UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999, OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________.
Commission File No. 0-12870.
FIRST WEST CHESTER CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2288763
(State or other jurisdiction (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 July
31, 1999 was 4,573,792.
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
Part I. FINANCIAL INFORMATION
<S> <C>
Item 1 - Financial Statements
Consolidated Statements of Condition
June 30, 1999 and December 31, 1998 3
Consolidated Statements of Income
Three and Six-Months Ended June 30, 1999 and 1998 4
Consolidated Statements of Stockholder's Equity 5
Consolidated Statements of Cash Flows
Six-Months Ended June 30, 1999 and 1998 6
Notes to Consolidated Financial Statements 7-8
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-23
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 24
Part II. OTHER INFORMATION
Item 1 - Legal Proceedings
Item 2 - Changes in Securities
Item 3 - Defaults upon Senior Securities
Item 4 - Submission of Matters to a Vote of Security Holders
Item 5 - Other Information
Item 6 - Exhibits and Reports on Form 8-K 25
Signatures 26
</TABLE>
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
(Dollars in thousands - except per share data) (Unaudited)
June 30 December 31,
1999 1998
---------- -----------
<S> <C> <C>
ASSETS
Cash and due from banks $ 25,266 $ 25,006
Federal funds sold - 5,675
--------- --------
Total cash and cash equivalents 25,266 30,681
--------- --------
Investment securities held-to-maturity (market value of $5,303 and $7,606 at
June 30, 1999 and December 31, 1998, respectively) 5,265 7,406
Investment securities available-for-sale at market value 112,308 102,380
Loans 327,554 320,395
Less allowance for loan losses (5,922) (5,877)
--------- --------
Net loans 321,632 314,518
Premises and equipment, net 9,465 9,579
Other assets 7,921 6,129
--------- --------
TOTAL ASSETS $ 481,857 $ 470,693
========= ========
LIABILITIES
Deposits
Non-interest bearing $ 76,715 $ 72,556
Interest bearing 352,504 345,842
--------- --------
Total deposits 429,219 418,398
Securities sold under repurchase agreements 2,610 2,795
Federal Home Loan Bank advances and other borrowings 4,310 5,027
Other liabilities 5,991 4,750
--------- --------
Total liabilities 442,130 430,970
--------- --------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00; authorized, 10,000,000 shares; 4,800 4,800
Outstanding, 4,799,666 shares at June 30, 1999 and December 31, 1998.
Additional paid-in capital 602 542
Retained earnings 37,054 35,675
Accumulated other Comprehensive Income (188) 292
Treasury stock, at cost: 225,874 shares at June 30, 1999 and
183,640 shares at December 31, 1998. (2,541) (1,586)
--------- --------
Total stockholders' equity 39,727 39,723
--------- --------
Total liabilities and stockholders' equity $ 481,857 $ 470,693
========= ========
Book Value Per Share $ 8.69 $ 8.61
The accompanying notes are an integral part of these statements.
</TABLE>
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 Six Months Ended
June 30, June 30,
---------------------- ---------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $6,808 $7,117 $13,445 $14,118
Investment securities 1,817 1,138 3,476 2,308
Federal funds sold 34 83 95 152
----- ----- ------ ------
Total interest income 8,659 8,338 17,016 16,578
----- ----- ------ ------
INTEREST EXPENSE
Deposits 3,444 3,383 6,855 6,674
Securities sold under repurchase agreements 22 23 53 60
Federal Home Loan Bank advances and other borrowings 91 76 176 172
----- ----- ------ ------
Total interest expense 3,557 3,482 7,084 6,906
----- ----- ------ ------
Net interest income 5,102 4,856 9,932 9,672
Provision for loan losses 171 188 309 412
----- ----- ------ ------
Net interest income after provision
for loan losses 4,931 4,668 9,623 9,260
----- ----- ------ ------
NON-INTEREST INCOME
Financial management services 629 560 1,258 1,121
Service charges on deposit accounts 256 265 502 519
Investment securities gains (losses), net 198 0 202 0
Other 319 327 629 588
----- ----- ------ ------
Total non-interest income 1,402 1,152 2,591 2,228
----- ----- ------ ------
NON-INTEREST EXPENSE
Salaries and employee benefits 2,401 2,268 4,747 4,481
Net occupancy and equipment 973 808 1,779 1,610
FDIC deposit insurance 12 11 24 22
Bank shares tax 117 87 217 175
Other 827 809 1,881 1,667
----- ----- ------ ------
Total non-interest expense 4,330 3,983 8,648 7,955
----- ----- ------ ------
Income before income taxes 2,003 1,837 3,566 3,533
INCOME TAXES 609 561 1,087 1,078
NET INCOME $1,394 $1,276 $ 2,479 $ 2,455
===== ===== ====== ======
PER SHARE DATA
Basic net income per common share(*) $ 0.30 $ 0.27 $ 0.54 $ 0.53
===== ===== ===== =====
Diluted net income per common share(*) $ 0.30 $ 0.27 $ 0.53 $ 0.53
===== ===== ===== =====
Dividends declared $ 0.12 $ 0.11 $ 0.24 $ 0.22
===== ===== ===== =====
Basic weighted average shares outstanding(*) 4,578,491 4,613,857 4,588,633 4,603,891
========= ========= ========= =========
Diluted weighted average shares outstanding(*) 4,631,111 4,678,665 4,648,016 4,673,085
========= ========= ========= =========
<FN>
(*)Please refer to the footnote titled "Earnings Per Share" for information on
this calculation.
