................................ 303 288 960 888
Other expenses..................................................... 989 660 2,465 1,972
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Total noninterest expense...................................... 2,397 1,946 6,733 5,880
------ ------ ------- -------
Income before income taxes......................................... 1,468 1,359 4,171 4,155
Provision for income tax expense................................... 318 279 871 855
------ ------ ------- -------
Net income..................................................... 1,150 1,080 3,300 3,300
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OTHER COMPREHENSIVE INCOME:
Unrealized gains on investment securities available-for-sale....... 506 564 1,135 787
Income tax expense related to other comprehensive income........... 171 192 385 268
------ ------ ------- -------
Other comprehensive income, net of income tax.................. 335 372 750 519
------ ------ ------- -------
Comprehensive income........................................... $1,485 $1,452 $ 4,050 $ 3,819
====== ====== ======= =======
PER SHARE DATA:
Net income......................................................... $ 0.52 $ 0.49 $ 1.50 $ 1.50
Cash dividends declared............................................ $ 0.10 $ 0.06 $ 0.24 $ 0.18
Average common shares.............................................. 2,205,844 2,201,245 2,205,048 2,200,473
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
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(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
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<S> <C> <C>
ASSETS:
Cash and due from banks............................................................. $ 7,206 $ 9,040
Federal funds sold.................................................................. 11,200 8,225
Investment securities available-for-sale............................................ 105,940 105,666
Loans held for sale, net............................................................ 229
Loans, net of unearned income....................................................... 250,301 250,227
Less: allowance for loan losses................................................... 3,804 3,798
-------- --------
Net loans........................................................................... 246,497 246,429
Premises and equipment, net......................................................... 5,116 3,772
Accrued interest receivable......................................................... 2,275 2,575
Other assets........................................................................ 6,022 6,104
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Total assets.................................................................... $384,485 $381,811
======== ========
LIABILITIES:
Deposits:
Noninterest-bearing............................................................... $ 33,513 $ 30,703
Interest-bearing.................................................................. 306,464 301,678
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Total deposits.................................................................. 339,977 332,381
Short-term borrowings............................................................... 9,575
Long-term debt...................................................................... 42 44
Accrued interest payable............................................................ 1,811 1,714
Other liabilities................................................................... 2,913 1,995
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Total liabilities............................................................... 344,743 345,709
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STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and outstanding:
September 30, 1998, 2,205,844 shares; December 31, 1997, 2,202,405 shares........... 728 727
Capital surplus..................................................................... 6,504 6,385
Retained earnings................................................................... 30,160 27,390
Net unrealized gain on available-for-sale securities................................ 2,350 1,600
-------- --------
Total stockholders' equity...................................................... 39,742 36,102
-------- --------
Total liabilities and stockholders' equity...................................... $384,485 $381,811
======== ========
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
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(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NET UNREALIZED TOTAL
COMMON CAPITAL RETAINED GAIN ON STOCKHOLDERS'
STOCK SURPLUS EARNINGS SECURITIES EQUITY
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<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997........................ $727 $6,385 $27,390 $1,600 $36,102
Net income........................................ 3,300 3,300
Dividends declared: $0.24 per share............... (530) (530)
Dividend reinvestment plan: 3,439 shares issued... 1 119 120
Net change in unrealized gain on securities....... 750 750
---- ------ ------- ------ -------
BALANCE, SEPTEMBER 30, 1998....................... $728 $6,504 $30,160 $2,350 $39,742
==== ====== ======= ====== =======
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
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(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30 1998 1997
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................................ $ 3,300 $ 3,300
Adjustments:
Provision for loan losses............................................................... 315 255
Depreciation, amortization and accretion................................................ 911 666
Amortization of loan fees............................................................... (140) (153)
Deferred income tax benefit............................................................. (16) (6)
Gains on sale of investment securities available-for-sale............................... (235)
Gains on sale of loans held for sale.................................................... (4)
Losses (gains) on other real estate..................................................... 131 (50)
Changes in:
Loans held for sale, net.............................................................. (225)
Interest receivable................................................................... 300 204
Other assets.......................................................................... (332) (358)
Interest payable...................................................................... 97 16
Other liabilities..................................................................... 567 264
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Net cash provided by operating activities........................................... 4,669 4,138
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of available-for-sale investment securities........................... 307
Proceeds from repayments of available-for-sale investment securities...................... 32,973 21,832
Purchases of available-for-sale investment securities..................................... (32,276) (22,827)
Proceeds from sale of other real estate................................................... 144 380
Net increases in lending activities....................................................... (457) (7,895)
Purchases of premises and equipment....................................................... (1,785) (837)
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Net cash used in investing activities............................................... (1,094) (9,347)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts............................. 2,617 667
Time deposits........................................................................... 4,979 (699)
Short-term borrowings................................................................... (9,575) 1,440
Payments on long-term debt................................................................ (2) (2)
Proceeds from issuance of common shares................................................... 120 33
Cash dividends paid....................................................................... (573) (506)
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Net cash provided by (used in) financing activities................................. (2,434) 933
------- -------
Net increase (decrease) in cash and cash equivalents................................ 1,141 (4,276)
Cash and cash equivalents at beginning of year...................................... 17,265 11,032
------- -------
Cash and cash equivalents at end of period.......................................... $18,406 $ 6,756
======= =======
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest................................................................................ $10,336 $10,474
Income taxes............................................................................ 766 712
Noncash items:
Transfer of loans to other real estate.................................................. 214 103
Change in net unrealized gains on available-for-sale securities......................... (750) (519)
Cash dividends declared................................................................. $ 530 $ 395
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements of Comm
Bancorp, Inc. and subsidiary, Community Bank and Trust Company
(collectively, the "Company") have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to form 10-Q and Article 10-01 of
Regulation S-X. In the opinion of management, all normal recurring
adjustments necessary for a fair presentation of the financial position and
results of operations for the periods have been included. All significant
intercompany balances and transactions have been eliminated in the
consolidation. Prior-period amounts are reclassified when necessary to
conform with the current year's presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reported periods. Actual
results could differ from those estimates. For additional information and
disclosures required under GAAP, reference is made to the Company's Annual
Report on Form 10-K for the period ended December 31, 1997.
2. ACCOUNTING FOR MORTGAGE-BACKED SECURITIES:
On October 9, 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard ("SFAS") No. 134, "Accounting
for Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This
Statement amends SFAS No. 65, "Accounting for Certain Mortgage Bank
Activities," to require that after securitization of mortgage loans held
for sale, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed securities or other retained interests as
available-for-sale, held-to-maturity or trading, based on its ability and
intent to sell or hold those investments, in accordance with the provisions
of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The Statement also requires a mortgage banking enterprise to
classify as trading any retained mortgage-backed securities that is commits
to sell before or during the securitization process. SFAS No. 134 is
effective for the first fiscal quarter beginning after December 15, 1998.
The anticipated adoption of SFAS No. 134 on January 1, 1999, is not
expected to have a material effect on the Company's operating results or
financial position as it has no retained mortgage-backed securities or
other interests from the securitization of mortgage loans held for sale.
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
----------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FORWARD-LOOKING DISCUSSION:
Certain statements in this Form 10-Q are forward-looking statements that
involve a number of risks and uncertainties. The following factors, among
others, may cause actual results to differ materially from projected
results:
Banking is affected, directly and indirectly, by local, national 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
Comm Bancorp, Inc. and its subsidiary, Community Bank and Trust Company,
(collectively, the "Company") may adversely affect its future results of
operations. Management, consisting of the Board of Directors and executive
officers, does not expect any particular factor to affect the Company's
results of operations. A downward trend in various sectors, including but
not limited to, 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
continue its current rates of income and growth.
The Company's earnings depend largely 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 affected by regulatory, economic and competitive factors that
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 strategy, management seeks to
control its exposure to interest rate changes by evaluating the maturity
and repricing characteristics of interest-earning assets and interest-
bearing liabilities.
In originating loans, the likelihood exists that some credit losses will
occur. This risk of loss varies with, among other things, general economic
conditions, loan type, 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. Management maintains
an allowance for loan losses based on, among other things, historical loan
loss experience, known inherent risks in the loan portfolio, adverse
situations that may affect a borrower's ability to repay, the estimated
value of any underlying collateral, and an evaluation of current economic
conditions. Management currently believes that the allowance for loan
losses is adequate, but there can be no assurance that nonperforming loans
will not increase in the future.
To a certain extent, the success of the Company is dependent upon the
general economic conditions in the geographic market served by the Company.
Although the Company expects that economic conditions will remain favorable
in its market area, no assurance can be given that such conditions will
continue. Adverse changes in economic conditions of its geographic market
area would likely impair the Company's loan collections and could otherwise
have a materially adverse effect on its consolidated results of operations
and financial position.
The banking industry is highly competitive, with rapid changes in product
delivery systems and in consolidation of service providers. The Company
has many larger competitors in terms of asset size. These competitors also
have substantially greater technical, marketing and financial resources.
Because of their size, many of these competitors offer products and
services the Company does not offer. The Company is constantly striving to
meet the convenience and needs of its customers and to enlarge its customer
base. No assurance can be given that these efforts will be successful in
maintaining and expanding the Company's customer base.
OPERATING ENVIRONMENT:
The Commerce Department reported that the gross domestic product ("GDP"),
the value of goods and services produced in the United States, grew at a
surprising pace of 3.3 percent during the third quarter of 1998. Most
economists expected a rate near the 1.8 percent level reported for the
prior quarter. The primary factor for the increase was the growth of
consumer spending aided to a lesser degree by a rise in inventories.
Specifically, personal-consumption spending largely for services rather
than goods was responsible for the improvement. Consumer spending is
significant to the level of economic growth as it accounts for nearly two-
thirds of the GDP. Despite the strength in the third quarter GDP, inflation
remained tame as indicated by a slight 0.8 percent rise in the GDP
inflation gauge. Moreover, the producer price index experienced only its
second increase in the past ten months at 0.3 percent while the consumer
price index showed no change for September. For the nine months ended
September 30, 1998, inflation is running at a 1.4 percent annual rate which
is less than the 11 year low reported last year. Strong economic growth
with little price change is usually a good sign for the future viability of
financial institutions as their profitability relies heavily on business
and consumer expenditures financed through borrowings. However, concerns of
a credit crunch, unsettled financial markets and slower growth worldwide
which could potentially lead to a recession has shaken confidence. The
credit crunch concerns are primarily a function of loan losses incurred
from hedge funds using borrowed funds from major money center banks and
Wall Street securities firms. Hedge funds made billion dollar bets on
interest rate spreads between risky emerging county bonds and U.S. Treasury
bonds. The losses were incurred when foreign governments began to fail and
the spread deteriorated between the price of the risky bonds and
Treasuries. As a result of these losses, such institutions are unwilling or
unable to extend additional credit to overseas borrowers. Consequently,
this reluctance could reduce foreign demand for domestic goods and may lead
to additional layoffs. Uncertain employment conditions and deterioration
in wealth from stock market volatility has caused consumer confidence to
weaken. The Consumer Confidence Board reported that its index of consumer
confidence fell 9.1 points to 117.3 in October of 1998. This was the fourth
straight month of decline leaving the index at a level not experienced
since December of 1996. This loss of confidence appears to have already
influenced the housing market as all major indicators experienced declines.
Housing starts fell 2.5 percent while building permits declined 4.5 percent
in September. New home sales fell 1.0 percent in September to an annual
sales rate of 822 thousand units. Moreover, the sale of existing homes
declined 1.1 percent in September to a seasonally adjusted annual rate of
4.68 million. This lack of confidence has also made its way to the business
sector as declining corporate profits, tighter credit conditions and excess
capacity have slowed business investment. The purchasing managers' survey
revealed a significant decline in the new orders index from 50.1 in
September to 45.7 in October. A similar decline occurring in 1990 signaled
the onset of a recession. Although alarming, weak confidence by itself
would not signal a major concern if not for the already low saving
patterns. The savings rate, savings as a percentage of after-tax income,
was minus 0.2 percent in September which is the worst performance since
1959. Negative savings occurs when people finance their spending through
taking loans, selling investments or depleting savings. For the nine months
ended September 30, 1998, the savings rate was 0.6 percent, down from 2.1
percent in 1997 and 2.9 percent in 1996. The combination of weak confidence
and low savings may reduce future consumption and lead to a significant
economic slowdown.
It now appears that the aforementioned factors could be significant as they
have influenced the Federal Reserve Open Market Committee ("FOMC") to ease
monetary policy twice within two weeks. On September 30, 1998, the FOMC cut
the federal funds rate by 25 basis points to 5.25 percent. Then
unexpectedly on October 15, 1998, it again reduced the overnight funds rate
by another quarter of a percentage and made a corresponding reduction to
the discount rate, lowering it to 4.75 percent. This marked the first time
the FOMC changed interest rates between regularly scheduled meetings since
April of 1994. The reductions were quickly followed by banks lowering their
prime rates to 8.0 percent in hopes of stimulating loan demand. This action
typically assists the economy by staving off an impending recession.
