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 September 30, 1998
----------------------------
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission file 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 November 6, 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 September 30, 1998 and
December 31, 1997 3
Consolidated Statement of Income (Unaudited)
for the Three Months and Nine Months Ended
September 30, 1998 and 1997 4
Consolidated Statement of Changes in
Stockholders' Equity for the Nine Months
Ended September 30, 1998 5
Consolidated Statement of Cash Flows
(Unaudited) for the Nine Months Ended
September 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 8-16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 17-19
PART II - OTHER INFORMATION 20
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 21
2
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED BALANCE SHEET (Unaudited)
(Dollars in thousands)
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 8,275 $ 6,382
Interest-bearing deposits in
other banks - 511
Federal funds sold 14,600 8,900
Investment securities available
for sale 33,321 20,183
Investment securities held to
maturity (market values of
$49,404 and $57,767) 48,744 57,448
Total loans 105,227 105,293
Less allowance for loan losses 2,738 2,729
------------- ------------
Net loans 102,489 102,564
Premises and equipment, net 3,279 3,008
Accrued interest receivable 1,768 1,849
Other assets 1,266 1,180
------------- ------------
TOTAL ASSETS $ 213,742 $ 202,025
============= ============
LIABILITIES
Deposits:
Noninterest-bearing demand $ 22,864 $ 22,549
Interest-bearing demand 28,707 25,086
Savings 36,771 35,274
Money market 13,288 12,733
Time 83,632 78,601
------------- ------------
Total deposits 185,262 174,243
Securities sold under agreements
to repurchase 1,659 1,674
U. S. Treasury demand notes 510 1,674
Accrued interest payable 586 546
Other liabilities 438 417
------------- ------------
TOTAL LIABILITIES 188,455 178,554
------------- ------------
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 8,724 7,245
Net unrealized gain on securities 563 226
------------- ------------
TOTAL STOCKHOLDERS' EQUITY 25,287 23,471
------------- ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 213,742 $ 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 September 30,
1998 1997
------------ ------------
<S> <C> <C>
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 2,371 $ 2,365
Interest-bearing deposits in
other banks 5 7
Interest on federal funds sold 225 136
Investment securities:
Taxable interest 1,048 1,020
Tax exempt interest 157 156
------------ ------------
Total interest and
dividend income 3,806 3,684
------------ ------------
INTEREST EXPENSE
Interest on deposits 1,485 1,452
Interest on borrowed funds 28 22
------------ ------------
Total interest expense 1,513 1,474
------------ ------------
NET INTEREST INCOME 2,293 2,210
Provision for loan losses 13 -
------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,280 2,210
------------ ------------
OTHER INCOME
Service charges on deposit
accounts 157 163
Other income 120 109
------------ ------------
Total other income 277 272
------------ ------------
OTHER EXPENSE
Salaries and employee benefits 842 786
Premises and equipment expense 226 217
Other expense 536 476
------------ ------------
Total other expense 1,604 1,479
------------ ------------
Income before income taxes 953 1,003
Income tax expense 263 281
------------ ------------
NET INCOME $ 690 $ 722
============ ============
EARNINGS PER SHARE $ 0.40 $ 0.41
CASH DIVIDENDS PER SHARE $ 0.12 $ 0.09
WEIGHTED AVERAGE SHARES
OUTSTANDING 1,742,400 1,742,400
<CAPTION>
Nine Months Ended September 30,
1998 1997
------------ ------------
<S> <C> <C>
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 7,176 $ 6,918
Interest-bearing deposits in
other banks 21 7
Interest on federal funds sold 507 434
Investment securities:
Taxable interest 3,026 2,998
Tax exempt interest 469 483
------------ ------------
Total interest and
dividend income 11,199 10,840
------------ ------------
INTEREST EXPENSE
Interest on deposits 4,306 4,292
Interest on borrowed funds 84 69
------------ ------------
Total interest expense 4,390 4,361
------------ ------------
NET INTEREST INCOME 6,809 6,479
Provision for loan losses 33 -
------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 6,776 6,479
------------ ------------
