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, 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 number 000-20163
-------------------------------------
FIRST PHILSON FINANCIAL CORPORATION
- -----------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 25-1511866
- ------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
534 Main Street, Berlin, PA 15530
- ------------------------------- -------------------------------
(Address of principal executive (Zip code)
offices)
(Registrant's telephone number, including area code)(814)267-4666
-------------
Not Applicable
- -----------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Check whether the registrant (1) 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
----- -----
As of August 7, 1998, there were 1,742,400 shares outstanding of
the issuer's common stock.
1
<PAGE>
First Philson Financial Corporation
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Page
------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet (Unaudited)
as of June 30, 1998 and December 31, 1997 3
Consolidated Statement of Income (Unaudited)
for the Three Months and Six Months Ended
June 30, 1998 and 1997 4
Consolidated Statement of Changes in
Stockholders' Equity for the Six Months
Ended June 30, 1998 5
Consolidated Statement of Cash Flows
(Unaudited) for the Six Months Ended
June 30, 1998 and 1997 6
Notes to Consolidated Financial Statements
(Unaudited) 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-14
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 15-17
PART II - OTHER INFORMATION 18
Item 1. Legal Proceedings
2. Changes in Securities
3. Defaults Upon Senior Securities
4. Submission of Matters to a Vote of Security Holders
5. Other Information
6. Exhibits and Reports on Form 8-K
Signatures 19
2
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED BALANCE SHEET (Unaudited)
(Dollars in thousands)
<CAPTION>
June 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 7,177 $ 6,382
Interest-bearing deposits in
other banks 512 511
Federal funds sold 16,300 8,900
Investment securities available
for sale 28,975 20,183
Investment securities held to
maturity (market values of
$50,276 and $57,767) 49,938 57,448
Total loans 103,008 105,293
Less allowance for loan losses 2,889 2,729
------------ ------------
Net loans 100,119 102,564
Premises and equipment, net 3,303 3,008
Accrued interest receivable 1,837 1,849
Other assets 1,261 1,180
------------ ------------
TOTAL ASSETS $ 209,422 $ 202,025
============ ============
LIABILITIES
Deposits:
Noninterest-bearing demand $ 22,995 $ 22,549
Interest-bearing demand 28,584 25,086
Savings 36,597 35,274
Money market 12,090 12,733
Time 80,947 78,601
------------ ------------
Total deposits 181,213 174,243
Securities sold under agreements
to repurchase 963 1,674
U. S. Treasury demand notes 1,828 1,674
Accrued interest payable 524 546
Other liabilities 414 417
------------ ------------
TOTAL LIABILITIES 184,942 178,554
------------ ------------
STOCKHOLDERS' EQUITY
Common stock ($2.50 par value,
10,000,000 shares authorized,
1,742,400 shares issued and
outstanding) 4,356 4,356
Capital surplus 11,644 11,644
Retained earnings 8,244 7,245
Net unrealized gain on securities 236 226
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 24,480 23,471
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 209,422 $ 202,025
============ ============
</TABLE>
See accompanying notes to the consolidated financial statements.
