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 March 31, 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 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 May 7, 1999, 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 as of
March 31, 1999 and December 31, 1998 3
Consolidated Statement of Income for the
Three Months Ended March 31, 1999 and 1998 4
Consolidated Statement of Changes in
Stockholders' Equity for the Three Months
Ended March 31, 1999 5
Consolidated Statement of Cash Flows
for the Three Months Ended March 31, 1999
and 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-15
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 16-18
PART II - OTHER INFORMATION 19
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 20
2
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
<CAPTION>
March 31, December 31,
1999 1998
------------- ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 7,497 $ 10,301
Federal funds sold 4,600 2,700
Investment securities available
for sale 44,160 42,690
Investment securities held to
maturity (market values of
$46,044 and $47,006) 45,843 46,554
Total loans 107,927 107,555
Less allowance for loan losses 2,840 2,731
------------- ------------
Net loans 105,087 104,824
Premises and equipment, net 3,558 3,512
Accrued interest receivable 1,792 1,886
Other assets 1,532 1,140
------------- ------------
TOTAL ASSETS $ 214,069 $ 213,607
============= ============
LIABILITIES
Deposits:
Noninterest-bearing demand $ 23,192 $ 24,663
Interest-bearing demand 28,817 29,087
Savings 37,827 37,070
Money market 12,603 11,991
Time 83,153 82,319
------------- ------------
Total deposits 185,592 185,130
Securities sold under agreements
to repurchase 1,211 1,807
U. S. Treasury demand notes 305 134
Accrued interest payable 554 553
Other liabilities 634 394
------------- ------------
TOTAL LIABILITIES 188,296 188,018
------------- ------------
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 9,602 9,163
Accumulated other comprehensive
income 171 426
------------- ------------
TOTAL STOCKHOLDERS' EQUITY 25,773 25,589
------------- ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 214,069 $ 213,607
============= ============
</TABLE>
See accompanying notes to the consolidated financial statements
and accountant's report.
3
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED STATEMENT OF INCOME
(Dollars in thousands, except per share amounts)
<CAPTION>
Three Months Ended March 31,
1999 1998
------------ ------------
<S> <C> <C>
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 2,309 $ 2,388
Interest-bearing deposits in
other banks - 8
Interest on federal funds sold 67 122
Investment securities:
Taxable interest 1,103 970
Tax-exempt interest 185 156
------------ ------------
Total interest and
dividend income 3,664 3,644
------------ ------------
INTEREST EXPENSE
Interest on deposits 1,376 1,401
Interest on borrowed funds 22 29
------------ ------------
Total interest expense 1,398 1,430
------------ ------------
NET INTEREST INCOME 2,266 2,214
Provision for loan losses 10 8
------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,256 2,206
------------ ------------
OTHER INCOME
Service charges on deposit
accounts 126 128
Other income 119 88
------------ ------------
Total other income 245 216
------------ ------------
OTHER EXPENSE
Salaries and employee benefits 856 830
Premises and equipment expense 252 238
Other expense 482 415
------------ ------------
Total other expense 1,590 1,483
------------ ------------
Income before income taxes 911 939
Income tax expense 237 254
------------ ------------
NET INCOME $ 674 $ 685
============ ============
EARNINGS PER SHARE $ 0.39 $ 0.39
CASH DIVIDENDS PER SHARE $ 0.13 $ 0.12
WEIGHTED AVERAGE SHARES
OUTSTANDING 1,742,400 1,742,400
</TABLE>
See accompanying notes to the consolidated financial statements
and accountant's report.
4
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY
<CAPTION>
Accumulated
Other
Comprehensive Total
Common Capital Retained Income Stockholders'
Stock Surplus Earnings (Loss) Equity
------ ------- -------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Balance,
December 31,
1998 $4,356 $11,644 $ 9,163 $ 426 $ 25,589
Net Income 674 674
Other
Comprehensive
income:
Unrelized
loss on
available
for sale
securities (255) (255)
Comprehensive
Income
Cash dividend
($.13 per
share) (235) (235)
------ ------- -------- ---------- ------------
Balance,
March 31,
1999 $4,356 $11,644 $ 9,602 $ 171 $ 25,773
====== ======= ======== ========== ============
<CAPTION>
Comprehensive
Income
-------------
<S> <C>
Balance,
December 31,
1998
Net Income $ 674
Other
Comprehensive
income:
Unrealized
loss on
available
for sale
securities (255)
Comprehensive -------------
Income $ 419
=============
</TABLE>
See accompanying notes to the consolidated financial statements
and accountant's report.
