UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 000-20163
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FIRST PHILSON FINANCIAL CORPORATION
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(Name of registrant as specified in its charter)
DELAWARE 25-1511866
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
534 Main Street, Berlin, PA 15530
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(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code)
(814) 267-4666
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange on
Title of each class: which registered:
Common Stock, $2.50 Par Value American Stock Exhange
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
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(Title of class)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
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Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained in this
form, and will not be contained, to the best of the Registrant's
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ( )
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The aggregate market value of the voting stock held by
nonaffiliates of the Registrant as of February 12, 1999 was
$67,659,000.
THE ISSUER WAS NOT INVOLVED IN BANKRUPTCY PROCEEDINGS DURING
THE PRECEDING FIVE YEARS.
As of March 12, 1999, there were 1,742,400 shares
outstanding of the Registrant's common stock, $2.50 par value.
DOCUMENTS INCORPORATED BY REFERENCE.
The 1998 Annual Report to Shareholders is incorporated
herein by reference in Parts I, II, III, and IV.
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PART I
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ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS DEVELOPMENT
First Philson Financial Corporation ("Philson") is a bank holding
company organized in 1985 under the Delaware General Corporation
Law and is registered under the Bank Holding Company Act, of
1956, as amended. First Philson Bank, N.A. (the "Bank") and Flex
Financial Consumer Discount Company ("Flex") are wholly-owned
subsidiaries of Philson. First Philson Bank, N.A. is the
surviving bank of the former National Bank of Western
Pennsylvania and The Philson National Bank, which merged on
January 1, 1991. The Bank is a national banking association
organized under the laws of the United States. In order for
Philson to offer product diversification within the surrounding
market area, Philson formed Flex. Flex was incorporated, as a
consumer discount company,under the laws of Pennsylvania, in May
1997 and began operations on September 22, 1997. Flex is
regulated by the Pennsylvania Department of Banking. Philson's
principal activities consist of owning and operating the Bank and
Flex.
Philson and its subsidiaries derive substantially all their
income from banking and bank-related services. Philson
functions primarily as a coordinating and servicing unit for its
subsidiaries in general management, loan policies and procedures,
accounting and taxes, loan review, auditing, investment advisory,
compliance, marketing, general corporate services, and financial
and strategic planning.
BUSINESS OF ISSUER
The business conducted by Philson and its subsidiaries is not
seasonal nor does it have any risks attendant to foreign sources.
The Bank conducts general banking business through nine
locations in Somerset and Fayette Counties, Pennsylvania. The
Bank is a full-service bank offering (1) retail banking services,
such as demand, savings and time deposits, money market accounts,
secured and unsecured loans, mortgage loans, safe deposit boxes,
holiday club accounts, money orders, and traveler's checks; (2)
lending, depository and related financial services to commercial,
industrial, financial, and governmental customers, such as real
estate mortgage loans, revolving credit arrangements, lines of
credit, real estate construction loans, business money market
and savings accounts, certificates of deposit, wire transfers,
and night depository; and (3) credit card operations through
MasterCard, VISA and Discover. The Bank also operates seven
automated bank teller machines, ("ATM's").
The Bank's deposit base is such that the loss of one depositor
or a related group of depositors would not have a materially
adverse effect on its business. In addition, the loan portfolio
is also diversified so that one industry or group of related
industries does not comprise a material portion of the loan
portfolio.
The Bank is federally chartered and is subject to primary
supervision by the Office of the Comptroller of the Currency
("OCC"). The Bank is also subject to the regulations of the
Board of Governors of the Federal Reserve Bank ("Federal Reserve
Board") and the Federal Deposit Insurance Corporation ("FDIC").
Its deposits are insured by the Bank Insurance Fund ("BIF") of
the FDIC.
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Flex conducts consumer lending through its one office located
in Somerset, Pennsylvania. Flex offers consumer discount loans,
sales finance loans, and first and second residential mortgage
loans, to customers within the surrounding market area.
SUPERVISION AND REGULATION - PHILSON
Philson is subject to the provisions of the Bank Holding Company
Act and to supervision by the Federal Reserve Board. The Bank
Holding Company Act requires Philson to secure the prior approval
of the Federal Reserve Board before it owns or controls, directly
or indirectly, more than 5.00% of the voting shares or
substantially all of the assets of any institution, including
another bank.
A bank holding company is prohibited from engaging in or
acquiring direct or indirect control of more than 5.00% of the
voting shares of any company engaged in nonbanking activities
unless the Federal Reserve Board, by order or regulation, has
found such activities to be so closely related to banking or
managing or controlling banks as to be a proper incident
thereto. In making this determination, the Federal Reserve Board
considers whether the performance of these activities by a bank
holding company would offer benefits to the public that outweigh
possible adverse effects.
Philson is required to file an annual report with the Federal
Reserve Board and any additional information that the Federal
Reserve Board may require pursuant to the Bank Holding Company
Act. The Federal Reserve Board may also make examinations of
Philson and any or all of its subsidiaries. Further, under
Section 106 of the 1970 amendments to the Bank Holding Company
Act and the Federal Reserve Board's regulations, a bank holding
company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension
of credit or provision of credit or provision of any property
or services. The so-called "Anti-tie-in" provisions state
generally that a bank may not extend credit, lease, sell
property or furnish any service to a customer on the condition
that the customer provide additional credit or service to the
bank, to its bank holding company or to any other subsidiary of
its bank holding company or on the condition that the customer
not obtain other credit or service from a competitor of the
bank, its bank holding company or any subsidiary of its bank
holding company.
Subsidiary banks of a bank holding company are subject to
certain restrictions imposed by the Federal Reserve Act on any
extension of credit to the bank holding company or any of its
subsidiaries, on investments in the stock or other securities
of the bank holding company and on taking of such stock or
securities as collateral for loans to any borrower.
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.
LEGISLATION AND REGULATORY CHANGES
From time to time, legislation is enacted which has the effect
of increasing the cost of doing business, limiting or expanding
permissible activities or affecting the competitive balance
between banks and other financial institutions. Proposals to
change the laws and regulations governing the operations
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and taxation of banks, bank holding companies and other financial
institutions are frequently made in Congress, and before various
bank regulatory agencies. No prediction can be made as to the
likelihood of any major changes or the impact such changes might
have on Philson and its subsidiary bank. Certain changes of
potential significance to Philson which have been enacted
recently and others which are currently under consideration by
Congress or various regulatory or professional agencies are
discussed below.
On August 9, 1989, major reform and financing legislation was
enacted into law in order to restructure the regulation of the
thrift industry, to address the financial condition of the
Federal Savings and Loan Insurance Corporation and to enhance
the supervisory powers of the federal bank and thrift regulatory
agencies. Financial Institutions Reform, Recovery and Enforce-
ment Act ("FIRREA") reorganized the FDIC by creating two deposit
insurance funds to be administered by the FDIC-- the Savings
Association Insurance Fund ("SAIF") and the BIF. FIRREA
established a new schedule for premiums to be paid by thrifts
and banks for deposit insurance coverage. The Bank became a
member of BIF. In addition, FIRREA reformed the real estate
appraisal process and required licensed or certified appraisers
to be engaged to render an appraisal on real estate loans above
certain threshold limits.
Other provisions of FIRREA include substantial changes to
enforcement powers available to regulators. The OCC, as the
primary regulator of national banks, is primarily responsible
for enforcement action, but the FDIC also has authority to
impose enforcement action independently after following certain
procedures. FIRREA also expands jurisdiction of the FDIC's
enforcement powers to all "institution-affiliated" parties,
including stockholders, attorneys, appraisers and accountants
who knowingly or recklessly participate in wrongful action
having or likely to have an adverse effect on an insured
institution.
FIRREA also provides regulators with far greater flexibility to
impose enforcement action on an institution that fails to comply
with its regulatory requirements, particularly with respect to
the capital requirements. Possible enforcement actions include
the imposition of a capital plan, termination of deposit
insurance and removal or temporary suspension of an officer,
director or other institution-affiliated party. The FDIC also
may recommend that the OCC take enforcement action. If action
is not taken by the OCC, the FDIC has the authority to compel
such action under certain circumstances.
The Federal Deposit Insurance Corporation Improvement Act
("FDICIA") was enacted on December 19, 1991, and made reforms
to a variety of bank regulatory laws. Some of these reforms
will have a direct impact on the Registrant and the Bank.
These new provisions are discussed below.
Annual full-scope, on-site examinations are required for all
FDIC-insured institutions such as the Bank. For small,
well-capitalized institutions that are well managed and in
outstanding condition, and whose ownership has not changed in
the preceding year, the examinations by the OCC may be at
18-month intervals. In 1996, federal bank regulators extended
the eligibility for 18-month examination cycles to "small"
institutions, banks and thrifts with up to $250 million in
assets, with an examination rating of at least CAMELS 2.
However, federal bank regulators retain the right to examine any
bank any time they believe there may be a cause.
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In order to reduce losses to the deposit insurance funds,
FDICIA established a format to more closely monitor the
FDIC-insured institutions and to enable prompt corrective
action by the appropriate federal supervisory agency if an
institution begins to experience any difficulty. FDICIA
established five "capital" categories. They are: (1) well
capitalized, (2) adequately capitalized, (3) undercapitalized,
(4) significantly undercapitalized and (5) critically
undercapitalized. Regulations promulgated by the FDIC Board of
Directors pursuant to the authority granted by the Insurance Act
of 1996 ("Funds Act") on November 26, 1996 retained the existing
BIF assessment schedule of 0 - 27 cents per $100 of deposits
depending upon an institution's risk classification, but
eliminated the statutorily-imposed minimum assessment amount.
The Funds Act also authorizes the Financing Corporation ("FICO")
to levy assessments on BIF-assessable deposits and stipulates
that the rate must equal one-fifth of the FICO assessment rate
that is applied to deposits assessable by the SAIF. "Capital
measures", i.e., the quantitative and qualitative criteria,
imposed more scrutiny and operational restrictions on banks as
they descend the capital categories from well capitalized to
critically undercapitalized. The most recent classification for
the Bank is "well capitalized".
At any time, an institution's primary federal supervisory
agency may reclassify it into a lower capital category. All
institutions are prohibited from declaring any dividends, making
any other capital distribution, or paying a management fee if it
would drop them down into any of the three undercapitalized
categories as a result. FDICIA provides an exception to this
requirement for stock redemptions that do not lower an
institution's capital and would improve its financial condition,
if the appropriate federal supervisory agency has consulted with
the FDIC and approved the redemption.
FDICIA requires the Bank to monitor its capital levels and
notify the OCC if its capital levels fall into a lower category.
The OCC would monitor the Bank's capital levels through call
reports and examination reports.
Pursuant to FDICIA, the OCC adopted a real estate lending rule
which set loan-to-value ("LTV") ratios for different types of
real estate loans. A LTV ratio is generally defined as the
total loan amount divided by the appraised value of the property
at the time the loan is originated. In addition to establishing
the LTV ratios as a guideline, the final ruling requires all real
estate loans to be based upon proper loan documentation and a
recent appraisal of the property.
Banks are expected to establish internal LTV limits for real
estate loans that do not exceed certain guidelines as outlined
under FDICIA. They are as follows:
1. For raw land loans, 65%;
2. For land development loans, 75%;
3. For commercial or multifamily construction loans, 80%;
4. For one-to-four family residential construction loans,
85%;
5. For improved property loans (completed commercial
properties; other income-producing property, including
farmland), 85%;
6. For owner-occupied 1-4 family and home equity loans,
< 90%. Loans can equal or exceed
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90% loan-to-value with credit enhancement in the form
of mortgage insurance or readily marketable collateral
(means listed securities, insured deposits, and gold
bullion).
The rule requires each bank to adopt and maintain a comprehensive
written real estate lending policy developed in conformance with
the following guidelines:
1. Establish limits and standards that are consistent
with safe and sound banking practices;
2. Establish prudent underwriting standards, including
LTV limits, that are clear and measurable;
3. Establish loan administration policies for its real
estate portfolio;
4. Establish documentation, approval and reporting
requirements to monitor compliance with its real
estate lending policies; and
5. Be reviewed and approved by the Bank's board of
directors at least annually.
Banks are expected to maintain a real estate lending policy
appropriate for the size of the institution and nature and scope of
its operations and markets. Real estate lending standards must
apply to loans secured by liens on (or interests in) real estate,
or loans made to finance construction or other improvements to real
estate, regardless of whether a lien has been taken on the property.
Furthermore, the OCC must establish non-capital standards for
the Bank. These standards shall cover: (1) internal controls,
information systems and internal audit systems, (2) loan
documentation, (3) credit underwriting, (4) interest rate exposure,
(5) asset growth, (6) compensation, fees and benefits, (7) other
operational and managerial standards and (8) asset quality,
earnings and stock valuation. The Bank must develop a plan if it
fails to meet any of these standards. There are sanctions that can
be imposed for failure to meet these standards and, if necessary,
to develop a plan.