3
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED STATEMENT OF INCOME (Unaudited)
(Dollars in thousands, except per share amounts)
<CAPTION>
Three Months Ended June 30,
1998 1997
------------ ------------
<S> <C> <C>
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 2,417 $ 2,291
Interest-bearing deposits in
other banks 8 -
Interest on federal funds sold 160 178
Investment securities:
Taxable interest 1,008 996
Tax exempt interest 156 155
------------ ------------
Total interest and
dividend income 3,749 3,620
------------ ------------
INTEREST EXPENSE
Interest on deposits 1,420 1,439
Interest on borrowed funds 27 26
------------ ------------
Total interest expense 1,447 1,465
------------ ------------
NET INTEREST INCOME 2,302 2,155
Provision for loan losses 12 -
------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,290 2,155
------------ ------------
OTHER INCOME
Service charges on deposit
accounts 141 148
Other income 101 94
------------ ------------
Total other income 242 242
------------ ------------
OTHER EXPENSE
Salaries and employee benefits 847 794
Premises and equipment expense 230 205
Other expense 445 446
------------ ------------
Total other expense 1,522 1,445
------------ ------------
Income before income taxes 1,010 952
Income tax expense 278 263
------------ ------------
NET INCOME $ 732 $ 689
============ ============
EARNINGS PER SHARE $ 0.42 $ 0.40
CASH DIVIDENDS PER SHARE $ 0.12 $ 0.09
WEIGHTED AVERAGE SHARES
OUTSTANDING 1,742,400 1,742,400
<CAPTION>
Six Months Ended June 30,
1998 1997
------------ ------------
<S> <C> <C>
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 4,805 $ 4,553
Interest-bearing deposits in
other banks 16 -
Interest on federal funds sold 282 298
Investment securities:
Taxable interest 1,978 1,978
Tax exempt interest 312 327
------------ ------------
Total interest and
dividend income 7,393 7,156
------------ ------------
INTEREST EXPENSE
Interest on deposits 2,821 2,840
Interest on borrowed funds 56 47
------------ ------------
Total interest expense 2,877 2,887
------------ ------------
NET INTEREST INCOME 4,516 4,269
Provision for loan losses 20 -
------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,496 4,269
------------ ------------
OTHER INCOME
Service charges on deposit
accounts 269 278
Other income 189 188
------------ ------------
Total other income 458 466
------------ ------------
OTHER EXPENSE
Salaries and employee benefits 1,677 1,569
Premises and equipment expense 468 404
Other expense 860 869
------------ ------------
Total other expense 3,005 2,842
------------ ------------
Income before income taxes 1,949 1,893
Income tax expense 532 516
------------ ------------
NET INCOME $ 1,417 $ 1,377
============ ============
EARNINGS PER SHARE $ 0.81 $ 0.79
CASH DIVIDENDS PER SHARE $ 0.24 $ 0.17
WEIGHTED AVERAGE SHARES
OUTSTANDING 1,742,400 1,742,400
</TABLE>
See accompanying notes to the consolidated financial statements.
4
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY
<CAPTION>
Unrealized
Gain
(Losses) on
Securities Total
Common Capital Retained Available Stockholders'
Stock Surplus Earnings for Sale Equity
------ ------- -------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Balance,
December 31,
1997 $4,356 $11,644 $ 7,245 $ 226 $ 23,471
Net Income 1,417 1,417
Other
Comprehensive
income, net
of tax,
unrealized
gain on
securities,
net of
reclassification
adjustment 10 10
Comprehensive
Income
Cash dividends
($.24 per
share) (418) (418)
------ ------- -------- ---------- ------------
Balance,
June 30,1998 $4,356 $11,644 $ 8,244 $ 236 $ 24,480
====== ======= ======== ========== ============
<CAPTION>
Comprehensive
Income
-------------
<S> <C>
Balance,
December 31,
1997
Net Income $ 1,417
Other
Comprehensive
income, net
of tax,
unrealized
gain on
securities,
net of
reclassification
adjustment 10
Comprehensive -------------
Income $ 1,427
=============
</TABLE>
See accompanying notes to the consolidated financial statements.
5
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
(Dollars in thousands)
<CAPTION>
Six Months Ended June 30,
1998 1997
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 1,417 $ 1,377
Adjustments to reconcile net
income to net cash provided
by operating activities:
Provision for loan losses 20 -
Depreciation, amortization
and accretion, net 153 108
Decrease (increase) in
accrued interest receivable 12 (23)
Decrease in accrued interest
payable (22) (5)
Other, net (89) (308)
------------ ------------
Net cash provided by
operating activities 1,491 1,149
------------ ------------
INVESTING ACTIVITIES
Net increase in interest-bearing
deposits in other banks (1) -
Proceeds from maturities and
repayments of investment
securities held to maturity 12,539 11,621
Purchase of investment securities
Held to maturity (5,002) (2,973)
Available for sale (8,770) (6,754)
Net decrease (increase) in loans 2,428 (1,453)
Purchase of premises and equipment (485) (235)
------------ ------------
Net cash provided by
investing activities 709 206
------------ ------------
FINANCING ACTIVITIES
Net increase in deposits 6,970 5,564
Decrease in securities sold
under agreements to repurchase (711) (58)
Increase in U.S. Treasury
demand notes 154 780
Cash dividends paid (418) (305)
------------ ------------
Net cash provided by
financing activities 5,995 5,981
------------ ------------
Increase in cash and
cash equivalents 8,195 7,336
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 15,282 15,416
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 23,477 $ 22,752
============ ============
</TABLE>
See accompanying notes to the consolidated financial statements.