5
<PAGE>
<TABLE>
First Philson Financial Corporation
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
<CAPTION>
Three Months Ended March 31,
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 674 $ 685
Adjustments to reconcile net
income to net cash provided
by operating activities:
Provision for loan losses 10 8
Depreciation, amortization
and accretion, net 108 73
Decrease (increase) in
accrued interest receivable 94 (94)
Increase in accrued interest
payable 1 10
Other, net 69 75
------------ ------------
Net cash provided by
operating activities 956 757
------------ ------------
INVESTING ACTIVITIES
Proceeds from maturities and
repayments of investment
securities:
Held to maturity 4,444 6,236
Available for sale 500 -
Purchase of investment securities:
Held to maturity (3,728) (3,000)
Available for sale (2,362) (2,899)
Net decrease (increase) in loans (370) 223
Purchase of premises and
equipment (146) (81)
------------ ------------
Net cash provided by
(used for) investing
activities (1,662) 479
------------ ------------
FINANCING ACTIVITIES
Net increase in deposits 462 425
Increase (decrease)in
securities sold under
agreements to repurchase (596) 227
Increase (decrease) in
U.S. Treasury demand notes 171 (917)
Cash dividends paid (235) (209)
------------ ------------
Net cash used for
financing activities (198) (474)
------------ ------------
Increase (decrease) in
cash and cash
equivalents (904) 762
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 13,001 15,282
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 12,097 $ 16,044
============ ============
</TABLE>
See accompanying notes to the consolidated financial statements
and accountant's report.
6
<PAGE>
First Philson Financial Corporation
Notes to Consolidated Financial Statements
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.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Financial Condition
Total assets at March 31, 1999 increased $462,000 from that
reported at December 31, 1998. Increases in federal funds sold
of $1,900,000 and investment securities available for sale of
$1,470,000, were funded primarily by decreases in cash and due
from banks of $2,804,000 and investment securities held to
maturity of $711,000.
The increase in investment securities available for sale was
primarily due to an increase in corporate notes available for
sale of $1,496,000, while the decrease in investment securities
held to maturity was primarily due to decreases of $999,000 in
U.S. Treasury securities held to maturity and $501,000 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 increased $263,000 primarily as the result of increases
in mortgage loans of $1,138,000 and Flex Financial loans of
$274,000, offset by a decrease in installment loans to
individuals of $1,403,000. The increase in mortgage loans
occurred essentially in fixed rate residential real estate loans
which increased $2,388,000, while variable rate commercial real
estate loans decreased by $865,000. The allowance for loan
losses increased $109,000 or 3.99% as the result of recoveries
and provisions exceeding charge-offs for the first three months
of 1999. As of March 31, 1999, the allowance for loan losses
represents 2.63% of the outstanding loan balances as compared to
2.54% for December 31, 1998. 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 and a half years and has gross net loans of
$1,896,000 as of March 31, 1999.
Total deposits increased $462,000 primarily as the result of
increases in savings of $757,000, money market deposits of
$612,000 and time deposits of $834,000, offset by a decrease in
noninterest-bearing demand deposits of $1,471,000. 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
$674,000, less dividend payments totaling $235,000, and a
decrease in accumulated comprehensive income of $255,000.
8
<PAGE>
Results of Operations
Comparison of Three Months Ended March 31, 1999 and 1998.
Philson's net income decreased by $11,000 for the first three
months of 1999, as compared to net income for the first three
months of 1998. Effecting net income positively was an increase
in interest and dividend income of $20,000 and a decrease in
interest expense of $32,000, while a negative effect to net
income consisted of an increase in other expense of $107,000.
Net interest income for 1999 increased $52,000 from 1998
primarily due to an increase in interest and dividend income,
offset by a decrease in interest expense. The increase in
interest and dividend income resulted primarily from an increase
in interest on investment securities of $162,000, offset by
decreases in interest and fees on loans of $79,000 and interest
on federal funds sold of $55,000. The increase in interest on
investment securities is attributable to an increase in the
average outstanding balance of securities available for sale of
$317,000, offset by a decrease in the average outstanding balance
of securities held to maturity of $147,000. The increase in the
average outstanding balance of securities available for sale was
primarily due to an increase in the average balance of corporate
notes, while the decrease in held to maturity securities was the
result of a decrease in the average balance of U.S. Government
Agency securities. The decrease in interest and fees on loans is
attributable to decreases in the average rate of return on loans,
primarily commercial loans variable and residential real estate
loans fixed and variable.