However, these rate cuts may not be effective as consumer borrowing has
grown rapidly in the past few years leaving most borrowers near their
maximum capacities. With respect to business customers, some financial
institutions are actually raising rates and tightening credit standards in
response to recent losses and regulatory warnings about loose credit
standards.
Local economic conditions have recently shown weakness similar to that
experienced on the national scene. During 1998, employment has registered
only a 0.9 percent increase relative to the same period of 1997. The slower
growth is due mainly to declines in government, manufacturing and retail
trade employment. Despite the modest employment growth, unemployment rates
for the Company's market area declined for all counties with the exception
of Wayne County. However, this favorable trend examined more closely is
misleading as a sharp slowdown in the labor force was primarily responsible
for the unemployment rate declines. With respect to the housing market,
sales of new and existing homes slowed in 1998 and are not expected to meet
1997 levels by year-end. A projected continuation of this slowdown is
troubling for area financial institutions due to the already saturated
competition for a dwindling market. Such conditions will probably lead to
further reductions in pricing and credit standards which could have lasting
adverse implications on future profitability and credit quality. Regional
income growth continued below the levels of the Commonwealth and nation.
This is due to a population which is declining at an accelerated rate, slow
growth of inflation adjusted wage and salary income, and a decline in non-
wage sources of income as a proportion of total income. On a positive note,
the growth of personal bankruptcy filings continued to decelerate,
remaining well below the Commonwealth and national rates.
The banking industry, with the exception of large money center banks,
continued its consistency of higher profitability during the third quarter
of 1998. Many money center banks incurred trading and investment losses
caused by deteriorating hedge funds and collapsing foreign economies. While
other banks were insulated by the foreign problems, they were not immune to
net interest margin compression brought on by the flat yield curve. The
flat yield curve seen through most of 1998 has steadily eroded net interest
margins, with the most severe compression in smaller banks. Although the
recent moves by the FOMC caused a more favorable yield curve slope, the
reduction in rates caused banks to cut their prime rate while competition
restricted the same reduction to its liability side. In addition,
competitive loan pricing and lower reinvestment rates on prepaying
mortgage-related assets suggests that margins will continue to be reduced.
Continuing to offset the declining interest rate margins was an increase in
revenues from a variety of newer fee-based businesses. A nationwide
composite of 137 banks indicated that the return on average assets and
return on equity ratios grew from 1.29 percent and 15.09 percent,
respectively, for the second quarter of 1998, to 1.31 percent and 15.62
percent, respectively, for the third quarter of 1998. Conversely, the net
interest margin of this group continued to decline from 4.41 percent in the
second quarter of 1998 to 4.28 percent in the third quarter. The net
interest margin was 4.51 percent for the third quarter of 1997. With the
exception of large money center banks with exposure to emerging markets,
credit quality remained solid during the third quarter. This strength was
evidenced by a reduction in the level of nonperforming assets as a
percentage of loans, net of unearned income. This ratio declined from 0.63
percent in the second quarter of 1998 to 0.61 percent in the third quarter.
The strength of the allowance for loan losses was stable for the quarter.
The ratio of the allowance for loan losses to loans, net of unearned
income, declined only 0.01 percent from the second quarter of 1998 to 1.48
percent. The coverage ratio of the allowance account to nonperforming loans
rose from 299.36 percent to 325.01 percent for the second and third
quarters of 1998, respectively. Although larger banks have reduced reserves
through charge-offs, most banks continue to have healthy levels of
unallocated reserves along with a solid credit outlook. The ratio of net
charge-offs to average loans increased slightly from 0.26 percent in the
second quarter to 0.28 percent in the third quarter of 1998 but was
favorable as compared to 0.34 percent recorded in the comparable quarter
last year. Capital adequacy declined as compared to the prior quarter. The
equity to asset ratio was 8.57 percent in the second quarter of 1998 and
8.33 percent in the third quarter of 1998. A primary factor in this
decline was the recent action taken by many financial institutions in
repurchasing their common stock as a result of their reduction in value due
to the recent stock market correction.
Results for the local peer group of 35 banks in Northeastern Pennsylvania
were similar to those of financial institutions throughout the nation.
Profitability ratios remained strong, however, the recent buildup in equity
capital caused return on average equity ratios to average approximately 325
basis points less than the level reported for banks nationally. Local
institutions reported a compression in their net interest margins as a
result of stronger competition on both sides of the balance sheet. Asset
quality and loan loss reserve positions improved as a result of recent
improvements in unemployment. Capital positions improved as a function of
greater levels of net income and fair value appreciation in investment
portfolios.
REVIEW OF FINANCIAL POSITION:
The Company's total assets increased at an annual rate of 3.7 percent for
the third quarter, from $381.0 million at June 30, 1998, to $384.5 million
at September 30, 1998. Although less than the comparable 11.5 percent
annual rate of the second quarter of 1998, this level was only slightly
lower than the 4.9 percent annual rate for the local peer group. Increases
in noninterest-bearing deposits and reductions in cash and due from banks
funded the rise in the Company's investment and loan portfolios during the
third quarter. Average assets totaled $374.8 million and $356.3 million for
the nine months ended September 30, 1998 and 1997, respectively. The
Company's investment portfolio grew $4.3 million during the third quarter
of 1998, from $101.6 million at the end of June to $105.9 million at the
end of September. Loans, net of unearned income increased from $246.8
million at June 30, 1998, to $250.3 million at September 30, 1998, a $3.5
million increase. Higher activities in residential mortgages and commercial
loans were primarily responsible for the positive change. For the nine
months ended September 30, 1998 and 1997, average loans amounted to $247.4
million and $239.3 million, respectively. Asset quality improved as
evidenced by a reduction in total nonperforming assets from $4.0 million at
June 30, 1998, to $3.8 million at September 30, 1998. Lower volumes of
loans past due 90 days or more and foreclosed assets offset by higher
levels of impaired loans caused the variation. The negative economic
reports recently issued caused management to increase its emphasis on
monitoring the credit quality of its portfolio in the third quarter of
1998. Such action resulted in the Company reducing the carrying values of
other real estate properties and placing additional past due loans on
nonaccrual status. The losses recognized from the write-downs and reversals
of uncollected accrued interest on loans placed on nonaccrual were offset
by gains on the sale of certain equity securities. Total deposits grew
during the third quarter of 1998 from $338.4 million at June 30, to $340.0
million at September 30. Noninterest-bearing accounts were responsible for
the increase as interest-bearing accounts were unchanged from the end of
the second quarter. For the nine months ended September 30, average total
deposits increased 4.3 percent from $320.2 million in 1997 to $334.0
million in 1998. Stockholders' equity increased from $38.5 million at June
30, 1998, to $39.7 million at September 30, 1998, a 3.1 percent increase.
Recognition of net income of $1.15 million and an increase in the
unrealized holding gain on the available-for-sale investment portfolio of
$335 partially offset by dividends, net of reinvestment, of $197 were
responsible for the improvement. On August 19, 1998, the Company's Board of
Directors approved a new dividend policy that will systematically increase
the dividend payout ratio to a level consistent with its peer group.
Accordingly, the dividend declared for the third quarter of 1998 was $0.10
per share compared to $0.07 per share for the previous quarter, a 43
percent increase. Cash dividends declared in 1998 totaled $0.24 per share,
a 33 percent increase, compared to $0.18 per share for the same period last
year.
INVESTMENT PORTFOLIO:
The yield curve continued its descent during the third quarter of 1998 as
turbulence in financial markets and worries about hedge funds caused fixed-
income investors to increase demand for U.S. Treasuries. Consequently,
prices of such bonds skyrocketed causing an inverse reaction on their
yields. Short-term rates, represented by the two-year constant maturity
Treasury, declined 119 basis points from 5.49 percent at June 30, 1998, to
4.30 percent on September 30, 1998. Similarly, long-term rates, represented
by the 30-year constant maturity Treasury, decreased, to a lesser extent,
by 64 basis point from 5.62 percent to 4.98 percent at June 30, and
September 30, 1998, respectively. The recent action taken by the FOMC has
begun to correct the slope of the yield curve so that investors are
compensated for investing funds for longer periods. Another significant
occurrence with respect to the bond market in the third quarter was the
widening of the spread between mortgage-backed securities and U.S.
Treasuries. This widening can be best exemplified by examining the spread
between the Federal National Mortgage Association ("FNMA") commitment rate
for 30-year loans and the 10-year constant maturity Treasury. This spread
grew from 143 basis points at the beginning of the third quarter to 201
basis points at the end of the quarter. The reason for the widening was
that investors needed to be compensated for taking on prepayment risk when
investing in mortgage-backed securities during a declining interest rate
environment. Lower interest rates typically increase principal cash flows
causing investors' returns to be reduced as they are forced to reinvest
these funds at lower rates.
As a result of these market conditions, management began the third quarter
by retaining a higher amount of its excess resources in federal funds sold
because of the flat yield curve and the lower comparable return on U.S.
Treasury issues. As the quarter progressed, the threat of a federal funds
rate cut grew stronger, and management shifted investment repayments not
utilized for lending to short-term high-quality mortgage-backed securities.
Management does not expect these holdings to be subject to significant
prepayment risk from further reductions in interest rates because of their
composition and structure and the low relative rates on the collateral
securitizing such investments. As a percentage of total mortgage-backed
securities, principal repayments only increased from 1.8 percent in January
to 2.0 percent in September despite a marked decrease in FNMA 30-year
commitment rate from the beginning of 1998 to the end of the third quarter.
This rate was 7.12 percent on January 31, 1998, decreasing 67 basis points
to 6.45 percent on September 30, 1998. Management does not expect further
reductions in interest rates to significantly increase the Company's
exposure to prepayment and reinvestment risk based on stress tests at
September 30, 1998. Given parallel instantaneous interest rate declines of
100, 200 and 300 basis points, monthly repayments on mortgage-backed
securities are expected to increase by $400, $773 and $1.1 million,
respectively, over the next twelve months as compared to prepayments under
an unchanged interest rate scenario. In the near-term, management expects
to continue investing excess funds into high-quality mortgage-backed
securities having short average and contractual maturities until slope
returns to the U.S. Treasury yield curve.
The following table sets forth the carrying values of the major
classifications of securities as they relate to the total investment
portfolio at September 30, 1998, and December 31, 1997:
<TABLE>
<CAPTION>
DISTRIBUTION OF INVESTMENT SECURITIES AVAILABLE-FOR-SALE
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- ---------------
AMOUNT % AMOUNT %
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities........................ $ 15,114 14.27% $ 28,583 27.05%
U.S. Government agencies........................ 2,638 2.49 10,388 9.83
State and municipals............................ 40,030 37.79 39,887 37.75
Mortgage-backed securities...................... 44,738 42.23 23,746 22.47
Equity securities............................... 3,420 3.22 3,062 2.90
-------- ------ -------- ------
Total......................................... $105,940 100.00% $105,666 100.00%
======== ====== ======== ======
</TABLE>
The Company's investment portfolio increased from $101.6 million at June
30, 1998, to $105.9 million at September 30, 1998. Investment portfolio
activity for the quarter included proceeds from repayments of $9.8 million
and purchases totaling $13.8 million. Acquisitions of mortgage-backed
securities offset by maturities of U.S. Treasury and Government agency
securities were primarily responsible for the change. The yield curve being
below the federal funds rate for most of 1998 caused a reduction in the
average volume of the investment portfolio from $98.5 million to $96.8
million for the nine months ended September 30, 1997 and 1998,
respectively. The Company's average investment in federal funds sold was
$6.0 million and $11.3 million, respectively, for the comparable periods of
1997 and 1998. The tax-equivalent yield on the investment portfolio
increased to 6.82 percent for the nine months ended September 30, 1998,
from 6.58 percent for the same period last year. However, this yield
declined from 6.90 percent for the second quarter of 1998 to 6.75 percent
for the third quarter of 1998, as short-term investments accounted for a
greater proportion of the overall portfolio. The declining interest rate
environment had a positive influence on the unrealized holding gain on the
available-for-sale investment portfolio. The investment portfolio's market
value exceeded its historical costs basis by $2.4 million at December 31,
1997. Comparable amounts at June 30, 1998, and September 30, 1998, were
$3.1 million and $3.6 million, respectively. The third quarter's fair value
appreciation would have been greater if not for the Company realizing a
portion of the gain through the sale of certain equity securities. As
aforementioned, management became more critical of its nonperforming assets
during the third quarter causing the Company to recognize losses from
foreclosed asset write-downs and uncollected interest reversals upon
placing loans on nonaccrual status. In order to offset these losses,
management sold $308 of equity securities realizing a gain of $235. The
modified duration of the Company's investment portfolio declined from 1.9
years at June 30, 1998, to 1.6 years at September 30, 1998, indicating that
portfolio is less susceptible to fair value fluctuations from interest rate
changes. Specifically, given immediate and parallel shifts of plus 100, 200
and 300 basis points, management expects price depreciations of 1.5
percent, 3.1 percent and 4.8 percent, respectively. Conversely, such
changes of minus 100, 200 and 300 basis points should result in portfolio
price appreciations of 1.4 percent, 2.9 percent and 4.4 percent,
respectively.
