FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998, OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________.
Commission File No. 0-12870.
FIRST WEST CHESTER CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania
23-2288763 (State or other
jurisdiction of (IRS Employer
incorporation or organization)
Identification No.)
9 North High Street, West Chester, Pennsylvania 19380
(Address of principal executive office) (Zip code)
(610) 692-1423
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The number of shares outstanding of Common Stock of the Registrant as of
November 1, 1998 was 2,310,013.
The number of shares outstanding of Common Stock of the Registrant as of
November 1, 1998 adjusted for 2-for-1 stock split payable November 24, 1998 to
shareholders of record on October 23, 1998 was 4,620,026.
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
INDEX
-----
<TABLE>
<CAPTION>
<S> <C>
PAGE
----
Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Statements of Condition
September 30, 1998 and December 31, 1997 3
Consolidated Statements of Income
Three- and Nine-Months Ended September 30, 1998 and 1997 4
Consolidated Statements of Stockholder's Equity 5
Consolidated Statements of Cash Flows
Nine-Months Ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7-8
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-25
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 26
Part II. OTHER INFORMATION
Item 1 - Legal Proceedings 27
Item 2 - Changes in Securities 27
Item 3 - Defaults upon Senior Securities 27
Item 4 - Submission of Matters to a Vote of Security Holders 27
Item 5 - Other Information 27
Item 6 - Exhibits and Reports on Form 8-K 27
Signatures 28
</TABLE>
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
(Dollars in thousands - except per share data)
(Unaudited)
September 30, December 31,
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 20,084 $ 22,248
Federal funds sold 8,950 4,200
Total cash and cash equivalents 29,034 26,448
--------- ---------
Investment securities held-to-maturity (market value of $8,673 and $12,237
at September 30, 1998 and December 31,
1997, respectively) 8,398 12,082
Investment securities available-for-sale at market value 82,816 65,516
Loans 317,568 318,899
Less allowance for possible loan losses (5,788) (5,900)
--------- ---------
Net loans 311,780 312,999
Premises and equipment, net 9,380 6,659
Other assets 5,911 7,664
--------- ---------
TOTAL ASSETS $ 447,319 $ 431,368
========= =========
LIABILITIES
Deposits
Non-interest bearing $ 66,243 $ 63,287
Interest bearing 323,268 310,962
--------- ---------
Total deposits 389,511 374,249
Securities sold under repurchase agreements 4,854 7,625
Federal Home Loan Bank advances and other borrowings 5,066 7,380
Other liabilities 8,095 5,901
--------- ---------
Total liabilities 407,526 395,155
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00; authorized, 5,000,000 shares; Outstanding,
4,620,026(*) shares at September 30, 1998 and
4,799,666(*) shares December 31, 1997. 4,800 2,400
Additional paid-in capital 422 2,729
Retained earnings 35,013 32,803
Net unrealized gain (loss) on securities available-for-sale 1,018 (33)
Treasury stock, at cost: 89,820 shares at September 30, 1998 and
103,700 shares at December 31, 1997. (1,460) (1,686)
--------- ---------
Total stockholders' equity 39,793 36,213
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 447,319 $ 431,368
========= =========
Book Value Per Share(*) $8.61 $7.54
==== ====
<FN>
(*) Adjusted for 2-for-1 stock split payable on November 24, 1998 to
shareholders of record on October 23, 1998.
</FN>
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in thousands - except per share data) Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1997 1998 1997
----- ---- ---- ----
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $ 7,041 $6,897 $21,136 $19,730
Investment securities 1,265 1,220 3,573 4,026
Federal funds sold 166 110 319 195
Deposits in banks -- -- -- 12
------ ----- ------ ------
Total interest income 8,472 8,227 25,028 23,963
------ ----- ------ ------
INTEREST EXPENSE
Deposits 3,477 3,260 10,151 9,401
Securities sold under repurchase agreements 25 82 86 214
Federal Home Loan Bank advances and other borrowings 86 109 258 284
------ ----- ------ ------
Total interest expense 3,588 3,451 10,495 9,899
------ ----- ------ ------
Net interest income 4,884 4,776 14,533 14,064
Provision for loan losses 201 290 613 946
------ ----- ------ ------
Net interest income after provision
for possible loan losses 4,683 4,486 13,920 13,118
------ ----- ------ ------
NON-INTEREST INCOME
Financial Management Services 573 500 1,693 1,500
Service charges on deposit accounts 270 242 788 722
Other 334 176 946 502
------ ----- ------ ------
Total non-interest income 1,177 918 3,427 2,724
------ ----- ------ ------
NON-INTEREST EXPENSE
Salaries and employee benefits 2,250 2,119 6,731 6,173
Net occupancy and equipment 838 748 2,448 2,221
FDIC deposit insurance 31 11 34 32
Bank shares tax (3) 85 172 255
Other 1,017 707 2,702 2,280
------ ----- ------ ------
Total non-interest expense 4,133 3,670 12,087 10,961
------ ----- ------ ------
Income before income taxes 1,727 1,734 5,260 4,881
INCOME TAXES 475 520 1,552 1,438
------ ----- ------ ------
NET INCOME $ 1,252 $1,214 $ 3,708 $ 3,443
====== ===== ====== ======
PER SHARE DATA
Basic Net income per common share (*) $ 0.27 $ 0.27 $0.80 $0.75
====== ====== ==== ====
Diluted net income per common share (*) $ 0.26 $ 0.27 $0.79 $0.74
====== ====== ==== ====
Dividends declared (*) $ 0.12 $ 0.11 $0.33 $0.29
====== ====== ==== ====
Weighted average shares outstanding (*) 4,619,450 4,583,894 4,609,134 4,579,564
========= ========= ========= =========
<FN>
(*) Adjusted for 2-for-1 stock split payable on November 24, 1998 to
shareholders of record on October 23, 1998.
</FN>
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997
--------- --------
<S> <C> <C>
Balance at January 1, $36,213 $33,175
Net income to date 3,708 3,443
Cash dividends declared (1,498) (1,348)
Net unrealized gain on securities available-for-sale 1,051 148
Treasury stock transactions 225 70
Paid in capital from treasury stock transactions 94 9
------ ------
Balance at September 30, $39,793 $35,497
====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------
(Dollars in thousands) 1998 1997
------------ -----------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 3,708 $ 3,443
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 889 750
Provision for loan losses 613 946
Amortization of investment security premiums
and accretion of discounts 150 10
Amortization of deferred fees on loans 47 14
Investment securities (gains) losses, net (2) 15
Decrease in other assets 1,210 501
Increase (decrease) in other liabilities 2,194 1,992
-------- --------
Net cash provided by operating activities 8,809 7,671
-------- --------
INVESTING ACTIVITIES
Decrease in interest bearing deposits in banks -- 1,000
(Increase) decrease in loans 560 (47,934)
Proceeds from sales of investment securities available-for-sale 12,640 27,564
Proceeds from maturities of investment securities available-for-sale 19,794 9,585
Proceeds from maturities of investment securities held-to-maturity 3,859 3,075
Purchases of investment securities available-for-sale (48,465) (16,624)
Purchase of premises and equipment, net (3,609) (508)
-------- --------
Net cash used in investing activities (15,221) (23,842)
-------- --------
FINANCING ACTIVITIES
Decrease in securities sold under repurchase agreements (2,525) 775
Increase in deposits 15,262 5,738
Increase in Federal Home Loan Bank advances and other borrowings (2,559) 9,915
Cash dividends (1,498) (1,348)
Treasury stock transactions 318 80
-------- --------
Net cash provided by financing activities 8,998 15,160
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 2,586 (1,011)
Cash and cash equivalents at beginning of period 26,448 25,756
-------- --------
Cash and cash equivalents at end of period $ 29,034 $ 24,745
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial
information. In the opinion of Management, all adjustments
(consisting only of normal recurring adjustments) necessary for a
fair presentation of the financial position and the results of
operations for the interim period presented have been included. For
further information, refer to the consolidated financial statements
and footnotes thereto included in First West Chester Corporation and
Subsidiaries' (the "Corporation") Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
2. The results of operations for the nine-month period ended September
30, 1998 are not necessarily indicative of the results to be expected
for the full year.