6
<PAGE>
First Philson Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
- ---------------------
The consolidated financial statements include the accounts of
First Philson Financial Corporation ("Philson") and its
wholly-owned subsidiaries, First Philson Bank, National
Association (the "Bank") and Flex Financial Consumer Discount
Company ("Flex Financial"). All significant intercompany
balances and transactions have been eliminated in the
consolidation.
The accompanying unaudited consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q
and therefore, do not necessarily include all information that
would be included in audited financial statements. The
information furnished reflects all adjustments which are, in the
opinion of Management, necessary for a fair statement of the
results of operations. All such adjustments are of a normal
recurring nature. The results of operations for the interim
periods are not necessarily indicative of the results to be
expected for the full year.
Reclassification of Comparative Amounts
- ---------------------------------------
Certain comparative amounts for the previous period have been
reclassified to conform to the current period classifications.
NOTE 2 - COMPREHENSIVE INCOME
Effective January 1, 1998, Philson adopted the Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." In adopting Statement No. 130, Philson is required to
present comprehensive income and its components in a full set of
general purpose financial statements. Philson has elected to
report the effects of Statement No. 130 as part of the Statement
of Changes in Stockholders' Equity.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Financial Condition
Total assets at June 30, 1998 increased $7,397,000 from that
reported at December 31, 1997. Increases in federal funds sold
of $7,400,000 and investment securities available for sale of
$8,792,000, were funded primarily by decreases in investment
securities held to maturity of $7,510,000 and net loans of
$2,445,000 and an increase in total deposits of $6,970,000.
The increase in investment securities available for sale was
primarily due to an increase in corporate notes available for
sale of $7,380,000, while the decrease in investment securities
held to maturity was primarily due to decreases of $5,072,000 in
U.S. Government agency securities held to maturity and
$2,191,000 in corporate notes held to maturity. The increase in
investment securities available for sale is the direct result of
Management's decision to invest in available for sale securities
in order to enhance the liquidity within the investment
portfolio. The decrease in investment securities held to
maturity resulted from maturities and calls.
Net loans decreased $2,445,000 primarily as the result of
decreases in commercial loans of $1,173,000 and mortgage loans of
$1,268,000. The decrease in commercial loans was the result of a
decrease in fixed rate non-taxable commercial loans, primarily
due to the school district tax anticipation loans being paid off
in June. The school district tax anticipation loans are bid each
year with the bid period being July 1 to June 30. The decrease
in mortgage loans occurred essentially in variable rate
residential real estate loans. The allowance for loan losses
increased $160,000 or 5.86% as the result of recoveries exceeding
charge-offs for the first six months of 1998. As of June 30,
1998, the allowance for loan losses represents 2.80% of the
outstanding loan balances as compared to 2.59% for December 31,
1997. Management continues to emphasize consumer and small
business lending. This has permitted Philson to meet the needs
of the communities for which it serves. During 1997, Philson
established Flex Financial, a consumer discount company, in order
to offer product diversification within the surrounding market
area. Flex Financial has been in operation approximately nine
months and has total loans of $1,051,000 as of June 30, 1998,
which is an increase of $708,000 from December 31, 1997.
The increase in equity capital was attributed to net earnings of
$1,417,000, an increase in net unrealized gains on available for
sale securities of $10,000, less dividend payments totaling
$418,000.
8
<PAGE>
Results of Operations
Comparison of Six Months Ended June 30, 1998 and 1997.
Philson's net income increased by $40,000 for the first six
months of 1998, as compared to net income for the first six
months of 1997. Effecting net income positively was an increase
in interest and dividend income of $237,000, while negative
effects to net income consisted of increases in other expense of
$163,000 and income taxes of $16,000.
Net interest income for 1998 increased $247,000 from 1997
primarily due to an increase in interest and dividend income.