In addition to analyzing the effects various risk elements may have on the
investment portfolio, management reviews the portfolio's performance
quarterly using a national digest that provides a complete risk and return
ranking of bank investment portfolio performance utilizing total return.
Total return is defined as the cumulative dollar return from an investment
in a given period. Total return is a superior measure to performance as
compared to tax-equivalent yield as it considers not only the sum of all
interest income but also reinvestment income on all proceeds from
repayments and capital gains and losses, whether realized or unrealized.
Results from the most recent quarterly report, indicated that the Company's
total return over the last twelve months was 8.3 percent as of June 30,
1998. This performance placed the Company in the upper 8.0 percent of the
892 bank holding companies reporting. In addition, this digest utilizes
average life to indicate the riskiness of a bank's investment portfolio.
The average life of the Company's portfolio over the last year was 1.35
years placing it in the upper 20th percentile with respect to quality.
The following table sets forth the maturity distribution of the amortized
cost, fair value and weighted-average, tax-equivalent yield of the
available-for-sale portfolio at September 30, 1998. The weighted-average
yield, based on amortized cost, has been computed for state and municipals
on a tax-equivalent basis using the statutory tax rate of 34.0 percent.
The distributions are based on contractual maturity with the exception of
mortgage-backed securities and equity securities. Mortgage-backed
securities have been presented based upon estimated cash flows, assuming no
change in the current interest rate environment. Equity securities with no
stated contractual maturities are included in the after ten year maturity
distribution. Expected maturities may differ from contractual maturities
because borrowers have the right to call or prepay obligations with or
without call or prepayment penalties.
<TABLE>
<CAPTION>
MATURITY DISTRIBUTION OF AVAILABLE-FOR-SALE PORTFOLIO
AFTER ONE AFTER FIVE
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
-----------------------------------------------------------------------------
SEPTEMBER 30, 1998 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. Treasury securities..... $15,024 5.84% $ 15,024 5.84%
U.S. Government agencies..... 2,000 5.38 $ 649 3.59% 2,649 4.94
State and municipals......... 1,860 5.68 5,519 6.93 $7,755 8.78% $22,775 8.19% 37,909 8.00
Mortgage-backed securities... 17,191 6.46 27,215 6.28 139 6.36 44,545 6.35
Equity securities............ 2,253 6.68 2,253 6.68
------- ------- ------ ------- --------
Total...................... $36,075 6.10% $33,383 6.34% $7,894 8.74% $25,028 8.05% $102,380 6.86%
======= ======= ====== ======= ========
Fair value:
U.S. Treasury securities..... $15,114 $ 15,114
U.S. Government agencies..... 2,000 $ 638 2,638
State and municipals......... 1,867 5,623 $8,295 $24,245 40,030
Mortgage-backed securities... 17,200 27,396 142 44,738
Equity securities............ 3,420 3,420
------- ------- ------ ------- --------
Total...................... $36,181 $33,657 $8,437 $27,665 $105,940
======= ======= ====== ======= ========
</TABLE>
LOAN PORTFOLIO:
Loans to finance one-to-four family residential properties account for the
majority of the Company's lending activities. Such credits accounted for
approximately one-half of total loan originations during the third quarter
of 1998. At September 30, 1998, residential mortgage loans as a percentage
of the Company's entire loan portfolio were 64.1 percent. Consequently,
management expects loan demand to weaken in the fourth quarter of 1998 as
a result of the recent downturn in the housing market, cyclical trends
caused by weather and increased competition.
As aforementioned, the housing market across the United States showed signs
of weakness recently as evidenced by declines in all major indicators.
Housing starts and building permits fell 2.5 percent and 4.5 percent,
respectively, in September. New home sales posted their third consecutive
decline falling 1.0 percent in September. The inventory of unsold homes
increased reducing the pressure on homebuilders to step up the pace of
housing starts. Sales of existing single-family homes fell for the second
consecutive month, to a seasonally adjusted annual rate of 4.68 million at
the end of the third quarter. The 1.1 percent decline in September followed
a 3.7 percent decline in the prior month. With the onset of consecutive
monthly declines in housing statistics, coupled with a higher level of
families already owning homes, it appears that the peak for the housing
cycle has ended. Lower rates should continue to support demand, however,
other key factors will work against this sector and should begin to produce
noticeable weakness by year-end. Falling consumer confidence, declining
investment portfolio wealth along with slower job and income growth will
hinder loan demand for housing. Similar conditions have been and are
expected to continue to be experienced throughout the Company's market
area.
Demand for consumer credit and business lending is also expected to be
weaker in the near-term. The Federal Reserve reported weaker demand for
consumer installment debt in a survey of senior lenders for August and
September. This weakness is expected to continue as high consumer debt
levels coupled with the reversal of wealth from declining stock prices
should have an adverse impact on demand. Although helpful in stimulating
demand for business loans, the influence of recent cuts in the prime rate
do not appear to have offset the impact of recent losses incurred causing
a reluctance by many banks to lend funds to their larger customers.
However, lending to small businesses is expected to remain strong both
locally and throughout the nation during the final quarter of 1998.
Originations to small businesses accounted for one-quarter of all loans
originated by the Company during the third quarter of 1998. Management,
anticipating increased activity in small business lending through the
planned expansion in its delivery system, strengthened its underwriting and
loan review departments.
The following table sets forth the major categories of the loan portfolio
at September 30, 1998, and December 31, 1997:
<TABLE>
<CAPTION>
DISTRIBUTION OF LOAN PORTFOLIO
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------------ -----------------
AMOUNT % AMOUNT %
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial, financial and others.......... $ 32,677 13.06% $ 38,996 15.58%
Real estate:
Construction............................ 2,440 0.97 2,096 0.84
Mortgage................................ 185,278 74.02 180,123 71.98
Consumer, net............................. 29,906 11.95 29,012 11.60
-------- ------ -------- ------
Loans, net of unearned income........... 250,301 100.00% 250,227 100.00%
====== ======
Less: allowance for loan losses........... 3,804 3,798
-------- --------
Net loans............................. $246,497 $246,429
======== ========
</TABLE>
Loans, net of unearned income, grew at an annual rate of 5.6 percent during
the third quarter of 1998. For the nine months ended September 30, 1998,
loans, net, adjusted for $7.0 million of loans to certain large
Pennsylvania-based banks, grew at 3.9 percent annualized. The comparable
rate for the peer group for the three quarters ended September 30, 1998,
was the same as the Company's third quarter growth rate. Management expects
to facilitate loan demand through core deposit increases and loan and
investment repayments. The loan portfolio's tax-equivalent yield increased
from 8.55 percent for the nine months ended September 30, 1997, to 8.56
percent for the comparable period this year. Such a small increase is, in
reality, a significant accomplishment considering the sharp reduction in
general market rates for these two periods. For the nine months ended
September 30, 1997 and 1998, average short-term interest rates fell 69
basis points while average long-term interest rates declined 102 basis
points. In a quarterly comparison, the Company experienced a reduction in
its loan portfolio's tax-equivalent yield from 8.59 percent in the second
quarter of 1998 to 8.45 percent in the third quarter of 1998. This
reduction is a reflection of the reversal of accrued interest on loans
placed on nonaccrual status.
With the increase in home prices and lower mortgage rates, the volume of
refinancings has intensified as borrowers have consolidated bills to make
lower aggregate debt burdens. Although refinancing has indeed picked up,
now accounting for more than half of current mortgage applications, the
rise is not as great as was expected. Moreover, refinances are not expected
to increase in the near-term as those holders of mortgages with rates of
8.0 percent or more have already refinanced. Based on the costs to
refinance, rates are still not low enough to induce homeowners with
aggregate mortgage debt outstanding of $2.7 trillion at 7.0 percent to 8.0
percent to refinance. A similar trend was seen for the Company during 1998
as it did not experience a significant change in the aggregate amount of
mortgage loans refinanced over the prior year. Refinances for the nine
months ended September 30, 1998, totaled $8.7 million as compared to $7.6
million for the comparable period of 1997.
The Company successfully began secondary mortgage banking activities during
the third quarter. Secondary mortgage banking activities consist primarily
of the origination of mortgage loans for sale to secondary market investors
and the subsequent internal servicing of those loans. This program affords
the Company an opportunity to competitively price loan products while
reducing its exposure to interest rate risk and increasing its liquidity.
The income generated from gains on the sale on loans and creation of
servicing fees will assist in increasing noninterest income. At September
30, 1998, the Company had $229 of residential mortgage loans held for sale.
Management continually examines the maturity distribution and interest rate
sensitivity of the loan portfolio to limit interest rate risk and manage
liquidity. The volume of loans repricing within the next twelve months,
increased from 30.5 percent at June 30, 1998, to 31.0 percent at September
30, 1998. Variable rate loans increased slightly during the third quarter
from $47.6 million at June 30, 1998, to $48.0 million at September 30,
1998.
The following table sets forth the maturity and repricing schedule of the
loan portfolio by major category at September 30, 1998:
<TABLE>
<CAPTION>
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
SEPTEMBER 30, 1998 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maturity schedule:
Commercial, financial and others..... $17,366 $ 8,931 $ 6,380 $ 32,677
Real estate:
Construction....................... 2,440 2,440
Mortgage........................... 22,280 54,914 108,084 185,278
Consumer, net........................ 10,361 15,311 4,234 29,906
------- ------- -------- --------
Total............................ $52,447 $79,156 $118,698 $250,301
======= ======= ======== ========
Repricing schedule:
Predetermined interest rates......... $29,523 $69,335 $103,462 $202,320
Floating or adjustable interest rates 47,981 47,981
------- ------- -------- --------
Total............................ $77,504 $69,335 $103,462 $250,301
======= ======= ======== ========
</TABLE>
ASSET QUALITY:
National and local economic conditions affecting asset quality remained
strong during the third quarter of 1998. The growth of personal
bankruptcies has recently slowed especially in the Company's quad-county
market area. Unemployment rates in the counties served by the Company
improved or remained at their already low levels, except for Wayne County
which experienced a 0.2 percent increase.
The following table sets forth unemployment rates for the United States,
Pennsylvania and market area counties at September 30, 1998, and June 30,
1998:
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
- ---------------------------------------------------------------------------------------
<S> <C> <C>
United States........................................... 4.4% 4.5%
Pennsylvania............................................ 4.3 4.3
Lackawanna ............................................. 4.8 5.6
Susquehanna............................................. 4.1 4.1
Wayne................................................... 5.1 4.9
Wyoming................................................. 6.0% 6.3%
</TABLE>
Despite the favorable trends in personal bankruptcies and unemployment,
there are other factors that may serve to weaken asset quality. Slower
income growth, higher levels of personal debt and recent wealth reductions
due to declines in the stock market are among these factors. Worker's
income lost ground as the slight increase in hourly earnings was more than
offset by a larger decline in the average workweek. Hourly earnings rose
0.1 percent in September down from 0.5 percent for the prior month.
However, the recent decline in the average workweek down to 34.4 hours in
September caused income to decline. Employers typically cut employees hours
prior to actually laying them off so that the recent workweek declines may
have serious implications in the future. In addition, job growth slowed in
September adding only one-fifth of the volume added in August. Such
conditions raised concerns from federal officials as they called for
continued vigilance in credit quality during a recent Federal Financial
Institutions Examination Council meeting. Institutions were told, depending
on their status, to bolster reserves, step up collection efforts, review
collateral and upgrade workout capacities in the event of an economic
downturn. The Company's management heeded these warnings by increasing its
emphasis on credit quality. During the third quarter of 1998, management
wrote-down other real estate properties due to reductions in their
appraised values and transferred certain credits to nonaccrual status. As
a result, the Company recognized losses which were offset by gains on the
sale of a portion of its equity holdings.
The following table sets forth information concerning nonperforming assets
at September 30, 1998, and December 31, 1997. The table includes all
credits classified for regulatory purposes. Also included are all material
credits that cause management to have serious doubts as to the borrowers'
ability to comply with present loan repayment terms.
<TABLE>
<CAPTION>
DISTRIBUTION OF NONPERFORMING ASSETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
Nonaccrual loans:
Commercial, financial and others............................... $ 283 $ 197
Real estate:
Construction.................................................
Mortgage..................................................... 1,600 2,063
Consumer, net.................................................. 12 12
------ ------
Total nonaccrual loans..................................... 1,895 2,272
------ ------
Restructured loans............................................. 178 189
------ ------
Total impaired loans....................................... 2,073 2,461
------ ------
Loans past due 90 days or more:
Commercial, financial and others............................... 156 321
Real estate:
Construction.................................................