3. On September 22, 1998 the Board of Directors authorized a 2-for-1
stock split in the form a of 100% stock dividend. The dividend is
payable November 24, 1998 to shareholders of record on October 23,
1998. The 1998 and 1997 common stock and per share data have been
adjusted to reflect the effects of the stock dividend.
Per share data is based on the weighted average number of shares of
common stock outstanding (on a post-split basis) during the period.
Diluted net income per share includes the effect of options granted
(on a post-split basis). All per share data in this report has been
restated to reflect the new standards imposed by the Financial
Accounting Standards Board Statement ("SFAS") No. 128, "Earnings Per
Share" which became effective for financial statements issued after
December 15, 1997.
4. The Corporation adopted SFAS No. 130, "Reporting Comprehensive
Income" which became effective January 1, 1998. This new standard
requires entities presenting a complete set of financial statements
to include details of comprehensive income. Comprehensive income
consists of net income or loss for the current period and income,
expenses, gains and losses that bypass the income statement and are
reported directly in a separate component of equity. Comprehensive
income/(loss) net of taxes for the three- and nine-month periods
ended September 30, 1998 was $874 thousand and $1,051 thousand,
compared to $233 thousand and $148 thousand in the same period last
year.
5. The Financial Accounting Standards Board ("FASB") issued SFAS No.
132, "Employers Disclosures About Pensions and Other Postretirement
Benefits" which amends FASB statements No. 87, 88 and 106. The
statement revises employers' disclosures about pension and other
post-retirement benefit plans and does not change the measurement of
recognition of these plans. It standardizes the disclosure
requirements and requires additional information on benefit
obligations and the fair value of plan assets that will facilitate
financial analysis, and eliminate certain disclosures that are no
longer useful. The statement is effective for fiscal years beginning
after December 15, 1997. Adoption of the new standard is not expected
to have a material impact on the Corporation's financial statements.
6. The American Institute of Certified Public Accountants ("AICPA")
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." The SOP
was issued to provide authoritative guidance on the subject of
accounting for the costs associated with the purchase or development
of computer software. The statement is effective for fiscal years
7
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
beginning after December 15, 1998. This statement is not expected to
have a material impact on the Corporation's financial statements.
7. FASB issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" which amends FASB statements No. 52, 80, 105, 119
and 107. The statement requires that entities recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The
statement is effective for fiscal quarters of fiscal years beginning
after June 15, 1999. Management is considering early adoption of the
statement, which is not expected to have a material impact on the
Corporation's financial statements.
8. Certain prior year amounts have been reclassified to conform to the
current year presentations.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
EARNINGS SUMMARY AND HIGHLIGHTS
Net income for the three-month period ended September 30, 1998 was
$1.25 million, an increase of 3.1% from $1.21 million for the same period in
1997. Net income for the nine-month period ended September 30, 1998 was $3.71
million, an increase of 7.7% from $3.40 million for the same period in 1997.
Increases in net income are primarily the result of increases in net interest
income and non-interest income, partially offset by increases in operating
expenses. Net income also benefited from a decrease in income tax expense for
the three-month period ended September 30, 1998. This decrease can be attributed
to tax credits which resulted from an investment in a community project
accounted for in the third quarter of 1998. In addition, net income benefited
from a reduction in the provision for loan loss expense through the nine-month
period. Cash dividends declared during the third quarter of 1998 increased to
$0.12 per share (on a post-split basis), a 9.5% increase compared to the third
quarter of 1997. Over the past ten years, the Corporation's practice has been to
pay a dividend of at least 35.0% of net income.
On September 22, 1998, The Board of Directors of First West Chester
Corporation authorized a "2 for 1" stock split in the form of a 100% stock
dividend. The dividend is payable on November 24, 1998 to shareholders of record
on October 23, 1998. The 1998 and 1997 common stock per share data has been
adjusted to reflect the effects of the stock dividend. In addition, the Board of
Directors authorized the repurchase of up to 50,000 shares (on a pre-split
basis) of common stock through open market transactions. The shares will be
purchased from time to time depending upon market conditions.
The "Consolidated Average Balance Sheet" on pages 14 and 15 may assist the
reader in the following discussion.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
PERFORMANCE RATIOS
Return on Average Assets 1.13% 1.16% 1.14% 1.12%
Return on Average Equity 13.06% 13.87% 13.07% 13.45%
Earnings Retained 57.59% 60.38% 59.60% 60.85%
Dividend Payout Ratio 42.41% 39.62% 40.40% 39.15%
</TABLE>
NET INTEREST INCOME
Net interest income is the difference between interest income on
interest-earning assets and interest expense on interest-bearing liabilities.
Net interest income for the three- and nine-month periods ended September 30,
1998, on a tax equivalent basis, was $4.9 million and $14.7 million, an increase
of 1.9% and 3.0% compared to the same periods in 1997, respectively. Average net
yields on interest-earning assets, on a tax equivalent basis, were 4.77% and
4.82% for the three- and nine-month periods ended September 30, 1998 compared to
4.95% and 4.98% for the same periods in 1997, respectively. Increases in net
interest income can be attributed to an increase in average interest-earning
assets of 5.6% or $22.1 million and 6.3% or $24.0 million for the three- and
nine-month periods ended September 30, 1998 compared to the same periods last
year. The increases in average interest-earning assets are primarily the result
of increases in loan activity and investment security acquisitions. While the
total amount of loans has increased, the loan growth rate has decreased compared
to the same period last year. The decrease in growth rate can be attributed to
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
the Corporation's decision to exit the third party automobile lending business
due to less than expected results. The decision took effect on July 3, 1998. The
Corporation will continue to service the existing portfolio totaling $24.3
million, but has ceased adding any additional volume. Decreases in the
Corporation's net yield on interest-earning assets are primarily the result of a
decrease in the yields earned on its interest earning assets and increases in
the cost or yield paid on interest bearing liabilities. The Corporation
anticipates continued pressure on net yields on interest-earning assets as
competition for new loan business remains very strong and the costs of
incremental deposit growth and other funding sources become more expensive.