The increase in interest and dividend income resulted primarily
from an increase in interest and fees on loans of $252,000. The
increase in interest and fees on loans is attributable to
increases in the average outstanding balance of commercial loans
of $2,283,000, receipt of interest and late charges on past due
mortgage loans of approximately $75,000, and interest income from
Flex Financial loans of $77,000. The increase in commercial
loans was primarily in fixed rate loans.
Other expense increased $163,000 for 1998 from 1997, primarily as
the result of increases in salaries and employee benefits of
$108,000 and premises and equipment expense of $64,000, offset
by a decrease in other expense of $9,000. The increase in
salaries and employee benefits is due to annual employee
increases, Flex Financial salaries, and an increase in the cost
of medical insurance. The increase in premises and equipment
expense in 1998 is the result of an increase in depreciation
expense and service contracts as a result of the installation of
the new mainframe computer system.
Results of Operations
Comparison of Three Months Ended June 30, 1998 and 1997.
Philson's net income increased by $43,000 for the second quarter
of 1998, as compared to net income for the second quarter of
1997. Effecting net income positively was an increase in
interest and dividend income of $129,000, while negative effects
to net income consisted of increases in other expense of $77,000
and income taxes of $15,000.
Net interest income for the second quarter of 1998 increased
$147,000 from the second quarter of 1997 primarily due to an
increase in interest and dividend income. The increase in
interest and dividend income resulted primarily from an increase
in interest and fees on loans of $126,000, offset by a decrease
in interest on federal funds sold of $18,000. The increase in
interest and fees on loans is attributable to an increase in the
average outstanding balance of commercial loans of $2,578,000,
receipt of interest and late charges on charged-off mortgage
loans of approximately $60,000, and interest income from Flex
Financial loans of $47,000. The increase in commercial loans was
primarily in fixed rate loans. The decrease in interest on
federal funds sold is due to a $1,247,000 decrease in the
average outstanding balance.
9
<PAGE>
Other expense increased $77,000 for 1998 from 1997, primarily as
the result of increases in salaries and employee benefits of
$53,000 and premises and equipment expense of $25,000. The
increase in salaries and employee benefits is due to annual
employee increases, Flex Financial salaries, and an increase in
the cost of medical insurance. The increase in premises and
equipment expense in 1998 is the result of an increase in
depreciation expense for the installation of the new mainframe
computer system.
Liquidity and Cash Flows
To ensure that Philson can satisfy customer credit needs for
current and future commitments and depository withdrawal
requirements, Philson manages the liquidity position by ensuring
that there are adequate short-term funding sources available for
those needs. Liquid assets consist of cash and due from banks,
interest-bearing deposits in other banks, federal funds sold,
investment securities available for sale and investment securities
held to maturity, maturing in one year or less. The following
table shows these liquidity sources, minus short-term borrowings as
of June 30, 1998 and December 31, 1997 (dollars in thousands).
Management feels that the liquidity position is strong and adequate
to cover any potential customer withdrawals and credit needs.
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
Cash and due from banks $ 7,177 $ 6,382
Interest-bearing deposits
in other banks 512 511
Federal funds sold 16,300 8,900
Investment securities
available for sale 28,975 20,183
Investment securities held
to maturity, maturing in
one year or less 23,087 25,646
------------ ------------
Total 76,051 61,622
Less short-term borrowings 2,791 3,348
------------ ------------
Net liquidity position $ 73,260 $ 58,274
============ ============
As a percent of
total assets 34.98% 28.84%
</TABLE>
10
<PAGE>
Capital Resources
Capital management is an ongoing process that consists of
providing equity for both current and future financial
positioning. Philson manages its capital to execute its
strategic business plans and support its growth and investments.
During the first six months of 1998, Philson increased its
capital base by $1,009,000 or 4.30%, primarily through retained
earnings. For the first six months of 1997, capital increased by
$1,118,000 or 5.27%.
Regulatory agencies have capital adequacy and risk-based capital
adequacy guidelines by which they monitor the capital adequacy of
financial institutions and holding companies. Philson has
complied with the regulatory requirements and expects to remain
in compliance in the future.
The first measure is risk-based capital which measures the
relationship between capital, segregated between Tier 1 and Tier
2 capital, and risk-weighted assets, as defined.