The OCC on December 20, 1992: (1) developed and prescribed
regulations which require that all assets and liabilities,
including contingent assets and liabilities, of the Bank be
reported in, or otherwise taken into account in the preparation of,
any balance sheet, financial statement, report of condition, or
other report prepared by the Bank required to be filed with any
federal bank regulatory agency; and (2) developed jointly with the
other federal bank regulatory agencies a method for the
Bank to provide supplemental disclosure of the estimated fair
market value of assets and liabilities, to the extent feasible and
practical, in any balance sheet, financial statement, report of
condition or other report prepared by the Bank required to be filed
with any federal bank regulatory agency.
Within the overall FDICIA is a separate subtitle called the "Bank
Enterprise Act of 1991". The thrust of this Act is to encourage
banking institutions to establish "basic transaction services for
consumers" or so-called "lifeline accounts". The FDIC assessment
rate shall be reduced for all lifeline depository accounts. This
Act establishes ten (10) factors which are the minimum requirements
to qualify as a lifeline depository account. Some of these factors
relate to minimum opening and balance amounts, minimum number of
monthly withdrawals, the absence of discriminatory practices
against low-income individuals and minimum service charges and
fees.
FDICIA also contains the Truth in Savings Act ("Regulation DD").
The purpose of this Act is to
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require the clear and uniform disclosure of the rates of interest
which are payable on deposit accounts by the Bank and the fees that
are assessable against deposit accounts, so that consumers can make
a meaningful comparison between the competing claims of the banks
with regard to deposit accounts and products. This Act requires
the Bank to include, in a clear and conspicuous manner, the
following information with each periodic statement of a deposit
account:
(a) the annual percentage yield earned;
(b) the amount of interest earned;
(c) the amount of any fees or charges imposed; and
(d) the number of days in the reporting period. This Act
allows for civil lawsuits to be initiated by customers
if the Bank violates any provision or regulation under
this Act.
Philson and the Bank are not aware of, as of the filing date of
this annual report, whether FDICIA and any rules and regulations
promulgated thereunder, would cause any materially adverse effect
upon the financial condition and income of Philson and the Bank.
The earnings of Philson are and will be affected by domestic
economic conditions and the monetary and fiscal policies of the
United States government and its agencies.
The monetary policies of the Federal Reserve Board have had, and
will likely continue to have, an important impact on the operating
results of commercial banks through its power to implement national
monetary policy in order, among other things, to curb inflation or
combat a recession. The Federal Reserve Board has a major effect
upon the levels of bank loans, investments and deposits through its
open market operations in United States government securities and
through its regulations of, among other things, the discount rate
on borrowings of member banks and the reserve requirements against
member bank deposits. It is not possible to predict the nature and
impact of future changes in monetary and fiscal policies.
The primary supervisory authority that regularly examines the Bank
is the OCC. The OCC has the authority under the Financial
Institutions Supervisory Act to prevent a national bank from
engaging in an unsafe or unsound practice in conducting its
business.
Federal and state banking laws and regulations govern, among other
things, the scope of a bank's business, the investments a bank may
make, the reserves against deposits a bank must maintain, loans a
bank makes and collateral it takes, the activities of a bank with
respect to mergers and consolidations and the establishment of
branches. All banks in Pennsylvania are permitted to maintain
branch offices in any county of the state. Branches may be
established only after approval by the OCC. The OCC is required to
grant approval only if it finds that there is a need for banking
services or facilities such as are contemplated by the proposed
branch. The OCC may disapprove the application if the bank does
not have the capital and surplus deemed necessary by the OCC, or if
the application relates to the establishment of a branch in a
county contiguous to the county in which the applicant's principal
place of business is located, and another banking institution that
has its principal place of business in the county in which the
proposed branch would be located, has in good faith, notified the
OCC of its intention to establish a branch in the same municipal
location in which the
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proposed branch would be located.
The Riegle-Neal Interstate Banking and Branch Efficiency Act of
1994 ("Riegle-Neal") provides for interstate mergers and
acquisitions of banks by bank holding companies beginning on
September 29, 1995 and interstate mergers among federally insured
depository institutions beginning June 1, 1997. Riegle-Neal does
not authorize interstate branch acquisitions, if not permitted by
state law. By legislation effective July 6, 1995, Pennsylvania
Banks are authorized to participate fully in interstate banking and
branching. A bank holding company may control one or more
Pennsylvania banks and with consent of the Department of Banking;
foreign bank holding companies may acquire control of a bank in
Pennsylvania. In addition, banks may establish branches in
Pennsylvania if their home state would permit Pennsylvania banks or
a national bank headquartered in Pennsylvania to establish a branch
in that state. Finally, Pennsylvania banks may establish branches
in other states subject to the approval of the Department of
Banking with respect to state banks but no such approval is
required for national banks.
A subsidiary bank of a bank holding company is subject to certain
restrictions imposed by the Federal Reserve Act on any extensions
of credit to the bank holding company or its subsidiaries, on
investments in the stock or other securities of the bank holding
company or its subsidiaries and on taking such stock or securities
as collateral for loans. The Federal Reserve Act and Federal
Reserve Board regulations also place certain limitations and
reporting requirements on extensions of credit by a bank to
principal shareholders of its parent holding company, among others,
and to related interests of such principal shareholders. In
addition, such legislation and regulations may affect the terms
upon which any person becoming a principal shareholder of a holding
company may obtain credit from banks with which the subsidiary bank
maintains a correspondent relationship.
Federal law also prohibits acquisitions of control of a bank
holding company without prior notice to certain federal bank
regulators. Control is defined for this purpose as the power,
directly or indirectly, to influence the management of policies of
the bank or bank holding company or to vote twenty-five percent
(25%) or more of any class of voting securities of the bank holding
company.
From time to time, various types of federal and state legislation
have been proposed that could result in additional regulations of,
and restrictions on, the business of the Bank. It cannot be
predicted whether any such legislation will be adopted or how such
legislation would affect the business of the Bank. As a
consequence of the extensive regulation of commercial banking
activities in the United States, the Bank's business is
particularly susceptible to being affected by federal legislation
and regulations that may increase the costs of doing business.
Under the Federal Deposit Insurance Act, the OCC possesses the
power to prohibit institutions regulated by it (such as the Bank)
from engaging in any activity that would be an unsafe and unsound
banking practice and in violation of the law. Moreover, the
Financial Institutions and Interest Rate Control Act of 1987
("FIRA") generally expands the circumstances under which officers
or directors of a bank may be removed by the institution's federal
supervisory agency; restricts lending by a bank to its executive
officers, directors, principal shareholders or related interests
thereof; restricts management personnel of a bank from serving as
directors or in other management positions with certain depository
institutions whose assets exceed a specified amount or which have
an office within a specified geographic area; and restricts
management personnel from borrowing from another institution that
has a correspondent relationship with their bank. Additionally,
FIRA requires that no person may acquire control of a bank unless
the appropriate federal supervisory agency has been
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given 60-days prior written notice and within that time has not
disapproved the acquisition or extended the period for disapproval.
Under the Bank Secrecy Act ("BSA"), the Bank is required to report
to the Internal Revenue Service currency transactions of more than
$10,000 or multiple transactions of which the Bank is aware in any
one day that aggregate in excess of $10,000. Civil and criminal
penalties are provided under the BSA for failure to file a required
report, for failure to supply information required by the BSA or
for filing a false or fraudulent report.
Under the Community Reinvestment Act of 1977 ("CRA"), the OCC is
required to assess the record of all financial institutions
regulated by it to determine if these institutions are meeting the
credit needs of the community, including low and moderate
neighborhoods, which they serve and to take this record into
account in its evaluation of any application made by any such
institutions for, among other things, approval of a branch or other
deposit facility, office relocation, a merger or an acquisition of
bank shares. FIRREA amended the CRA to require, among other
things, that the OCC make publicly available an evaluation of the
Bank's record of meeting the credit needs of its entire community
including low- and moderate-income neighborhoods. This evaluation
includes a descriptive rating ("outstanding", "satisfactory",
"needs to improve", or "substantial noncompliance") and a statement
describing the basis for the rating. The most recent rating for
the Bank is "outstanding".
FIRREA changed the capital requirements applicable to national
banks. The OCC has issued risk-based capital guidelines, which
supplement existing capital requirements. The guidelines require
all United States banks and bank holding companies to maintain a
minimum risk-based capital ratio of 8.00% (of which at least
one-half must be in the form of Tier I capital since December 31,
1994). Assets will be assigned to five risk categories, with
higher levels of capital being required for the categories
perceived as representing greater risk. The required capital
ratios will represent equity and, to the extent permitted,
non-equity capital as a percentage of total risk-weighted assets.
The risk-based capital guidelines are designed to make regulatory
capital requirements more sensitive to differences in risk profiles
among banks and bank holding companies and to minimize
disincentives for holding liquid assets. On the basis of an
analysis of the guidelines and projected composition of Philson's
assets, it is not expected that such risk-based capital guidelines
will have a material effect on the Bank's business and capital
plans.
As of December 31, 1998, Philson's total risk-based capital ratio
was 19.72% of which 18.46% was Tier I capital in the form of common
stockholders' equity. This percentage exceeds the minimum capital
ratio required under the risk-based capital guidelines. For
further discussion, see the "Notes to Consolidated Financial
Statements" of the 1998 Annual Report, (Exhibit 13.b, pages 18 and
19), incorporated herein by reference, and Item 7 Management's
Discussion and Analysis or Plan of Operations contained within this
report, page 29.
Furthermore, FDICIA mandates the federal banking regulatory
agencies to revise their respective risk-based capital standards
for banks and thrifts to ensure that those standards take adequate
account of interest-rate risk, concentration of credit risk and the
risks of nontraditional activities.
Philson nor its subsidiaries are dependent on deposits nor exposed
by loan concentrations to a single customer or to a small group of
customers, the loss of any one or more of which would have a
materially adverse effect on the financial condition of Philson or
its subsidiaries.
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Philson faces strong competition from other commercial banks,
savings banks, savings and loan associations, and several other
financial or investment service institutions for business in the
communities they serve. Several of these institutions are
affiliated with major banking and financial institutions, such as
United States National Bank, PNC Financial Corporation, BT
Financial, First Commonwealth Financial Corporation, and National
City Bank, which are substantially larger and have greater
financial resources than Philson.
As the financial services industry continues to expand, the scope
of potential competition affecting the subsidiaries will also
increase. For most of the services that the subsidiaries perform,
there is also competition from credit unions and issuers of
commercial paper and money market funds. Such institutions, as
well as brokerage houses, consumer finance companies, factors,
insurance companies, and pension trusts, are important competitors
for various types of financial services. In addition, personal and
corporate trust investment counseling services are offered by
insurance companies and other firms and individuals.
As of December 31, 1998, Philson had 105 full-time employees and
126 total employees. Philson has never experienced a work stoppage
and Philson believes that relations with its employees are good.
None of Philson's employees are covered by collective bargaining
agreements.
ITEM 2. PROPERTIES
Philson has nine bank branch offices located in Somerset and
Fayette Counties, Pennsylvania and one consumer discount company
office located in Somerset, Pennsylvania. All property owned or
leased by Philson, including premises and equipment, is adequately
insured with coverage reviewed annually.
The main office of Philson is located at 534 Main Street, Berlin,
Pennsylvania 15530. At December 31, 1998, Philson leased one of
its bank branch facilities and its consumer discount company office
and paid approximately $2,364 a month for these offices. All other
branch offices are owned by Philson including its main office which
is used as its principal executive office. Philson believes that
the facilities are in good condition and are sufficient for its
existing activities and potential growth.
Philson, through its subsidiaries, does grant real estate
mortgages. For further detail on the types of mortgages, see the
"Notes to Consolidated Financial Statements" of the 1998 Annual
Report, (Exhibit 13.b, page 14), incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS
Management, after consulting with Philson's legal counsel, is not
aware of any litigation that would have a material adverse effect
on the consolidated financial position of Philson. There are no
proceedings pending other than ordinary routine litigation incident
to the business of Philson, the Bank, and Flex. In addition,
management does not know of any material proceedings contemplated
by governmental authorities against Philson, the Bank, or Flex.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of Philson's security
holders during the fourth quarter of the fiscal year ended December
31, 1998.
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PART II
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ITEM 5. MARKET FOR PHILSON'S COMMON STOCK AND DIVIDENDS
As of December 3, 1997, Philson's Common Stock began trading on the
American Stock Exchange ("AMEX"). The following table sets forth:
(1) the quarterly high and low prices for a share of Philson's
Common Stock during the periods indicated as reported by the
Management of Philson and (2) quarterly dividends paid on a Common
Share with respect to each quarter since January 1, 1997. The
following quotations represent the process between buyers and
sellers and do not include retail markup, markdowns or commission.