OTHER INCOME
Service charges on deposit
accounts 426 441
Other income 309 297
------------ ------------
Total other income 735 738
------------ ------------
OTHER EXPENSE
Salaries and employee benefits 2,519 2,355
Premises and equipment expense 694 621
Other expense 1,396 1,345
------------ ------------
Total other expense 4,609 4,321
------------ ------------
Income before income taxes 2,902 2,896
Income tax expense 795 797
------------ ------------
NET INCOME $ 2,107 $ 2,099
============ ============
EARNINGS PER SHARE $ 1.21 $ 1.20
CASH DIVIDENDS PER SHARE $ 0.36 $ 0.26
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 2,107 2,107
Other
Comprehensive
income, net
of tax,
unrealized
gain on
securities 337 337
Comprehensive
Income
Cash dividends
($.36 per
share) (628) (628)
------ ------- -------- ---------- ------------
Balance,
September 30,
1998 $4,356 $11,644 $ 8,724 $ 563 $ 25,287
====== ======= ======== ========== ============
<CAPTION>
Comprehensive
Income
-------------
<S> <C>
Balance,
December 31,
1997
Net Income $ 2,107
Other
Comprehensive
income, net
of tax,
unrealized
gain on
securities 337
Comprehensive -------------
Income $ 2,444
=============
</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>
Nine Months Ended September 30,
1998 1997
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 2,107 $ 2,099
Adjustments to reconcile net
income to net cash provided
by operating activities:
Provision for loan losses 33 -
Depreciation, amortization
and accretion, net 242 157
Decrease (increase) in
accrued interest receivable 81 (197)
Increase in accrued interest
payable 40 35
Other, net (238) (25)
------------ ------------
Net cash provided by
operating activities 2,265 2,069
------------ ------------
INVESTING ACTIVITIES
Net decrease (increase)in
interest-bearing deposits
in other banks 511 (510)
Proceeds from maturities and
repayments of investment
securities
Held to maturity 19,356 18,014
Available for sale 385 -
Purchase of investment securities
Held to maturity (10,616) (3,972)
Available for sale (13,005) (11,819)
Net decrease (increase) in loans 44 (5,282)
Purchase of premises and
equipment (559) (572)
------------ ------------
Net cash used for
investing activities (3,884) (4,141)
------------ ------------
FINANCING ACTIVITIES
Net increase in deposits 11,019 3,735
Decrease in securities sold
under agreements to repurchase (15) (292)
Increase (decrease) in
U.S. Treasury demand notes (1,164) 976
Cash dividends paid (628) (457)
------------ ------------
Net cash provided by
financing activities 9,212 3,962
------------ ------------
Increase in cash and
cash equivalents 7,593 1,890
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 15,282 15,416
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 22,875 $ 17,306
============ ============
</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 September 30, 1998 increased $11,717,000 from
that reported at December 31, 1997. Increases in federal funds
sold of $5,700,000 and investment securities available for sale
of $13,138,000, were funded primarily by a decrease in investment
securities held to maturity of $8,704,000 and an increase in
total deposits of $11,019,000.
The increase in investment securities available for sale was
primarily due to an increase in corporate notes available for
sale of $10,539,000, while the decrease in investment securities
held to maturity was primarily due to decreases of $3,567,000 in
U.S. Government agency securities held to maturity and
$3,542,000 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 $75,000 primarily as the result of a
decrease in mortgage loans of $1,432,000, offset, by an increase
in commercial loans of $844,000. The decrease in mortgage loans
occurred essentially in variable rate residential real estate
loans which decreased $3,225,000, while fixed rate residential
real estate loans increased by $1,813,000. The increase in
commercial loans was primarily attributed to an increase in fixed
rate commercial loans. The allowance for loan losses increased
$9,000 or 0.33% as the result of recoveries and provisions
exceeding charge-offs for the first nine months of 1998. As of
September 30, 1998, the allowance for loan losses represents
2.60% 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
one year and has gross net loans of $1,377,000 as of September
30, 1998, which is an increase of $1,034,000 from December 31,
1997.