Tier 1 capital generally consists of stockholders' equity,
non-cumulative perpetual preferred stock and minority interest in
consolidated subsidiaries. Tier 2 capital includes the allowance
for loan losses up to 1.25% of risk-weighted assets, cumulative
preferred stock, term subordinated debt and other hybrid capital
instruments. Tier 1 and Tier 2 capital are reduced by such items
as goodwill and other certain intangible assets. Additionally,
Tier 2 capital cannot exceed 50% of the minimum capital
requirements, which is 8% for 1998. Total capital is the sum of
Tier 1 and Tier 2 capital. Risk-weighted assets are derived by
applying certain predetermined percentages, ranging from 0 to
100% to on-balance-sheet assets and off-balance-sheet items
based upon their defined measure of credit risk.
The secured measure is the leverage capital ratio which evaluates
capital adequacy based upon Tier 1 capital in relation to
quarterly average assets, adjusted for the allowance for loan
losses, goodwill and certain other intangible assets. The
minimum leverage capital ratio for the highest rated institutions
is 3%, with all other institutions expected to maintain higher
ratios.
Furthermore, pursuant to the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the Federal
Banking Regulators have set the minimum risk-based capital
ratios for a well capitalized banking institution at 6% Tier 1
capital, 10% total capital and 5% leverage capital. Philson has
exceeded all these capital ratios and expects to exceed these
ratios in the future to continue to be classified as well
capitalized.
Management has calculated and monitored the following capital
ratios in order to assess compliance with these regulatory
guidelines for Philson at June 30, 1998 and December 31, 1997,
(dollars in thousands):
11
<PAGE>
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
Amount Ratio Amount Ratio
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Total Capital
(to Weighted Assets)
Actual $ 25,831 20.56% $ 24,770 20.51%
For Capital Adequacy
Purposes 10,053 8.00 9,662 8.00
To Be Well Capitalized 12,566 10.00 12,077 10.00
Tier 1 Capital Ratio
(to Weighted Assets)
Actual $ 24,244 19.29% $ 23,245 19.25%
For Capital Adequacy
Purposes 5,026 4.00 4,831 4.00
To Be Well Capitalized 7,539 6.00 7,246 6.00
Tier 1 Capital
(to Average Assets)
Actual $ 24,244 11.72% $ 23,245 11.40%
For Capital Adequacy
Purposes 8,276 4.00 8,153 4.00
To Be Well Capitalized 10,346 5.00 10,192 5.00
</TABLE>
Management is not aware of any current recommendations by
regulatory authorities which, if implemented, would have a
material effect on Philson's liquidity, capital resources or
operations other than what has been disclosed.
<TABLE>
<CAPTION>
SIGNIFICANT RATIOS June 30, 1998 December 31, 1997
- ---------------------- ---------------- -------------------
<S> <C> <C>
Return on Average
Assets (Annualized) 1.40% 1.35%
Return on Average
Equity (Annualized) 11.86% 12.17%
Dividend Payout Ratio 29.26% 24.41%
</TABLE>
Non-performing Assets and Risk Elements
Reviews of the loan portfolio are conducted by an internal
committee quarterly and annually by an outside consultant. The
results of the outside consultant are then compared to the
internal reviews with detailed explanations of differences, if
any. Commercial loans and residential mortgages are placed on a
non-accrual status when principal and interest become 90 days
past due. Delinquent loans are reviewed monthly by senior
management and the Loan Committee of the Board. Generally, all
consumer loans and commercial loans less than $100,000 and not
secured by real estate, will be charged-off at 90 days past due,
while all loans secured by real estate and in the process of
foreclosure will be charged-off at 180 days past due. All
commercial loans greater than $100,000 and not secured by real
estate, will be subject to the conditions of the action plan
between Philson and the customer to correct the default.
12
<PAGE>
A loan remains on a non-accrual status until principal and
interest become current and a consistent track record of payments
is established, or it is determined to be uncollectible and is
charged-off against the allowance for loan losses. A loan would
be classified as restructured when the terms have been modified,
because of deterioration in the financial position of the
borrowers, to provide for a reduction of either interest or
principal. It is Management's opinion that Philson did not have
any loans that met the definitions of a restructured loan or an
impaired loan as of June 30, 1998 and December 31, 1997.