</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>
Six Months Ended
June 30,
------------------------
(Dollars in thousands) 1999 1998
------ ------
<S> <C> <C>
Balance at January 1, $39,723 $36,213
Net income to date 2,479 2,455
Cash dividends declared (1,101) (967)
Net unrealized gain (loss) on securities available-for-sale (479) 177
Treasury stock transactions 60 207
Paid in capital from treasury stock transactions (955) 92
------ ------
Balance at June 30, $39,727 $38,177
======= ======
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
Six Months Ended
June 30,
---------------------------
(Dollars in thousands) 1999 1998
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 2,479 $ 2,455
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 285 535
Provision for loan losses 309 412
Amortization of investment security premiums
and accretion of discounts 116 81
Amortization of deferred fees on loans 16 13
Investment securities (gains) losses, net (205) 3
(Increase) Decrease in other assets (2,271) 961
Increase in other liabilities 1,240 1,175
--------- ---------
Net cash provided by operating activities 1,970 5,635
--------- ---------
INVESTING ACTIVITIES
Increase in loans (7,439) (1,664)
Proceeds from sales of investment securities available-for-sale 12,338 6,159
Proceeds from maturities of investment securities available-for-sale 16,903 12,687
Proceeds from maturities of investment securities held-to-maturity 2,375 1,394
Purchases of investment securities available-for-sale (39,314) (20,668)
Purchase of premises and equipment, net (170) (1,223)
--------- ---------
Net cash used in investing activities (15,307) (3,315)
---------- ---------
FINANCING ACTIVITIES
Decrease in securities sold under repurchase agreements (185) (5,651)
Increase in deposits 10,821 13,513
Decrease in Federal Home Loan Bank advances and other borrowings (717) (2,521)
Cash dividends (1,101) (967)
Treasury stock transactions (895) 299
--------- ---------
Net cash provided by financing activities 7,923 4,673
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (5,414) 6,993
Cash and cash equivalents at beginning of period 30,681 26,448
--------- ---------
Cash and cash equivalents at end of period $ 25,266 $ 33,441
========= =========
The accompanying notes are an integral part of these statements.
</TABLE>
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, 1998.
2. The results of operations for the three and six-month period ended
June 30, 1999 are not necessarily indicative of the results to be
expected for the full year.
3. Earnings per share is based on the weighted average number of shares
of common stock outstanding during the period. Diluted net income per
share includes the effect of options granted. 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 has adopted the provisions of FASB issued SFAS No.
130, Reporting of Comprehensive Income, which establishes standards
for reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of financial
statements. This statement also requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is
displayed with the same prominence as others financial statements.
Other comprehensive income/(loss) net of taxes for the three- and
six-month periods ended June 30, 1999 was $106 thousand and $(479)
thousand, compared to $100 thousand and $177 thousand in the same
period last year.
5. On January 1, 1998, the Corporation adopted SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information". SFAS No.
131 redefines how operating segments are determined and requires
disclosure of certain financial and descriptive information about a
Company's operating segments. Management has concluded that under
current conditions, the corporation will report one business segment.
6. 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
postretirement 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. This statement is not expected to have a
material impact on the Corporation's financial statements.
7
<PAGE>
FIRST WEST CHESTER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
7. The American Institute of Certified Public Accountants ("AICPA")
issued Statement of Option ("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
beginning after December 15, 1998. This statement is not expected to
have a material impact on the Corporation's financial statements.
8. FASB issued SFAS No. 137 an amendment of FASB Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities". 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 quarters of fiscal years beginning after June 15, 2000. The
statement is not expected to have a material impact on the
Corporation's financial statements.
9. 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
This discussion is intended to further your understanding of the
consolidated financial condition and results of operations of First West Chester
Corporation (the "Corporation") and its wholly-owned subsidiaries, The First
National Bank of West Chester (the "Bank") and 323 East Gay Street Corp
("EGSC"). It should be read in conjunction with the consolidated financial
statements included in this report.
In addition to historical information, this discussion and analysis
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 can often be
identified by the use of forward-looking terminology such as "believes,"
"expects," "intends," "may," "will," "should" "or anticipates" or similar
terminology. These statements involve risks and uncertainties and are based on
various assumptions. Investors and prospective investors are cautioned that such
statements are only projections. The risks and uncertainties noted below, among
others, could cause the Corporation's actual future results to differ materially
from those described in forward looking statements made in this report or
presented elsewhere by Management from time to time.
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 causing increased loan losses; (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 of competing
financial institutions 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) impact of changes in
interest rates on customer behavior; (g) unforeseen difficulties in implementing
the Corporation's Year 2000 compliance plan or contingency plans; (h) failure of
suppliers and customers to be Year 2000 compliant; (i) estimated changes in net
interest income; (j) anticipated pressure on net yields; and (k) branch
locations. These risks and uncertainties are all difficult to predict and most
are beyond the control of the Corporation's Management.
Although the Corporation believes that its expectations are based on
reasonable assumptions, readers are cautioned that such statements are only
projections. The Corporation undertakes no obligation to publicly release any
revisions to the forward-looking statements to reflect events or circumstances
after the date of this report.