The increase in total deposits is the result of increases in
interest-bearing demand of $3,621,000, savings of $1,497,000 and
time deposits of $5,031,000. These increases resulted from
offering a competitive rate on deposit accounts and the active
involvement by management and the board of directors in promoting
the various banking products, which include deposit accounts.
The increase in equity capital was attributed to net earnings of
$2,107,000, an increase in net unrealized gains on available for
sale securities of $337,000, less dividend payments totaling
$628,000.
8
<PAGE>
Results of Operations
Comparison of Nine Months Ended September 30, 1998 and 1997.
Philson's net income increased by $8,000 for the first nine
months of 1998, as compared to net income for the first nine
months of 1997. Effecting net income positively was an increase
in interest and dividend income of $359,000, while negative
effects to net income consisted of increases in interest expense
of $29,000 and other expense of $288,000.
Net interest income for 1998 increased $330,000 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 $258,000. The
increase in interest and fees on loans is attributable to
increases in the average outstanding balance of commercial loans
of $1,871,000, receipt of interest and late charges on past due
mortgage loans of approximately $75,000, and interest income from
Flex Financial loans of $140,000. The increase in commercial
loans was primarily in fixed rate loans.
The increase in interest expense is attributable to increases in
interest on deposit accounts of $14,000 and interest on borrowed
funds of $15,000. The increase in interest on deposit accounts
is primarily attributable to increases of approximately
$1,529,000 in the average outstanding balance of interest-bearing
demand deposits and approximately $633,000 in the average
outstanding balance of savings deposits. The increase in interest
on borrowed funds is due to an increase in the average
outstanding balance of securities sold under agreements to
repurchase.
Other expense increased $288,000 for 1998 from 1997, as the
direct result of increases in salaries and employee benefits of
$164,000, premises and equipment expense of $73,000, and other
expense of $51,000. 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.
The increase in other expense is primarily due to expenses
related to offering the debit card, changing MAC card processors,
and an overall increase in other expense categories.
9
<PAGE>
Results of Operations
Comparison of Three Months Ended September 30, 1998 and 1997.
Philson's net income decreased by $32,000 for the third quarter
of 1998, as compared to net income for the third quarter of 1997.
Effecting net income positively was an increase in interest and
dividend income of $122,000, while negative effects to net income
consisted of increases in interest expense of $39,000 and other
expense of $125,000.
Net interest income for the third quarter of 1998 increased
$83,000 from the third quarter of 1997 primarily due to an
increase in interest and dividend income, being offset by an
increase in interest expense. The increase in interest and
dividend income resulted primarily from an increase in interest
on federal funds sold of $89,000 and interest on investment
securities of $29,000. The increase in interest on federal funds
sold is attributable to an increase in the average outstanding
balance of federal funds sold. The increase in interest on
investment securities is due to an increase in the average
outstanding balance of investment securities available for sale
of $19,946,000, offset by a decrease in the average outstanding
balance of investment securities held to maturity of $16,735,000.
The increase in interest and fees on loans is primarily
attributable to interest income on Flex Financial loans of
$64,000, offset by a decrease in interest income of $56,000 on
mortgage loans. The decrease in interest income on mortgage
loans for the third quarter of 1998 is primarily due to decreases
in the average outstanding balance and average rate earned on
variable rate mortgages.
Other expense increased $125,000 for 1998 from 1997, primarily as
the result of increases in salaries and employee benefits of
$56,000 and other expense of $60,000. 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, offset by a
decrease in maintenance and repair expenses associated with a
branch office in 1997. The increase in other expense is
primarily due to expenses related to offering the debit card,
changing MAC card processors, and an overall increase in other
expense categories.
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 September 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.