Mortgage..................................................... 919 2,536
Consumer, net.................................................. 337 312
------ ------
Total loans past due 90 days or more....................... 1,412 3,169
------ ------
Total nonperforming loans.................................. 3,485 5,630
------ ------
Foreclosed assets.............................................. 344 405
------ ------
Total nonperforming assets................................. $3,829 $6,035
====== ======
Ratios:
Impaired loans as a percentage of loans, net................... 0.83% 0.98%
Nonperforming loans as a percentage of loans, net.............. 1.39 2.25
Nonperforming assets as a percentage of loans, net............. 1.53% 2.41%
</TABLE>
Aggregate nonperforming assets amounted to $6.0 million at December 31,
1997, $4.0 million at June 30, 1998, and $3.8 million at September 30,
1998. Nonperforming assets as a percentage of loans, net of unearned
income, continued to improve declining from 2.41 percent at the end of 1997
to 1.63 percent at June 30, 1998, and 1.53 percent at September 30, 1998.
In comparison, the local peer group's ratios were 1.22 percent, 1.23
percent and 1.18 percent, respectively. The primary influence for the
improvement in the Company's results as compared to year-end 1997 was a
marked reduction in the level of accruing loans past due 90 days or more.
For the quarter ended September 30, 1998, the slight reduction of $197 in
nonperforming assets was primarily a result of the write-downs on
foreclosed assets. The volume of nonperforming loans was relatively
unchanged at September 30, 1998, as compared to the previous quarter as
loans past due 90 days or more were transferred into the nonaccrual
category. As a result, impaired loans as a percentage of loans, net of
unearned income, increased to 0.83 percent at September 30, 1998, from 0.63
percent at June 30, 1998. The comparable ratio for the peer group at the
end of the third quarter was 0.68 percent. Management expects such problem
loans to decrease in the final quarter as a result of enforcing the
stricter formalized collection efforts with respect to impaired loans.
The following table sets forth information relating to the Company's
recorded investment in impaired loans at September 30, 1998, and December
31, 1997:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Impaired loans:
With a related allowance....................................... $1,895 $2,272
With no related allowance...................................... 178 189
------ ------
Total........................................................ $2,073 $2,461
====== ======
</TABLE>
Impaired loans include a $178 restructured loan to one commercial customer.
This loan continued to perform in accordance with its modified terms during
1998.
The following table sets forth a reconcilement of the allowance for loan
losses account related to impaired loans for the nine months ended
September 30, 1998:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
- ---------------------------------------------------------------------------------------
<S> <C>
Balance at January 1.............................................................. $541
Provision for loan losses......................................................... 86
Loans charged-off................................................................. 117
Loans recovered................................................................... 33
----
Balance at period-end............................................................. $543
====
</TABLE>
The following table sets forth the amount of interest income that would
have been recognized had the loans been current and the terms of the loan
not been modified, the amount of interest income recognized, the amount
recognized using the cash-basis method and the average recorded investment
in impaired loans for the three months and nine months ended September 30,
1998 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross interest due under terms.................. $ 40 $ 42 $ 128 $ 108
Interest income recognized...................... 25 29 89 33
------ ------ ------ ------
Interest income not recognized.................. $ 15 $ 13 $ 39 $ 75
====== ====== ====== ======
Interest income recognized (cash-basis)......... $ 25 $ 29 $ 89 $ 33
Average recorded investment in impaired loans... $1,631 $2,833 $1,716 $1,950
</TABLE>
Cash received on impaired loans applied as a reduction to principal totaled
$464 for the nine months ended September 30, 1998, and $267 for the same
period of 1997. For the quarter ended September 30, 1998, cash receipts on
impaired loans equaled $254 as compared to $148 for the quarter ended
September 30, 1997. No commitments to extend additional funds to these
parties existed at September 30, 1998.
The allowance for loan losses account is established through charges to
earnings in the form of a provision for loan losses. Loans, or portions of
loans, determined to be uncollectible are charged against the allowance
account with any subsequent recoveries being credited to the account.
Nonaccrual, restructured and large delinquent commercial and real estate
loans are reviewed monthly to determine if carrying value reductions are
warranted. Consumer loans are considered losses when they are 120 days
past due, except those expected to be recovered through insurance or
collateral disposition proceeds. Under GAAP, the allowance for loan losses
related to impaired loans is based on discounted cash flows using the
loan's initial effective interest rate or the fair value of the collateral
for certain collateral-dependent loans. Management uses historical loss
experience as a starting point for evaluating the adequacy of the Company's
allowance account. However, it also considers a number of relevant factors
that would likely cause estimated credit losses associated with the
Company's current portfolio to differ from historical loss experience.
These factors include, among others, changes in lending policies and
procedures, economic conditions, nature and volume of the portfolio, loan
review system, volumes of past due and classified loans, concentrations,
borrowers' financial status, and collateral value.
In addition to management's assessment, various regulatory agencies, as an
integral part of their routine annual examination process, review the
Company's allowance for loan losses. These agencies may require the
Company to recognize additions to the allowance, beyond normal monthly
provisions, based on their judgments concerning information available to
them at the time of their examination. No such charge was deemed necessary
upon the conclusion of the latest examination during the third quarter of
1997, as regulators considered the Company's allowance for loan losses
account adequate based on risk characteristics and size of the loan
portfolio. Upon reviewing the 1997 report, management was unaware of any
significant recommendation with respect to the loan portfolio that would
materially affect future liquidity or capital resources.
Management utilizes the federal banking regulatory agencies' Interagency
Policy Statement on the Allowance for Loan and Lease Losses in assessing
the adequacy of its allowance for loan losses account. The policy
statement provides guidance on the nature and purpose of the allowance,
related responsibilities of management and examiners, loan review systems
and international transfer risk matters. The analytical tool for assessing
the reasonableness of the allowance for loan losses account included in
this policy statement has been used on a consistent basis by the Company
since the first quarter of 1994. The tool involves a comparison of the
reported loss allowance against the sum of specified percentages, based on
industry averages, applied to certain loan classifications. In addition to
utilizing this tool, management will continue to perform a thorough
analysis of the Company's loan portfolio since the calculation does not
take into account differences between institutions, their portfolios, and
their underwriting, collection and credit-rating policies. Management
considered the Company adequately reserved at September 30, 1998, based on
the results of this regulatory calculation. However, management is
currently considering making additional allocations beyond its normal
monthly provision during the final quarter of 1998 based on the
aforementioned regulatory cautions and local economic conditions.
The allowance for loan losses can generally absorb losses throughout the
loan portfolio, although in some instances allocation is made for specific
loans or groups of loans. Accordingly, the following table attempts to
allocate this reserve among the major categories. However, it should not
be interpreted as an indication that charge-offs in future periods will
occur in these amounts or proportions, or that the allocation indicates
future charge-off trends.
<TABLE>
<CAPTION>
DISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- --------------
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial, financial and others................... $1,324 13.06% $1,322 15.58%
Real estate:
Construction..................................... 0.97 0.84
Mortgage......................................... 1,278 74.02 1,277 71.98
Consumer, net...................................... 1,202 11.95 1,199 11.60
------ ------ ------ ------
Total.......................................... $3,804 100.00% $3,798 100.00%
====== ====== ====== ======
</TABLE>
The allowance for loan losses account was $3,804 at September 30, 1998, as
compared to $3,798 at December 31, 1997. For the quarter ended September
30, 1998, this account decreased by $85 as a result of net charge-offs
exceeding the third quarter provision of $105. The increased volume of
loans charged-off in the third quarter was a result of a higher level of
management scrutiny with respect to credit quality. As a percentage of
nonperforming loans, the allowance account covered 109.2 percent at
September 30, 1998, as compared to 110.3 percent and 67.5 percent at June
30, 1998, and December 31, 1997, respectively. For the local peer group
this ratio was 88.1 percent at September 30, 1998. The comparable ratio
continued to be much greater for the national peer group at 352.0. Relative
to all nonperforming assets, the allowance account covered 99.3 percent at
September 30, 1998, a slight improvement over the 96.6 percent recorded at
the end of the previous quarter. This ratio was 62.9 percent at year-end
1997. The Company's allowance for loan losses account as a percentage of
period-end loans was 1.52 percent at September 30, 1998. This figure is a
reduction from 1.58 percent at June 30, 1998, but equals the level reported
at year-end 1997. The third quarter reduction in such ratio was a function
of the greater volume of net loans charged-off during the quarter.
Past due loans that have not been satisfied through repossession,
foreclosure, or related actions were evaluated individually to determine if
all or part of the outstanding balance should be charged against the
allowance for loan losses account. Subsequent recoveries, if any, were
credited to the allowance account. Net charge-offs equaled $309 for the
nine months ended September 30, 1998, compared to $268 for the same period
of 1997.
The following table sets forth a reconcilement of the allowance for loan
losses account and illustrates the charge-offs and recoveries by major loan
category for the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30,
1998
- --------------------------------------------------------------------------------------
<S> <C>
Allowance for loan losses at beginning of period............................... $3,798
Loans charged-off:
Commercial, financial and others............................................... 162
Real estate:
Construction.................................................................
Mortgage..................................................................... 100
Consumer, net.................................................................. 194
------
Total...................................................................... 456
------
Loans recovered:
Commercial, financial and others............................................... 59
Real estate:
Construction.................................................................
Mortgage..................................................................... 34
Consumer, net.................................................................. 54
------
Total...................................................................... 147
------
Net loans charged-off.......................................................... 309
------
Provision charged to operating expense......................................... 315
------
Allowance for loan losses at end of period..................................... $3,804
======
Ratios:
Net loans charged-off as a percentage of average loans outstanding............. 0.12%
Allowance for loan losses as a percentage of period end loans.................. 1.52%
</TABLE>
DEPOSITS:
The declining interest rate environment has made it more difficult for
financial institutions to achieve acceptable returns on their loans and
investments. Many banks combated the yield declines by either taking on
additional credit risk or significantly lengthening the average lives of
these financial instruments. As an alternative strategy, management has
chosen to become less aggressive with respect to deposit pricing,
sacrificing aggressive growth until such time when an adequate spread
between earning assets and interest-bearing liabilities returns. The recent
volatility in the stock market and resulting capital depreciation in
portfolio values along with the yield reduction in U.S. Treasury securities
has caused depositors to return to banks. In the quarter ended September
30, 1998, the spread between bank time deposits and corresponding Treasury
yields reversed. During the second quarter of 1998, the average time
deposit yield was 33 basis points below the yield on the U.S. Treasury.
Conversely, the average time deposit yield was 67 basis points above the
yield on the U.S. Treasury during the third quarter of 1998. Accordingly,
management expects any negative repercussions of not aggressively pricing
deposits to be mitigated as investors concerned for the safety of their
stock portfolio, liquidate their holdings and transfer these funds into
time deposits.
The success of the aforementioned pricing strategy could be hampered by
President Clinton's signing of the Credit Union Membership Act on August 7,
1998. The Act allows occupation-based credit unions to accept new members
from groups of fewer than 3,000 people even if the new members have no
common bond of occupation with the original members. It also gives the
National Credit Union Administration authority to allow members of a larger
group to join an existing credit union if the agency determines that the
group could not sustain its own credit union. In addition to increasing
deposit competition, the Act places further pressure on banks as it allows
credit unions to make business loans up to 12.25 percent of their net
worth. Management expects this legislation to impact its product pricing in
the future because of the significant influence credit unions have in its
market area.
The cost of deposits during the third quarter of 1998 continued to be more
expensive to financial institution in the Company's market area as compared
to other regions of Pennsylvania. The cost of a one year certificate of
deposit ranged from 4.29 percent in the northwest portion of the
Commonwealth to 5.00 percent in the northeast. The results were similar
when comparing the cost of long-term funds as the northeast sector exceeded
the rates offered by all other areas with the exception of the southwest.
The Company's annualized rate of deposit growth in the third quarter of
1998 slowed to 1.9 percent from 11.4 percent during the previous quarter.
For the nine months ended September 30, 1998, the annualized deposit growth
rate of 3.1 percent was slightly lower than the peer group's rate of 4.1
percent. Demand deposits were primary responsible for the third quarter
growth as the level of time deposits and interest-bearing transaction type
accounts were constant throughout the period. Demand deposits increased as
management was successful in attracting a higher concentration of
commercial customers. However, the Company continues to trail its peer
group with respect to the level of this type of low cost deposit. During
1998, demand deposits averaged 13.3 percent of total assets for the peer
group as compared to 8.5 percent for the Company. Average demand deposits
accounted for 7.6 percent of the Company's total average assets in 1997.