EARNINGS AND DIVIDEND SUMMARY
Net income for the three-month period ended June 30, 1999 was $1.394
million, an increase of 9.25% from $1.276 million for the same period in 1998.
Net income for the six-month period ended June 30, 1999 was $2.479 million, an
increase of 1.0% from $2.455 million for the same period in 1998. Increases in
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
net income are the direct result of increases in interest income earned on
investment securities, a reduction in the provision for loan loss expense, and
gains on the sale of certain equity securities. Cash dividends declared during
the second quarter of 1999 increased to $0.12 per share, a 9.1% increase
compared to $0.11 per share in the second quarter of 1998. Over the past ten
years, the Corporation's practice has been to pay a dividend of at least 35.0%
of net income.
AVERAGE INTEREST RATES (ON A TAX EQUIVALENT BASIS)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- --------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
SELECTED RATIOS
Return on Average Assets 1.15% 1.18% 1.04% 1.14%
Return on Average Equity 14.10% 13.57% 12.52% 13.22%
Earnings Retained 60.62% 61.99% 77.85% 60.61%
Dividend Payout Ratio 39.38% 38.01% 44.41% 39.39%
Book Value Per Share $8.69 $16.53 $8.69 $16.53
</TABLE>
The "Consolidated Average Balance Sheet" on pages 15 and 16 may assist the
reader in following this discussion.
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 six-month periods ended June 30, 1999, on
a tax equivalent basis, was $5.2 million and $10.1 million, compared to $4.9
million and $9.8 million for the same periods in 1998, respectively. Net yields
on interest-earning assets, on a tax equivalent basis, were 4.58% and 4.51% for
the three- and six-month periods ended June 30, 1999 compared to 4.84% and 4.85%
for the same periods in 1998, respectively. Average interest-earning assets
increased approximately $48.8 million to $454.9 million during the second
quarter of 1999 from $48.8 million in the same period last year. The increase in
average earning assets was primarily the result of increased investment activity
and, to a lesser extent, an increase in average loans outstanding.
The decrease in the average net yield on interest-earning assets for
the three-and six-month periods ended June 30, 1999 was primarily the result of
a decrease in the average yield earned on interest-earning assets, partially
offset by a decrease in the average yield paid on interest bearing liabilities.
The decrease in the average net yield earned on interest-earning assets can be
attributed to decreases in loan demand, which resulted in more assets being
reinvested in lower yielding investments as opposed to higher yielding loans.
While loan demand through the first half of this year has been light, the
Corporation started experiencing some modest growth towards the end of the
second quarter. The Corporation anticipates continued pressure on the net yield
on interest-earning assets as competition for new loan business remains very
strong and the cost of incremental deposit growth and other funding sources
becomes more expensive.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
AVERAGE INTEREST RATES (ON A TAX EQUIVALENT BASIS)
<TABLE>
<CAPTION>
Three Months Six Months
Yield On: Ended June 30, Ended June 30,
--------- ------------------- ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest Earning Assets 7.70% 8.27% 7.64% 8.28%
Interest Bearing Liabilities 4.01% 4.30% 3.97% 4.27%
---- ---- ---- ----
Net Interest Spread 3.69% 3.97% 3.67% 4.01%
Contribution of Interest Free Funds 0.89% 0.87% 0.84% 0.84%
---- ---- ---- ----
Net Yield on Interest Earning Assets 4.58% 4.84% 4.51% 4.85%
==== ==== ==== ====
</TABLE>
INTEREST INCOME ON FEDERAL FUNDS SOLD
Interest income on federal funds sold for the three- and six-month
periods ended June 30, 1999, decreased 59.0% and 23.0% to $34 thousand and $117
thousand, respectively, when compared to the same periods in 1998. The decrease
in interest income on federal funds is the direct result of a 53.6% and 27.9%
decrease in the average balance of federal funds sold for the three- and six-
month periods ended June 30, 1999, respectively, when compared to the same
periods in 1998. Additionally, a 66 basis point (one basis point is equal to one
hundredth of one percent) decrease in the rates earned for the three month
period ended June 30, 1999 contributed to the decrease. The decrease in interest
income for the six- month period ended June 30, 1999 was partially offset by a
37 basis point increase in rates earned when compared to the same period in
1998.
INTEREST INCOME ON INVESTMENT SECURITIES
On a tax equivalent basis, interest income on investment securities
increased 59.7% and 28.0% for the three and six-month periods ended June 30,
1999 to $1.8 million and $3.0 million, respectively, when compared to the same
periods in 1998. The increases for the three- and six-month periods is primarily
due to an increase in average investment security balances of 56.1% and 55.9%.
For the three- month period, a 14 basis point increase in the yield earned
contributed to the increase in income. For the six- month period, the increase
in income was partially offset by a 111 basis point decrease in the yield earned
compared to the same period last year. Increases in average investment security
balances are the result of the combined effect of modest loan growth offset by
proportionally larger increases in deposits over the last twelve months.