AVERAGE INTEREST RATES (ON A TAX EQUIVALENT BASIS)
<TABLE>
<CAPTION>
Three Months Nine Months
Yield On: Ended September 30, Ended September 30,
--------- ------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest Earning Assets 8.24% 8.47% 8.27% 8.43%
Interest Bearing Liabilities 4.33% 4.32% 4.29% 4.22%
---- ---- ---- ----
Net Interest Spread 3.91% 4.15% 3.98% 4.21%
Contribution of Interest Free Funds 0.86% 0.80% 0.84% 0.77%
---- ---- ---- ----
Net Yield on Interest Earning Assets 4.77% 4.95% 4.82% 4.98%
==== ==== ==== ====
</TABLE>
INTEREST INCOME ON FEDERAL FUNDS
Interest income on federal funds sold for the three- and nine-month
periods ended September 30, 1998 increased 51.8% and 62.8% to $167 thousand and
$319 thousand, respectively, when compared to the same periods in 1997. The
increase in interest income on federal funds sold for the three- and nine-month
periods ended September 30, 1998 is primarily the result of a $4.0 million and
$3.4 million increase in average balances, respectively, partially offset in the
nine-month period by lower rates paid.
INTEREST INCOME ON INVESTMENT SECURITIES
On a tax equivalent basis, interest income on investment securities
increased 3.4% and decreased 11.4% for the three- and nine-month periods ended
September 30, 1998 to $1.27 million and $3.60 million, respectively, when
compared to the same period in 1997. The increase for the three-month period is
due to an increase in the average balance of $8.6 million offset by a 48 basis
point decrease in the yield earned on investment securities when compared to the
same period last year. The decrease for the nine-month period is due to a
decrease in average balance of $4.7 million and a 40 basis point decrease in the
yield earned on securities when compared to the same period last year. Proceeds
from the sale of investment securities and maturities have been used to fund
continued loan growth over the last three quarters.
INTEREST INCOME ON LOANS
On a tax equivalent basis, interest income on loans generated by the
Corporation's loan portfolio increased 1.9% and 6.9% to $7.1 million and $21.3
million for the three- and nine-month periods ended September 30, 1998, compared
to the same periods in 1997, respectively. The increase in interest income on
loans for the three- and nine-month periods ended September 30, 1998 is
attributable to a $9.4 million and $25.6 million increase in average loans
outstanding, respectively, partially offset by 11 and 15 basis point decreases
in average interest rates earned compared to the same time periods in 1997,
respectively. The decreases in the average rates earned on the Corporation's
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
loan portfolio are a direct result of increased competition for new and existing
loan relationships and volume increases in lower yielding third party automobile
related loans (occurring during the first and second quarters of 1998) and
leases. As noted earlier, the third party automobile lending portfolio failed to
meet expected results prompting the Corporation's decision to cease adding
additional volume while continuing to service the existing portfolio as of July
3, 1998. Pricing and fee competition on large (over $500,000) loans (new and
renewals) remains strong. It is anticipated that this pricing pressure will
continue to put pressure on net interest margins. A reduction in fees will also
result in a direct decrease in non-interest income.
INTEREST EXPENSE ON DEPOSIT ACCOUNTS
Interest expense on deposit accounts increased 6.7% and 8.0% for the
three- and nine-month periods ended September 30, 1998 to $3.5 million and $10.2
million, compared to the same periods in 1997. The increase for the three-month
period ended September 30, 1998 is the result of increases in average
interest-bearing deposits of $21.2 million, partially offset by a 2 basis point
decrease in the average rates paid on interest-bearing deposits. The increase
for the nine-month period ended September 30, 1998 is the result of increases in
average interest-bearing deposits of $20.2 million and a 5 basis point increase
in average rates paid on interest-bearing deposits.
The Corporation's effective rate on interest-bearing deposits increased
from 4.21% to 4.26% for the nine-month ended September 30, 1997 and 1998,
respectively. Rates being paid on interest bearing liabilities has increased due
to competition. Competition for deposits from non-banking institutions, such as,
credit unions and mutual fund companies continues to increase. Despite this
competition, the Corporation's deposit base is growing and is expected to
increase for future time periods. The Corporation's new Frazer branch site
opened for business on August 3, 1998. This and other new branches are expected
to expand the Corporation's deposit base.
INTEREST EXPENSE ON SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Interest expense on securities sold under repurchase agreements
decreased 68.3% and 59.8% to $26 thousand and $86 thousand for the three- and
nine-month periods ended September 30, 1998 compared to the same time periods in
1997. The decreases are primarily attributable to $7.6 million and $5.7 million
decreases in average securities sold under repurchase agreements outstanding,
partially offset by 117 and 47 basis point decreases on average rates paid
compared to the three- and nine-month periods ended September 30, 1997,
respectively.
INTEREST EXPENSE ON FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
Interest expense on borrowings decreased 21.1% and 9.2% for the three-
and nine-month periods ended September 30, 1998, respectively. The need for
borrowings has decreased as a result of increased deposit growth and a decrease
in loan growth rate. Borrowings at any time consist of one or more of the
following: Overnight Fed Funds purchased, Federal Home Loan Bank ("FHLB") Term
Advances, FHLB Open Repo and Repo Plus Advances.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
PROVISION FOR POSSIBLE LOAN LOSSES
During the three- and nine-month periods ended September 30, 1998, the
Corporation recorded a $201 thousand and a $613 thousand provision for possible
loan losses, compared to $290 thousand and $946 thousand for the same periods in
1997. The decrease in the provision expense can be attributed to a decreased
rate in loan growth for the three- and nine-month periods ended September 30,
1998, compared to the same periods in 1997. The allowance for possible loan
losses as a percentage of total loans was 1.82% at September 30, 1998, and 1.85%
at December 31, 1997. See the section titled "Allowance For Possible Loan
Losses" for additional discussion.
NON-INTEREST INCOME
Total non-interest income increased 28.2% and 25.8% to $1.2 million and
$3.4 million for the three- and nine-month periods ended September 30, 1998,
compared to the same periods in 1997. The primary component of non-interest
income is Financial Management Services revenue, which increased 14.6% and 12.9%
to $573 thousand and $1.7 million for the three- and nine-month periods ended
September 30, 1998, respectively, compared to the same periods in 1997. The
market value of Financial Management Services' assets increased $46.0 million to
$370.0 million at September 30, 1998 from $324.0 million at September 30, 1997.
The increase in Financial Management Services= assets and revenues is primarily
the result of market appreciation and new account relationships acquired through
stronger marketing efforts.
Service charges on deposit accounts increased 11.6% and 9.2% to $270
thousand and $788 thousand for the three- and nine-month period ended September
30, 1998, respectively, compared to the same periods in 1997. The increases
relate to increases in the volume of deposit accounts and more effective
enforcement of service charge policies.