10
<PAGE>
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Cash and due from banks $ 8,275 $ 6,382
Interest-bearing deposits
in other banks - 511
Federal funds sold 14,600 8,900
Investment securities
available for sale 33,321 20,183
Investment securities held
to maturity, maturing in
one year or less 19,820 25,646
------------- ------------
Total 76,016 61,622
Less short-term borrowings 2,169 3,348
------------- ------------
Net liquidity position $ 73,847 $ 58,274
============= ============
As a percent of
total assets 34.55% 28.84%
</TABLE>
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 nine months of 1998, Philson increased its
capital base by $1,816,000 or 7.74%, primarily through retained
earnings. For the first nine months of 1997, capital increased
by $1,769,000 or 8.34%.
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.
11
<PAGE>
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 September 30, 1998 and December 31,
1997, (dollars in thousands):
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
Amount Ratio Amount Ratio
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Total Capital
(to Weighted Assets)
Actual $ 26,363 20.28% $ 24,770 20.51%
For Capital Adequacy
Purposes 10,401 8.00 9,662 8.00
To Be Well Capitalized 13,001 10.00 12,077 10.00
Tier 1 Capital Ratio
(to Weighted Assets)
Actual $ 24,724 19.02% $ 23,245 19.25%
For Capital Adequacy
Purposes 5,200 4.00 4,831 4.00
To Be Well Capitalized 7,801 6.00 7,246 6.00
Tier 1 Capital
(to Average Assets)
Actual $ 24,724 11.58% $ 23,245 11.40%
For Capital Adequacy
Purposes 8,537 4.00 8,153 4.00
To Be Well Capitalized 10,671 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 September 30, 1998 December 31, 1997
- ---------------------- ------------------ -------------------
<S> <C> <C>
Return on Average
Assets (Annualized) 1.36% 1.35%
Return on Average
Equity (Annualized) 11.55% 12.17%
Dividend Payout Ratio 29.69% 24.41%
</TABLE>
12
<PAGE>
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.
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 September 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 September 30, 1998 and December 31,
1997 (dollars in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Loans on non-accrual status $ 218 $ 364
Loans past due 90 days or more 263 464
------------- ------------
Total non-performing loans 481 828
------------- ------------
Other real estate 1 1
------------- ------------
Total non-performing assets $ 482 $ 829
============= ============
Non-performing loans as a
percent of total loans 0.46% 0.79%
Non-performing assets as a
percent of total loans 0.46% 0.79%
Non-performing assets as a
percent of total assets 0.23% 0.41%
</TABLE>
13
<PAGE>
Year 2000 Compliance Issues
The following section contains forward-looking statements which
involve risks and uncertainties. The actual impact on Philson of
the Year 2000 issue could materially differ from that which is
anticipated in the forward-looking statements as a result of
certain factors identified below.
The "Year 2000 Problem" (Y2K) arose because many existing
computer programs use only the last two digits to refer to a
year. Therefore, these computer programs do not properly
recognize a year that begins with "20" instead of the familiar
"19". If not corrected, many computer applications could fail or
create erroneous results by or at the year 2000. This could
cause entire system failures, miscalculations, and disruptions of
normal business operations including, among other things, a
temporary inability to process transactions, send statements, or
engage in similar day to day business activities. The extent of
the potential impact of the Year 2000 Problem is not yet known,
and if not timely corrected, it could affect the global economy.
The Bank is subject to the regulation and oversight of various
banking regulators, whose oversight includes the provision of
specific time tables, programs and guidance regarding Year 2000
issues. Regulatory examination of the Bank's Year 2000 programs
are conducted on a quarterly basis and reports are submitted by
the Bank to the banking regulators on a periodic basis.
Corporation's State of Readiness
- --------------------------------
Philson is committed to ensuring that it and its subsidiaries
daily operations suffer little or no impact from the century date
change. Philson has applied due diligence throughout the Y2K
process, following guidelines contained in the series of Federal
Financial Institutions Examinations Council's Interagency
Guidelines. The guidelines identify the following phases:
awareness, assessment, renovation or remediation, testing or
validation and implementation.