INTEREST INCOME ON LOANS
Loan interest income, on a tax equivalent basis, generated by the
Corporation's loan portfolio decreased 3.8% and 1.0% to $6.9 million and $14.0
million for the three- and six-month periods ended June 30, 1999, compared to
the same periods in 1998, respectively. The decrease in interest income for
these periods is the direct result of a 57 and 23, respectively, basis point
decrease in the rates earned on the loan portfolio. These rate reductions can be
attributed to increased competition for new and existing loan relationships and
the generally lower interest rate environment through the second quarter of 1999
as compared to the corresponding periods in 1998. It is anticipated that pricing
pressure will continue to reduce overall loan yields and net interest margins
for future time periods. Fee reductions will affect non-interest income.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTEREST EXPENSE ON DEPOSIT ACCOUNTS
Interest expense on deposit accounts increased 1.8% and 2.3% for the
three- and six-month periods ended June 30, 1999 to $3.4 million and $6.8
million, compared to the same periods in 1998. The increase for the three-month
period ended June 30, 1999 is the result of an increase in average
interest-bearing deposits of $26.8 million, partially offset by a 26 basis point
decrease in the rates paid on interest-bearing deposits. The increase for the
six-month period ended June 30, 1999 is the result of an increase in average
interest-bearing deposits of $32.5 million, partially offset by a 31 basis point
decrease in rates paid on interest-bearing deposits.
Competition for deposits from non-banking institutions such as credit
union and mutual fund companies continues to grow. Despite the competition, the
Corporation's deposit base continues to grow and growth is expected to continue
for future time periods. The Corporation believes it has benefited from customer
fallout during the latest wave of merger activity of regional institutions.
Additionally, growth can be attributed to the opening of the new branch sites in
the Frazer area and our new Matlack Training Center branch, which opened on
August 30, 1998 and, June 7, 1999 respectively. Other future branch sites are
expected to expand the Bank's deposit base further. The Corporation's effective
rate on interest-bearing deposits decreased from 4.30% to 3.97% for the three
month period ended June 30, 1999, and from 4.27% to 3.97% for the six month
periods ended June 30, 1999, when compared to the three- and six-month periods
ended June 30, 1998.
INTEREST EXPENSE ON SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Interest expense on securities sold under repurchase agreements
decreased 4.3% and 25.0% to $22 thousand and $45 thousand for the three- and
six-month periods ended June 30, 1999, respectively, compared to the same
periods in 1998. The decreases are primarily attributable to $129 thousand and
$718 thousand decreases in average securities sold under repurchase agreements
outstanding, partially offset by a 5 basis point increase and 19 basis point
decrease in rates paid, compared to the three- and six-month periods ended June
30, 1998, respectively.
INTEREST EXPENSE ON FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
Interest expense on borrowings increased 19.7% and decreased 2.9% for
the three- and six-month periods ended June 30, 1999, respectively. The need for
borrowings in the three-months ended June 30, 1999 is due to a short term
slowdown of deposit growth and a modest upturn in loan demand during this
period. Borrowings consist of overnight Fed Funds purchased, Federal Home Loan
Bank ("FHLB") FlexLine, FHLB term advances and FHLB Open Repo and Repo Plus
advances.
PROVISION FOR LOAN LOSSES
During the three- and six-month periods ended June 30, 1999, the
Corporation recorded a $171 thousand and a $309 thousand provision for loan
losses compared to $188 thousand and $412 thousand for the same periods in 1998.
The decrease in the provision expense is a result of a decreased rate in loan
growth for the three- and six-month periods ended June 30, 1999, compared to the
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
same periods in 1998 and an overall decrease in total non performing assets. The
allowance for loan losses as a percentage of total loans was 1.81% at June 30,
1999, 1.83% at December 31, 1998 and 1.85% at June 30, 1998, respectively. See
the section titled "Allowance For Loan Losses" for additional discussion.
NON-INTEREST INCOME
Total non-interest income increased 21.7% and 16.3% to $1.4 million and
$2.6 million for the three- and six-month periods ended June 30, 1999,
respectively, compared to the same periods in 1998. The primary component of
non-interest income is Financial Management Services revenue, which increased
12.3% and 12.2% to $629 thousand and $1.3 million for both the three- and
six-month periods ended June 30, 1999, respectively, compared to the same
periods in 1998. In addition, gains on the sale of certain equity securities
partially offset by decreases in service charges on deposit accounts contributed
to the increase. During the first and second quarters management sold equity
securities that were purchased in 1998 with excess liquidity. Due to favorable
market conditioning the Corporation experienced gains on the sales of
approximately $198 thousand for the three- month period and $202 thousand for
the six month-period ended June 30, 1999, compared to $0 during the same period
in 1998. Service charges decreased 3.4% and 3.3% to $256 thousand and $502
thousand for the three- and six-month period ended June 30, 1999, respectively,
compared to the same periods in 1998.
NON-INTEREST EXPENSE
Total non-interest expense for the three- and six-month periods ended
June 30, 1999 increased 8.71% to $4.3 million and $8.6 million as compared to
the same periods in 1998. The various components of non-interest expense changes
are discussed below.
Employee salaries and benefits increased 5.86% and 5.94% to $2.4
million and $4.8 million for the three-month and six-month periods ended June
30, 1999 compared to the same periods in 1998. Increased staff, annual employee
raises, a new salary administration program, and a proportional increase in
employee benefits are primarily responsible for the increase. Average full time
equivalent staff increased from 197 for the period ended June 30, 1998 to 209
for the period ended June 30, 1999.