The following table presents information concerning
non-performing assets including non-accrual loans and loans 90
days or more past due for June 30, 1998 and December 31, 1997
(dollars in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---------- ------------
<S> <C> <C>
Loans on non-accrual status $ 309 $ 364
Loans past due 90 days or more - 464
---------- ------------
Total non-performing loans 309 828
---------- ------------
Other real estate 1 1
---------- ------------
Total non-performing assets $ 310 $ 829
========== ============
Non-performing loans as a
percent of total loans 0.30% 0.79%
Non-performing assets as a
percent of total loans 0.30% 0.79%
Non-performing assets as a
percent of total assets 0.15% 0.41%
</TABLE>
Year 2000 Compliance
Philson and its subsidiaries primary business activities are
heavily dependent upon the use of sophisticated computer systems.
As the millennium ("year 2000" or "Y2K") approaches, many computer
systems worldwide do not have the capability of recognizing the
year 2000 or years thereafter. To date, Philson and its
subsidiaries have received confirmations from its primary vendors
that plans have been developed by them to address and correct the
issues associated with the year 2000 problem.
Philson has established a management committee to identify all of
the functions potentially affected by the year 2000, and to ensure
that re-programming of the affected systems will be completed by
December 31, 1998, thus allowing adequate time for testing. The
management committee meets on a regular basis to determine the
status and progress of the year 2000 project. Philson does not
13
<PAGE>
anticipate that the year 2000 issue will pose any significant
operational problems or will have any material impact on its
results of operations.
Testing continues to be done on the existing PC hardware and
software for year 2000 compliance. There are four phases of
testing to be completed. The first three phases address hardware
and software testing with the final phase addressing the
recommendations from certified network engineers and if needed,
any corrective actions by Philson. Completion of these phases is
expected by end of the third quarter 1998. The mainframe system
will be tested for year 2000 compliance by December 1998. A
significant portion of the costs of testing are not likely to be
incremental costs to Philson, but will represent the redeployment
of existing resources.
14
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, Philson's primary components of market
risk are interest rate volatility and liquidity risk. Because of
the nature of Philson's operations, Philson is not subject to
currency exchange or commodity price risk, and since Philson has no
trading portfolio, it is not subject to trading risk. At June 30,
1998 and December 31, 1997, Philson does not have any hedging
transactions in place such as interest rate swaps and caps.
Philson currently has highly rated available for sale securities
that represent 36.7% of its investment portfolio and, therefore,
equity price risk is not significant. Fluctuations in interest
rates will ultimately impact both the level of income and expense
recorded on a large portion of Philson's assets and liabilities,
and the market value of all interest earning assets, other than
those which possess a short term maturity. Since all of Philson's
interest bearing liabilities and virtually all of Philson's
interest earning assets are located at the Bank, virtually all of
Philson's interest rate risk lies at the Bank level. As a result,
all significant interest rate risk management procedures are
performed at the Bank level. The Bank's loan portfolio,
concentrated primarily within the surrounding market area, is
subject to risks associated with the local economy.
The Bank's interest rate management strategy is designed to
stabilize net interest income and preserve capital over a broad
range of interest rate movements. Interest rate sensitivity is
measured as the difference between the volume of assets and
liabilities that are subject to repricing in a future period of
time. These differences are known as interest sensitivity gaps.
Philson utilized gap management and simulation modeling as the
primary means of measuring interest rate risk. Gap analysis
identifies and quantifies Philson's exposure or vulnerability to
changes in interest rates in relationship to Philson's interest
rate sensitivity position. A rate sensitive asset or liability is
one which is capable of being repriced (i.e. the interest rate can
be adjusted or principal can be reinvested) within a specified
period of time. Subtracting total rate sensitive liabilities (RSL)
from total rate sensitive assets (RSA) within specified time
horizons nets Philson's gap positions. These gaps will reflect
Philson's exposure to changes in market interest rates, as
discussed below.