Other non-interest income increased 89.4% and 88.5% to $334 thousand
and $946 thousand for the three- and nine-month periods ended September 30, 1998
compared to the same periods in 1997. The increases are attributed to income
from service charges for non-customer ATM transactions, which commenced during
the second quarter of 1998. Income from the sale of residential mortgages to the
secondary market during the first and second quarters of 1998 also contributed
to the increases in other non-interest income.
NON-INTEREST EXPENSE
Total non-interest expense for the three- and nine-month periods ended
September 30, 1998 increased 12.6% and 10.3% to $4.1 million and $12.1 million
compared to the same periods in 1997. The various components of non-interest
expense changes are discussed below.
Salaries and employee benefits increased 6.2% and 9.0% for the three-
and nine-month periods ended September 30, 1998 to $2.3 million and $6.7 million
compared to the same periods in 1997, respectively. Employee raises, promotions
and a proportional increase in employee benefits are primarily responsible for
the increases. The hiring of additional staff also contributed to the increases.
Average full time equivalent staff increased from 189 for the period ended
September 30, 1997 to 203 for the period ended September 30, 1998.
Net occupancy, equipment, and data processing expense increased 12.0%
and 10.2% for the three- and nine-month period ended September 30, 1998 to $838
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
thousand and $2.4 million compared to the same periods in 1997, respectively.
The increases are a direct result in the increased number of personal computers
and related equipment costs, which are a necessary part of the Corporations core
system conversion. The conversion is scheduled to occur during the fourth
quarter 1998. See section titled "Building Improvements and Technology Projects"
for additional information.
Other non-interest expense increased 43.8% and 18.5% to $1.0 million
and $2.7 million for the three- and nine-month periods ended September 30, 1998
compared to the same periods in 1997. This increase can be attributed to
increases in the Corporation's marketing and loan related legal expenses as well
as additional operating expenses associated with the increases in staff and
premises which occurred through the third quarter 1998.
Construction on the Corporation's new Frazer area branch has been
completed. The branch opened for business on August 3, 1998. Preliminary plans
for additional branches continue to be pursued. The Corporation believes that
the costs associated with opening new branch sites will have a direct impact on
all the components of non-interest expense. It is anticipated that the increases
in costs will be offset over time by an increase in net interest and fee income
generated by business in the new marketing areas.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CONSOLIDATED AVERAGE BALANCE SHEET
AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES FOR THE
THREE MONTHS ENDED SEPTEMBER 30,
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997
--------------------------------- -------------------------------
Daily Daily
Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold $ 11,908 $ 167 5.61% $ 7,862 $ 110 5.60%
Investment securities
Taxable 82,500 1,245 6.04% 73,371 1,193 6.50%
Tax-exempt (1) 1,502 29 7.60% 2,011 39 7.69%
------- ------ ------- ------
Total investment securities 84,002 1,274 6.06% 75,382 1,232 6.54%
------- ------ ------- ------
Loans (2)
Taxable 311,710 6,932 8.90% 299,708 6,753 9.01%
Tax-exempt (1) 6,423 158 9.86% 8,985 208 9.27%
------- ------ ------- ------
Total loans 318,133 7,090 8.91% 308,693 6,961 9.02%
------- ------ ------- ------
Total interest earning assets 414,043 8,531 8.24% 391,937 8,303 8.47%
Non-interest earning assets
Allowance for possible loan losses (5,881) (5,732)
Cash and due from banks 21,056 19,853
Other assets 13,907 12,842
------- -------
Total assets $443,125 $418,900
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings, NOWS & money market deposits $186,108 $ 1,642 3.53% $173,691 $ 1,362 3.14%
Certificates of deposits and other time 138,027 1,835 5.32% 129,206 1,898 5.88%
------- ------ ------- ------
Total interest bearing deposits 324,135 3,477 4.29% 302,897 3,260 4.31%
Securities sold under repurchase agreements 2,334 26 4.46% 9,957 82 3.29%
Federal Home Loan Bank advances and
Other Borrowings 5,093 86 6.75% 6,953 109 6.27%
------- ------ ------- ------
Total interest bearing liabilities 331,562 3,589 4.33% 319,807 3,451 4.32%
------- ------ ------- ------
Non-interest bearing liabilities
Non-interest bearing demand deposits 65,047 57,538
Other liabilities 8,168 6,543
------- -------
Total liabilities 404,777 383,888
Stockholders' equity 38,348 35,012
------- -------
Total liabilities and stockholders' equity $443,125 $418,900
======= =======
Net interest income $ 4,942 $ 4,852
====== ======
Net yield on interest earning assets 4.77% 4.95%
==== ====
<FN>
(1) The indicated income and annual rate are presented on a taxable equivalent basis using the Federal marginal rate of 34%
adjusted for the 20% interest expense disallowance for 1998 and 1997.
(2) Non-accruing loans are included in the average balance.
</FN>
</TABLE>
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CONSOLIDATED AVERAGE BALANCE SHEET
AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES FOR THE
NINE MONTHS ENDED SEPTEMBER 30,
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997
-------------------------------- ---------------------------------
Daily Daily
Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold $ 7,680 $ 319 5.54% $ 4,271 $ 196 6.12%
Interest bearing deposits in banks -- -- -- 264 12 6.06%
Investment securities
Taxable 76,805 3,513 6.10% 80,652 3,937 6.51%
Tax-exempt (1) 1,490 86 7.69% 2,294 127 7.40%
------- ------ ------- ------
Total investment securities 78,295 3,599 6.13% 82,946 4,064 6.53%
------- ------ ------- ------
Loans (2)
Taxable 314,084 20,790 8.83% 286,511 19,307 8.98%
Tax-exempt (1) 6,619 502 10.12% 8,603 613 9.50%
------- ------ ------- ------
Total loans 320,703 21,292 8.85% 295,114 19,920 9.00%
------- ------ ------- ------
Total Interest Earning Assets 406,678 25,210 8.27% 382,595 24,192 8.43%
Non-interest earning assets
Allowance for possible loan losses (5,924) (5,483)
Cash and due from banks 20,113 18,647
Other assets 13,747 13,711
------- -------
Total assets $434,614 $409,508
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings, NOWS & money market deposits $182,773 $ 4,306 3.14% $173,286 $ 4,048 3.11%
Certificates of deposits and other time 134,989 5,845 5.77% 124,296 5,353 5.74%
------- ------ ------- ------
Total interest bearing deposits 317,762 10,151 4.26% 297,582 9,401 4.21%
Securities sold under repurchase agreements 3,069 86 3.74% 8,734 214 3.27%
Federal Home Loan Bank advances and
Other borrowings 5,343 258 6.44% 6,202 284 6.11%
------- ------ ------- ------
Total interest bearing liabilities 326,174 10,495 4.29% 312,518 9,899 4.22%
------- ------ ------- ------
Non-interest bearing liabilities
Non-interest bearing demand deposits 63,502 56,741
Other liabilities 7,124 6,117
------- -------
Total liabilities 396,800 375,376
Stockholders' equity 37,814 34,132
------- -------
Total liabilities and stockholders' equity $434,614 $409,508
======= =======
Net interest income $14,715 $14,293
====== ======
Net yield on interest earning assets 4.82% 4.98%
==== ====
<FN>
(1) The indicated income and annual rate are presented on a taxable equivalent basis using the Federal marginal rate of 34%
adjusted for the 20% interest expense disallowance for 1998 and 1997.