Net occupancy, equipment, and data processing expense increased 20.4%
and 10.5% to $973 thousand and $1.8 million for the three- and six-month periods
ended June 30, 1999, compared to the same periods last year, respectively. The
increase is the direct result of increased computer and related equipment costs
associated with the completion of the Core-System conversion process, the phase
out of certain main-frame related costs, a payroll conversion and direct Y2K
costs. Increases in the Corporation's facilities, such as our newly open
branches in the Frazer area and on Matlack Street, also contributed to the
increase. See "Building Improvements and Technology Projects" and "Year 2000
Issues" sections for more detail.
Total other non-interest expense increased 2.2% and 12.8% to $827
thousand and $1.8 million for the three-month and six-month periods ended June
30, 1999 compared to the same periods in 1998. This increase can be attributed
to increased marketing efforts to attract new customers and to promote its
corporate image.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Planning for additional branch sites continues. The Corporation believes
that the costs associated with the opening of 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.
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
THREE MONTHS ENDED JUNE 30,
<TABLE>
<CAPTION>
(Dollars in thousands) 1999 1998
---------------------------------- -------------------------------
Daily Daily
Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold $ 2,809 $ 34 4.84% $ 6,035 $ 83 5.50%
Investment securities
Taxable 116,051 1,787 6.16% 74,353 1,119 6.02%
Tax-exempt (1) 2,312 43 7.38% 1,490 27 7.29%
--------- ----- ------- -----
Total investment securities 118,363 1,830 6.18% 75,843 1,146 6.04%
--------- ----- ------- -----
Loans (2)
Taxable 327,926 6,742 8.22% 317,760 7,003 8.82%
Tax-exempt (1) 5,876 157 10.68% 6,489 166 10.20%
--------- ----- ------- -----
Total loans 333,802 6,899 8.27% 324,249 7,169 8.84%
--------- ----- ------- -----
Total interest earning assets 454,974 8,763 7.70% 406,127 8,398 8.27%
Non-interest earning assets
Allowance for loan losses (5,961) (5,970)
Cash and due from banks 21,923 20,148
Other assets 15,997 13,652
--------- --------
Total assets $ 486,933 $433,957
========= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings, NOWS & money market deposits $ 195,551 $1,477 3.02% $181,542 $1,605 3.54%
Certificates of deposits and other time 147,988 1,967 5.32% 135,239 1,778 5.26%
--------- ----- ------- -----
Total interest bearing deposits 343,539 3,444 4.01% 316,781 3,383 4.27%
Securities sold under repurchase agreements 2,194 22 4.01% 2,323 23 3.96%
Federal Home Loan Bank advances and
other borrowings 5,904 91 6.17% 4,853 76 6.26%
--------- ----- ------- -----
Total interest bearing liabilities 351,637 3,557 4.05% 323,957 3,482 4.30%
--------- ----- ------- -----
Non-interest bearing liabilities
Non-interest bearing demand deposits 72,213 65,211
Other liabilities 12,454 7,164
--------- -------
Total liabilities 436,304 396,332
Stockholders' equity 50,629 37,625
-------- -------
Total liabilities and stockholders' equity $ 486,933 $433,957
======= =======
Net interest income $5,206 $4,916
===== =====
Net yield on interest earning assets 4.58%
==== 4.84%
====
<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 TEFRA 20%
interest expense disallowance for 1999 and 1998.
(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
CONSOLIDATED AVERAGE BALANCE SHEET
AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES FOR THE
SIX MONTHS ENDED JUNE 30,
<TABLE>
<CAPTION>
(Dollars in thousands) 1999 1998
-------------------------------- -------------------------------
Daily Daily
Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold $ 3,989 $ 117 5.87% $ 5,531 $ 152 5.50%
Investment securities
Taxable 115,253 2,906 5.04% 73,910 2,268 6.14%
Tax-exempt (1) 2,320 70 6.03% 1,484 57 7.73%
------- ------ ------- -------
Total investment securities 117,573 2,976 5.06% 75,394 2,325 6.17%
------- ------
Loans (2)
Taxable 321,738 13,745 8.54% 315,293 13,882 8.81%
Tax-exempt (1) 5,816 323 11.11% 6,716 326 9.71%
------- ------ ------- -------
Total loans 327,554 14,068 8.59% 322,009 14,208 8.82%
------- ------ ------- -------
Total Interest Earning Assets 449,116 17,161 7.64% 402,934 16,685 8.28%
Non-interest earning assets
Allowance for loan losses (5,937) (5,946)
Cash and due from banks 21,301 19,635
Other assets 12,662 13,666 13,666
------- ------- -------
Total assets $477,142 $430,289
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings, NOWS & money market deposits $198,244 $ 3,082 3.11% $181,077 $ 2,838 3.13%
Certificates of deposits and other time 148,754 3,745 5.04% 133,445 3,836 5.75%
------- ------ ------- -------
Total interest bearing deposits 346,998 6,827 3.93% 314,522 6,674 4.24%
Securities sold under repurchase agreements 2,725 45 3.30% 3,443 60 3.49%
Federal Home Loan Bank advances and
other borrowings 4,874 167 6.85% 5,469 172 6.29%
------- ------ ------- -------
Total interest bearing liabilities 354,597 7,039 3.97% 323,434 6,906 4.27%
======= ------- -------
Non-interest bearing liabilities
Non-interest bearing demand deposits 70,777 62,717
Other liabilities 6,644 6,984
------- -------
Total liabilities 432,018 393,135
Stockholders' equity 45,124 37,154
------- -------
Total liabilities and stockholders' equity $477,142 $430,289
======= =======
Net interest income $10,122 $ 9,779
====== =======
Net yield on interest earning assets 4.51% 4.85%
==== ====
<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 TEFRA 20%
interest expense disallowance for 1999 and 1998.