Aggregate deposits averaged $334.0 million for the nine month ended
September 30, 1998, compared to $320.2 million for the same period last
year. The increase was attributed to the Company's expansion of its
delivery system through the acquisition of two community banking offices in
the fourth quarter of 1997. The cost of interest-bearing deposits declined
16 basis points from 4.78 percent in 1997 to 4.61 percent in 1998.
Conversely, the cost of such deposits rose from 4.24 percent in 1997 to
4.37 percent in 1998 for the peer group. For the third quarter of 1998, the
Company's cost of interest-bearing deposits declined to 4.58 percent from
4.64 percent and 4.61 percent in the first and second quarters of 1998,
respectively. Management expects this trend to continue in the near term
based on the implementation of its aforementioned pricing strategy and the
expected continuation of reductions in general market rates. Moreover,
management's recent introduction of a fixed-rate annuity program will serve
as an alternative product offering for those customers desiring higher
returns without adversely affecting the Company's cost of funds.
The following table sets forth the average amount of and the rate paid on
the major classifications of deposits for the nine months ended September
30, 1998, and September 30, 1997:
<TABLE>
<CAPTION>
DEPOSIT DISTRIBUTION
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
----------------- -----------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest-bearing:
Money market accounts....................... $ 17,393 3.05% $ 16,331 3.14%
NOW accounts................................ 21,186 2.17 18,054 2.19
Savings accounts............................ 64,282 2.59 65,254 2.96
Time less than $100......................... 175,654 5.62 163,471 5.71
Time $100 or more........................... 23,741 5.91 30,114 6.15
-------- --------
Total interest-bearing.................... 302,256 4.61% 293,224 4.78%
Noninterest-bearing......................... 31,739 27,021
-------- --------
Total deposits............................ $333,995 $320,245
======== ========
</TABLE>
Volatile deposits, time deposits in denominations of $100 or more,
increased from $20.8 million at December 31, 1997, to $25.3 million at
September 30, 1998. The level of such deposits was relatively unchanged
during the third quarter of 1998. The Company's average cost of these
deposits declined significantly from 6.15 percent in 1997 to 5.91 percent
in 1998. The peer group cost for $100 or more time deposits was 5.50
percent in 1998. The total amount of interest expense recognized by the
Company on these deposits decreased from $1.4 million in 1997 to $1.1
million in 1998 as the rate reduction more than offset the volume increase.
Despite the increased volume, the Company relies less on this higher
costing deposit as compared to its peer group. Average time deposits of
$100 or more accounted for 6.3 percent of average total assets in 1998 for
the Company. Comparatively, this type of deposit averaged 10.6 percent for
the peer group in 1998.
The following table sets forth maturities of time deposits of $100 or more
for September 30, 1998, and December 31, 1997:
<TABLE>
<CAPTION>
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
SEPTEMBER 30, DECEMBER 31,
1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Within three months........................................... $ 8,876 $ 3,195
After three months but within six months...................... 3,166 2,819
After six months but within twelve months..................... 5,337 6,334
After twelve months........................................... 7,954 8,484
------- -------
Total....................................................... $25,333 $20,832
======= =======
</TABLE>
MARKET RISK SENSITIVITY:
Market risk is the risk to a company's financial position resulting from
changes in market rates or prices, such as, interest rates, foreign
exchange rates or commodity prices. The Company has no exposure to foreign
currency exchange risk nor does it have any specific exposure to commodity
price risk. The major area of market risk exposure to the Company is
interest rate risk. The Company's exposure to interest rate risk can be
explained as the potential for change in its reported earnings and/or the
market value of its net worth. Variations in interest rates affect the
Company's earnings by changing its net interest income and its level of
other interest-sensitive income and operating expenses. Interest rate
changes also affect the underlying value of the Company's assets,
liabilities and off-balance sheet items. These changes arise because the
present value of future cash flows, and often the cash flows themselves,
change with interest rates. The affects of the changes in these present
values reflect the change in the Company's underlying economic value and
provide a basis for the expected change in future earnings related to
interest rates. Interest rate risk is inherent in the role of banks as
financial intermediaries, however a bank with a high exposure to interest
rate risk may experience lower earnings, impaired liquidity and capital
positions and, most likely, a greater risk of insolvency. Therefore, banks
must carefully evaluate interest rate risk to promote safety and soundness
in their activities.
The Company utilizes interest rate sensitivity management in an attempt to
limit and, to the extent possible, control the effects interest rate
fluctuations have on net interest income and the market value of financial
instruments. The responsibility of such management has been delegated to
the Asset Liability Management Committee ("ALCO"). Specifically, ALCO
utilizes a number of computerized modeling techniques to monitor and
attempt to control influences that market changes have on the Company's
rate sensitive assets and liabilities. One such technique utilizes a static
gap report, which attempts to measure the Company's interest rate exposure
by calculating the net amount of rate sensitive assets ("RSA") and rate
sensitive liabilities ("RSL") that reprice within specific time intervals.
A positive gap, indicated by an RSA/RSL ratio greater than 1.0, means that
earnings will be impacted favorably if interest rates rise and adversely if
interest rates fall during the period. A negative gap tends to indicate
that earnings will be affected inversely to interest rate changes.
The following table sets forth the Company's interest rate sensitivity gap
position at September 30, 1998, illustrating RSA and RSL at their related
carrying values. The distributions in the table are based on a combination
of maturities, call provisions, repricing frequencies and prepayment
patterns. Variable-rate assets and liabilities are distributed based on
the repricing frequency of the instrument. Mortgage instruments are
distributed in accordance with estimated cash flows, assuming there is no
change in the current interest rate environment.
<TABLE>
<CAPTION>
INTEREST RATE SENSITIVITY
DUE AFTER DUE AFTER
THREE MONTHS ONE YEAR
DUE WITHIN BUT WITHIN BUT WITHIN DUE AFTER
SEPTEMBER 30, 1998 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Rate sensitive assets:
Investment securities............... $ 9,248 $ 26,933 $ 33,657 $ 36,102 $105,940
Loans, held for sale................ 229 229
Loans, net of unearned income....... 55,976 21,528 69,335 103,462 250,301
Federal funds sold.................. 11,200 11,200
------- -------- -------- -------- --------
Total............................. $76,653 $ 48,461 $102,992 $139,564 $367,670
======= ======== ======== ======== ========
Rate sensitive liabilities:
Money market accounts............... $ 19,443 $ 19,443
NOW accounts........................ 21,029 21,029
Savings accounts.................... $ 63,853 63,853
Time deposits less than $100........ $32,784 55,939 87,428 $ 655 176,806
Time deposits $100 or more.......... 8,876 8,503 7,954 25,333
Long-term debt...................... 1 1 8 32 42
------- -------- -------- -------- --------
Total............................. $41,661 $104,915 $159,243 $ 687 $306,506
======= ======== ======== ======== ========
Rate sensitivity gap:
Period............................ $34,992 $(56,454) $(56,251) $138,877
Cumulative........................ $34,992 $(21,462) $(77,713) $ 61,164 $ 61,164
RSA/RSL ratio:
Period............................ 1.84 0.46 0.65 203.15
Cumulative........................ 1.84 0.85 0.75 1.20 1.20
</TABLE>
At September 30, 1998, the Company's ratio of cumulative one-year rate
sensitive assets to rate sensitive liabilities improved slightly to 0.85
from 0.84 at June 30, 1998. Based upon the guidelines set forth in the
Company's asset/liability management policy, this ratio fell within the 0.7
and 1.3 deemed by management to be acceptable. A $3.2 million increase in
RSA exceeding a $1.0 million rise in RSL was responsible for the change.
Specifically, greater volumes of loans and investments maturing or
repricing within one-year more than offset the $1.0 million increase in
time deposits less than $100. According to the results of the static gap
report, the Company was liability rate-sensitive for the cumulative one-
year period. This indicates that should general market rates increase, the
likelihood exists that net interest income would be adversely affected.
Conversely, a decline in general market rates would likely have a favorable
effect on net interest income. However, these forward-looking statements
are qualified in the aforementioned section entitled "Forward-Looking
Discussion" in this Management's Discussion and Analysis.
With respect to the three-month interest rate sensitivity gap position, the
RSA/RSL ratio declined slightly from 1.85 at June 30, 1998, to 1.84 at
September 30, 1998. However, the volume of net RSA increased from $33.3
million at the end of the second quarter to $35.0 million at the end of the
third quarter. The $1.7 million change was a result of higher volumes of
loans repricing or maturing within three months exceeding increased levels
of time deposits for this time frame.
Static gap analysis, although a credible measuring tool, does not fully
illustrate the impact of interest rate changes on future earnings. First,
market rate changes normally do not equally or simultaneously affect all
categories of assets and liabilities. Second, assets and liabilities that
can contractually reprice within the same period may not do so at the same
time or to the same magnitude. Third, the interest rate sensitivity table
presents a one-day position. Variations occur daily as the Company adjusts
its rate sensitivity throughout the year. Finally, assumptions must be
made in constructing such a table. For example, the conservative nature of
the Company's Asset/Liability Management Policy assigns money market and
NOW accounts to the due after three but within twelve months repricing
interval. In reality, these items may reprice less frequently and in
different magnitudes than changes in general interest rate levels.
As a result of the static gap report's failure to address the dynamic
changes in the balance sheet composition or prevailing interest rates, the
Company enhances its asset/liability management by using a simulation
model. This model creates pro forma net interest income results under
various interest rate assumptions ("shocks"). Model results based on
September 30, 1998, financial information adjusted for expected volume and
timing changes of RSA and RSL over the next twelve months, indicated a
continued improvement in the Company's exposure to interest rate risk.
Based on the results, the Company will be nearly insensitive to changes in
interest rates over the next year. Specifically, instantaneous and parallel
shifts in general market rates of plus 100 basis points will cause net
interest income to improve slightly by $38. Conversely, a shift of the same
magnitude in the opposite direction will cause only a $37 decline in net
interest income. Management will attempt to retain the Company's favorable
interest rate risk position during the final quarter of 1998 through
continued vigilance in its product pricing.
In addition to the aforementioned techniques, the Company utilizes a
tabular presentation in complying with the Quantitative and Qualitative
disclosure requirements about market risk in accordance with Regulation S-K
of the Securities Exchange Act of 1934. Such information is only required
for interim financial statements if there has been a material change in the
Company's reported market risks since the end of the most recent fiscal
year. Management, after reviewing the results of the report, deemed no such
disclosure to be required at September 30, 1998.
Inflation impacts financial institutions differently than it does
commercial and industrial companies that have significant investments in
fixed assets and inventories. Most of the Company's assets are monetary in
nature and change correspondingly with variations in the inflation rate.
It is difficult to precisely measure the impact of inflation on the
Company, however management believes that its exposure to inflation can be
mitigated through asset/liability management.
LIQUIDITY:
Liquidity is defined as a company's ability to generate cash at a
reasonable cost in order to satisfy commitments to borrowers as well as to
meet the demands of depositors and debtholders. Principal sources of
liquidity are found in core deposits and loan and investment payments and
prepayments. Management considers the Company's available-for-sale
portfolio as a secondary source of liquidity. As a final source of
liquidity, the Company has the ability to exercise existing credit
arrangements. The Company manages liquidity daily, thus enabling
management to effectively monitor fluctuations in the Company's liquidity
position and to adapt its position according to market changes. Management
believes the Company's liquidity is adequate to meet both present and
future financial obligations and commitments on a timely basis. There are
presently no known trends, demands, commitments, events or uncertainties
that have resulted or are reasonably likely to result in material changes
with respect to the Company's liquidity.
The Company's liquidity position weakened slightly during the third quarter
of 1998 as evidenced by a reduction in the Company's net increase in cash
and cash equivalents from $5.9 million at June 30, 1998, to $1.1 million at
September 30, 1998. Despite this reduction, the Company's key liquidity
ratios improved during the third quarter of 1998. The Company's net noncore
funding dependence ratio, defined as the difference between noncore funds,
time deposits $100 or more and brokered time deposits less than $100, and
short-term investments to long-term assets, was negative 6.7 percent and
negative 6.9 percent at June 30, 1998, and September 30, 1998,
respectively. The net short-term noncore funding dependence ratio, defined
as the difference between noncore funds maturing within one year, including
borrowed funds, less short-term investments to long-term assets, was
negative 9.2 percent at June 30, 1998, and negative 9.4 percent at
September 30, 1998. Conversely, the peer group experienced a small
deterioration in their ratios during the third quarter. The peer group's
net noncore funding dependence ratio weakened from 7.8 percent at June 30,
1998, to 9.8 percent at September 30, 1998. A similar change was seen in
the peer group's net short-term noncore funding ratio changing from 2.2
percent to 3.6 percent at the end of the second and third quarters of 1998,
respectively. Management will continue to implement product pricing
strategies to assure that the Company has adequate liquidity to support
future growth.