They may not necessarily represent actual transactions and the
amounts for 1997 have been adjusted for the four-for-one stock
split.
<TABLE>
<CAPTION>
Stock Prices
------------------ Dividends
Low High Paid
------- ------- ---------
<S> <C> <C> <C>
1998:
- -----
First Quarter $ 25.63 $ 29.25 $ 0.12
Second Quarter 23.00 26.38 0.12
Third Quarter 21.75 26.63 0.12
Fourth Quarter 26.25 43.00 0.13
1997:
- -----
First Quarter $ 13.50 $ 14.00 $ 0.08
Second Quarter 14.00 15.00 0.09
Third Quarter 15.00 15.13 0.09
Fourth Quarter 15.50 29.00 0.12
</TABLE>
As of December 31, 1998, there were approximately 648
shareholders of record of Philson's common stock.
ITEM 6. SELECTED FINANCIAL DATA
The required information is contained in the "Financial
Highlights" of the 1998 Annual Report, (Exhibit 13.a, listed
on page 3), incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATIONS
The following is a more detailed discussion of certain
significant factors that affected Philson's consolidated
operating results, interest rate sensitivity, financial
condition, liquidity, and capital resources for the years ended
December 31, 1998, 1997, and 1996. Reference should be made to
the "Consolidated Financial Statements and Notes to the
Consolidated Financial Statements" of the 1998 Annual Report,
(Exhibit 13.b, pages 6 - 22), incorporated herein by reference,
as well as the "Financial Highlights" of the 1998 Annual Report,
(Exhibit 13.a, listed on page 3), incorporated herein by
reference, for a complete understanding of the following
discussion and analysis. All increases, decreases and related
ratios represent comparisons to the previous year-end. Certain
comparative amounts for 1997 and 1996 have been reclassified to
conform to 1998 presentations.
11
<PAGE>
Summary of Earnings
- -------------------
Philson's net income increased by $50,000 in 1998, $341,000 in
1997, and $447,000 in 1996. Net income per share was $1.60,
$1.57, and $1.37 respectively, for the same time periods.
Philson's Return on Average Assets ("ROA") was 1.33% for 1998,
1.35% for 1997, and 1.20% for 1996, while the Return on Average
Equity ("ROE") was 11.24%, 12.17%, and 11.76%, respectively.
Net Interest Income
- -------------------
Net interest income is the difference between the interest earned
on loans, investment securities, and federal funds sold
("Interest-earning assets") and the interest paid on deposits and
borrowings ("Interest-bearing liabilities"). Net interest income
is affected principally by the spread between the yield on
interest-earning assets and the cost of interest-bearing
liabilities and by the relative dollar amounts of such assets and
liabilities.
Since the earnings provided by tax-exempt securities such as
investments in obligations of state and political subdivisions,
and loans such as those to counties, municipalities and school
districts, are a significant component of net interest income, it
is more meaningful to analyze net interest income on a
tax-equivalent basis, shown on pages 14 and 15. The tax-equivalent
adjustment is based upon the federal corporate income
tax rate of 34%.
On a fully tax-equivalent basis, net interest income increased
$435,000 in 1998, $617,000 in 1997, and $643,000 in 1996.
Average interest-earning assets increased $6,707,000 in 1998,
$2,969,000 in 1997, and $2,273,000 in 1996. Average
interest-bearing liabilities increased $4,073,000 in 1998, and
decreased $280,000 in 1997 and $1,074,000 in 1996.
The net interest margin, which is a ratio of the net interest
income on a tax-equivalent basis divided by the average earning
assets, was 4.81% for 1998, 4.75% for 1997, and 4.50% for 1996.
As a percentage of average total assets, average earning assets
were 94.90% in 1998, 95.25% in 1997 and 95.39% in 1996.
Philson's Asset/Liability Committee ("ALCO") continually strives
to effectively manage interest rate risk and to minimize the
impact of interest rate fluctuations on the net interest margin.
Philson continues to focus its efforts on generating quality loan
growth and investing in highly rated securities.
1998
- ----
Net interest income increased in 1998 due to an increase in
interest income of $460,000 and an increase in interest expense
of $25,000. The increase in interest income resulted primarily
from increases in interest and fees on loans of $257,000,
interest on investment securities of $89,000, and interest on
federal funds sold of $109,000. The increase in interest and
fees on loans was attributable to an increase in the average
outstanding balance of commercial loans of $1.6 million,
primarily fixed rate commercial loans. The increase in interest
on investment securities was due to a decrease in the average
outstanding balance of investment securities held to maturity of
$17.9 million, offset by an increase of $20.3 million in the
average outstanding balance of investment securities available
for sale. The decrease in investment securities held to
maturity is the result of maturities and calls and Management's
decision to invest in available for sale securities in 1997 in
order to enhance liquidity. The increase in interest on federal
funds sold was due to a $2.2 million increase in the average
outstanding balance.
12
<PAGE>
The increase in interest expense resulted primarily from
increases in the average outstanding balance of time deposits of
$942,000 and securities sold under agreements to repurchase
$434,000, offset by an 8-basis point decrease in the cost of
interest-bearing liabilities.
The increase in the margin was a direct result of higher
interest-earning assets. To meet the goals set forth in
Philson's Strategic Plan for business development, Management
held regular meetings to review and enhance the sales call
program implemented in prior years to promote new business and to
meet the needs of the communities for which it serves.
Management was able to increase the interest rate spread from
1997 through the continual pursuit of noninterest-bearing
business deposits and by controlling the overall cost of funds.
1997
- ----
Net interest income increased in 1997 due to an increase in
interest income of $467,000 and a decrease in interest expense of
$150,000. The increase in interest income resulted from
increases in interest and fees on loans of $634,000 and interest
on federal funds sold of $207,000, offset by a decrease in
interest on investment securities of $390,000. The increase in
interest and fees on loans was attributable to an increase in the
average outstanding balance of mortgage loans of $5.5 million,
primarily fixed rate residential and commercial real estate
loans. The increase in interest on federal funds sold was due to
a $3.6 million increase in the average outstanding balance and an
11-basis point increase in the net yield. The decrease in
interest on investment securities was due to a decrease in the
average outstanding balance of investment securities held to
maturity of $16 million, offset by an increase of $8.5 million
in the average outstanding balance of investment securities
available for sale and a 10-basis point increase in the net
yields of the investment portfolio. The decrease in investment
securities held to maturity is the result of maturities and calls
and Management's decision to invest in available for sale
securities in 1997 in order to enhance liquidity.
The decrease in interest expense resulted from a $1.8 million
reduction in the average outstanding balance of securities sold
under agreements to repurchase and a 9-basis point decrease in
the cost of interest-bearing liabilities.
The increase in the margin was a direct result of higher
interest-earning assets and lower interest-bearing liabilities.
To meet the goals set forth in Philson's Strategic Plan for
business development, Management held regular meetings to review
and enhance the sales call program implemented in prior years to
promote new business and to meet the needs of the communities for
which it serves. Management was able to increase the interest
rate spread from 1996 through the continual pursuit of
noninterest-bearing business deposits, higher yielding
investments, residential mortgage and home equity loans, and
small business loans.
The following is an analysis of the average balance sheet and net
interest income for the three years ended December 31, 1998, 1997
and 1996 (dollars in thousands).
13
<PAGE>
<TABLE>
AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
<CAPTION>
1998
--------------------------
Average Yield/
Balance Interest Rate
<F1>
--------- --------- ------
<S> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans receivable <F2> <F3> <F4> $105,500 $ 9,658 9.15%
Investment securities available
for sale:
Taxable 27,508 1,642 5.97%
Tax-exempt <F4> 1,654 150 9.07%
Investment securities held
to maturity:
Taxable 41,366 2,440 5.90%
Tax-exempt <F4> 9,548 810 8.48%
Interest-bearing deposits in
other banks 310 21 6.77%
Federal funds sold 13,082 706 5.40%
--------- --------- ------
Total interest-earning assets 198,968 15,427 7.75%
--------- --------- ------
Noninterest-earning assets:
Cash and due from banks 7,146
Other assets 6,370
Less allowance for loan losses 2,833
---------
Total noninterest-earning assets 10,683
---------
TOTAL ASSETS $209,651
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits $ 28,594 $ 301 1.05%
Savings deposits 36,465 986 2.70%
Money market deposits 12,434 315 2.53%
Time deposits 80,952 4,151 5.13%
Securities sold under
agreements to repurchase 1,974 76 3.85%
Other borrowings 566 35 6.18%
--------- --------- ------
Total interest-bearing
liabilities 160,985 5,864 3.64%
--------- --------- ------
Noninterest-bearing liabilities
and stockholders' equity:
Noninterest-bearing demand
deposits 22,718
Other liabilities 1,210
Stockholders' equity 24,738
---------
Total noninterest-bearing
liabilities and stockholders'
equity 48,666
---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $209,651
=========
Net interest income; interest
rate spread $ 9,563 4.11%
========= ======
Net yield on earning assets (Margin) 4.81%
======
<CAPTION>
1997
--------------------------
Average Yield/
Balance Interest Rate
<F1>
--------- --------- ------
<S> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans receivable <F2> <F3> <F4> $103,473 $ 9,401 9.09%
Investment securities available
for sale:
Taxable 8,574 536 6.25%
Tax-exempt <F4> 329 31 9.42%
Investment securities held to
maturity:
Taxable 58,032 3,458 5.96%
Tax-exempt <F4> 10,759 928 8.63%
Interest-bearing deposits in
other banks 243 16 6.58%
Federal funds sold 10,851 597 5.50%
--------- --------- ------
Total interest-earning assets 192,261 14,967 7.78%
--------- --------- ------
Noninterest-earning assets:
Cash and due from banks 6,669
Other assets 5,691
Less allowance for loan losses 2,778
---------
Total noninterest-earning assets 9,582
---------
TOTAL ASSETS $201,843
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits $ 26,580 $ 293 1.10%
Savings deposits 35,630 995 2.79%
Money market deposits 12,483 311 2.49%
Time deposits 80,010 4,142 5.18%
Securities sold under
agreements to repurchase 1,540 62 4.03%
Other borrowings 669 36 5.38%
--------- --------- ------
Total interest-bearing
liabilities 156,912 5,839 3.72%
--------- --------- ------
Noninterest-bearing liabilities
and stockholders' equity:
Noninterest-bearing demand
deposits 21,284
Other liabilities 1,209
Stockholders' equity 22,438
---------
Total noninterest-bearing
liabilities and stockholders'
equity 44,931
---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $201,843
=========
Net interest income; interest
rate spread $ 9,128 4.06%
======== ======
Net yield on earning assets (Margin) 4.75%
======
<CAPTION>
1996
--------------------------
Average Yield/
Balance Interest Rate
<F1>
--------- --------- ------
<S> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans receivable <F2> <F3> <F4> $ 96,898 $ 8,767 9.05%
Investment securities available
for sale:
Taxable 393 24 6.11%
Tax-exempt <F4> - - -
Investment securities held to
maturity:
Taxable 73,125 4,316 5.90%
Tax-exempt <F4> 11,639 1,003 8.62%
Interest-bearing deposits in
other banks - - -
Federal funds sold 7,237 390 5.39%
--------- --------- ------
Total interest-earning assets 189,292 14,500 7.66%
--------- --------- ------
Noninterest-earning assets:
Cash and due from banks 6,595
Other assets 5,525
Less allowance for loan losses 2,962
---------
Total noninterest-earning assets 9,158
---------
TOTAL ASSETS $198,450
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits $ 25,378 $ 377 1.49%
Savings deposits 36,515 1,054 2.89%
Money market deposits 12,365 315 2.55%
Time deposits 79,074 4,107 5.19%
Securities sold under
agreements to repurchase 3,309 108 3.26%
Other borrowings 551 28 5.08%
--------- --------- ------
Total interest-bearing
liabilities 157,192 5,989 3.81%
--------- --------- ------
Noninterest-bearing liabilities
and stockholders' equity:
Noninterest-bearing demand
deposits 19,705
Other liabilities 1,220
Stockholders' equity 20,333
---------
Total noninterest-bearing
liabilities and stockholders'
equity 41,258
---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $198,450
=========
Net interest income; interest
rate spread $ 8,511 3.85%
========= ======
Net yield on earning assets (Margin) 4.50%
======
<FN>
<F1> Average balances are computed using daily average balances.
<F2> Non-accrual loans are included in the average balances.
<F3> Interest on loans includes fee income.
<F4> Interest on earning assets has been computed on a tax
equivalent basis using the federal income tax statutory
rate of 34%.