(2) Non-accruing loans are included in the average balance.
</FN>
</TABLE>
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INCOME TAXES
Income tax expense for the three- and six-month periods ended June 30,
1999 was $609 thousand and $1.1 million, compared to $561 thousand and $1.1
million in the same periods last year. This represents effective tax rates of
30.5% in each of these periods.
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 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. In addition, new deposits to NOW, money-market,
savings, and smaller denomination certificates of deposit accounts provide
additional liquidity. 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 and credit facilities. 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:
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
DEPOSIT ANALYSIS
<TABLE>
<CAPTION>
(Dollars in thousands) June 30, 1999 December 31, 1998 Average Balances
------------------------- ---------------------------- -----------------------
Average Effective Average Effective Dollar Percentage
DEPOSIT TYPE Balance Yield Balance Yield Variance Variance
- ------------ ------- ----- ------- ----- -------- --------
<S> <C> <C> <C> <C> <C> <C>
NOW Accounts $ 57,266 1.70% $ 55,203 2.04% $ 2,063 3.74%
Money Market 26,226 2.88 27,596 3.09 (1,370) (4.96)
Statement Savings 48,899 2.97 47,046 3.28 1,853 3.94
Other Savings 2,290 2.71 2,382 2.73 (92) (3.86)
CD's Less than $100,000 120,138 5.40 114,372 5.81 5,766 5.04
-------- ------- -------
Total Core Deposits 254,819 3.82 246,599 4.15 8,220 3.33
Non-Interest Bearing
Demand Deposit Accounts 70,777 -- 64,705 -- 6,072 9.38
-------- ------- -------
Total Core and Non-Interest
Bearing Deposits 325,596 2.99 311,304 3.29 14,292 4.59
-------- ------- -------
Tiered Savings 63,562 3.96 51,854 4.09 11,708 22.58
CD's Greater than $100,000 28,617 5.18 23,453 5.63 5,164 22.02
-------- -------- -------
Total Deposits $417,775 3.29 $386,611 3.54 $ 13,678 8.06
======= ======= =======
</TABLE>
The Bank, as a member of the FHLB, maintains a credit facility secured
by the Bank's mortgage-related assets. Additionally, the FHLB offers several
other credit related products which are available to the Bank. FHLB borrowings
provide additional funds to meet the Bank's liquidity needs. As of June 30, 1999
the amount outstanding under the Bank's line of credit with the FHLB was $0. The
Bank currently has a maximum borrowing capacity with the FHLB of approximately
$117.0 million. During the three- and six-month period of 1999, average FHLB
advances were approximately $4.9 and $5.9 million respectively and consisted of
term advances representing a combination of maturities. The average interest
rate on these advances was approximately 6.9% and 6.2% respectively. FHLB
advances are collateralized by a pledge on the Bank's entire portfolio of
unencumbered investment securities, certain mortgage loans and a lien on the
Bank'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
$181.5 million or 37.7% of total assets at June 30, 1999 compared with a
negative $104.1 million or 23.7% of total assets at June 30, 1998. 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.
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTEREST SENSITIVITY ANALYSIS
AS OF JUNE 30, 1999
<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
Investment securities $ 33,351 $ 55,668 $ 28,554 $ -- $ 117,573
Loans and leases 90,777 179,611 57,164 (5,922) 321,630
Cash and cash equivalents -- -- -- 25,266 25,266
Premises & equipment -- -- -- 9,465 9,465
Other assets 4,392 -- -- 3,530 7,922
----------- ---------- ---------- --------- ----------
Total assets $ 128,520 $ 235,279 $ 85,718 $ 32,339 $ 481,857
=========== ========== ========== ========== ==========
LIABILITIES AND CAPITAL
Interest bearing deposits $ 307,043 $45,461 $ -- $ -- $ 352,504
Non-interest bearing deposit -- -- -- 76,715 76,715
Borrowed funds 2,610 -- -- -- 2,610
FHLB advances 331 2,634 1,345 -- 4,310
Other liabilities -- -- -- 5,991 5,991
Capital -- -- -- 39,727 39,727
----------- ---------- ---------- --------- ----------
Total liabilities & capital $ 309,984 $ 48,095 $ 1,345 $ 122,433 $ 481,857
=========== ========== ========== ========== ==========
Net interest rate
sensitivity gap $ (181,464) $ 187,184 $ 84,373 $ (90,094 $ --
=========== ========== ========== ==========
Cumulative interest rate
sensitivity gap $ (181,464) $ 5,720 $ 90,093 $ -- $ --
=========== ========== ========== ========== =========
Cumulative interest rate
sensitivity gap divided
by total assets (37.7%) 1.2% 19.4%
======= ==== ======
</TABLE>
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is an amount that Management believes
will be adequate to absorb 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.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ANALYSIS OF CHANGES IN THE ALLOWANCE FOR LOAN LOSSES
AND COMPARISON OF LOANS OUTSTANDING
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, June 30,
-------------------------- --------------------------
(Dollars in thousands) 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance at beginning of period $ 5,937 $ 5,940 $ 5,877 $ 5,900
--------- --------- -------- ---------
Provision charged to operating expense 171 188 309 412
--------- --------- --------- ---------
Recoveries of loans previously charged-off 27 11 75 18
Loans charged-off (213) (227) (339) (418)
--------- --------- --------- ---------
Net loans charged-off (186) (216) (264) (400)
--------- --------- --------- ---------
Balance at end of period $ 5,922 $ 5,912 $ 5,922 $ 5,912
========= ========= ========= =========
Period-end loans outstanding $ 327,554 $ 320,150 $ 327,554 $ 320,150
Average loans outstanding $ 333,802 $ 324,249 $ 327,003 $ 322,009
Allowance for loan losses as a