Since many of Philson's deposit liabilities are capable of being
immediately repriced, a portion of the investment portfolio
consists of available for sale securities and Philson offers
variable rate loan products in order to maintain a proper balance
in its ability to reprice various interest bearing assets and
liabilities. Furthermore, Philson's deposit rates are not tied to
an external index over which Philson could exercise no control. As
a result, although changing market interest rates impact repricing,
Philson has retained much of its control over repricing.
Philson actively manages interest rate risk through the use of a
simulation model which measures the sensitivity of future net
interest income and the net portfolio value to changes in interest
rates. The repricing analysis is based upon the repricing
intervals of variable rate assets and liabilities and upon
contractual maturities of fixed rate instruments with adjustments
for principal amortization of appropriate balance sheet items and
projected prepayments for loans and mortgage-backed securities.
Prepayment projections are developed from historical prepayment
data for each type of asset. The following table in summary form
shows Philson's repricing analysis at June 30, 1998.
15
<PAGE>
<TABLE>
<CAPTION>
0-90 91-180 181-365
Days Days Days
------- ------- -------
<S> <C> <C> <C>
RATE-SENSITIVE ASSETS:
Loans $21,890 $10,107 $17,396
Investment securities
available for sale 1,900 - 897
Investment securities
held to maturity 5,470 9,999 7,618
Interest-bearing
deposits in other
banks 512 - -
Federal funds sold 16,300 - -
------- -------- --------
Total rate-sensitive
assets 46,072 20,106 25,911
------- -------- --------
RATE-SENSITIVE
LIABILITIES:
Deposits 33,597 18,696 30,642
Borrowings 2,791 - -
------- -------- --------
Total rate-sensitive
liabilities 36,388 18,696 30,642
------- -------- --------
Interest sensitivity
gap $9,684 $ 1,410 ($4,731)
Cumulative interest
sensitivity gap $9,684 $11,094 $6,363
Cumulative interest
sensitivity gap
ratio to total assets 4.62% 5.30% 3.04%
<CAPTION>
1 to 5 Over
Years 5 Years Total
------- -------- --------
<S> <C> <C> <C>
RATE-SENSITIVE ASSETS:
Loans $37,265 $16,350 $103,008
Investment securities
available for sale 25,187 991 28,975
Investment securities
held to maturity 18,990 7,861 49,938
Interest-bearing
deposits in other
banks - - 512
Federal funds sold - - 16,300
------- -------- --------
Total rate-sensitive
assets 81,442 25,202 198,733
------- -------- --------
RATE-SENSITIVE
LIABILITIES:
Deposits 75,218 65 158,218
Borrowings - - 2,791
------- -------- --------
Total rate-sensitive
liabilities 75,218 65 161,009
------- -------- --------
Interest sensitivity
gap $ 6,224 $25,137 $ 37,724
Cumulative interest
sensitivity gap $12,587 $37,724
Cumulative interest
sensitivity gap
ratio to total assets 6.01% 18.01%
</TABLE>
The simulation model also calculates earnings of Philson based upon
what are estimated to be the largest foreseeable rate increase and
the largest foreseeable decrease. Such analysis translates
interest rate movements and Philson's rate sensitivity position
into dollar amounts by which earnings may fluctuate as a result of
rate changes. Based upon the economic forecasts of the most likely
interest rate movement, Philson's 12 month percentage deviation of
earnings from a flat rate scenario would be less than 1 percent
(1%).
The data included in the Interest Sensitivity table indicates that
Philson is asset sensitive within one year. During times of rising
interest rates, an asset sensitive gap could positively affect net
interest income as rates would be increased on a larger volume of
assets as compared to deposits. As a result, interest income would
increase more rapidly than interest expense. An asset sensitive
gap could negatively affect net interest income in an environment
of decreasing interest rates as a greater amount of interest
bearing assets would be repricing at lower rates. Generally, a
liability sensitive gap indicates that declining interest rates
could positively affect net interest income as interest expense on
liabilities would decrease more rapidly than interest income would
decline. Conversely, rising rates could
16
<PAGE>
negatively affect net interest income as income from assets would
increase less rapidly than deposit costs. Although rate
sensitivity analysis enables Philson to minimize interest rate
risk, the magnitude of rate increases or decreases on assets versus
liabilities may not correlate directly. As a result, fluctuations
in interest spreads can occur even when repricing capabilities are
perfectly matched.