Management has initiated an enterprise-wide program to prepare
Philson's computer systems and applications for the Year 2000.
Philson has developed a comprehensive inventory of all mainframe
and PC based applications, third-party relationships,
environmental systems, proprietary programs and non-computer
related systems (such as postage meters and fax machines). Based
on an ongoing assessment and testing, Philson has determined that
it will be required to modify or replace portions of its software
and hardware so that its computer systems will properly use dates
beyond December 31, 1999. To date, Philson has completed the
awareness and assessment phases and is currently in the process
of renovating, testing, and implementing the needed changes to
its mission critical systems and equipment to be Year 2000
ready.
Philson has developed implementation plans which prioritize tasks
and establish implementation timeframes. The implementation
plans are being followed to ensure that modifications and
conversions are implemented and thoroughly tested on a timely
basis. Based on progress made to date, management anticipates
that software for the primary information systems will be Year
2000 compliant by December 31, 1998. Other less essential
software applications will be modified and /or replaced
14
<PAGE>
during 1999 which would enable all internal software applications
to become Year 2000 compliant prior to the Year 2000. Philson
believes that as a result of modifications to existing software
and hardware and conversions to new software, the Year 2000
Problem can be mitigated. However, if such modifications and
conversions are not made, or are not completed on a timely basis,
the Year 2000 Problem could have a material adverse impact on the
operations of Philson.
Philson has taken steps to communicate with the unrelated parties
with whom it deals to coordinate Year 2000 compliance.
Additionally, we are dependent on external suppliers, such as,
wire transfer systems, telephone systems, electric companies, and
other utility companies for continuation of service. Philson has
also assessed the impact, if any, the century date change may
have on its credit risk. In determining the loan loss reserve,
estimated credit risk associated with the Year 2000 readiness of
loan customers has been taken into consideration.
Philson has initiated communications with all of its significant
vendors, suppliers and large commercial customers to determine
the extent to which Philson is vulnerable to those
third-parties' failure to remedy their own Year 2000 Problems.
Philson's Y2K Project Manager has evaluated each vendors' Y2K
readiness efforts which includes their Y2K status and target
dates. Philson does not believe that the cost of addressing the
Y2K issues will be a material event or uncertainty that would
cause reported financial information not to be necessarily
indicative of future operating results or financial conditions,
nor does it believe that the costs or the consequences of
incomplete or untimely resolution of its Year 2000 issues
represent a known material event or uncertainty that is
reasonably likely to affect its future financial results, or
cause its reported financial information not to be necessarily
indicative of future operating results or future financial
condition.
Costs of Year 2000
- ------------------
The Year 2000 project costs include the costs and time associated
with the impact of third-parties' Year 2000 issues, and are based
on presently available information. The total cost of the project
is being funded through operating cash flows. Philson continues to
evaluate appropriate courses of corrective action, including
replacement of certain systems whose associated costs would be
recorded as assets and amortized. Accordingly, Philson does not
expect the amounts required to be expensed over the next 15 months
to have a material effect on the financial position or results of
operations. However, if compliance is not achieved in a timely
manner by Philson or any of its significant related third-parties,
be it a supplier of services or customer, the Y2K issue could
possibly have a material effect on Philson's operations and
financial position.
Risks of Year 2000
- ------------------
At present, management believes it's progress in remedying
Philsons' systems, programs and applications and installing Y2K
compliant upgrades is on target. The Y2K computer problem creates
risk for Philson from unforseen problems in its own computer
systems and PC based computer applications.
15
<PAGE>
Contingency Plans
- -----------------
Philson is in the process of obtaining back-up service providers,
working up contingency plans and assessing the potential adverse
risks to Philson. Philson's contingency plans involve the use of
manual labor to compensate for the loss of certain automated
computer systems and inconveniences caused by disruption in command
systems.