Percentage of period-end loans outstanding 1.81% 1.85% 1.81% 1.85%
Net charge-offs to average loans
Outstanding 0.08% 0.07% 0.08% 0.12%
</TABLE>
Non-performing loans include loans on non-accrual status and loans past
due 90 days or more and still accruing. The Bank'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.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
NON-PERFORMING LOANS AND ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
-------------------------- ------------
(Dollars in thousands) 1999 1998 1998
---- ---- ----
<S> <C> <C> <C>
Past due over 90 days and still accruing $ 176 $ 413 $ 546
Non-accrual loans 1,443 1,895 1,316
----- ------ ------
Total non-performing loans 1,619 2,308 1,862
Other real estate owned 192 712 192
----- ----- ------
Total non-performing assets $1,811 $3,020 $ 2,054
===== ===== ======
Non-performing loans as a percentage
of total loans (gross) 0.49% 0.72% 0.58%
Allowance for loan losses as a
percentage of non-performing loans 369.49% 256.15% 315.60%
Allowance for loan losses as a
percentage of total loans and
other real estate owned 0.55% 0.94% 0.60%
Allowance for loan losses as a
percentage of non-performing assets 330.31% 195.76% 286.10%
</TABLE>
The allowance for loan losses as a percentage of non-performing loans
ratio indicates that the allowance for loan losses is sufficient to cover the
principal of all non-performing loans at June 30, 1999. 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. Management intends to liquidate OREO in the most expedient and
cost-effective manner. This process could take up to twenty-four months,
although swifter disposition is anticipated. The decrease in other real estate
owned for the period ended June 30, 1998, is the result of a 1998 sale of
foreclosed property.
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. The Corporation decided to withdraw from
third party automobile lending on July 10, 1998 due to less than expected
results. The Corporation will continue to service the existing portfolio but has
not added any additional volume. This portfolio totaled approximately $16
million and $24 million as of June 30, 1999 and December 31, 1998 respectively.
Approximately 4.18% and 9.92% of this portfolio was past due 30 or more days as
of June 30, 1999 and December 31, 1998.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
LOAN IMPAIRMENT
The bank identifies a loan 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 on impaired loans
and no income is recognized until all recorded amounts of interest and principal
are recovered in full.
The balance of impaired loans was $1,027,000, $919,000, and $1,351,000
at June 30, 1999, December 31, 1998, and June 30, 1998 respectively. The
associated allowance for impaired loans was $296,000, $286,000 and $297,000 at
June 30, 1999, December 31, 1998, and June 30, 1998, respectively.
For the three-month and six-month period ended June 30, 1999, activity
in the allowance for impaired loan losses include a provision of $10,000 and
$60,000, respectively, write offs of $0 and $3,000, respectively, and recoveries
of $0 and $0, respectively. Interest income of $0 was recorded for both periods
while contractual interest amounted to $25,000 for the three-months ended June
30, 1999 and $48,000 for the six-months ended June 30, 1999. Cash collected on
loans for the three-month and six-month period ended June 30, 1999 was $51,000
and $76,000, respectively, all of which was applied to principal.
For the three-month and six-month period ended June 30, 1998, activity
in the allowance for impaired loan losses include a provision of $25,000 and
$75,000, respectively, write offs of $2,000 and $84,000, respectively, and
recoveries of $0 and $0, respectively. Interest income of $0 was recorded for
both periods while contractual interest amounted to $31,000 for the three-months
ended June 30, 1998 and $59,000 for the six-months ended June 30, 1998. Cash
collected on loans for the three-month and six-month period ended June 30, 1998
was $11,000 and $21,000, respectively, all of which was applied to principal.
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 September of 1998, the Corporation purchased 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 new building at 887
Matlack Street, which opened on June 7, 1999 and houses a branch teller training
center that is open to the public as well as the new location for the
administrative services, audit, compliance and facilities departments. During
1998, the Corporation also entered into an agreement to purchase additional land
in the Lionville area to accommodate future expansion.
In November 1998, the Corporation completed a conversion of its Core
Processing system to the Jack Henry and Associates, Inc. ("JHA") Silverlake
system. JHA is a major provider of community bank core processing systems.
Technology projects in process during the second quarter of 1999 include the
building and upgrade of the Corporation's local and wide area networks and
payroll processing.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
First National Bank has begun the testing phase for the JHA Internet
banking solution, Net-Teller. This system will allow our customers to access
their accounts and make transactions over the Internet. Also included in
Net-Teller is a bill payment option, which allows our customers to pay their
bills over the Internet. A fourth quarter roll out of Net-Teller is anticipated.
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 automated 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 August 30, 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 conducted an independent test on the Silverlake system and related
hardware during the week of March 7, 1999. The Corporation has documented and
evaluated the results of that test and is satisfied with the results.