It is the policy of Philson to generally maintain a gap of between
.70 and 1.20 for the one year time horizon, although Philson
typically attempts to maintain a ratio of near 1.00 in order to
minimize the impact of changes in market interest rates. When
Management believes that interest rates will increase it can take
actions to increase the RSA/RSL ratio. When Management believes
interest rates will decline, it can take actions to decrease the
RSA/RSL ratio.
Changes in market interest rates can also affect Philson's
liquidity position through the impact rate changes may have on the
market value of Philson's investment portfolio. Rapid increases in
market rates can negatively impact the market values of investment
securities. As securities values decline it becomes more difficult
to sell investments to meet liquidity demands without incurring a
loss. Philson can address this by increasing liquid funds which
may be utilized to meet unexpected liquidity needs when a decline
occurs in the volume of securities which may be sold without
Philson incurring a net loss.
Information shown elsewhere in this 10Q, specifically within
Management's Discussion and Analysis, will assist in the
understanding of how Philson is positioned to react to changing
interest rates. In particular, the section on Financial Condition,
that contains the discussion of the investment securities
portfolio, loan portfolio, non-performing assets and risk elements,
allowance for loan losses, deposits, liquidity and cash flows,
inflation and changing prices, and capital resources should be
considered together with the discussion on interest rate
sensitivity.
17
<PAGE>
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
None.
Item 2 - Changes in Securities
None.
Item 3 - Defaults upon Senior Securities
None.
Item 4 - Submission of Matters to a Vote of Security Holders
(a) Annual Meeting April 21, 1998
(b) The following directors were elected at the
annual meeting to serve for a three year term or
until a mandatory retirement age is reached:
Richard P. Bulow Theodore Deskevich
Gregory A. Croner H. Dean White
The following directors' terms continued after
the annual meeting:
Lewis W. Berkley George R. Shafer
James E. Croner Gary Sterner
Tommy R. Croner Earl K. Wahl, Jr.
George W. Hay
The results of the annual meeting were as follows:
FOR AGAINST ABSTAINED
-------- ------- ---------
Richard P. Bulow 1,320,023 14,568 407,809
Gregory A. Croner 1,331,575 3,016 407,809
Theodore Deskevich 1,331,711 2,880 407,809
H. Dean White 1,332,023 2,568 407,809
Item 5 - Other Information
None.
Item 6 - Exhibits and Reports on Form 8-K
No reports have been filed for 1998.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act
of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
FIRST PHILSON FINANCIAL CORPORATION
-------------------------------------
(Registrant)
Date August 12, 1998 By /s/ George W. Hay
---------------------- --------------------------------
George W. Hay
President and Chief Executive
Officer
By /s/ Theodore Deskevich
--------------------------------
Theodore Deskevich
Executive Vice President and
Chief Financial Officer
19
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 7,177
<INT-BEARING-DEPOSITS> 512
<FED-FUNDS-SOLD> 16,300
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 28,975
<INVESTMENTS-CARRYING> 49,938
<INVESTMENTS-MARKET> 50,276
<LOANS> 103,008
<ALLOWANCE> 2,889
<TOTAL-ASSETS> 209,422
<DEPOSITS> 181,213
<SHORT-TERM> 2,791
<LIABILITIES-OTHER> 938
<LONG-TERM> 0
0
0
<COMMON> 4,356
<OTHER-SE> 20,124
<TOTAL-LIABILITIES-AND-EQUITY> 209,422
<INTEREST-LOAN> 4,805
<INTEREST-INVEST> 2,290
<INTEREST-OTHER> 298
<INTEREST-TOTAL> 7,393
<INTEREST-DEPOSIT> 2,821
<INTEREST-EXPENSE> 2,877
<INTEREST-INCOME-NET> 4,516
<LOAN-LOSSES> 20
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 3,005
<INCOME-PRETAX> 1,949
<INCOME-PRE-EXTRAORDINARY> 1,949
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,417
<EPS-PRIMARY> 0.81
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.86
<LOANS-NON> 309
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,729
<CHARGE-OFFS> 293
<RECOVERIES> 433
<ALLOWANCE-CLOSE> 2,889
<ALLOWANCE-DOMESTIC> 2,889
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