The consolidated statements of cash flows present the change in cash and
cash equivalents from operating, investing and financing activities. Cash
and cash equivalents, consisting of cash on hand, cash items in the process
of collection, noninterest-bearing deposits with other banks, balances with
the Federal Reserve Bank ("FRB") and Federal Home Loan Bank of Pittsburgh
and federal funds sold increased $1.1 million for the nine months ended
September 30, 1998. Net cash provided by operating activities amounted to
$4.7 million which resulted primarily from net income.
Management increased its lending and investment activities during the third
quarter causing a reversal in the position of cash flows related to
investing activities from the prior quarter. The Company reported a net
increase in cash flows from investment activities of $6.6 million for the
first half of 1998. At September 30, 1998, the Company reported net cash
used in investing activities of $1.1 million. Purchases exceeding repayment
proceeds on available-for-sale investment securities by $4.0 million and a
$3.7 million net increase in lending activities were primarily responsible
for the change.
Net cash used in financing activities totaled $2.4 million for the nine
months ended September 30, 1998, a decrease of $1.5 million compared to the
first six months of 1998. Increased volumes of transaction accounts and, to
a lesser extent, time deposits caused the improvement. The recent deposit
increase may signal a renewed interest in the Company's products given the
recent weakness experienced by the stock market.
CAPITAL ADEQUACY:
As aforementioned, during the third quarter of 1998, the Board of
Director's ratified an amended dividend policy that will systematically
increase the Company's dividend payout ratio to a level consistent with its
peer group. Cash dividends declared as a percentage of net income improved
from 14.4 percent for the second quarter to 19.2 percent for the third
quarter of 1998. For the nine months ended September 30, 1997 and 1998,
cash dividends declared as a percentage of net income equaled 12.0 percent
and 16.1 percent, respectively. Presently, the Board of Directors expects
the Company to pay dividends in the future. However, these decisions are
based on operating results, financial and economic decisions, capital
needs, growth objectives, appropriate dividend restrictions related to the
Company and other relevant factors.
For the third quarter of 1998, the Company's stockholders' equity improved
$1,288 from $38,454 at June 30, 1998, to $39,742 at September 30, 1998.
Such improvement was attributed to the generation of $1,150 of net income
partially offset by dividends, net of reinvestments, of $197 and aided by
the recognition of net unrealized gains of $335.
Management attempts to assure capital adequacy by monitoring the current
and projected positions of the Company to support future growth, while
providing stockholders with an attractive long-term appreciation of their
investments. A recent history of bank failures prompted regulatory
agencies to adopt minimum capital adequacy requirements that include
mandatory and discretionary supervisory actions for noncompliance. On June
4, 1998, the FRB issued a final rule, which became effective June 30, 1998,
amending the Tier I leverage capital standard for bank holding companies.
Under the new regulation, bank holding companies that are either rated
composite "1" under the BOPEC ("bank subsidiaries, other nonbank
subsidiaries, parent companies, earnings-consolidated and capital adequacy-
consolidated") rating system or those that have implemented the FRB's risk-
based capital market risk measure, must maintain a Leverage ratio, Tier I
capital to total average assets less intangibles, of at least 3.0 percent.
For all other bank holding companies, a Leverage ratio of 4.0 percent must
be maintained. For institutions with supervisory, financial, operational
or managerial weaknesses or those anticipating or experiencing significant
growth, higher-than-minimum capital ratios are required. The Company's
minimum ratio of Tier I capital to adjusted total average assets was 4.0
percent at June 30, 1998 and 1997. Other minimum capital ratio
requirements are a Tier I capital to risk-adjusted assets ratio of 4.0
percent and a total capital to risk-adjusted assets ratio of 8.0 percent.
If an institution is deemed to be undercapitalized under these standards,
banking law prescribes an increasing amount of regulatory intervention,
including the required institution of a capital restoration plan and
restrictions on the growth of assets, branches or lines of business.
Further restrictions are applied to significantly or critically
undercapitalized institutions, including restrictions on interest payable
on accounts, dismissal of management and appointment of a receiver. For
well capitalized institutions, banking law provides authority for
regulatory intervention where the institution is deemed to be engaging in
unsafe and unsound practices or receives a less than satisfactory
examination report rating.
Under GAAP, banks not subject to a supervisory directive will exclude
unrealized holding gains and losses, net of income taxes, on available-for-
sale debt securities when calculating Tier I capital. However, net
unrealized holding losses on available-for-sale marketable equity
securities will continue to be deducted from Tier I capital. This
regulatory accounting rule does not effect reporting for financial
statement purposes. Accordingly, for financial accounting presentations,
banks will continue to report available-for-sale and debt and equity
securities at fair value, with unrealized holding gains and losses, net of
income taxes, excluded from earnings and reported in a separate component
of stockholders' equity.
The Company exceeded all relevant regulatory capital measurements at
September 30, 1998, and was considered well capitalized. Regulatory
agencies define institutions not under a written directive to maintain
certain capital levels as well capitalized if they exceed the following:
(i) a Tier I risk-based ratio of at least 6.0 percent; (ii) a total risk-
based ratio of at least 10.0 percent; and (iii) a Leverage ratio of at
least 5.0 percent. The Company continued to experience improvement in its
capital level as evidenced by the increase in its Leverage ratio. Such
ratio was 8.6 percent, 8.9 percent and 9.1 percent at December 31, 1997,
June 30, 1998, and September 30, 1998, respectively. Such ratio for the
local peer group was 8.9 percent at September 30, 1998.
The following table sets forth the Company's capital ratios at September
30, 1998 and 1997, as well as the required minimum ratios for capital
adequacy purposes and to be well capitalized under the prompt corrective
action provisions as defined by the Federal Deposit Insurance Corporation
Act of 1991 ("FDICIA").
<TABLE>
<CAPTION>
RISK-ADJUSTED CAPITAL
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------------------------------------------------
SEPTEMBER 30 1998 1997 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BASIS FOR RATIOS:
Tier I capital to risk-adjusted assets... $ 33,903 $ 31,830 $ 8,282 $ 7,658 $12,423 $11,487
Total capital to risk-adjusted assets.... 36,506 34,242 16,564 15,317 20,704 19,146
Tier I capital to total average assets
less goodwill........................... 33,903 31,830 $14,878 $14,199 $18,597 $17,749
Risk-adjusted assets..................... 200,007 183,997
Risk-adjusted off-balance sheet items.... 7,037 7,461
Average assets for Leverage ratio........ $371,938 $354,979
RATIOS:
Tier I capital as a percentage of risk-
adjusted assets and off-balance sheet
items................................... 16.4% 16.6% 4.0% 4.0% 6.0% 6.0%
Total of Tier I and Tier II capital as a
percentage of risk-adjusted assets and
off-balance sheet items................. 17.6 17.9 8.0 8.0 10.0 10.0
Tier I capital as a percentage of total
average assets less goodwill............ 9.1% 9.0% 4.0% 4.0% 5.0% 5.0%
</TABLE>
REVIEW OF FINANCIAL PERFORMANCE:
The Company's 1998 earnings thus far were characterized by improvements in
net interest income offset by higher reported noninterest expenses as a
result of acquiring two community banking offices during the fourth quarter
of 1997. The Company reported net income of $1,150 or $0.52 per share for
the third quarter of 1998, a 6.5 percent increase, as compared to $1,080 or
$0.49 per share for the same period last year. The three months ended
September 30, 1998, included a $235 gain on the sale of equity securities
which offset losses recognized on foreclosed property devaluations and
interest income adjustments caused by placing certain loans on nonaccrual
status. Year-to-date earnings in 1998 totaled $3.3 million or $1.50 per
share equaling the amount reported in 1997. Results of 1997 included a one-
time addition to revenue of $250 from a litigation settlement. For the nine
months ended September 30, 1998 and 1997, comprehensive income amounted to
$4,050 and $3,819, respectively. Comprehensive income for the third quarter
of 1998 was $1,485, a $33 increase as compared to the same period last
year. Return on average equity was 11.72 percent for the three months and
11.67 percent for the nine months ended September 30, 1998, compared to
12.90 percent and 13.62 percent, respectively, for the same periods last
year. Return on average assets was 1.19 percent and 1.18 percent for the
three and nine months ended September 30, 1998, respectively, as compared
to 1.19 percent and 1.24 percent for the respective periods of 1997.
Comparable return on average equity and return on average asset ratios for
the local peer group were 11.73 percent and 1.19 percent, respectively, for
the nine months ended September 30, 1998.
The most significant factor that can have a material effect on the
financial performance of all industries is the Year 2000 ("Y2K"). In
summary, the Y2K issue arose as a result of many existing computer programs
using the last two digits rather than four of a date to define the
applicable year. These computer systems may interpret a date ending in
"00" as the year 1900 instead of the year 2000. If not corrected, this
could result in a system failure or miscalculation causing a disruption of
operation, including, among other things, a temporary inability to process
transactions or engage in normal business activities.
The Securities and Exchange Commission ("SEC") issued Release Nos. 33-7558
and 34-40277, ("the Release") on August 4, 1998. The Release came about
because the SEC does not believe that existing Y2K disclosures provide
enough specific information for an investor to make a meaningful
determination of a company's Y2K risks. This Release provides guidance for
public companies, investment advisors, investment companies and municipal
securities issuers regarding their disclosure obligations about Y2K issues.
The SEC, in this Release, requires the aforementioned parties to disclose
the following items in the Management's Discussion and Analysis of
Financial Condition and Results of Operations section of their disclosure
documents: (i) the company's state of readiness; (ii) the costs to address
the company's Y2K issues; (iii) the risks of the company's Y2K issues and
(iv) the company's contingency plans.
In addition, the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, the Office to the Comptroller of the
Currency and the Office of Thrift Supervision issued "Interagency
Guidelines Establishing Year 2000 Standards for Safety and Soundness" (the
"Guidelines") on October 15, 1998. The Guidelines, issued under Section 39
of the Federal Deposit Insurance Act, provide insured depository
institutions and state member banks with certain steps that must be taken
regarding the awareness, assessment, renovation, validation and
implementation phases of their Y2K efforts to achieve Y2K readiness. The
Guidelines also provide the aforementioned banking agencies an enforcement
tool to address serious Y2K deficiencies in the banks, thrifts and credit
unions they supervise.
The Company is very dependent upon information technology ("IT") systems to
perform its daily operations. Early in 1997 management initiated an
enterprise-wide program to address the Y2K issue and the effects it will
have on the Company. A formal Century Date Change Preparedness ("CDC")
Policy was devised and approved by the Board of Directors. This CDC Policy
called for a Y2K project plan to coordinate and oversee the various phases,
assessment, renovation, testing and implementation of the Company's Y2K
preparedness. The Chief Operating Officer of the Company was appointed
coordinator of the Y2K Project Plan and the Data Processing Steering
Committee serves as oversight for the project. The progress of the Y2K
project plan including: (i) an overview of the plan's progress; (ii) the
status of compliance for mission critical hardware and software; (iii) the
results of hardware and software testing and implementation; (iv) the
evaluation of significant customers in addressing Y2K issues in their
business and (v) the assessment of the need for implementation of any
contingency plan for those areas that will not be compliant will be
reported to the Board of Directors on a quarterly basis or more frequently
as significant events occur.
It has always been the Company's practice to remain current in its IT
systems. In doing so, the Company's exposure to risk related to Y2K
compliance of its IT systems has been greatly reduced. The following
operations of the Company have been identified as mission critical, vital
to the successful continuance of a core business activity: (i) system
hardware; (ii) account processing; (iii) items processing; (iv) image
statement rendering; (v) teller transactions; (vi) trust accounting and
(vii) loan document preparation software. In addition, there are IT
systems and non-IT systems that are not considered mission critical. The
following table provides a description of the Company's systems, how the
assessment, renovation and testing for each system is being addressed,
whether or not the system is compliant, target dates for completion and
contingency plans for non compliant systems:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
Y2K ESTIMATED
COMPLIANT COMPLETION CONTINGENCY
DESCRIPTION OF SYSTEM ASSESSMENT RENOVATION TESTING (YES/NO) DATE PLAN
- --------------------------------------------------------------------------------------------------------------
<S> <S> <S> <S> <S> <C> <C>
MISSION-CRITICAL IT
SYSTEMS:
Hardware:
System 4300 processor Certification from None Complete Yes
responsible vendor
Operating:
Unix Operating system Non compliant Upgrade to Incomplete No 12/31/98
Version 3.0.2
Account processing:
Software, Release 2.6.5B Non compliant Upgrade to
Release 3.0
Software, Release 3.0 Certification from None Complete Yes
responsible vendor
Item processing:
Software Version 3.22 Certification from None Incomplete No 12/31/98 (1)
responsible vendor
Image Statement rendering:
Software Version 1.2 Certification from None Incomplete No 12/31/98 (1)
responsible vendor
Teller transaction:
Software No certification Perform Incomplete No 12/31/98 (2)
available internal testing
Trust accounting:
Software Version 5.0 Certification from None Complete Yes
responsible vendor
Loan document preparation: Certification from None Complete Yes
Software responsible vendor
- -------------------------------------------------------------------------------------------------------------
NONMISSION-CRITICAL IT
SYSTEMS:
Communications
Software/Data Certification Non-compliant Incomplete No 12/31/98 (3)
requested systems will be
upgraded or
Certification converted to new
is reviewed for products
compliance
Hardware No certification Perform Incomplete No 12/31/98 (4)
available internal
testing on all
hardware
- -----------------------------------------------------------------------------------------------------------------
NONMISSION-CRITICAL
NON-IT SYSTEMS:
Imbedded technology Written Non-compliant Complete Yes (5)
certification is systems will be
requested from upgraded or
each vendor converted to new
products
Certification is
reviewed for
compliance
Other items-date stamps, Review items for Internal testing Complete Yes (5)
forms, checks, date sensitivity will be
calculators, etc. performed if
needed
Items will be
replaced as
needed
- -----------------------------------------------------------------------------------------------------------------
(1) Responsible vendor is developing testing plan.