The decrease in interest expense is attributable to decreases in
interest on deposit accounts of $25,000 and interest on borrowed
funds of $7,000. The decrease in interest on deposit accounts is
primarily attributable to decreases in the average rate paid on
interest-bearing demand deposits, savings, and time deposits,
offset by an increase in the average outstanding balance of time
deposits. The decrease in interest on borrowed funds is due to
decreases in both the average outstanding balance and average
rate paid on borrowed funds.
Other expense increased $107,000 for 1999 from 1998, as the
direct result of increases in salaries and employee benefits of
$26,000, premises and equipment expense of $14,000, and other
expense of $67,000. The increase in salaries and employee
benefits is due to annual employee increases and an increase in
the cost of medical insurance. The increase in premises and
equipment expense in 1999 is the result of increases in
maintenance and repairs to bank buildings and depreciation
expense. The increase in other expense is primarily due to an
increase in holding company expenses and an overall increase in
other expense categories. The increase in holding company
expenses is primarily due to expenses associated with the merger
agreement with BT Financial Corportation.
9
<PAGE>
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 March 31, 1999 and December 31, 1998 (dollars
in thousands). Management feels that the liquidity position is
strong and adequate to cover any potential customer withdrawals
and credit needs.
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Cash and due from banks $ 7,497 $ 10,301
Federal funds sold 4,600 2,700
Investment securities
available for sale 44,160 42,690
Investment securities held
to maturity, maturing in
one year or less 10,825 10,317
------------- ------------
Total 67,082 66,008
Less short-term borrowings 1,516 1,941
------------- ------------
Net liquidity position $ 65,566 $ 64,067
============= ============
As a percent of
total assets 30.63% 29.99%
</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 three months of 1999, Philson increased its
capital base by $184,000 or .72%, primarily through retained
earnings.
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
10
<PAGE>
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 March 31, 1999 and December 31, 1998,
(dollars in thousands):
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
Amount Ratio Amount Ratio
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Total Capital
(to Risk-weighted
Assets)
Actual $ 27,321 20.03% $ 26,880 19.72%
For Capital Adequacy
Purposes 10,913 8.00 10,906 8.00
To Be Well Capitalized 13,641 10.00 13,632 10.00
Tier 1 Capital Ratio
(to Risk-weighted
Assets)
Actual $ 25,602 18.77% $ 25,163 18.46%
For Capital Adequacy
Purposes 5,456 4.00 5,453 4.00
To Be Well Capitalized 8,185 6.00 8,179 6.00
Tier 1 Capital
(to Average Assets)
Actual $ 25,602 11.97% $ 25,163 11.68%
For Capital Adequacy
Purposes 8,558 4.00 8,617 4.00
To Be Well Capitalized 10,698 5.00 10,771 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.
11
<PAGE>
<TABLE>
<CAPTION>
SIGNIFICANT RATIOS March 31, 1999 December 31, 1998
- ---------------------- ------------------ -------------------
<S> <C> <C>
Return on Average
Assets (Annualized) 1.28% 1.33%
Return on Average
Equity (Annualized) 10.60% 11.24%
Dividend Payout Ratio 34.87% 31.03%
</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.
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 March 31, 1999 and December 31, 1998.
The following table presents information concerning
non-performing assets including non-accrual loans and loans 90
days or more past due for March 31, 1999 and December 31, 1998
(dollars in thousands):
12
<PAGE>
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Loans on non-accrual status $ 141 $ 177
Loans past due 90 days or more 67 50
------------- ------------
Total non-performing loans 208 227
------------- ------------
Other real estate 91 1
------------- ------------
Total non-performing assets $ 299 $ 228
============= ============
Non-performing loans as a
percent of total loans 0.19% 0.21%
Non-performing assets as a
percent of total loans 0.28% 0.21%
Non-performing assets as a
percent of total assets 0.14% 0.11%
</TABLE>
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,
13
<PAGE>
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 determined that it
would be required to modify or replace portions of its software
and hardware so that its computer systems would properly use
dates beyond December 31, 1999. To date, Philson has completed
the awareness, assessment, renovation, testing, and
implementation phases to make 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 time frames. The implementation
plans are being followed to ensure that modifications and
conversions are implemented and thoroughly tested on a timely
basis. The Bank has completed most of its Y2K testing and has
found no material problems. The Bank has corrected all problems
that were found during the tests. Other less essential software
applications will be modified and/or replaced 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, Philson is 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. The risk associated with the Year 2000
readiness of commercial loan and deposit customers has been taken
into consideration and evaluated.
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. Further, Philson does not
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.
14
<PAGE>
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
9 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.
Contingency Plans
- -----------------
Philson's Year 2000 Committee has developed a contingency plan
which covers the Bank's mission critical systems. The committee
has assessed 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. Philson
has also developed a disaster recovery site with Sun Guard for
its critical 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. The
plan is updated on a regular basis.