(2) Non-accruing loans are included in the average balance.
</FN>
</TABLE>
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INCOME TAXES
Income tax expense for the three- and nine-month periods ended
September 30, 1998 was $475 thousand and $1.6 million, respectively, compared to
$520 thousand and $1.4 million for the same periods last year. This represents
effective tax rates of 27.5% and 29.5% for the three- and nine-month periods
ended September 30, 1998, compared with 29.9% and 29.5% for the same periods in
1997, respectively. Tax-exempt instruments as a percentage of total average
assets were 1.9% and 2.8% at September 30, 1998 and 1997, respectfully. Tax
rates were effected by tax credits which resulted from an investment in a
community development project that were accounted for in the second quarter of
1997 and third quarter of 1998.
LIQUIDITY MANAGEMENT AND INTEREST RATE SENSITIVITY
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for business expansion. Liquidity management addresses the
Corporation's ability to meet deposit withdrawals either on demand or at
contractual maturity, to repay borrowings as they mature and to make new loans
and investments as opportunities arise. Liquidity is managed on a daily basis
enabling Senior Management to effectively monitor changes in liquidity and to
react accordingly to fluctuations in market conditions. The primary source of
liquidity for the Corporation is its available-for-sale portfolio of liquid
investment grade securities. Funding sources also include NOW, money-market,
savings, and smaller denomination certificates of deposit accounts. The
Corporation considers funds from such sources to comprise its "core" deposit
base because of the historical stability of such sources of funds. Additional
liquidity comes from the Corporation's non-interest bearing demand deposit
accounts. Other deposit sources include a three-tiered savings product and
certificates of deposit in excess of $100,000. Details of core deposits,
non-interest bearing demand deposit accounts and other deposit sources are
highlighted in the following table:
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
DEPOSIT ANALYSIS
<TABLE>
<CAPTION>
(Annualized)
(Dollars in thousands) September 30, 1998 December 31, 1997 Average Balance
-------------------- ------------------- -------------------------
Average Effective Average Effective Dollar Percentage
Balance Yield Balance Yield Variance Variance
------- ----- ------- ----- -------- --------
<S> <C> <C> <C> <C> <C> <C>
NOW Accounts $ 55,430 2.13% $ 52,758 2.19% $ 2,672 5.06%
Money Market 28,046 3.14 28,433 3.15 (387) (1.36)
Statement Savings 46,723 3.30 48,381 3.31 (1,658) (3.43)
Other Savings 2,520 2.75 2,996 2.74 (476) (15.89)
CD's Less than $100,000 112,860 5.80 108,022 5.80 4,838 4.48
------- ------- ------
Total Core Deposits 245,579 4.16 240,590 4.16 4,989 2.07
Demand Deposit Accounts 63,502 -- 57,659 -- 5,843 10.13
------- ------- ------
Total Core and Demand
Deposits Accounts 309,081 -- 298,249 3.35 10,832 3.63
------- ------- ------
Tiered Savings 50,054 4.14 41,184 4.14 8,870 21.54
CD's Greater than $100,000 22,129 5.65 17,415 5.54 4,714 27.07
------- ------- ------
Total Deposits $381,264 -- $356,848 3.55 $24,416 6.84
======= ======= ======
</TABLE>
The Corporation, as a member of FHLB, maintains a $10 million line of
credit secured by the Corporation's mortgage related assets. As of September 30,
1998, the amount outstanding on this line of credit was $0. In addition to the
line of credit, the Corporation has additional borrowing capacity at FHLB of
approximately $94 million. During the third quarter of 1998, average FHLB
advances were approximately $5.1 million and consisted of terms advances
representing a combination of maturities. The average interest rate on these
advances was approximately 6.75%. FHLB advances are collateralized by a pledge
on the Corporation's entire portfolio of unencumbered investment securities,
certain mortgage loans and a lien on the Corporation's FHLB stock.
The goal of interest rate sensitivity management is to avoid
fluctuating net interest margins, and to enhance consistent growth of net
interest income through periods of changing interest rates. Such sensitivity is
measured as the difference in the volume of assets and liabilities in the
existing portfolio that are subject to repricing in a future time period. The
Corporation's net interest rate sensitivity gap within one year is a negative
$109.2 million or 24.4% of total assets at September 30, 1998, compared with
negative $118 million or 28.2% at September 30, 1997, respectively. The
Corporation=s gap position is one factor used to evaluate interest rate risk and
the stability of net interest margins. Other factors include computer
simulations of what might happen to net interest income under various interest
rate forecasts and scenarios. Management monitors interest rate risk as a
regular part of bank operations with the intention of maintaining a stable net
interest margin.
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTEREST SENSITIVITY ANALYSIS
AS OF SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
(Dollars in thousands)
One Over
Within through five Non-rate
one year five years years sensitive Total
-------- ---------- ----- --------- -----
<S> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold $ 8,950 $ -- $ -- $ -- $ 8,950
Investment securities 34,769 35,501 20,944 -- 91,214
Loans and leases 119,008 179,519 19,041 (5,788) 311,780
Cash and cash equivalents -- -- -- 20,084 20,084
Premises & equipment -- -- -- 9,380 9,380
Other assets 2,029 -- -- 3,882 5,911
----------- ---------- ---------- ---------- ----------
Total assets $ 164,756 $ 215,020 $ 39,985 $ 27,558 $ 447,319
=========== ========== ========== ========== ==========
LIABILITIES AND CAPITAL
Non-interest bearing deposit $ -- $ -- $ -- $ 66,243 $ 66,243
Interest bearing deposits 267,188 54,787 1,293 -- 323,268
FHLB Term Advance 1,941 3,103 22 -- 5,066
Borrowed funds 4,854 -- -- -- 4,854
Other liabilities -- -- -- 8,095 8,095
Capital -- -- -- 39,793 39,793
----------- ---------- ---------- ---------- ----------
Total liabilities & capital $ 273,983 $ 57,890 $ 1,315 $ 114,131 $ 447,319
=========== ========== ========== ========== ==========
Net interest rate
sensitivity gap $ (109,227) $ 157,130 $ 38,670 $ (86,573) $ --
========== ========== ========== ========= ==========
Cumulative interest rate
sensitivity gap $ (109,227) $ 47,903 $ 86,573 $ -- $ --
========== ========== ========== ========== ==========
Cumulative interest rate
sensitivity gap divided
by total assets (24.4%) 10.7% 19.4%
========== ===== =========
</TABLE>
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The allowance for possible loan losses is an amount that Management
believes will be adequate to absorb possible loan losses on existing loans that
may become uncollectible based on evaluations of the collectibility of loans.
The evaluations take into consideration such factors as changes in the nature
and volume of the loan portfolio, overall portfolio quality, adequacy of
collateral, review of specific problem loans, and current economic conditions
that may affect the borrower's ability to pay.