The Corporation's check processing and imaging systems, operate on a
combination of NCR, Unisys, Novell and Microsoft hardware and software. Parts of
this system required certain upgrades. These upgrades were installed and tested
in the second quarter of 1999. The Corporation is satisfied with the results of
these tests. The Corporation has completed Y2K testing on all PC hardware and
software. Any machines failing these tests are being replaced or repaired. The
PC hardware and software repair and replacement process will be complete by
September 30, 1999.
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
is relying on testing conducted by STS and is also relying on Proxy Tests
conducted by certain STS customers. Testing and related documentation was
completed by March 31, 1999.
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Costs to Address the Corporation's Year 2000 Issues
- -------------------------------------------------------
The Corporation incurred direct Y2K project costs of $87 thousand
through June 30, 1999. The Corporation has incurred total direct and indirect
Y2K project costs of $230 thousand through June 30, 1999. The Corporation
anticipates that its total Y2K project cost will not exceed $300,000. 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 lack of Y2K 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 potentially
resulting in costly business interruptions; and (3) inability of loan customers
to repay amounts due.
The Corporation has initiated formal communications with all of 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. The Corporation completed its review of the Y2K
capabilities of its significant vendors in the second quarter of 1999. The
Corporation is continuing its evaluation of each loan customer's response and is
formulating a Y2K risk assessment for the loan portfolio as a whole. This
process is expected to continue through September 30, 1999.
Cash Contingency and Customer Awareness Programs
- ------------------------------------------------
The Corporation has a cash contingency plan to meet anticipated
year-end customer needs. The Corporation is also participating in several
customer / community awareness seminars. These seminars are designed to educate
our customers and the community about Y2K risk and the steps the Corporation is
taking to prepare itself. The Corporation has an ongoing employee awareness
program with similar objectives.
The Corporation's Contingency Plan
- ----------------------------------
The Corporation has developed several back-up system contingency plans,
which are designed to render the Corporation operational for a period of one to
thirty days should a Y2K problem surface. These contingency plans utilize
secondary computer systems and / or various manual tasks, which include but are
not limited to the following:
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
1. Maintenance of loan data on Microsoft Excel spreadsheets or paper ledgers;
2. Maintenance of core deposit account information on Microsoft Excel
spreadsheets or paper ledgers;
3. Manual sorting of deposit tickets and checks by account number; and
4. Maintenance of FMS account information on Microsoft Excel spreadsheets
or manual ledgers;
5. A check processing contingency plan involving the use of a used
reader-sorter and JHA's proof of deposit program is being developed and
should be operational by September 30, 1999.
The Corporation is in the process of validating and testing its Y2K Contingency
plan and anticipates completion of this task by September 30, 1999. At this time
the Corporation cannot estimate the cost, if any, that might be required to
implement such contingency Y2K preparedness plans.
Other
- -----
Financial institution regulators have intensively focused upon Y2K
exposures, issuing guidance concerning the responsibilities of senior management
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 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.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CAPITAL ADEQUACY
The Corporation is subject to Risk-Based Capital Guidelines adopted by
the Federal Reserve Board ("FRB") for bank holding companies. The Bank is also
subject to similar capital requirements adopted by the Office of the Comptroller
of the Currency. Under these requirements, the regulatory agencies have set
minimum thresholds for Tier I Capital, Total Capital, and Leverage ratios. At
June 30, 1999, 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>
June 30, December 31,
RISK-BASED ----------------------- ------------ "Well Capitalized"
CAPITAL RATIOS 1999 1998 1998 Requirements
- -------------- ---- ---- ---- ----------------
<S> <C> <C> <C> <C>
Corporation
-----------
Leverage Ratio 8.20% 8.76% 8.59% 5.00%
Tier I Capital Ratio 11.44% 11.48% 11.67% 6.00%
Total Risk-Based Capital Ratio 11.69% 12.74% 12.95% 10.00%
Bank
----
Leverage Ratio 7.96% 8.57% 8.36% 5.00%
Tier I Capital Ratio 11.09% 11.23% 11.35% 6.00%
Total Risk-Based Capital Ratio 12.33% 12.49% 12.62% 10.00%
</TABLE>
The Bank 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 a negative .36% and a positive 10.85% for the six
months ended June 30, 1999 and 1998, respectively. The growth rate is computed
by annualizing the change in equity during the last period and dividing it by
total stockholder's equity at June 30, 1999 and 1998, respectively.
26
<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 1998 Annual Report
of the Corporation, filed as an exhibit to its Form 10-K for the fiscal year
ended December 31, 1998 with the SEC via EDGAR. Please refer to the
"Management's Discussion and Analysis" section on pages 27-28 of the
Corporation's 1998 Annual Report for additional information.
27
<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
--------------------------------
None
(a) Exhibits
--------
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,
1998.
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, 1998.
27. Financial Data Schedule.
------------------------
(b) Reports on Form 8-K
-------------------
None
28
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST WEST CHESTER CORPORATION
Charles E. Swope
-------------------
/s/ Charles E. Swope
President
DATE: August 13, 1999
J. Duncan Smith
--------------------
/s/ J. Duncan Smith
Treasurer
(Principal Accounting
and Financial Officer)
29
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
First West Chester Corporation's FDS Period end June 30, 1999
</LEGEND>
<CIK> 0000744126
<NAME> First West Chester Corporation
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