</FN>
</TABLE>
14
<PAGE>
The following analysis shows the effects of the changes in
volumes and rates on interest income and interest expense
(dollars in thousands).
<TABLE>
ANALYSIS OF CHANGES IN NET INTEREST INCOME
<CAPTION>
1998 vs. 1997
--------------------------------
Net Due to changes in
Increase ---------------------
(Decrease) Volume <F1> Rate <F4>
---------- ----------- ---------
<S> <C> <C> <C>
INTEREST INCOME:
Loans receivable <F2> <F3> $ 257 $ 184 $ 73
Investment securities
available for sale:
Taxable 1,106 1,184 (78)
Tax-exempt <F2> 119 125 (6)
Investment securities held
to maturity:
Taxable (1,018) (993) (25)
Tax-exempt <F2> (118) (105) (13)
Interest-bearing deposits
in other banks 5 4 1
Federal funds sold 109 123 (14)
---------- ----------- ---------
Total interest income 460 522 (62)
---------- ----------- ---------
INTEREST EXPENSE:
Deposits 12 139 (127)
Borrowings 13 15 (2)
---------- ----------- ---------
Total interest expense 25 154 (129)
---------- ----------- ---------
NET INTEREST INCOME $ 435 $ 368 $ 67
========== =========== =========
<CAPTION>
1997 vs. 1996
--------------------------------
Net Due to changes in
Increase ---------------------
(Decrease) Volume <F1> Rate <F4>
---------- ----------- ---------
<S> <C> <C> <C>
INTEREST INCOME:
Loans receivable <F2> <F3> $ 634 $ 595 $ 39
Investment securities
available for sale:
Taxable 512 500 12
Tax-exempt <F2> 31 31 -
Investment securities held
to maturity:
Taxable (858) (891) 33
Tax-exempt <F2> (75) (76) 1
Interest-bearing deposits
in other banks 16 16 -
Federal funds sold 207 195 12
---------- ----------- ---------
Total interest income 467 370 97
---------- ----------- ---------
INTEREST EXPENSE:
Deposits (112) 52 (164)
Borrowings (38) (58) 20
---------- ----------- ---------
Total interest expense (150) (6) (144)
---------- ----------- ---------
NET INTEREST INCOME $ 617 $ 376 $ 241
========== =========== =========
<FN>
<F1> Average volume information was computed using daily average
balances.
<F2> Interest on earning assets has been computed on a tax
equivalent basis using the federal income tax statutory
rate of 34%.
<F3> Non-accrual loans are included in the average balances.
<F4> Changes in interest income or expense, not arising solely
as a result of volume or rate variances, are allocated to
rate variances due to the interest sensitivity of assets
and liabilities.
</FN>
</TABLE>
Interest Sensitivity
- --------------------
One of the principle functions of Philson's asset/liability
management program is to measure the risk to net income which may
result from changes in interest rates. This is accomplished
through management of the relationship between interest
rate-sensitive assets and liabilities, and attempts to minimize
the fluctuations in net interest margins and thereby achieve
consistent growth of net interest income in periods of changing
interest rates while maintaining a balance between interest
rate-sensitive assets and liabilities.
15
<PAGE>
The difference between interest rate-sensitive assets and
liabilities within any specific time frame is the measurement of
interest sensitivity. This is referred to as "gap". A positive
gap means Philson's assets will reprice more frequently than its
liabilities. This position is more advantageous if interest
rates rise. Conversely, a negative gap means Philson's
liabilities will reprice more frequently than its assets and is
more beneficial when interest rates fall.
The following table reflects the gap for the various time
intervals (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1998
----------------------------------------------------
0-90 91-180 181-365 1 to 5 Over
Days Days Days Years 5 Years Total
------- ------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
RATE-
SENSITIVE
ASSETS:
Loans $20,784 $ 9,228 $17,314 $41,509 $18,720 $107,555
Investment
securities
available
for sale 2,171 400 3,433 33,994 2,692 42,690
Investment
securities
held to
maturity 3,498 3,125 3,694 24,703 11,534 46,554
Federal
funds sold 2,700 - - - - 2,700
------- ------- ------- -------- -------- --------
Total rate-
sensitive
assets 29,153 12,753 24,441 100,206 32,946 199,499
------- ------- ------- -------- -------- --------
RATE-
SENSITIVE
LIABILITIES:
Deposits 34,576 20,867 32,975 71,986 63 160,467
Borrowings 1,941 - - - - 1,941
------- ------- ------- -------- -------- --------
Total rate-
sensitive
liabilities 36,517 20,867 32,975 71,986 63 162,408
------- ------- ------- -------- -------- --------
Interest
sensitivity
gap $(7,364)$(8,114)$(8,534) $28,220 $32,883 $ 37,091
Cumulative
interest
sensitivity
gap $(7,364)$(15,478)$(24,012)$4,208 $37,091
Cumulative
interest
sensitivity
gap ratio
to total
assets -3.45% -7.25% -11.24% 1.97% 17.36%
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
December 31, 1997
----------------------------------------------------
0-90 91-180 181-365 1 to 5 Over
Days Days Days Years 5 Years Total
------- ------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
RATE-
SENSITIVE
ASSETS:
Loans $22,837 $10,265 $20,133 $36,380 $15,678 $105,293
Investment
securities
available
for sale 1,161 - 386 18,128 508 20,183
Investment
securities
held to
maturity 5,188 4,995 15,463 24,592 7,210 57,448
Interest-
bearing
deposits
in other
banks - - 511 - - 511
Federal
funds sold 8,900 - - - - 8,900
------- ------- ------- -------- -------- --------
Total rate-
sensitive
assets 38,086 15,260 36,493 79,100 23,396 192,335
------- ------- ------- -------- -------- --------
RATE-
SENSITIVE
LIABILITIES:
Deposits 34,446 19,213 26,845 71,114 76 151,694
Borrowings 3,348 - - - - 3,348
------- ------- ------- -------- -------- --------
Total rate-
sensitive
liabilities 37,794 19,213 26,845 71,114 76 155,042
------- ------- ------- -------- -------- --------
Interest
sensitivity
gap $ 292 $(3,953)$ 9,648 $ 7,986 $23,320 $ 37,293
Cumulative
interest
sensitivity
gap $ 292 $(3,661)$ 5,987 $13,973 $37,293
Cumulative
interest
sensitivity
gap ratio
to total
assets 0.14% -1.81% 2.96% 6.92% 18.46%
</TABLE>
Provision for Loan Losses
- -------------------------
In providing for loans to customers, financial institutions are
subject to the risk of loan losses as one of the costs of
lending. While Management recognizes and charges the allowance
for loan losses for loan accounts which are determined to be
uncollectible, experience indicates that at any point in time,
possible losses may exist in the loan portfolio which are not
specifically identifiable. Therefore, based upon Management's
evaluation of the loan portfolio and the related allowance, an
amount is determined and charged to earnings to maintain the
allowance for loan losses at a level adequate to recognize the
potential risks. The amount charged to earnings is based upon
several factors such as, quarterly reviews of all significant
loans and commitments outstanding, a continuing review of problem
or non-performing loans and overall loan portfolio quality. In
addition, Management exercises judgment with respect to economic
conditions and the potential impact on the existing loan
portfolio. Management believes that based on its evaluation of
the loan portfolio, the allowance for loan losses is adequate for
all known and potential loan losses.
Other Income
- ------------
Other income contributed 6.40% for 1998, 6.54% for 1997, and
6.28% for 1996 to total income.
1998
- ----
The increase in 1998 resulted from an increase in other income,
offset by a decrease in service charges. Other income increased
as a result of increases in commissions from the acceptance of
Discover Card, Visa check card income (debit card), and fees
from Flex Financial for commissions
17
<PAGE>
from the sale of life and accident and health insurance on
consumer discount loans. Service charges decreased primarily due
to a decrease in overdraft income. The decrease in overdraft
income is the direct result of fewer overdrafts due to customers
signing up for overdraft protection. Management continually
reviews and refines other income sources in order to improve
efficiency and increase revenues where possible.
1997
- ----
The increase in 1997 resulted from increases in service charges
and other income. Service charges, the largest component of
total other income, increased from a growth in overdraft income
and a growth in deposit fee income. The increase in overdraft
income was due to Management's decision to enforce the overdraft
policy and more overdraft items being processed in 1997, while
the increase in deposit fee income is attributable to an increase
in the number of deposit accounts. Other income increased as a
result of increases in commissions from the acceptance of
Discover Card and fees for non-customer usage of Philson ATM's.
A new ATM was installed in Ohiopyle, Pennsylvania. Management
continually reviews and refines other income sources in order to
improve efficiency and increase revenues where possible.
Other Expense
- -------------
Other expense increased $352,000 or 5.93% in 1998 and $161,000
or 2.79% in 1997, and decreased $10,000 or .17% in 1996.
1998
- ----
The increase in 1998 resulted primarily from increases in
salaries and employee benefits of $207,000, equipment expense of
$98,000 and other expense of $59,000.
The increase in salaries and benefits was affected by increases
in salaries of $129,000, cash-op matching expense of $10,000 and
medical insurance of $30,000. The increase in salaries was due
to annual employee increases and a full year of salaries for the
subsidiary Flex. The increase in medical insurance was due to
increases in medical premiums.
The increase in equipment expense was the direct result of an
increase in depreciation expense on furniture and equipment of
$85,000, primarily as a result of depreciation on the new
mainframe. The old mainframe system had been fully depreciated
in 1996 and not replaced until the last quarter of 1997.
The increase in other expense resulted primarily from expenses
associated with the offering of the Visa check card, higher bank
card expenses due to converting to a different MAC processor, and
higher holding company expenses due to a donation of $29,000, to
a local hospital, and an increase in franchise tax of $35,000.
The increase in franchise tax is due to increasing the number of
shares authorized during the fourth quarter of 1997 in order to
issue the four-for-one stock split and list Philson on the
American Stock Exchange.
1997
- ----
The increase in 1997 resulted from increases in salaries and
employee benefits of $177,000 and other expense of $117,000 which
was offset by a decrease in occupancy expense of $118,000.
The increase in salaries and benefits was affected by increases
in salaries of $127,000, pension
18
<PAGE>
expense of $14,000 and medical insurance of $9,000. The increase
in salaries was due to annual employee increases and salaries for
the new subsidiary, Flex. The increase in medical insurance was
due to increases in medical premiums.
The decrease in occupancy expense was the direct result of a
decrease in maintenance and repairs of $125,000. The decrease
from 1996 is due to several offices being repaired in 1996 to
improve the delivery of customer service.
The increase in other expense resulted primarily from expenses
associated with the start up and operations of Flex, expenses
related to the four-for-one stock split and the listing of
Philson on the American Stock Exchange, and the implementation of
other parts of the Strategic Business and Strategic Technology
Plans.
Efficiency Ratio
- ----------------
Due to the sensitivity of the operating expense ratio to changes
in the size of the balance sheet, Management looks at trends in
the efficiency ratio to assess the changing relationship between
operating expenses and income. The efficiency ratio measures the
amount of cost expended by Philson to generate a given level of
revenues in the normal course of business. The lower the ratio,
the better Philson is utilizing its operating expenses.
Philson's efficiency ratios were 59.42% for 1998, 58.55% for
1997, and 61.13% for 1996.
Income Taxes
- ------------
Income tax expense represented 27.20% for 1998, 27.35% for 1997,
and 26.07% for 1996 as a percentage of pretax income. The
increase of $11,000 in 1998 and $185,000 in 1997 was a result of
higher earnings. See the "Notes to the Consolidated Financial
Statements" of the 1998 Annual Report, (Exhibit 13.b, page 16),
incorporated herein by reference, for more discussion.
FINANCIAL CONDITION
Investment Securities Portfolio
- -------------------------------
Investment securities held to maturity decreased $10,894,000 in
1998 and $21,254,000 in 1997, while investment securities
available for sale increased $22,507,000 and $19,604,000,
respectively. The decrease in investment securities held to
maturity resulted from maturities and calls which were reinvested
in investment securities available for sale. Management made
the decision in 1997 to invest in available for sale securities
in order to enhance liquidity.
Utilizing the investment policy, Management closely monitors
concentration and diversification levels of the investment
portfolio. Exceptions are reported on a quarterly basis to the
ALCO and Investment Committee. As of December 31, 1998, Philson
holds no securities from any single issuer that were greater than
10% of stockholders' equity as outlined in the investment policy.
The market value of the investment securities held to maturity at
December 31, 1998 and 1997 was $47,006,000 and $57,767,000,
respectively. See the "Notes to the Consolidated Financial
Statements" of the 1998 Annual Report, (Exhibit 13.b, pages 12,
13, 19, and 20), incorporated herein by reference, for further
discussion on the investment securities portfolio.