A contingency plan has been developed for mission-critical
and required mainframe and PC based applications,
third-party relationships, environmental systems, proprietary
programs and non-computer related systems. The plan includes both
a remediation contingency plan and a business resumption
contingency plan. This contingency plan identifies scheduled
completion dates, test dates and trigger dates. The trigger date
is the date Philson would implement the contingency plan.
16
<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 September
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 40.6% 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 September 30, 1998.
17
<PAGE>
<TABLE>
<CAPTION>
0-90 91-180 181-365
Days Days Days
------- ------- -------
<S> <C> <C> <C>
RATE-SENSITIVE ASSETS:
Loans $ 22,767 $ 9,157 $18,797
Investment securities
available for sale 1,525 500 1,410
Investment securities
held to maturity 10,000 4,496 5,324
Federal funds sold 14,600 - -
------- -------- --------
Total rate-sensitive
assets 48,892 14,153 25,531
------- -------- --------
RATE-SENSITIVE
LIABILITIES:
Deposits 35,563 18,068 32,570
Borrowings 2,169 - -
------- -------- --------
Total rate-sensitive
liabilities 37,732 18,068 32,570
------- -------- --------
Interest sensitivity
gap $11,160 ($3,915) ($7,039)
Cumulative interest
sensitivity gap $11,160 $ 7,245 $ 206
Cumulative interest
sensitivity gap
ratio to total assets 5.22% 3.39% 0.10%
<CAPTION>
1 to 5 Over
Years 5 Years Total
------- -------- --------
<S> <C> <C> <C>
RATE-SENSITIVE ASSETS:
Loans $39,212 $15,294 $105,227
Investment securities
available for sale 28,848 1,038 33,321
Investment securities
held to maturity 21,173 7,751 48,744
Federal funds sold - - 14,600
------- -------- --------
Total rate-sensitive
assets 89,233 24,083 201,892
------- -------- --------
RATE-SENSITIVE
LIABILITIES:
Deposits 76,135 62 162,398
Borrowings - - 2,169
------- -------- --------
Total rate-sensitive
liabilities 76,135 62 164,567
------- -------- --------
Interest sensitivity
gap $13,098 $24,021 $ 37,325
Cumulative interest
sensitivity gap $13,304 $37,325
Cumulative interest
sensitivity gap
ratio to total assets 6.22% 17.46%
</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 on
net interest margin 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 negatively affect net
interest income as income from assets would increase less rapidly
than deposit
18
<PAGE>
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.
19
<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
None.
Item 5 - Other Information
None.
Item 6 - Exhibits and Reports on Form 8-K
No reports have been filed for 1998.
20
<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 November 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
21
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 8,275
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 14,600
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 33,321
<INVESTMENTS-CARRYING> 48,744
<INVESTMENTS-MARKET> 49,404
<LOANS> 105,227
<ALLOWANCE> 2,738
<TOTAL-ASSETS> 213,742
<DEPOSITS> 185,262
<SHORT-TERM> 2,169
<LIABILITIES-OTHER> 1,024
<LONG-TERM> 0
0
0
<COMMON> 4,356
<OTHER-SE> 20,931
<TOTAL-LIABILITIES-AND-EQUITY> 213,742
<INTEREST-LOAN> 7,176
<INTEREST-INVEST> 3,495
<INTEREST-OTHER> 528
<INTEREST-TOTAL> 11,199
<INTEREST-DEPOSIT> 4,306
<INTEREST-EXPENSE> 4,390
<INTEREST-INCOME-NET> 6,809
<LOAN-LOSSES> 33
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,609
<INCOME-PRETAX> 2,902
<INCOME-PRE-EXTRAORDINARY> 2,902
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,107
<EPS-PRIMARY> 1.21
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.80
<LOANS-NON> 218
<LOANS-PAST> 263
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,729
<CHARGE-OFFS> 477
<RECOVERIES> 453
<ALLOWANCE-CLOSE> 2,738
<ALLOWANCE-DOMESTIC> 2,738
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