15
<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 March 31, 1999 and December 31, 1998, 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 49.1% 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 March 31, 1999.
16
<PAGE>
<TABLE>
<CAPTION>
0-90 91-180 181-365
Days Days Days
------- ------- -------
<S> <C> <C> <C>
RATE-SENSITIVE ASSETS:
Loans $ 19,986 $ 9,009 $15,400
Investment securities
available for sale 2,048 1,004 3,874
Investment securities
held to maturity 3,125 2,199 5,501
Federal funds sold 4,600 - -
------- -------- --------
Total rate-sensitive
assets 29,759 12,212 24,775
------- -------- --------
RATE-SENSITIVE
LIABILITIES:
Deposits 38,810 19,643 33,350
Borrowings 1,516 - -
------- -------- --------
Total rate-sensitive
liabilities 40,326 19,643 33,350
------- -------- --------
Interest sensitivity
gap ($10,567) ($7,431) ($8,575)
Cumulative interest
sensitivity gap ($10,567) ($17,998) ($26,573)
Cumulative interest
sensitivity gap
ratio to total assets -4.94% -8.41% -12.41%
<CAPTION>
1 to 5 Over
Years 5 Years Total
------- -------- --------
<S> <C> <C> <C>
RATE-SENSITIVE ASSETS:
Loans $44,260 $19,272 $107,927
Investment securities
available for sale 34,217 3,017 44,160
Investment securities
held to maturity 24,865 10,153 45,843
Federal funds sold - - 4,600
------- -------- --------
Total rate-sensitive
assets 103,342 32,442 202,530
------- -------- --------
RATE-SENSITIVE
LIABILITIES:
Deposits 70,534 63 162,400
Borrowings - - 1,516
------- -------- --------
Total rate-sensitive
liabilities 70,534 63 163,916
------- -------- --------
Interest sensitivity
gap $32,808 $32,379 $ 38,614
Cumulative interest
sensitivity gap $ 6,235 $38,614
Cumulative interest
sensitivity gap
ratio to total assets 2.91% 18.04%
</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 liability 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
17
<PAGE>
costs. Although rate sensitivity analysis enable 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 Form 10-Q, 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.
18
<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
A Form 8-K was filed on March 12, 1999, filed via
Edgar (File No. 0001-13599), and hereby incorporated
by reference.
19
<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 May 13, 1999 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
20
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 7,497
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4,600
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 44,160
<INVESTMENTS-CARRYING> 45,843
<INVESTMENTS-MARKET> 46,044
<LOANS> 107,927
<ALLOWANCE> 2,840
<TOTAL-ASSETS> 214,069
<DEPOSITS> 185,592
<SHORT-TERM> 1,516
<LIABILITIES-OTHER> 1,188
<LONG-TERM> 0
0
0
<COMMON> 4,356
<OTHER-SE> 21,417
<TOTAL-LIABILITIES-AND-EQUITY> 214,069
<INTEREST-LOAN> 2,309
<INTEREST-INVEST> 1,288
<INTEREST-OTHER> 67
<INTEREST-TOTAL> 3,664
<INTEREST-DEPOSIT> 1,376
<INTEREST-EXPENSE> 1,398
<INTEREST-INCOME-NET> 2,266
<LOAN-LOSSES> 10
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,590
<INCOME-PRETAX> 911
<INCOME-PRE-EXTRAORDINARY> 911
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 674
<EPS-PRIMARY> 0.39
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.47
<LOANS-NON> 141
<LOANS-PAST> 67
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,731
<CHARGE-OFFS> 1
<RECOVERIES> 100
<ALLOWANCE-CLOSE> 2,840
<ALLOWANCE-DOMESTIC> 2,840
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
SNODGRASS
Certified Public Accountants and Consultants
Board of Directors
First Philson Financial Corporation
We have reviewed the consolidated balance sheet of
First Philson Financial Corporation and its subsidiaries as of
March 31, 1999, and the related consolidated statements of
income, changes in stockholders' equity, and cash
flows for the three months ended March 31, 1999. These
financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants.
A review of interim financial information consists principally
of applying analytical procedures to financial data and
making inquiries of persons responsible for financial
and accounting matters. It is substantially less in
scope than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is an
expression of opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the aforementioned
consolidated financial statements for them to be in conformity
with generally accepted accounting principles.
/s/S.R. Snodgrass, A.C.
Wexford, PA
April 28, 1999
S.R. Snodgrass, A.C.
101 Bradford Road Wexford, PA 15090-6909 Phone: 724-934-0344
Facsimile: 724-934-0345