The following schedule presents the composition of the investment
portfolio as of the three most recent years ended at December 31,
1998, 1997 and 1996 (dollars in thousands):
19
<PAGE>
<TABLE>
<CAPTION>
AMORTIZED COST:
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
U.S. Treasury securities $ 6,994 $ 7,983 $11,987
U.S. Government agency securities 29,769 37,239 38,961
Obligations of states and political
subdivisions 12,796 11,160 12,214
Corporate notes 31,479 19,328 14,664
Mortgage-backed securities 6,041 649 876
Equity securities 1,519 929 551
-------- -------- --------
Total $88,598 $77,288 $79,253
======== ======== ========
</TABLE>
The amortized cost of investment securities available for sale
and held to maturity are shown below by concentration and
maturity distribution at December 31, 1998 (dollars in
thousands):
<TABLE>
INVESTMENT SECURITIES MATURITY DISTRIBUTION
<CAPTION>
Within 1 Year 1 Year to 5 Years
------------------- -----------------
<F*> <F*>
Weighted Weighted
Amount Yield Amount Yield
-------- --------- -------- --------
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities $ 998 6.17% $ - -
U.S. Government agency
securities 250 5.85% 8,307 5.71%
Obligations of states and
political subdivisions - - 1,528 5.88%
Other securities 3,049 6.38% 23,717 5.93%
-------- --------- -------- --------
Total available for sale$ 4,297 6.30% $33,552 5.87%
-------- --------- -------- --------
HELD TO MATURITY
U.S. Treasury securities $ 1,000 6.37% $ 4,996 5.63%
U.S. Government agency
securities 8,193 6.65% 13,019 5.34%
Obligations of states and
political subdivisions - - 3,036 5.99%
Other securities 1,124 6.34% 3,652 6.31%
-------- --------- -------- --------
Total held to maturity $10,317 6.59% $24,703 5.62%
-------- --------- -------- --------
Total debt securities $14,614 6.50% $58,255 5.77%
======== ========= ======== ========
<CAPTION>
5 Years to 10 Years Over 10 Years
------------------- -----------------
<F*> <F*>
Weighted Weighted
Amount Yield Amount Yield
-------- --------- -------- --------
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities $ - - $ - -
U.S. Government agency
securities - - - -
Obligations of states and
political subdivisions 1,924 4.64% 244 4.05%
Other securities 508 5.14% - -
-------- --------- -------- --------
Total available for sale$ 2,432 4.74% $ 244 4.05%
-------- --------- -------- --------
HELD TO MATURITY
U.S. Treasury securities $ - - $ - -
U.S. Government agency
securities - - - -
Obligations of states and
political subdivisions 5,058 5.38% 1,006 6.13%
Other securities 4,255 5.63% 1,215 6.24%
-------- --------- -------- --------
Total held to maturity $ 9,313 5.49% $ 2,221 6.19%
-------- --------- -------- --------
Total debt securities $11,745 5.34% $ 2,465 5.98%
======== ========= ======== ========
<CAPTION>
Total
-------------------
<F*>
Weighted
Amount Yield
-------- ---------
<S> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities $ 998 6.17%
U.S. Government agency
securities 8,557 5.72%
Obligations of states and
political subdivisions 3,696 5.11%
Other securities 27,274 5.96%
-------- ---------
Total available for sale$40,525 5.84%
-------- ---------
HELD TO MATURITY
U.S. Treasury securities $ 5,996 5.75%
U.S. Government agency
securities 21,212 5.85%
Obligations of states and
political subdivisions 9,100 5.66%
Other securities 10,246 6.02%
-------- ---------
Total held to maturity $46,554 5.84%
-------- ---------
Total debt securities $87,079 5.84%
======== =========
<FN>
<F*> The weighted average yield has not been computed on a tax
equivalent basis.
</FN>
</TABLE>
20
<PAGE>
Loan Portfolio
- --------------
Total loans increased by $2,262,000 or 2.15% in 1998 and
$4,639,000 or 4.61% in 1997. Consumer lending fueled the growth
in 1997 and 1998, primarily in the residential mortgage and home
equity areas in 1997 and loans to individuals in 1998. As in
1997 and 1998, Management intends to concentrate on consumer and
small business lending in 1999, utilizing the Bank and Flex.
This will permit Philson to meet the needs of the communities for
which it serves. For further discussion on loan composition,
loan maturities and rate sensitivity of the loan portfolio, see
the "Notes to the Consolidated Financial Statements" of the 1998
Annual Report, (Exhibit 13.b, page 14), incorporated herein by
reference.
The following is a schedule of loans by classification for the
five most recent years ended December 31, (dollars in
thousands):
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
Percent Percent
Amount of Total Amount of Total
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Commercial, financial
and agricultural $ 19,213 17.86% $ 19,244 18.28%
Real estate - mortgage:
Residential 61,376 57.07% 61,616 58.52%
Commercial 11,994 11.15% 11,412 10.84%
Installment loans to
individuals 14,972 13.92% 13,021 12.36%
-------- --------- -------- ---------
Total loans 107,555 100.00% 105,293 100.00%
========= =========
Less allowance for
loan losses 2,731 2,729
-------- --------
Net loans $104,824 $102,564
======== ========
<CAPTION>
1996 1995
------------------ ------------------
Percent Percent
Amount of Total Amount of Total
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Commercial, financial
and agricultural $ 17,891 17.77% $ 14,631 15.80%
Real estate - mortgage:
Residential 58,797 58.42% 52,433 56.60%
Commercial 10,916 10.84% 10,672 11.52%
Installment loans to
individuals 13,050 12.97% 14,896 16.08%
-------- --------- -------- ---------
Total loans 100,654 100.00% 92,632 100.00%
========= =========
Less allowance for
loan losses 3,017 2,882
-------- --------
Net loans $ 97,637 $ 89,750
======== ========
21
<PAGE>
<CAPTION>
1994
------------------
Percent
Amount of Total
-------- ---------
<S> <C> <C>
Commercial, financial
and agricultural $ 13,119 14.70%
Real estate - mortgage:
Residential 49,138 55.06%
Commercial 10,405 11.66%
Installment loans to
individuals 16,580 18.58%
-------- ---------
Total loans 89,242 100.00%
=========
Less allowance for
loan losses 2,727
--------
Net loans $ 86,515
========
</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 definition of a restructured loan or the
definition of an impaired loan for December 31, 1998 and 1997.
The following table presents information concerning non-performing
assets including non-accrual loans and loans 90 days
or more past due for the five most recent years ended December
31, (dollars in thousands).
22
<PAGE>
<TABLE>
NON-PERFORMING LOANS AND OTHER NON-PERFORMING ASSETS
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Loans on non-accrual status $ 177 $ 364 $ 676
Loans past due 90 days or more 50 464 23
------ ------ ------
TOTAL NON-PERFORMING LOANS 227 828 699
------ ------ ------
Other real estate 1 1 1
------ ------ ------
TOTAL NON-PERFORMING ASSETS $ 228 $ 829 $ 700
====== ====== ======
Non-performing loans as
a percent of total loans 0.21% 0.79% 0.69%
Non-performing assets as
a percent of total loans 0.21% 0.79% 0.70%
Non-performing assets as
a percent of total assets 0.11% 0.41% 0.35%
<CAPTION>
1995 1994
------ ------
<S> <C> <C>
Loans on non-accrual status $ 102 $ 428
Loans past due 90 days or more 52 20
------ ------
TOTAL NON-PERFORMING LOANS 154 448
------ ------
Other real estate 31 2
------ ------
TOTAL NON-PERFORMING ASSETS $ 185 $ 450
====== ======
Non-performing loans as
a percent of total loans 0.17% 0.50%
Non-performing assets as
a percent of total loans 0.20% 0.50%
Non-performing assets as
a percent of total assets 0.09% 0.23%
</TABLE>
Allowance for Loan Losses
- -------------------------
The allowance for loan losses increased $2,000 in 1998 due to
provisions totaling $44,000, offset by net charge-offs of
$42,000, and decreased in 1997 due to net charge-offs of
$308,000. Net charge-offs as a percent of average loans
outstanding were .04% at December 31, 1998 and .30% for December
31, 1997. For December 31, 1998 and 1997, the allowance for
loan losses represents 2.54% and 2.59% of total loans,
respectively.
The allowance for loan losses is maintained at a level sufficient
to provide for estimated loan losses based on evaluating known
and inherent risks in the loan portfolio. The allowance is based
on Management's continuing analysis of the pertinent factors
underlying the quality of the loan portfolio. These factors
include changes in the size and composition of the loan
portfolio, actual loan loss experience, current and anticipated
economic conditions, and detailed analysis of individual loans
and credits for which full collectability may not be assured.
The detailed analysis includes estimates of the fair market value
of collateral and the existence of potential alternative sources
of repayment. The appropriate allowance level is estimated based
upon factors and trends identified by Management on a continuing
basis.
The ultimate recovery of all loans is susceptible to future
market factors beyond Philson's control. These factors may
result in losses or recoveries differing significantly from those
provided by Management's estimates of the allowance for loan
losses.
23
<PAGE>
The Bank has a Resource Recovery Department which continually
pursues and monitors delinquent and charged-off loans. This
department assists Management in maintaining low levels of both
non-performing and charged-off loans and is primarily responsible
for the recoveries of previously charged-off loans.
The following tables present analysis of the allowance for loan
losses for the five most recent years ended December 31, (dollars
in thousands). In the table, Allocation of the Allowance for
Loan Losses, a portion of the allowance for loan losses is
specifically allocated or restricted to individual loans or a
group of loans. Any remaining allowance for loan losses would be
available to absorb losses on other loans.
<TABLE>
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
LOANS OUTSTANDING AT END OF PERIOD $107,555 $105,293 $100,654
AVERAGE LOANS OUTSTANDING $105,500 $103,473 $ 96,898
ALLOWANCE FOR LOAN LOSSES:
BALANCE AT BEGINNING OF PERIOD $ 2,729 $ 3,017 $ 2,882
CHARGE-OFFS:
Commercial, financial and
agriculture - - -
Real estate-mortgage:
Residential 413 294 191
Commercial 171 273 -
Installment loans to individuals 26 31 53
-------- -------- --------
Total charge-offs 610 598 244
RECOVERIES:
Commercial, financial and
agriculture - 4 -
Real estate-mortgage:
Residential 245 252 124
Commercial 273 - 197
Installment loans to individuals 50 34 58
-------- -------- --------
Total recoveries 568 290 379
Net Recoveries (Charge-offs) (42) (308) 135
Additions charged (credited) to
operations 44 20 -
-------- -------- --------
BALANCE AT END OF PERIOD $ 2,731 $ 2,729 $ 3,017
======== ======== ========
Ratio of net-recoveries (charge-offs)
during the period to average loans
outstanding during the period (0.04%) (0.30%) 0.14%
Allowance for loan losses as a
percent of total loans outstanding 2.54% 2.59% 3.00%
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
LOANS OUTSTANDING AT END OF PERIOD $ 92,632 $ 89,242
AVERAGE LOANS OUTSTANDING $ 90,948 $ 88,180
ALLOWANCE FOR LOAN LOSSES:
BALANCE AT BEGINNING OF PERIOD $ 2,727 $ 2,754
CHARGE-OFFS:
Commercial, financial and
agriculture 37 -
Real estate-mortgage:
Residential 127 175
Commercial - -
Installment loans to individuals 85 151
-------- --------
Total charge-offs 249 326
RECOVERIES:
Commercial, financial and
agriculture 32 1
Real estate-mortgage:
Residential 70 164
Commercial 191 150
Installment loans to individuals 111 102
-------- --------
Total recoveries 404 417
Net Recoveries (Charge-offs) 155 91
Additions charged (credited) to
operations - (118)
-------- --------
BALANCE AT END OF PERIOD $ 2,882 $ 2,727
======== ========
Ratio of net-recoveries (charge-offs)
during the period to average loans
outstanding during the period 0.17% 0.10%
Allowance for loan losses as a
percent of total loans outstanding 3.11% 3.06%
</TABLE>
24
<PAGE>
<TABLE>
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<CAPTION>
1998 1997 1996
-------- -------- -------
<S> <C> <C> <C>
Commercial, financial and agriculture $ 1,560 $ 1,503 $ 1,882
Real estate - mortgage:
Residential 379 464 461
Commercial 469 287 95
Installment loans to individuals 202 246 319
Off-balance-sheet risk 121 229 260
-------- -------- -------
Total $ 2,731 $ 2,729 $ 3,017
======== ======== =======
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Commercial, financial and agriculture $ 1,650 $ 1,507
Real estate - mortgage:
Residential 380 303
Commercial 210 197
Installment loans to individuals 389 546
Off-balance-sheet risk 253 174
-------- --------
Total $ 2,882 $ 2,727
======== ========
</TABLE>
Deposits
- --------
At December 31, 1998 and 1997, total deposits increased
$10,887,000 or 6.25% and $763,000 or .44%, respectively. The
increase in total deposits in 1998 is the result of increases in
noninterest-bearing demand of $2,114,000 or 9.38%, interest-bearing
demand of $4,001,000 or 15.95%, savings of $1,796,000 or
5.09%, and time deposits of $3,718,000 or 4.73%. 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
deposits. Noninterest-bearing demand deposits increased
$1,982,000 or 9.64% in 1997 and was attributed to decreases in
interest-bearing deposits with the balance of the increase from
new accounts. See the "Notes to the Consolidated Financial
Statements" of the 1998 Annual Report, (Exhibit 13.b, page 15),
incorporated herein by reference, for maturities on time deposits
of $100,000 or more.