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ANALYSIS OF CHANGES IN THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
AND COMPARISON OF LOANS OUTSTANDING
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- -------------
(Dollars in thousands) 1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance at beginning of period $ 5,912 $ 5,653 $ 5,900 $ 5,218
------- ------- ------
Provision charged to operating expense 201 290 613 946
------- ------- ------ ------
Recoveries of loans previously charged-off 9 12 26 80
Loans charged-off (334) (55) (751) (344)
------- ------- ------ ------
Net loans charged-off (325) (43) (725) (264)
------- ------- ------ ------
Balance at end of period $ 5,788 $ 5,900 $ 5,788 $ 5,900
====== ====== ====== ======
Period-end loans outstanding $317,568 $312,237 $317,568 $312,237
Average loans outstanding $318,133 $308,693 $320,703 $295,114
Allowance for possible loan losses as a
percentage of period-end loans outstanding 1.82% 1.89% 1.82% 1.89%
Ratio of net charge-offs to average loans
outstanding (annualized) 0.40% 0.04% 0.31% 0.12%
</TABLE>
NON-PERFORMING LOANS AND ASSETS
Non-performing loans include loans on non-accrual status and loans past
due 90 days or more and still accruing. The Corporation's policy is to write
down all non-performing loans to net realizable value based on updated
appraisals. Non-performing loans are generally collateralized by real estate and
are in the process of collection. Management is not aware of any loans other
than those included in the following table that would be considered potential
problem loans and cause Management to have doubts as to the borrower's ability
to comply with loan repayment terms.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
September 30, December 31,
------------- ------------
(Dollars in thousands) 1998 1997 1997
----- ---- ----
<S> <C> <C> <C>
Past due over 90 days and still accruing $ 614 $ 619 $ 466
Non-accrual loans 2,183 1,258 1,443
----- ----- -----
Total non-performing loans 2,797 1,877 1,909
Other real estate owned 192 851 1,651
----- ----- -----
Total non-performing assets $2,989 $2,728 $3,560
===== ===== =====
Non-performing loans as a percentage
of total loans 0.88% 0.60% 0.60%
Allowance for possible loan losses as a
percentage of non-performing loans 206.94% 314.33% 309.10%
Non-performing assets as a percentage
of total loans and other real estate owned 0.94% 0.87% 1.11%
Allowance for possible loan losses as a
percentage of non-performing assets 193.64% 216.28% 165.70%
</TABLE>
The allowance for possible loan losses as a percentage of
non-performing loans ratio indicates that the allowance for possible loan losses
is sufficient to cover the principal of all non-performing loans at September
30, 1998. Other Real Estate Owned ("OREO") represents residential and commercial
real estate that has been written down to realizable value (net of estimated
disposal costs) based on professional appraisals. In July 1998, the Corporation
liquidated from OREO a commercial property for a net amount of $505 thousand
resulting in a $15 thousand loss.
Management is not aware of any loans other than those included in these
tables and mentioned in this paragraph that would be considered potential
problem loans and cause Management to have doubts as to the borrower's ability
to comply with loan repayment terms. During 1997, the Corporation increased
third party automobile loans $23 million to $24 million. During 1998, these
loans had grown approximately $3 million to $27 million. As of September 30,
1998 these loans totaled approximately $24 million. These loans are unseasoned
and have increased non-performing loan numbers. As of September 30, 1998
approximately 7.41% of this portfolio was past due. In addition, approximately
$130 thousand in repossessed vehicles is included in other assets. The
Corporation decided to withdraw from third party automobile lending due to less
than expected results. The Corporation will continue to service the existing
portfolio but has not added any additional volume since July 3, 1998. At
September 30, 1998 there were no concentrations of loans exceeding 10% of total
loans which are not otherwise disclosed.
LOAN IMPAIRMENT
In accordance with FAS 114, the Corporation identifies certain loans as
impaired when it is probable that interest and principal will not be collected
according to the contractual terms of the loan agreement. The accrual of
interest is discontinued in such loans and no income is recognized until all
recorded amounts of interest and principal are recovered in full. These loans
are included in the non-accrual loans total in the above analysis.
Loan impairment is measured by estimating the expected future cash
flows and discounting them at the respective effective interest rate or by
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
valuing the underlying collateral. The recorded investment in these loans and
the valuation for credit losses related to loan impairment are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) September 30, 1998 September 30, 1997 December 31,1997
------------------ ------------------ ----------------
<S> <C> <C> <C>
Principal amount of impaired loans $1,690 $1,093 $1,121
Less valuation allowance (338) (331) (306)
----- ------ -----
$1,352 $ 762 $ 815
===== ===== =====
</TABLE>
The activity in the valuation allowance for the three- and nine-month periods
ended September 30, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
----------------------- ------------------------
Three Nine Three Nine
Months Months Months Months
Ended Ended Ended Ended
----- ----- ----- -----
<S> <C> <C> <C> <C>
Valuation allowance at beginning of period $ 297 $ 306 $ 318 $ 419
Provision for loan impairment 50 125 50 125
Direct charge-offs (9) (93) (37) (213)
Recoveries -- -- -- --
----- ----- -----
Valuation allowance at end of period $ 338 $ 338 $ 331 $ 331
===== ===== ===== =====
</TABLE>
Total cash collected on impaired loans during the three- and nine-month
periods ended September 30, 1998 was $102 thousand and $123 thousand of which
$81 thousand and $102 thousand were credited to the principal balances
outstanding. During the three- and nine-month periods ended September 30, 1998,
$20 thousand was credited to interest income for both periods, respectively.
Interest that would have been accrued on impaired loans during the three- and
nine-month periods ended September 30, 1998 was $38 thousand and $97 thousand,
respectively. Interest income recognized during the three- and nine-month
periods ended September 30, 1998 was $20 thousand.
Total cash collected on impaired loans during the three- and nine-month
periods ended September 30, 1997 was $64 thousand and $276 thousand,
respectively, of which $63 thousand and $245 thousand was credited to the
principal balance outstanding. During the three-month period ended September 30,
1997, $1 thousand was credited to interest. Interest that would have been
accrued on impaired loans during the three- and nine- month periods ended
September 30, 1997 was $13 thousand and $38 thousand, respectively. Interest
income recognized during the three- and nine-month periods ended September 30,
1997 was $0 and $36 thousand, respectively.
BUILDING IMPROVEMENTS AND TECHNOLOGY PROJECTS
During 1998, the Corporation completed construction of a 2,750 square
foot branch office in the Frazer area. The Branch opened for business on August
3, 1998.
In December 1997, the Corporation entered into an agreement to purchase
a 25,000 square foot office building adjacent to the Corporation's existing
Operation Center in West Chester, Pennsylvania for approximately $1.7 million.
The Corporation took possession of the property in September 1998 and expects to
occupy the building sometime during 1999.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In September 1998, the Corporation entered into an agreement to
purchase approximately five acres of land in Chester County, Pennsylvania for
approximately $1.4 million. The Corporation is scheduled to take possession of
the land in September 1999.