(2) Options as to upgrade or new product are being considered.
(3) Options are determined on an individual product basis. A cost/benefit analysis is performed
to determine if an upgrade to a new version or a conversion to a new product would be appropriate.
(4) Hardware that is not able to handle the Y2K will be replaced.
(5) Contingency options as to alternate products and suppliers are being compiled.
</TABLE>
The Company believes that through completion of its Y2K project plan it
will successfully mitigate any Y2K problems associated with its mission-
critical IT systems. All mission-critical IT systems are currently either
Y2K compliant or will be by the end of 1998. Significant testing has been
performed on all software and hardware that is currently Y2K compliant to
ensure compliance. Future testing will be performed during the remainder
of 1998 as other applications become compliant. The Company expects to be
fully compliant relative to its IT systems and non-IT systems at December
31, 1998. Based on estimates from third party vendors and assessments of
the Data Processing Steering Committee, the Company expects to spend
approximately $100.0 thousand to become fully compliant. These costs will
be funded through normal operations and will not have a material effect on
the operating results or financial position of the Company.
The effects of the Y2K on the Company will depend not only on its efforts
to address those issues, but also on the way the issues are addressed by
third parties with whom the Company has a significant relationship. These
third parties include, among others, major loan and deposit customers,
businesses that provide products and services to the Company and
governmental agencies. Management is taking various steps to assess the
risks and mitigate the potential problems that may arise in the event a
significant third party is not Y2K compliant.
The Company recognizes that a commercial customers' profitability and
liquidity positions could be adversely affected if their systems fail to
properly handle the century date change. This could lead to delinquencies
on loans, possible defaults and bankruptcy filings, in extreme cases. The
Company will review present commercial customers with aggregate outstanding
borrowings in excess of $150.0 thousand, requesting their financial
statements and certification as to their Y2K compliance. A questionnaire
regarding the Y2K is already incorporated into the commercial loan
application process and requires all potential loan customers to attest to
their Y2K compliance.
The Company also realizes that education is a key element in trying to
mitigate potential Y2K problems. During the second quarter of 1998 the
Company utilized several mediums to convey Y2K readiness to its current and
potential individual and business customers. With the ever growing
popularity of the Internet, the Company chose to discuss the Y2K in its
home page on the World Wide Web. The Company also conducted a series of
breakfast seminars for its customers to identify their potential exposures
related to the Y2K. In the fourth quarter of 1998 the Company will include
with customer's account statements brochures discussing Y2K awareness.
Regardless of the Company's efforts, there can be no assurance that
significant third parties will be successful in adequately addressing their
own Y2K issues. The Company is preparing contingency plans to address the
possibility that significant third parties will not be successful. This
involves: (i) identifying alternate vendors and sources for products and
services; (ii) determining means of internal corrective action and (iii)
providing increases to reserves for potential credit losses. No assurance
can be made, however, that these plans will alleviate any risks to the
Company. There may also be certain significant third parties, such as
utility and telecommunication companies, where alternative arrangements or
sources are limited or unavailable. Y2K issues, if not adequately addressed
by the Company and/or third parties, could have a material adverse effect
on the Company's business, consolidated results of operations and financial
position.
The preceding Y2K discussion contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements include, but are not limited to, (i) whether or not testing will
be accurate; (ii) the estimated costs associated with becoming Y2K
compliant; (iii) the date by which the Company expects to be fully
compliant and (iv) the successfulness of any contingency plans. These
statements are made using current estimates and assumptions about future
events. There can be no assurance that these estimates will be achieved and
actual results could differ materially from those anticipated. The factors
that might lead to material differences include, among others, (i) the
ability to accurately identify all mission-critical systems; (ii) accuracy
of the testing performed; (iii) whether or not third party certifications
are accurate; (iv) whether or not material customers, suppliers,
governmental agencies and other significant third parties are successful in
their Y2K efforts; (iv) the adequacy of contingency plans and (v) the
ability to implement contingency plans.
NET INTEREST INCOME:
The Company derives its largest source of operating income from net
interest income. Net interest income is defined as the amount by which
interest and fees on loans and other investments exceeds interest expense
incurred on deposits and other funding sources used to support such assets.
Net interest margin is the percentage of net interest income on a tax-
equivalent basis to average earning assets. Changes in volumes and rates
of earning assets and liabilities, in response to changes in general market
rates, are the primary factors affecting net interest income. Additional
factors influencing the level of net interest income include the
composition of earning assets and interest-bearing liabilities and the
level of nonperforming assets.
Management analyzes interest income and interest expense by segregating
rate and volume components of earning assets and interest-bearing
liabilities. The following table demonstrates the impact changes in the
interest rates earned and paid on assets and liabilities, along with
changes in the volume of earning assets and interest-bearing liabilities,
have on net interest income. Earning assets averages include nonaccrual
loans. Investment averages include available-for-sale securities at
amortized cost. Investment securities and loans are adjusted to a tax-
equivalent basis using a statutory tax rate of 34.0 percent. The net
change attributable to the combined impact of rate and volume has been
allocated proportionately to the change due to rate and the change due to
volume.
<TABLE>
<CAPTION>
NET INTEREST INCOME CHANGES DUE TO RATE AND VOLUME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 VS. 1997 1998 VS. 1997
INCREASE (DECREASE) INCREASE (DECREASE)
ATTRIBUTABLE TO ATTRIBUTABLE TO
--------------------- ---------------------
TOTAL TOTAL
CHANGE RATE VOLUME CHANGE RATE VOLUME
------ ---- ------ ------ ---- ------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans:
Taxable.............................. $178 $ (57) $235 $641 $ 641
Tax-exempt........................... (35) (35) (99) $ 16 (115)
Investments:
Taxable.............................. 67 79 (12) 107 202 (95)
Tax-exempt........................... (14) 14 (11) (70) 59
Federal funds sold..................... 83 (2) 85 219 219
---- ----- ---- ---- ----- -----
Total interest income.............. 293 6 287 857 148 709
---- ----- ---- ---- ----- -----
Interest expense:
Money market accounts.................. 1 (9) 10 14 (12) 26
NOW accounts........................... 18 (5) 23 48 (3) 51
Savings accounts....................... (45) (44) (1) (199) (178) (21)
Time deposits less than $100........... 81 (62) 143 409 (110) 519
Time deposits $100 or more............. (51) (24) (27) (336) (52) (284)
Other borrowings....................... 1 2 (1) 7 1 6
---- ----- ---- ---- ----- -----
Total interest expense............. 5 (142) 147 (57) (354) 297
---- ----- ---- ---- ----- -----
Net interest income................ $288 $ 148 $140 $914 $ 502 $ 412
==== ===== ==== ==== ===== =====
</TABLE>
Net interest income, on a tax-equivalent basis, for the nine months ended
September 30, 1998, was $10,817, an increase of $914 or 9.2 percent, as
compared to the same period last year. Favorable changes in rate and volume
shared in this improvement. The Company's net interest margin improved from
3.85 percent to 4.07 percent for the nine months ended September 30, 1997
and 1998, respectively. Conversely, the peer group experienced a reduction
in its net interest margin from 4.64 percent in 1997 to 4.54 percent in
1998. For the three quarters ended September 30, 1997 and 1998, the
Company's net interest spread improved from 3.15 percent to 3.38 percent,
respectively. This 23 basis point increase resulted from a 6 basis point
increase in the yield on earning assets and a 17 basis point decrease in
the cost of interest-bearing liabilities. The yield on taxable investments
increasing from 5.51 percent in 1997 to 5.99 percent in 1998 was primarily
responsible for the favorable rate variance on earning assets. The
increased yield on taxable investments is a function of the improvement in
spreads on U.S. Government agency mortgage-backed securities. Offsetting
this improvement was a negative rate variance of $70 caused by a 22 basis
point decrease in the tax-equivalent yield on tax-exempt investments. Of
greater importance to the improvement due to rate changes was the reduction
in the Company's cost of funds. For the nine months ended September 30,
1998, the cost of funds was 4.61 percent as compared to 4.78 percent for
the same period in 1997. Management has become more stringent with respect
to deposit pricing given the recent decline in general market rates and the
limited availability of profitable opportunities without incurring an
inordinate level of risk. All categories of interest-bearing deposits
assisted in the improvement with savings and time deposits less than $100
contributing the most. The cost of savings accounts declining from 2.96
percent in 1997 to 2.59 percent in 1998 caused a $178 increase in net
interest income. Similarly, a 9 basis point decrease in the cost of time
deposits less than $100 positively affected net interest income by $110
comparing 1997 to 1998.
Volume variances also influenced net interest income as average earning
assets increased at a faster pace than average interest-bearing liabilities
caused earnings to rise by $412. Average earning assets grew $11.8 million
while average interest-bearing liabilities increased $9.2 million from 1997
to 1998. Specifically, higher volumes of taxable loans and federal funds
sold, partially offset by a greater level of time deposits, were primarily
responsible for the favorable variance. For the nine months ended September
30, 1998, taxable loans averaged $240.1 million, an increase of $10.0
million over the $230.1 million reported for the same period of 1997. Such
increase caused a $641 improvement in interest income. In addition, a $219
favorable volume variance resulted from a near doubling of the Company's
average investment in overnight funds. Federal funds sold grew from $6.0
million in 1997 to $11.3 million in 1998. The market anticipated a FOMC
easing of its monetary policy during most of 1998. As a result, the yield
on federal funds sold was near or exceeded the entire yield curve for most
of the year. Management, not willing to take on an inordinate level of
risk, retained excess funds in overnight funds. Aggregate average time
deposits increased to $199.4 million in 1998 from $193.6 million in 1997.
The additional $5.8 million of time deposits in 1998 increased the
Company's interest expense by $235.
For the quarter ended September 30, 1998, tax-equivalent net interest
income increased $288 compared to the same period of 1997. Changes due to
volume and rate shared equally in the third quarter's improvement. The net
interest margin for the three months ended September 30, 1998 and 1997, was
4.01 percent and 3.86 percent, respectively. However, the net interest
margin in the third quarter was a decline from the 4.09 percent in the
prior quarter as the result of the reversal of previously accrued interest
income on loans placed on nonaccrual status. The 43 basis point increase in
the yield on taxable investments, offset partially by a 9 basis point
decrease in the yield on taxable loans, was primarily responsible for the
$6 change in interest income attributable to the rate variance. The rate
variance had a more significant affect on interest expense resulting in a
$142 increase in net interest income. A decrease in the cost of all forms
of deposits aided the positive change. Similar to the year-to-date results,
the cause of the favorable volume variance was a greater average volume of
taxable loans and federal funds sold partially offset by a greater average
level of time deposits. Increases of $10.8 million, $6.1 million and $8.1
million were reported over the same quarter last year in the average
volumes of taxable loans, federal funds sold and time deposits,
respectively.