The following table sets forth the average amounts and average
rates paid on each of the following deposit categories at
December 31, 1998, 1997, and 1996 (dollars in thousands).
<TABLE>
<CAPTION>
1998 1997
----------------- -----------------
Average Average Average Average
Balance Rate Balance Rate
--------- ------- --------- -------
<S> <C> <C> <C> <C>
Noninterest-bearing demand $ 22,718 - $ 21,284 -
Interest-bearing demand 28,594 1.05% 26,580 1.10%
Savings 36,465 2.70% 35,630 2.79%
Money market 12,434 2.53% 12,483 2.49%
Time 80,952 5.13% 80,010 5.18%
--------- ------- --------- -------
Total $181,163 3.18% $175,987 3.26%
========= ======= ========= =======
<CAPTION>
1996
-----------------
Average Average
Balance Rate
--------- -------
<S> <C> <C
Noninterest-bearing demand $ 19,705 -
Interest-bearing demand 25,378 1.49%
Savings 36,515 2.89%
Money market 12,365 2.55%
Time 79,074 5.19%
--------- -------
Total $173,037 3.38%
========= =======
</TABLE>
25
<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, at December 31, 1998, 1997, and 1996 (dollars in
thousands). Management feels that the liquidity position is
strong and adequate to cover any potential customer withdrawals
and credit needs.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash and due from banks $10,301 $ 6,382 $ 8,916
Interest-bearing deposits in
other banks - 511 -
Federal funds sold 2,700 8,900 6,500
Investment securities available
for sale 42,690 20,183 579
Investment securities held to
maturity maturing in one year
or less 10,317 25,646 18,512
-------- -------- --------
Total 66,008 61,622 34,507
Less short-term borrowings 1,941 3,348 2,013
-------- -------- --------
Net liquidity position $64,067 $58,274 $32,494
======== ======== ========
As a percent of total assets 29.99% 28.84% 16.44%
======== ======== ========
</TABLE>
Inflation and Changing Prices
- -----------------------------
Management is aware of the impact inflation has on interest rates
and therefore, the impact it can have on Philson's performance.
The ability of a financial institution to cope with inflation can
only be determined by analysis and monitoring of its asset and
liability structure. Philson monitors its asset and liability
position, with particular emphasis on the mix of interest
rate-sensitive assets and liabilities, in order to reduce the effect
of inflation upon its performance. However, it must be
remembered that the asset and liability structure of a financial
institution is substantially different from that of an industrial
corporation in that virtually all assets and liabilities are
monetary in nature, meaning that they have been or will be
converted into a fixed number of dollars regardless of changes in
prices. Examples of monetary items include cash, loans and
deposits. Non-monetary items are those assets and liabilities
which do not gain or lose purchasing power solely as a result of
general price level changes. Examples of non-monetary items are
premises and equipment.
Inflation can have a more direct impact on categories of
noninterest expenses such as salaries and wages, employee benefit
costs and supplies. These expenses normally fluctuate more in
line with changes in general price level and are very closely
monitored by Management for both the effects of inflation and
increases relating to such items as staffing levels, usage of
supplies and occupancy costs.
26
<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 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 timeframes. 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,
27
<PAGE>
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 vendor's 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.
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
12 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 mission critical systems.
A contingency plan has been developed for mission-critical and
required mainframe and PC based
28
<PAGE>
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.
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 1998, Philson increased its capital base $2,118,000 or
9.02%, primarily through retained earnings. For 1997, the
capital increased $2,272,000 or 10.72%.
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 risked-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.
Further information is contained in the 1998 Annual Report under
the sections captioned "Financial Highlights", (Exhibit 13.a,
listed on page 3), and "Notes to Consolidated Financial
Statements" , (Exhibit 13.b, pages 18 and 19), incorporated
herein by reference.
29
<PAGE>
ITEM 7A. 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 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 47.8% 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 table
shown in Management's Discussion and Analysis under the section
Interest Sensitivity, pages 17 and 18, sets forth, in summary
form, Philson's repricing analysis at December 31, 1998.
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
30
<PAGE>
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 expense of 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 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 10K, 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.
31
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Philson's Consolidated Financial Statements and notes thereto are
contained in the 1998 Annual Report, (Exhibit 13.b, pages 6 -
22), incorporated herein by reference.
Philson does not meet both of the tests under Item 302(a)(5) of
Regulation S-K, and therefore, is not required to provide
supplementary financial data.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
========
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A. Identification of Directors
---------------------------
The Corporation's Certificate of Incorporation provides that
there shall be three classes of directors as nearly equal in
number as possible, each class being elected for a three-year
term and only one class being elected each year beginning in
1985. The total number of directors shall be that number from
time to time determined by a resolution adopted by a majority
vote of the directors then in office or by resolution of the
stockholders at a meeting thereof. There shall be not less than
three directors. The number of directors for 1999 has been set
at 11.
In the following tables are set forth as to each of the
nominees for election as Class II directors and as to each of the
continuing Class I and Class III directors his age, principal
occupation and business experience, the period during which he
has served as a director of the Corporation, the Bank or an
affiliate and other business relationships. There are no family
relationships between any of the directors and executive officers
listed below except Mr. Berkley and Mr. Hay are first cousins,
and the Messrs. Croner are first cousins.
<TABLE>
Nominees For Election As Class II Directors
Terms Expire in 2002
<CAPTION>
Directorship
Name and Principal Director in other
Occupation <F1> Age Since <F2><F3> Reporting Companies
- ------------------ --- -------------- ---------------------
<S> <C> <C> <C>
Tommy R. Croner 56 1990 Pro Fac Cooperative
President,
T. Rich, Inc.
(family farm
corporation)
32
<PAGE>
<CAPTION>
Directorship
Name and Principal Director in other
Occupation <F1> Age Since <F2><F3> Reporting Companies
- ------------------ --- -------------- ---------------------
<S> <C> <C> <C>
George W. Hay 57 1986 None
President and Chief
Executive Officer of
the Corporation and
Bank
George R. Shafer 65 1994 None
Pharmacist - President
Somerset Drug Co., Inc.
<CAPTION>
Class III Directors
Terms Expire in 2000
Directorship
Name and Principal Director in other
Occupation <F1> Age Since <F2><F3> Reporting Companies
- ------------------ --- -------------- ---------------------
<S> <C> <C> <C>
Lewis W. Berkley 67 1971 None
Retired, Former
Owner,Crystal
Springs Farm
and Berkline
Holsteins
James E. Croner 55 1984 None
President, Croner,
Inc. (Coal Operator)
Gary W. Sterner 63 1965 None
Retired Investor
Earl K. Wahl, Jr. 58 1985 None
Private Investor
33
<PAGE>
<CAPTION>
Class I Directors
Terms Expire in 2001
Directorship
Name and Principal Director in other
Occupation <F1> Age Since <F2><F3> Reporting Companies
- ------------------ --- -------------- ---------------------
<S> <C> <C> <C>
Richard P. Bulow 61 1994 None
Registered Securities
Representative
Gregory A. Croner 47 1985 None
Secretary, Treasurer
Croner, Inc.
(Coal Operator)
Theodore Deskevich 53 1994 None
Treasurer of the
Corporation and
Executive Vice
President and Chief
Financial Officer of
the Bank
H. Dean White 71 1993 None
Retired, Former
School Administrator
<FN>
<F1> All directors and nominees, other than Richard P. Bulow,
have held the positions indicated or another senior
executive position with the same entity or one of its
affiliates or predecessors for the past five years.
Until October, 1994, Richard P. Bulow was a private
investor.
<F2> Reflects the earlier of the first year as a director of
the Corporation, the Bank or Philson National Bank or
N.B.W.P., Inc. or National Bank of Western Pennsylvania,
predecessors to the Corporation and the Bank, respectively.
<F3> All incumbent directors were elected by the stockholders.
</FN>
</TABLE>
34
<PAGE>
B. Executive Officers
------------------
The following persons are considered to be Executive
Officers of the Corporation by virtue of their position with
the Corporation or the Bank.
<TABLE>
<CAPTION>
Name Age Position Business Experience<F1>
---- --- -------- -------------------
<S> <C> <C> <C>
George W. Hay 57 President and Chief
Executive Officer
of the Corporation
and the Bank
Theodore Deskevich 53 Treasurer of the
Corporation and
Executive Vice
President and
Chief Financial
Officer of the Bank
Cathy E. Webreck 49 Secretary of the
Corporation and
Secretary of the
Bank
David A. Finui 44 Senior Vice
President
of the Bank
James D. Zimmerman 40 Senior Vice
President
of the Bank
<FN>
<F1> Each of the above persons, has held an executive position
with the Corporation or Bank for the past five years.
</FN>
</TABLE>
Compliance with Section 16(a) of the Securities Exchange Act of
1934
- -----------------------------------------------------------------
Section 16(a) of the Exchange Act requires Philson's officers,
directors and persons owning more than 10% of Philson's Common
Stock to file reports of ownership and changes in ownership with
the Securities and Exchange Commission ("SEC"). Officers,
directors and such shareholders are required by regulation to
furnish Philson with copies of all Section 16(a) forms they file.
Except as stated below in Item 12. Security Ownership of Certain
Beneficial Owners and Management, Philson knows of no person who
owned 10% or more of its Common Stock.
Based upon review of copies of the forms furnished to Philson,
Philson believes that during 1998 all Section 16(a) filing
requirements were complied with in a timely manner, except that
Gregory Croner was late in filing a Form 4. A later transaction,
for which a Form 4 was not filed, is included in his Form 5.
35
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
- ----------------------
The following table sets forth the cash compensation
paid or to be paid by the Bank for services rendered during
1998 to Mr. Hay, the Chief Executive Officer. No other
officer's compensation exceeded $100,000. The Corporation
pays no salaries or benefits.
<TABLE>
SUMMARY COMPENSATION TABLE
Annual Compensation <F1><F2>
-------------------
<CAPTION>
Name and
Principal All Other Annual
Position Year Salary Bonus Compensation <F3><F4>
- -------- ---- ------ ----- ------------
<S> <C> <C> <C> <C>
George W. Hay 1998 $170,000 $25,000 $26,994
Chief Executive 1997 $160,000 $25,000 $19,222
Officer <F5><F6> 1996 $155,000 0 $19,222
<FN>
<F1> Information with respect to group life, health,
hospitalization and medical reimbursement plans is not
included as they do not discriminate in favor of officers
or directors and are available generally to all salaried
employees.
<F2> Does not include amounts attributable to miscellaneous
benefits. In the opinion of management of the Corporation,
the cost of providing such benefits during 1998 did not
exceed the lesser of $50,000 or 10% of Mr. Hay's total
salary and bonus.
<F3> This represents the Bank's contributions to the Bank's
Cash-Op Plan on behalf of Mr. Hay and the premiums paid
in each year for a policy providing additional retirement
benefits. See "Compensation According To Plans - Salary
Continuation Agreement".
<F4> The Corporation has no restricted stock, stock option or
other long-term incentive plans.
<F5> Mr. Hay entered into an Employment Agreement with the
Bank which provides for his salary and bonus, the use of
an automobile and all other benefits offered to all
salaried employees. In the event of a sale or merger
of the Bank, Mr. Hay's compensation will continue for at
least five years after the effective date at compensation
and benefits not less than those being received at the
time of the sale or merger. Mr. Hay may terminate his
employment at any time after the sale or merger, but his
compensation will continue for the period of the Agreement.
<F6> The Bank maintains an Employee Stock Ownership Plan which
is available to all salaried employee. As of March 16, 1999,
1,216 shares of Common stock were allocated to Mr. Hay's
account.
</FN>
</TABLE>
36
<PAGE>
Compensation Committee Report
- -----------------------------
on Executive Compensation
- -------------------------
The Human Resource Committee, acting as a compensation
committee, has the responsibility to recommend to the Bank's
Board of Directors the compensation of the Chief Executive
Officer and other persons who are deemed to be executive
officers of the Bank. The Committee also evaluates performance
of management and considers management successor planning and
related matters. The Committee reviews with the Bank's Board
of Directors all aspects of the compensation of the highest
paid officers.