During 1997, the Corporation completed an in depth review of its core
processing system and concluded that a new core processing system was needed for
competitive reasons. After extensive research, the Corporation selected Jack
Henry and Associates Inc. ("JHA") to provide the new core processing system. JHA
is a major provider of community bank core processing systems. Specifically, the
Corporation contracted with JHA to purchase its Silverlake System, related
hardware, installation and training services. First year contract costs are
estimated to be $1.2 million. The conversion process has commenced and is
expected to be completed in the fourth quarter of this year.
YEAR 2000 ISSUES
State of Readiness
- ------------------
The Corporation has adopted a Year 2000 ("Y2K") policy to address the
inability of certain information systems and automated equipment to properly
recognize and process dates containing the Y2K and beyond, (the "Y2K Issue"). If
not corrected, these systems and equipment could produce inaccurate or
unpredictable results commencing on January 1, 2000. The Corporation, similar to
most financial services providers, is particularly vulnerable to the potential
impact of the Y2K Issue due to the nature of financial information. Potential
impacts to the Corporation may arise from software, computer hardware, and other
equipment failure both within the Corporation's direct control and outside of
the Corporation's ownership yet with which the Corporation electronically or
operationally interfaces. The Corporation has no internally generated software
coding to correct. Substantially all of the software utilized by the Corporation
is purchased or licensed from external providers.
In order to address the Y2K Issue, the Corporation has developed and
implemented a five phase compliance plan. The compliance plan is divided into
the following major components: (1) Awareness; (2) Assessment; (3) Renovation;
(4) Validation and Testing; and (5) Implementation. The Corporation has
completed the first three phases of the plan for all of its mission-critical
systems and is currently working on the final two phases. The Corporation
anticipates that the validation, testing and implementation phases of
mission-critical systems will be substantially completed by March 31, 1999.
JHA has tested the unmodified version of its Silverlake system and the
Federal Financial Institutions Examination Council ("FFIEC") has reviewed JHA
test procedures and has provided the Corporation with a copy of the results. The
Corporation will conduct an independent test on the Silverlake system and
related hardware during the week of March 7, 1999. Testing will consist of an
integrated test for critical dates and a baseline test.
The Corporation's Financial Management Services Department outsources
its core processing to Sunguard Trust System Inc.'s ("STS") Charlotte. STS is a
provider of data processing services to the financial services industry. STS has
informed the Corporation that, based upon tests, which it has conducted and is
currently conducting, it believes its systems are Y2K compliant. The Corporation
will rely on testing conducted by STS and will also rely on Proxy Tests
conducted by certain STS customers. The Corporation anticipates testing to be
completed by December 31, 1998.
The Costs to Address the Corporation's Year 2000 Issues
- -------------------------------------------------------
The Corporation has incurred direct Y2K project cost of $19 thousand as
of September 30, 1998. The Corporation anticipates that its total Y2K project
cost will not exceed $150,000. This estimated project cost is based upon
currently available information and includes expenses for the review and testing
by third parties, including government entities. However, there can be no
guarantee that the hardware, software, and systems of such third parties will be
free of unfavorable Y2K issues and therefore not present a material adverse
impact upon the Corporation. The aforementioned Y2K project cost estimate also
may change as the Corporation progresses in its Y2K program and obtains
additional information associated with, and conducts further testing concerning,
third parties. At this time, no significant projects have been delayed as a
result of the Corporation's Y2K effort.
Risk Assessment
- ---------------
In assessing the Corporation's Y2K exposure the Corporation is
identifying those suppliers and customers whose possible lack of the Y2K Issue
preparedness might expose the Corporation to financial loss. Financial loss
includes but is not limited to the following: (1) monies paid to suppliers for
which no performance is rendered; (2) inability of suppliers to furnish
necessary items may result in costly business interruptions; and (3) inability
of loan customers to repay amounts due.
22
<PAGE>
The Corporation has initiated formal communications with its
significant vendors and large loan customers (over $250,000) to determine its
vulnerability as a result of the failure of those third parties to remediate
their own Y2K Issues. For significant vendors, the Corporation will review their
Y2K capabilities by December 31, 1998 or make plans to switch to new vendors
with systems that are Y2K compliant. For large loan customers, the Corporation
will take appropriate action based upon each customer's response to the
Corporation's Y2K communication.
The Corporation's Contingency Plan
- ----------------------------------
The Corporation has developed labor intensive contingency plans, which
are designed to render the Corporation operational for a period of seven to
fourteen days should a Y2K problem surface. These contingency plans consist of
various manual tasks, which include but are not limited to the following:
1. Maintenance of new loan input and loan payments collected are to be
maintained on Microsoft Excel spreadsheets;
2. Maintenance of core deposit account information as well as account
closings are to maintained on Microsoft Excel spreadsheets;
3. Manual sorting of deposit tickets and checks by account number; and
4. Manual preparation of billing notices
At this time the Corporation cannot estimate the cost, if any, that
might be required to implement such contingency plans.
Other
- -----
Financial institution regulators have intensively focused upon Y2K
exposures, issuing guidance concerning the responsibilities of senior management
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
and directors in addressing the Y2K Issue. Y2K testing and certification is
being addressed as a key safety and soundness issue in conjunction with
regulatory exams. In May 1997, the FFIEC issued an interagency statement to the
chief executive officers of all federally supervised financial institutions
regarding Y2K project management awareness. The FFIEC has highly prioritized Y2K
compliance in order to avoid major disruptions to the operations of financial
institutions and the country's financial systems when the new century begins.
The FFIEC statement provides guidance to financial institutions, providers of
data services, and all examining personnel of the federal banking agencies
regarding the Y2K Issue.
The federal banking agencies, including the Office of the Comptroller
and the Currency ("OCC") have been conducting Y2K compliance examinations. The
failure to implement an adequate Y2K program can be identified as an unsafe and
unsound banking practice. The Corporation and the Bank are subject to regulation
and supervision by the OCC which regularly conducts reviews of the safety and
soundness of the Corporation's operations, including the Corporation's progress
in becoming Y2K compliant. The OCC has established an examination procedure
which contains three categories of ratings: "Satisfactory", "Needs Improvement",
and "Unsatisfactory". Institutions that receive a Y2K rating of Unsatisfactory
may be subject to formal enforcement action, supervisory agreements, cease and
desist orders, civil money penalties, or the appointment of a conservator. In
addition, federal banking agencies will be taking into account Y2K compliance
programs when reviewing applications and may deny an application based on Y2K
related issues. Failure by the Corporation to adequately prepare for Y2K issues
could negatively impact the Corporation's banking operations, including the
imposition of restrictions upon its operations by the OCC.
Despite the Corporation's activities in regards to the Y2K Issue, there
can be no assurance that partial or total systems interruptions or the costs
necessary to update hardware and software would not have a material adverse
effect upon the Corporation's business, financial condition, results of
operations, and business prospects.