The following table sets forth a summary of net interest income for major
categories of earning assets and interest-bearing liabilities:
<TABLE>
<CAPTION>
SUMMARY OF NET INTEREST INCOME
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
--------------------------- ---------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Earning assets:
Loans:
Taxable..................................... $240,053 $15,387 8.57% $230,105 $14,746 8.57%
Tax-exempt.................................. 7,298 453 8.30 9,145 552 8.07
Investments:
Taxable..................................... 58,295 2,613 5.99 60,773 2,506 5.51
Tax-exempt.................................. 38,541 2,329 8.08 37,697 2,340 8.30
Federal funds sold............................ 11,313 468 5.53 6,022 249 5.53
-------- ------- -------- -------
Total earning assets...................... 355,500 21,250 7.99% 343,742 20,393 7.93%
Less: allowance for loan losses.............. 3,899 3,910
Other assets.................................. 23,233 16,506
-------- --------
Total assets.............................. $374,834 $356,338
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 17,393 397 3.05% $ 16,331 383 3.14%
NOW accounts.................................. 21,186 344 2.17 18,054 296 2.19
Savings accounts.............................. 64,282 1,246 2.59 65,254 1,445 2.96
Time deposits less than $100.................. 175,654 7,386 5.62 163,471 6,977 5.71
Time deposits $100 or more.................... 23,741 1,050 5.91 30,114 1,386 6.15
Short-term borrowings......................... 141 7 6.64 20 1 6.68
Long-term debt................................ 43 3 9.33 44 2 6.08
-------- ------- -------- -------
Total interest-bearing liabilities........ 302,440 10,433 4.61% 293,288 10,490 4.78%
Noninterest-bearing deposits.................. 31,739 27,021
Other liabilities............................. 2,862 3,634
Stockholders' equity.......................... 37,793 32,395
-------- ------- -------- -------
Total liabilities and stockholders' equity $374,834 10,433 $356,338 10,490
======== ------- ======== -------
Net interest/income spread................ $10,817 3.38% $ 9,903 3.15%
======= =======
Net interest margin....................... 4.07% 3.85%
Tax-equivalent adjustments:
Loans......................................... $ 154 $ 188
Investments................................... 792 795
------- -------
Total adjustments......................... $ 946 $ 983
======= =======
Note: Average balance was calculated using average daily balances and includes nonaccrual loans. Available-
for-sale securities, included in investment securities, are stated at amortized cost with the related
average unrealized holding gains of $2,519 and $952 at September 30, 1998 and 1997, respectively,
included in other assets. Tax-equivalent adjustment was calculated using the prevailing statutory rate
of 34.0 percent.
</TABLE>
PROVISION FOR LOAN LOSSES:
The Company makes provisions for loan losses based on evaluations of its
allowance for loan losses account. Factors such as previous loan
experience, overall loan portfolio characteristics, prevailing economic
conditions and other relevant factors are considered when determining the
provision. Based on its most recent evaluation, management believes that
the provision was adequate to allow the allowance account to absorb any
known and inherent losses in the portfolio.
For the nine months ended September 30, 1998, the Company's provision for
loan losses was $315, a $60 increase over the amount reported for the same
period last year. Despite a reduction in the provisions by many of the
Company's competitors, management believes additional allocations are
prudent given the recently reported concerns for national and local credit
quality and the slowdown in economic conditions. For the third quarters of
1998 and 1997, the Company's provision remained at $105.
NONINTEREST INCOME:
Noninterest income was nearly unchanged for the nine months ended September
30, 1998 and 1997. Service charges, fees and commissions remained at $1.1
million for each period. The Company reported similar amounts of
nonrecurring noninterest income during 1998 and 1997. During the third
quarter of 1998, the Company recognized a $235 gain on the sale of certain
equity securities. Included in the year-to-date 1997 results was a
litigation recovery of $250. The litigation recovery was awarded to the
Company's wholly-owned subsidiary, Community Bank and Trust Company, with
respect to its business relationship with a securities broker prior to
1995.
For the quarter ended September 30, 1998, noninterest income totaled $619
as compared to $358 for the same period last year. Service charges, fees
and commissions increased $22 or 6.1 percent from $358 for the three months
ended September 30, 1997, to $380 for the same period this year. Higher
volumes of transaction accounts in 1998 caused the favorable increase. As
aforementioned, the Company began operation of its secondary mortgage
banking activities during the third quarter of 1998 resulting in the
recognition of $4 of net gains on the sale of loans. Management's
aggressive marketing and product pricing of loans originated for sale to
secondary market investors should cause the gains on the sale of such
loans and subsequent servicing fees to become a more prominent portion of
noninterest income in the future.
NONINTEREST EXPENSE:
The general components of noninterest expense include the costs of
providing salaries and necessary benefits to employees, maintaining
facilities and general operating costs such as insurance, supplies,
advertising, data processing and other related expenses. Several of these
costs and expenses are variable while the remainder are fixed. In its
efforts to control the variable portion of these expenses, management
employs budgets and other related strategies.
For the three quarters ended September 30, 1998, noninterest expenses
totaled $6,733, an increase of $853 or 14.5 percent as compared to the same
period of 1997. The Company's net overhead ratio for the nine months ended
September 30, 1998, was 2.0 percent, an increase over the 1.8 percent
recorded for the corresponding period of 1997. Such ratio remains more
favorable than performance of the Company's peer group at 2.7 percent.
Moreover, the Company's operating efficiency ratio, as defined as
noninterest expense adjusted for other real estate expense as a percentage
of net interest income and noninterest income less nonrecurring gains and
losses, continued to be superior to the level reported for the local peer
group. The Company's operating efficiency ratio for the nine months ended
September 30, 1998, was 61.7 percent. Such ratio weakened from the 56.8
percent of last year but remained better than the peer group's ratio at
62.5 percent. Higher levels of operating expenses caused by the acquisition
of two community banking offices during the fourth quarter of 1997 resulted
in the slight deterioration in the Company's operating efficiency ratio.
The Company is furthering its planned delivery system expansion through the
building of two full-service community banking offices scheduled for
completion during the first half of 1999. In addition to providing
facilities for branch banking activities, the office located in Clarks
Summit, Pennsylvania will be built to suit the centralization of all of the
Company's administrative divisions into a single corporate center. As is
true for all expansions, management expects the implementation of such plan
to have an adverse affect on the Company's earnings in the near-term until
such time when adequate business can be generated to offset the increased
level of noninterest expenses. Management expects capital expenditures for
such offices to amount to $5.2 million. The Company will fund these
projects through normal operations.
The following table sets forth the major components of noninterest expenses
for the three months and nine months ended September 30, 1998, and 1997:
<TABLE>
<CAPTION>
NONINTEREST EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Salaries and employee benefits expense:
Salaries and payroll taxes..................... $ 933 $ 858 $2,810 $2,531
Employee benefits.............................. 172 140 498 489
------ ------ ------ ------
Salaries and employee benefits expense....... 1,105 998 3,308 3,020
------ ------ ------ ------
Net occupancy and equipment expense:
Net occupancy expense.......................... 123 136 393 436
Equipment expense.............................. 180 152 567 452
------ ------ ------ ------
Net occupancy and equipment expense.......... 303 288 960 888
------ ------ ------ ------
Other expenses:
Marketing expense.............................. 129 77 258 221
Other taxes.................................... 73 58 206 188
Stationery and supplies........................ 94 84 275 262
Contractual services........................... 253 204 699 644
Insurance including FDIC assessment............ 25 19 62 60
Other.......................................... 415 218 965 597
------ ------ ------ ------
Other expenses............................... 989 660 2,465 1,972
------ ------ ------ ------
Total noninterest expense.................. $2,397 $1,946 $6,733 $5,880
====== ====== ====== ======
</TABLE>
Salaries and employee benefits expenses totaled $3,308 for the nine months
ended September 30, 1998, an increase of $288 or 9.5 percent over the
amount reported for the comparable period of 1997. The majority of the
increase was a result of additional staffing for the newly acquired offices
coupled with performance increases effective in the first quarter of 1998.
For the comparable third quarters of 1998 and 1997, salaries and employee
benefits expenses amounted to $1,105 and $998, respectively. In addition to
the reasons mentioned for the year-to-date change, increased medical
insurance costs contributed to the unfavorable variance.
Occupancy and equipment expense aggregated $960 for the three quarters
ended September 30, 1998, a $72 increase over the same period last year.
This increase was primarily attributed to increased depreciation and rental
expenses on the newly acquired community banking offices. Despite the
increase, the Company still has a favorable occupancy expense ratio as
compared to the peer group. For the nine months ended September 30,1998,
the Company's occupancy expenses as a percentage of average assets was
0.34 percent compared to 0.42 percent for the peer group. Such expenses for
the third quarter of 1998 totaled $303 as compared to $288 for the same
period last year. Reasons for the change are similar to those given for the
year-to-date fluctuations.
For the nine months ended September 30, 1998, other expenses amounted to
$2,465, a $493 or 25.0 percent increase from the same period of 1997. Core
deposit intangible amortization along with write-downs incurred on
foreclosed property devaluations were the main reasons for the increases.
Other expenses increased from $660 for the three months ended September 30,
1997, to $989 for the same period this year. In addition to the reasons
mentioned for the nine month change, the Company reported higher marketing
expenses in the third quarter of 1998.
On June 19, 1998, the Federal Deposit Insurance Corporation ("FDIC") issued
FIL-66-98, "Deposit Insurance Assessment Rate Schedules and Financing
Corporation Assessment Rates," announcing the deposit insurance premiums
for the Bank Insurance Fund ("BIF") and Savings Association Insurance
Fund("SAIF") for the second semi-annual assessment period of 1998. The
release noted that the FDIC voted to maintain the BIF and SAIF assessment
rate schedules of 0 to 27 basis points per year for the second half of
1998. The Company was classified in the Well Capitalized Supervisory Risk
Subgroup at September 30, 1998. Accordingly, the Company was again exempt
from payment of a BIF assessment for the second half of 1998. However, the
Company along with all banks continued to be assessed quarterly for their
assistance in interest payments on Financing Corporation ("FICO")bonds used
to capitalize the SAIF. The Company's FICO assessment was $40 for 1998.
INCOME TAXES:
The Company's effective tax rates for the three and nine months ended
September 30, 1998, were 21.7 percent and 20.9 percent, respectively. The
comparable rates for 1997 were 20.5 percent and 20.6 percent, respectively.
Higher levels of earnings along with lower amounts of tax-exempt income
were primarily responsible for the slightly higher effective tax rates.
However, the Company continues to enjoy an advantageous tax position as
compared to the peer group. For the nine months ended September 30, 1998,
the peer groups' effective tax rate was 24.2 percent. Management utilizes
tax-exempt income on loans and investments coupled with the benefit of tax
credits from an ownership in a limited partnership to lower its tax burden.
It is management's determination that a valuation reserve need not be
established for the deferred tax assets as it is more likely than not that
these assets could be principally realized through carryback to taxable
income in prior years and by future reversals of existing taxable temporary
differences or, to a lesser extent, through future taxable income. The
Company performs quarterly reviews on the tax criteria related to the
recognition of deferred tax assets.
COMM BANCORP, INC.
OTHER INFORMATION
----------------------------------------------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
NONE
Item 2. Changes in Securities and Use of Proceeds
NONE
Item 3. Defaults Upon Senior Securities
NONE
Item 4. Submission of Matters to a Vote of Security Holders.
NONE
Item 5. Other Information
NONE
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit No. Description
27 Financial Data Schedule-September 30, 1998.
(b) Reports on Form 8-K
Item No. Description
5 On August 19, 1998, the Company filed a report on
Form 8-K, disclosing the Board of Directors
approval of a Dividend Policy that will
systematically increase its dividend payout ratio
consistent with its peer group.
7(c) Form of Press Release detailing the Company's
change to its Dividend Policy.
COMM BANCORP, INC.
FORM 10-Q
SIGNATURE PAGE
--------------
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.
Registrant, Comm Bancorp, Inc.
Date: November 12, 1998 /s/ David L. Baker
----------------- -------------------------
David L. Baker
Chief Executive Officer
Date: November 12, 1998 /s/ Scott A. Seasock
----------------- -------------------------
Scott A. Seasock
Chief Financial Officer
(Principal Financial Officer)
Date: November 12, 1998 /s/ Stephanie A. Ganz
----------------- -------------------------
Stephanie A. Ganz
Vice President of Finance
(Principal Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENTS OF OPERATIONS AND CONSOLIDATED BALANCE SHEETS
FOUND ON PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 7,206
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 11,200
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 105,940
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 250,301
<ALLOWANCE> 3,804
<TOTAL-ASSETS> 384,485
<DEPOSITS> 339,977
<SHORT-TERM> 0
<LIABILITIES-OTHER> 4,724
<LONG-TERM> 42
0
0
<COMMON> 728
<OTHER-SE> 39,014
<TOTAL-LIABILITIES-AND-EQUITY> 384,485
<INTEREST-LOAN> 15,686
<INTEREST-INVEST> 4,150
<INTEREST-OTHER> 468
<INTEREST-TOTAL> 20,304
<INTEREST-DEPOSIT> 10,423
<INTEREST-EXPENSE> 10,433
<INTEREST-INCOME-NET> 9,871
<LOAN-LOSSES> 315
<SECURITIES-GAINS> 235
<EXPENSE-OTHER> 6,733
<INCOME-PRETAX> 4,171
<INCOME-PRE-EXTRAORDINARY> 4,171
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,300
<EPS-PRIMARY> 1.50
<EPS-DILUTED> 1.50
<YIELD-ACTUAL> 7.99
<LOANS-NON> 1,895
<LOANS-PAST> 1,412
<LOANS-TROUBLED> 178
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,798
<CHARGE-OFFS> 456
<RECOVERIES> 147
<ALLOWANCE-CLOSE> 3,804
<ALLOWANCE-DOMESTIC> 3,804
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