A salary plan is reviewed for consistency with industry
peer group surveys. The peer group consists of banks within
the area of similar asset size and additional banks elsewhere
within the same asset range. Judgments are made with respect
to the value contributed to the Corporation and the Bank by
the various officer positions, including the Chief Executive
Officer. Individual salary levels are based upon relative
importance of the job and performance of the officers in the
position.
As a result of these reviews, salary increases are
determined by the Board of Directors. Management of the Bank
determines salaries and increases for all other officers and
employees based upon performance.
Submitted by Messrs. Bulow, J. Croner, G. Croner, T. Croner, Hay,
Shafer, Sterner and White.
Compensation According to Plans
- -------------------------------
Retirement Plan
All eligible employees of the Bank are covered by an
Employee Retirement Plan. The retirement plan is a non-
contributory, defined benefit pension plan which provides a
normal retirement benefit based on each participant's years
of service with the Bank and the participant's average monthly
compensation, which is defined as the compensation received
during any 60 consecutive months during the last 120 months
prior to retirement, divided by 60, which produces the highest
average.
Benefits are equal to one percent of average monthly
compensation multiplied by the full years of credited service
to normal retirement date. Benefits under the retirement plan
are not subject to any deduction for Social Security or other
offset amounts. Directors are not entitled to benefits under
the retirement plan unless they are also active employees of
the Bank. The following table sets forth the estimated annual
benefits payable to an employee retiring in 1998 under the
retirement plan, reflecting applicable limitations under
Federal tax laws:
37
<PAGE>
<TABLE>
<CAPTION>
Years of service at retirement
Average Annual ------------------------------
Compensation 10 20 30 40
- -------------- -- -- -- --
<S> <C> <C> <C> <C>
$ 60,000 $ 7,877 $15,753 $23,630 $30,568
$ 80,000 $11,177 $22,253 $33,530 $43,118
$105,000 $15,302 $30,603 $45,905 $58,806
$130,000 $19,427 $38,853 $58,280 $74,493
$155,000 $23,387 $46,773 $70,160 $89,553
$180,000 $23,387 $46,773 $70,160 $89,553
</TABLE>
As of December 31, 1998, Mr. Hay had been credited with 12
years of service for purposes of the retirement plan.
The approximate accrued benefit at age 65 (or retirement
if later) based on years of credited service is $26,353 for
Mr. Hay. Covered compensation is based on salary shown in the
Summary Compensation Table.
Salary Continuation Agreement
The Bank has entered into a Salary Continuation Agreement
("Agreement") which provides for additional payments to Mr.
Hay. Pursuant to the Agreement, Mr. Hay, upon retirement at
age 65, will receive $4,500 a month from the Bank for the
remainder of his lifetime. This sum shall be reduced by $300
per month for each year or fraction thereof retirement precedes
January 1, 2007 unless termination of employment is by reason
of death or disability. On disability, Mr. Hay will receive
full payment as normal retirement. If death, payment shall be
to his beneficiary in the amount of $3,500 for 180 months. If
Mr. Hay should die after retirement, payments he was receiving
will be paid to his beneficiary until an aggregate of 120
payments are made. If Mr. Hay is discharged without cause,
payments will be made as if he had taken early retirement.
In the event of discharge for cause, no benefits will be paid.
The Bank has acquired an insurance policy to provide for
performance of its liabilities and pays the premiums for such
policy. Neither Mr. Hay nor his beneficiary have any right in
or claim against the policy.
Compensation of Directors
- -------------------------
G. Croner, Chairman of the Board, receives $750 for
each Board meeting attended. All other directors are paid $600
for each Board meeting they attend, and all directors, except
Messrs. Hay and Deskevich, are paid $125 for each committee
meeting they attend. Messrs. Hay and Deskevich, as officers, are
not compensated for attending committee meetings. A total of
$108,375 was paid as director's fees in 1998.
38
<PAGE>
STOCKHOLDERS RETURN PERFORMANCE
Set forth below is a graph comparing the yearly percentage
change in the cumulative total stockholder return on the
Corporation's Common Stock against the cumulative total return
of S & P Total Return 500 Stock Index and Peer Group Index for
the five years beginning January 1, 1994 and ending December 31,
1998.
[Performance graph ommitted.]
[Following is a description of the Performance Graph in tabular
format.]
December 31
1993 1994 1995 1996 1997 1998<F1>
Corporation 100 119.74 135.68 154.88 327.27 513.57
S & P 500 100 99.26 139.31 171.21 228.26 293.36
Peer Group 100 114.38 135.65 165.21 232.38 256.31
[FN]
<F1> Data obtained from Hopper Soliday & Co.
</FN>
39
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
There is set forth below information with respect to the
beneficial ownership, as of March 16, 1999, of certain persons,
including directors and nominees for director, of shares of the
Common Stock.
<TABLE>
<CAPTION>
Name of Beneficial Amount and Nature Percent of Class
- ------------------ ----------------- ----------------
Owner of Ownership <F1><F2>
- ----- ---------------------
<S> <C> <C>
Lewis W. Berkley 13,876 <F*>
Berlin, Pennsylvania
Richard P. Bulow 4,200 <F*>
Somerset, Pennsylvania
Gregory A. Croner <F3> 186,019 10.68%
Berlin, Pennsylvania
James E. Croner <F4> 129,832 7.45%
Berlin, Pennsylvania
Tommy R. Croner 11,648 <F*>
Berlin, Pennsylvania
Theodore Deskevich <F5> 4,189 <F*>
Somerset, Pennsylvania
George W. Hay <F5> 36,896 2.12%
Rockwood, Pennsylvania
George R. Shafer 5,680 <F*>
Somerset, Pennsylvania
Gary W. Sterner 56,000 3.21%
Biglerville, Pennsylvania
Earl K. Wahl, Jr. 18,992 1.09%
Somerset, Pennsylvania
H. Dean White 5,450 <F*>
Indian Head, Pennsylvania
Officers, Directors and 480,796 27.59%
Nominees for Directors
as a Group <F5><F6>
- ----------
<FN>
<F*>Less than l%
<Fl> The securities "beneficially owned" by an individual are
determined in accordance with the definition of "beneficial
ownership" set forth in the General rules and Regulations
of the Securities and Exchange Commission ("SEC") and may
include securities owned by or for the individual's spouse
and minor children and any other relative who has the same
home, as well as securities to which the individual has or
shares voting or investment power or has the right to
acquire beneficial ownership within sixty (60) days after
the Record Date. Beneficial ownership may be disclaimed as
to certain of the securities.
<F2> Information furnished by the Directors and Officers and the
Corporation.
<F3> Includes indirect ownership of 134,308 shares of Common
Stock through corporate ownership interests and family
trusts.
<F4> Includes indirect ownership of 82,480 shares of Common
Stock through corporate ownership.
40
<PAGE>
<F5> Includes 1,216 shares of Common Stock held in the Employee
Stock Ownership Plan of First Philson Bank, N.A. (the
"Bank") credited to Mr. Hay, 189 shares credited to Mr.
Deskevich and 8,141 shares credited to participating
officers as a group.
<F6> The group consists of fourteen persons as of March 16, 1999,
being one officer of the Corporation and two senior
officers of the Bank, directors and nominees for director.
</FN>
</TABLE>
Principal Holders of Stock
Except as set forth in the following table, no person is
known to the Corporation's management to own of record or
beneficially as of March 16, 1999, 5% or more of the outstanding
Common Stock:
<TABLE>
<CAPTION>
Common Stock
-----------------------
Amount Percent
Name and Address ------- -------
Beneficial Owner
- ----------------
<S> <C> <C>
First Philson Bank, N.A. 159,743 9.17%
Employee Stock Ownership Plan
Berlin, Pennsylvania 15530
Gregory A. Croner <F1> 186,019 10.68%
Berlin, Pennsylvania 15530
James E. Croner <F2> 129,832 7.45%
Berlin, Pennsylvania 15530
<FN>
<F1> Includes indirect ownership of 134,308 shares of Common
Stock through corporate ownership interests and family
trusts.
<F2> Includes indirect ownership of 82,480 shares of Common
Stock through corporate interests and/or corporate
retirement accounts.
</FN>
</TABLE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There have been no material transactions, proposed or
consummated, between Philson, the Bank, and Flex with any
director or executive officer, or any associate of the foregoing
persons. Philson, the Bank, and Flex have had and intend to
continue to have banking and financial transactions in the
ordinary course of business with directors and officers and their
associates on comparable terms and with similar interest rates as
those prevailing from time to time for other customers. The
required information is contained in the "Notes to Consolidated
Financial Statements" of the 1998 Annual Report, (Exhibit 13.b,
page 14), incorporated herein by reference.
41
<PAGE>
PART IV
=======
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(A)1. The Annual Report to Shareholders of the Registrant for
the fiscal year ended December 31, 1998.
(A)2. All schedules are omitted because they are not
applicable or the required information is shown in the
financial statements or notes thereto.
(A)3. Exhibits.
Exhibit Number Referred to
Item 601 of Regulation S-K Description of Exhibit
- -------------------------- -----------------------------------
2 None.
3(i)(a) Articles of Incorporation filed on
October 2, 1990, at Exhibit 3(i)
to Form S-4 (No. 33-35933), and
hereby incorporated by reference.
3(i)(b) Amendment to Articles of
Incorporation effective October 21,
1997, filed via Edgar on Form 8A
(File No. 001-13599) on
November 12, 1997, and hereby
incorporated by reference.
3(ii) By-laws of the Registrant filed on
October 2, 1990, at Exhibit 3(ii)
to Form S-4 (No. 33-35933), and
hereby incorporated by reference.
4 None.
9 None.
10 None.
11 Included herein at Exhibit 13b,
at pages 7 and 11 of Philson's
Annual Report to Shareholders.
12 None.
13 Excerpts from the Annual Report to
Shareholders for Fiscal Year Ended
December 31, 1998.
13.a "Financial Highlights", listed on
page 3 of the 1998 Annual Report to
Shareholders.
42
<PAGE>
Exhibit Number Referred to
Item 601 of Regulation S-K Description of Exhibit
- -------------------------- -----------------------------------
13.b "Consolidated Financial Statements
and Notes thereto", pages 6 - 22
of the 1998 Annual Report to
Shareholders.
16 None.
18 None.
19 None.
21 List of Subsidiaries
Name State of Incorporation
------------ ----------------------
First Philson
Bank, N.A. Pennsylvania
Flex Financial
Consumer Discount
Company Pennsylvania
23 Report of Independent Auditors.
24 None.
27 Financial Data Schedule.
REPORTS ON FORM 8-K. Form 8-K filed on March 12, 1999,
filed via Edgar (File No. 001-
13599), and hereby incorporated
by reference.
43
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the
Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST PHILSON FINANCIAL CORPORATION
- -----------------------------------
(Registrant)
By: /s/ George W. Hay By: /s/ Theodore Deskevich
-------------------------- --------------------------
George W. Hay, Theodore Deskevich,
President and Chief Executive Vice President
Executive Officer and C.F.O.
Date: March 16, 1999 Date: March 16, 1999
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the
dates indicated.
By: /s/ Gregory A. Croner By: /s/ Lewis W. Berkley
-------------------------- --------------------------
Gregory A. Croner, Lewis W. Berkley,
Chairman of the Board Vice Chairman of the Board
Date: March 16, 1999 Date: March 16, 1999
By: /s/ Richard P. Bulow By: /s/
-------------------------- --------------------------
Richard P. Bulow, Director Tommy R. Croner, Director
Date: March 16, 1999 Date: March 16, 1999
By: /s/ Theodore Deskevich By: /s/ George W. Hay
-------------------------- --------------------------
Theodore Deskevich, Director George W. Hay, Director
Date: March 16, 1999 Date: March 16, 1999
44
<PAGE>
By: /s/ Gary W. Sterner By: /s/ Earl K. Wahl
-------------------------- --------------------------
Gary W. Sterner, Director Earl K. Wahl, Director
Date: March 16, 1999 Date: March 16, 1999
By: /s/ H. Dean White By: /s/
-------------------------- --------------------------
H. Dean White, Director George R. Shafer, Director
Date: March 16, 1999 Date: March 16, 1999
By: /s/ James E. Croner
--------------------------
James E. Croner, Director
Date: March 16, 1999
45
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
(Dollars in thousands)
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
- --------------------
BALANCE SHEET DATA
Total assets $213,607 $202,025 $197,665 $198,918 $191,945
Total loans 107,555 105,293 100,654 92,632 89,242
Total deposits 185,130 174,243 173,480 170,858 166,700
Stockholders'equity 25,589 23,471 21,199 19,334 17,783
- --------------------
EARNINGS DATA
Net interest income 9,131 8,702 8,070 7,429 7,173
Other income 1,025 1,017 942 887 1,012
Other expense 6,292 5,940 5,779 5,789 6,170
Net income 2,781 2,731 2,390 1,943 1,800
- --------------------
PER SHARE DATA
Net income 1.60 1.57 1.37 1.12 1.03
Book value 14.69 13.47 12.17 11.10 10.21
Cash dividends
paid 0.49 0.38 0.31 0.22 0.05
Dividend payout
ratio 31.03 24.41 22.78 20.17 4.84
- --------------------
RATIOS
Return on average
assets 1.33% 1.35% 1.20% 0.99% 0.93%
Return on average
equity 11.24% 12.17% 11.76% 10.44% 10.57%
Average equity to
average assets 11.80% 11.12% 10.25% 9.49% 8.80%
Net loans to
deposits 56.62% 58.86% 56.28% 52.53% 51.90%
- --------------------
Per share information has been adjusted to reflect a
four-for-one stock split for all years prior to 1997.