CAPITAL ADEQUACY
The Corporation is subject to Risk-Based Capital Guidelines adopted by
the Federal Reserve Board ("FRB") for bank holding companies. The Corporation is
also subject to similar capital requirements adopted by the OCC. Under these
requirements, the regulatory agencies have set minimum thresholds for Tier I
Capital, Total Capital, and Leverage ratios. At September 30, 1998, both the
Corporation's and the Bank's capital exceeded all minimum regulatory
requirements, and were considered "well capitalized" as defined in the
regulations issued pursuant to the FDIC Improvement Act of 1991. The
Corporation's Risk-Based Capital Ratios, shown below, have been computed in
accordance with regulatory accounting policies.
<TABLE>
<CAPTION>
RISK-BASED September 30, December 31, "Well Capitalized"
CAPITAL RATIOS -------------------------- ------------ Requirements
1998 1997 1997 ----------------
---- ---- ----
<S> <C> <C> <C> <C>
Corporation
- -----------
Leverage Ratio 8.75% 8.48% 8.57% 5.00%
Tier I Capital Ratio 11.71% 11.30% 11.22% 6.00%
Total Risk-Based Capital Ratio 12.96% 12.56% 12.48% 10.00%
Bank
- ----
Leverage Ratio 8.56% 8.57% 8.30% 5.00%
Tier I Capital Ratio 11.46% 11.22% 10.89% 6.00%
Total Risk-Based Capital Ratio 12.71% 12.48% 12.14% 10.00%
</TABLE>
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Corporation is not under any agreement with the regulatory
authorities nor is it aware of any current recommendations by the regulatory
authorities that, if they were to be implemented, would have a material affect
on liquidity, capital resources or operations of the Corporation. The internal
capital growth rate for the Corporation was 13.18% and 9.33% for the nine months
ended September 30, 1998 and 1997, respectively. The growth rate is computed by
annualizing the change in equity during the last period and doubling it by total
stockholders equity at September 30, 1998 and 1997, respectively.
FORWARD-LOOKING STATEMENTS
This report contains statements relating to future results of the
Corporation that are considered "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. These statements relate
to among other things, planned investments in new technology, branch locations,
anticipated pressures on net yields, and the Y2K Issue.
Risks and uncertainties could cause actual future results and investments
to differ materially from those contemplated in such forward-looking statements.
These risks and uncertainties include, but are not limited to, the following:
(a) loan growth and/or loan margins may be less than expected, due to
competitive pressures in the banking industry and/or changes in the interest
rate environment; (b) general economic conditions in the Corporation's market
area may be less favorable than expected, resulting in, among other things, a
deterioration in credit quality; (c) costs of the Corporation's planned training
initiatives, product development, branch expansion, new technology and operating
systems may exceed expectations; (d) volatility in the Corporation's market area
due to recent mergers may have unanticipated consequences, such as customer
turnover; (e) changes in the regulatory environment, securities markets, general
business conditions and inflation may be adverse; (f) unforeseen difficulties in
implementing the Y2K compliance plan or contingency plans; and (g) failure of
suppliers and customers to be Y2K compliant. These risks and uncertainties are
all difficult to predict and most are beyond the control of the Corporation's
Management.
Readers are cautioned not to place undue reliance on these and similar
forward-looking statements, which speak only as the date of this report. The
Corporation undertakes no obligation to publicly release any revisions to these
forward-looking statements to reflect events or circumstances after the date of
this report.
25
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Corporation's assessment of
its sensitivity to market risk since its presentation in the 1997 Annual Report
of the Corporation, filed as an exhibit to its Form 10-K for the fiscal year
ended December 31, 1997, with the SEC via EDGAR. Please refer to the
"Management's Discussion and Analysis" section on pages 22-23 of the
Corporation's 1997 Annual Report for this assessment.
26
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
Various actions and proceedings are presently pending to which
the Corporation is a party. These actions and proceedings
arise out of routine operations and, in Management's opinion,
will not, either individually or in the aggregate, have a
material adverse effect on the consolidated financial position
of the Corporation and its subsidiaries.
Item 2. Changes in Securities
---------------------
None
Item 3. Defaults upon Senior Securities
-------------------------------
None
Item 4. Submission of Matters to Vote of Security Holders
-------------------------------------------------
None
Item 5. Other Information
-----------------
None
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
--------
The following is a list of exhibits incorporated by
reference into this report:
3(i). Articles of Incorporation. Copy of the Corporation's Articles of
Incorporation, as amended, is incorporated herein by reference to Exhibit 3(i)
to the Corporation's Annual Report on Form 10-K for the year ended December 31,
1997.
3(ii). Bylaws of the Corporation, as amended. Copy of the Corporation's
Bylaws, as amended, is incorporated herein by reference to Exhibit 3(ii) to the
Corporation's Annual Report on Form 10-K for the year ended December 31, 1997.
27. Financial Data Schedule.
-----------------------
(b) Reports on Form 8-K
-------------------
A Form 8-K was filed on September 22, 1998 with the SEC via
EDGAR pertaining to a press release on the stock dividend
described herein on pages 7 and 9 and the Corporation's plan
to repurchase 50,000 shares on a pre-split basis described
herein on page 9.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized as amended.
FIRST WEST CHESTER CORPORATION
Charles E. Swope
/s/ Charles E. Swope
____________________
President
DATE: November 16, 1998
J. Duncan Smith
/s/ J. Duncan Smith
____________________
Treasurer
(Principal Accounting
and Financial Officer)
28
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
First West Chester Corporation's FDS
</LEGEND>
<CIK> 0000744126
<NAME> First West Chester Corporation
<MULTIPLIER> 1000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jul-01-1998
<PERIOD-END> Sep-30-1998
<EXCHANGE-RATE> 1.000
<CASH> 20,084
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 8,950
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 82,816
<INVESTMENTS-CARRYING> 8,398
<INVESTMENTS-MARKET> 8,673
<LOANS> 317,568
<ALLOWANCE> (5,788)
<TOTAL-ASSETS> 447,319
<DEPOSITS> 389,511
<SHORT-TERM> 6,795
<LIABILITIES-OTHER> 11,220
<LONG-TERM> 0
0
0
<COMMON> 2,400
<OTHER-SE> 37,393
<TOTAL-LIABILITIES-AND-EQUITY> 447,319
<INTEREST-LOAN> 21,186
<INTEREST-INVEST> 3,573
<INTEREST-OTHER> 319
<INTEREST-TOTAL> 25,028
<INTEREST-DEPOSIT> 10,151
<INTEREST-EXPENSE> 344
<INTEREST-INCOME-NET> 10,495
<LOAN-LOSSES> 613
<SECURITIES-GAINS> 2
<EXPENSE-OTHER> 3,427
<INCOME-PRETAX> 5,260
<INCOME-PRE-EXTRAORDINARY> 5,260
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,708
<EPS-PRIMARY> .80
<EPS-DILUTED> .79
<YIELD-ACTUAL> 4.82
<LOANS-NON> 2,183
<LOANS-PAST> 614
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5,900
<CHARGE-OFFS> 751
<RECOVERIES> 26
<ALLOWANCE-CLOSE> 5,788
<ALLOWANCE-DOMESTIC> 5,788
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