</TABLE>
3
<PAGE>
<TABLE>
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
<CAPTION>
December 31,
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Cash and due from banks $ 10,301 $ 6,382
Interest-bearing deposits
in other banks - 511
Federal funds sold 2,700 8,900
Investment securities
available for sale 42,690 20,183
Investment securities
held to maturity (market
values of $47,006 and $57,767) 46,554 57,448
Total loans 107,555 105,293
Less allowance for loan losses 2,731 2,729
---------- ----------
Net loans 104,824 102,564
Premises and equipment, net 3,512 3,008
Accrued interest receivable 1,886 1,849
Other assets 1,140 1,180
---------- ----------
TOTAL ASSETS $ 213,607 $ 202,025
========== ==========
LIABILITIES
Deposits:
Noninterest-bearing demand $ 24,663 $ 22,549
Interest-bearing demand 29,087 25,086
Savings 37,070 35,274
Money market 11,991 12,733
Time 82,319 78,601
---------- ----------
Total deposits 185,130 174,243
Securities sold under
agreements to repurchase 1,807 1,674
U. S. Treasury demand notes 134 1,674
Accrued interest payable 553 546
Other liabilities 394 417
---------- ----------
TOTAL LIABILITIES 188,018 178,554
---------- ----------
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 9,163 7,245
Unrealized gain on securities 426 226
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 25,589 23,471
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 213,607 $ 202,025
========== ==========
See accompanying notes to the consolidated financial
statements.
</TABLE>
6
<PAGE>
<TABLE>
CONSOLIDATED STATEMENT OF INCOME
(Dollars in thousands, except per share amounts)
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 9,552 $ 9,301 $ 8,667
Interest-bearing
deposits in other banks 21 16 -
Federal funds sold 706 597 390
Investment securities:
Taxable interest 4,083 3,993 4,340
Tax-exempt interest 633 634 662
-------- -------- --------
Total interest income 14,995 14,541 14,059
-------- -------- --------
INTEREST EXPENSE
Deposits 5,753 5,741 5,853
Securities sold under
agreements to repurchase 76 62 108
U. S. Treasury demand notes 35 36 28
-------- -------- --------
Total interest expense 5,864 5,839 5,989
-------- -------- --------
NET INTEREST INCOME 9,131 8,702 8,070
Provision for loan losses 44 20 -
-------- -------- --------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 9,087 8,682 8,070
-------- -------- --------
OTHER INCOME
Service charges on
deposit accounts 595 621 555
Other income 430 396 387
-------- -------- --------
Total other income 1,025 1,017 942
-------- -------- --------
OTHER EXPENSE
Salaries and employee
benefits 3,391 3,184 3,007
Occupancy expense, net 332 344 462
Equipment expense 585 487 502
Other expense 1,984 1,925 1,808
-------- -------- --------
Total other expense 6,292 5,940 5,779
-------- -------- --------
Income before income taxes 3,820 3,759 3,233
Income tax expense 1,039 1,028 843
-------- -------- --------
NET INCOME $ 2,781 $ 2,731 $ 2,390
======== ======== ========
EARNINGS PER SHARE $ 1.60 $ 1.57 $ 1.37
WEIGHTED AVERAGE SHARES
OUTSTANDING 1,742,400 1,742,400 1,742,400
See accompanying notes to the consolidated financial
statements.
</TABLE>
7
<PAGE>
<TABLE>
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
<CAPTION>
Unrealized
Common Capital Retained Gain on
Stock Surplus Earnings Securities Total
------ ------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
BALANCE,
DECEMBER 31,1995 $4,356 $2,354 $12,624 $ - $19,334
Net income 2,390 2,390
Other Comprehen-
sive Income:
Unrealized gain
on available
for sale
securities, net
of reclassifi-
cation adjustment 19 19
Comprehensive
Income
Cash dividends
($.31 per share) (544) (544)
------ ------- -------- ---------- --------
BALANCE,
DECEMBER 31,1996 4,356 2,354 14,470 19 21,199
Net income 2,731 2,731
Other comprehen-
sive income:
Unrealized gain
on available
for sale
securities, net
of reclassifi-
cation adjustment 207 207
Comprehensive
Income
Transfer 9,290 (9,290) -
Cash dividends
($.38 per share) (666) (666)
------ ------- -------- ---------- --------
BALANCE,
DECEMBER 31,1997 4,356 11,644 7,245 226 23,471
Net income 2,781 2,781
Other Comprehen-
sive Income:
Unrealized gain
on available
for sale
securities, net
of reclassifi-
cation adjustment 200 200
Comprehensive
Income
Cash dividends
($.49 per share) (863) (863)
------ ------- -------- ---------- --------
BALANCE,
DECEMBER 31,1998 $4,356 $11,644 $ 9,163 $ 426 $25,589
====== ======= ======== ========== ========
<CAPTION>
Comprehensive
Income
-------------
<S> <C>
BALANCE,
DECEMBER 31,1995
Net Income $ 2,390
Other Comprehen-
sive Income:
Unrealized gain
on available
for sale
securities, net
of reclassifi-
cation adjustment 19
-------------
Comprehensive
Income $ 2,409
=============
BALANCE,
DECEMBER 31,1996
Net Income $ 2,731
Other Comprehen-
sive Income:
Unrealized gain
on available
for sale
securities, net
of reclassifi-
cation adjustment 207
-------------
Comprehensive
Income $ 2,938
=============
BALANCE,
DECEMBER 31,1997
Net Income $ 2,781
Other Comprehen-
sive Income:
Unrealized gain
on available
for sale
securities, net
of reclassifi-
cation adjustment 200
-------------
Comprehensive
Income $ 2,981
=============
See accompanying notes to the consolidated financial
statements.
</TABLE>
8
<PAGE>
<TABLE>
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 2,781 $ 2,731 $ 2,390
Adjustments to reconcile
net income to net cash
provided by operating
activities:
Provision for loan
losses 44 20 -
Depreciation,
amortization
and accretion, net 346 224 315
Decrease (increase) in
accrued interest
receivable (37) (142) 214
Increase (decrease) in
accrued interest
payable 7 (6) (38)
Deferred income tax 20 60 5
Other, net (111) (119) (113)
-------- -------- --------
Net cash provided by
operating activities 3,050 2,768 2,773
-------- -------- --------
INVESTING ACTIVITIES
Net decrease (increase)
in interest-bearing
deposits in other banks 511 (511) -
Proceeds from maturities
and repayments of
investment securities:
Held to maturity 30,703 25,304 27,839
Available for sale 476 - -
Purchase of investment
securities:
Held to maturity (19,769) (3,985) (18,401)
Available for sale (22,669) (19,278) (551)
Net increase in loans (2,309) (4,950) (7,897)
Purchase of premises and
equipment (891) (914) (242)
Proceeds from sales of
other real estate owned - - 62
-------- -------- --------
Net cash provided
by (used for)
investing activities (13,948) (4,334) 810
-------- -------- --------
FINANCING ACTIVITIES
Net increase in deposits 10,887 763 2,622
Increase (decrease) in
securities sold under
agreements to repurchase 133 506 (6,194)
Increase (decrease) in U. S.
Treasury demand notes (1,540) 829 562
Cash dividends paid (863) (666) (544)
-------- -------- --------
Net cash provided by
(used for) financing
activities 8,617 1,432 (3,554)
-------- -------- --------
Increase (decrease)
in cash and cash
equivalents (2,281) (134) 29
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 15,282 15,416 15,387
-------- -------- --------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $13,001 $15,282 $15,416
======== ======== ========
See accompanying notes to the consolidated financial
statements.
</TABLE>
9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
- -------------------------------------------------------------
A summary of the significant accounting and reporting
policies applied in the presentation of the accompanying
financial statements follows:
Nature of Operations and Basis of Presentation
----------------------------------------------
First Philson Financial Corporation ("Philson") is a
Delaware corporation and is registered under the Bank
Holding Company Act. Philson was organized to be the
holding company of First Philson Bank, N.A. (the "Bank").
Flex Financial Consumer Discount Company ("Flex") was
incorporated, under the laws of Pennsylvania, in May 1997,
and began operations in September 1997. Flex is a
wholly-owned subsidiary of Philson and provides consumer
loans within the surrounding market area. Philson and its
subsidiaries derive substantially all their income from
banking and bank-related services which include interest
earnings on commercial mortgage, residential real estate,
consumer, and commercial loan financing, as well as interest
earnings on investment securities and deposit services to
its customers. The Bank is a federally chartered national
association which provides banking services to communities
in south-central and southwestern Pennsylvania. Philson is
supervised by the Federal Reserve Board; the Bank is subject
to regulation and supervision by the Office of the
Comptroller of the Currency; and Flex is subject to
regulation and supervision by the Pennsylvania Department
of Banking.
The consolidated financial statements include the accounts
of Philson and its subsidiaries, the Bank and Flex.
All intercompany items have been eliminated in
consolidation. The consolidated financial statements have
been prepared in conformity with generally accepted accounting
principles. In preparing the financial statements,
management is required to make certain estimates and
assumptions that affect the reported amounts of assets and
liabilities as of the balance sheet date and revenues and
expenses for the period. Actual results could differ
significantly from those estimates.
Investment Securities
---------------------
Investment securities are classified, at the time of
purchase, based upon management's intentions, as
securities held to maturity or securities available for
sale. Debt securities acquired with the intent and ability
to hold to maturity are stated at cost adjusted for
amortization of premium and accretion of discount which
are computed using a method which approximates a level
yield and recognized as adjustments of interest income.
Certain debt and equity securities have been classified as
available for sale to serve principally as a source of
liquidity. Unrealized holding gains and losses for
available for sale securities are reported as a separate
component of stockholders' equity, net of deferred tax,
until realized. Realized securities gains and losses,
if any, are computed using the specific identification
method. Interest and dividends on investment securities
are recognized as income when earned.
Loans
-----
Interest on loans is recognized as interest income
on the accrual method. For loans on which interest is 90
days past due, accrual of income is discontinued, and any
previously accrued interest is reversed against current
income. Income is subsequently recognized only to the
extent that cash payments are received until the loan is
current and, in management's judgement, the borrower has
the ability and intent to make periodic interest and
principal payments at which time the loan is returned to
accrual status.
Loan origination and commitment fees and certain direct
loan origination costs are being deferred and the net
amount amortized as an adjustment to the related loan's
yield. These amounts are being amortized over the
contractual life of the related loans.
Allowance for Loan Losses
-------------------------
The allowance for loan losses represents the amount which
management estimates is adequate to provide for potential
losses in its loan portfolio. The allowance method is
used in providing for loan losses. Accordingly, all loan
losses are charged to the allowance and all recoveries are
credited to it. The allowance for loan losses is
established through a provision for loan losses charged
to operations. The provision for loan losses is based on
management's periodic evaluation of individual loans,
economic factors, past loan loss experience, changes in the
composition and volume of the portfolio, and other relevant
factors. The estimates used in determining the adequacy of
the allowance for loan losses, including the amounts and
timing of future cash flows expected on impaired loans,
are particularly susceptible to changes in the near term.
Impaired loans are commercial and commercial real estate
loans for which it is probable that Philson will not be
able to collect all amounts due according to the
contractual terms of the loan agreement. Philson
individually evaluates such loans for impairment and does
not aggregate loans by major risk classifications. The
definition of "impaired loans" is not the same as the
definition of "nonaccrual loans," although the two
categories overlap. Management may choose to place a
loan on nonaccrual status due to payment delinquency or
uncertain collectibility, while not classifying the loan
as impaired if the loan is not a commercial or commercial
real estate loan. Factors considered by management in
determining impairment include payment status and
collateral value. The amount of impairment for
10
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(Continued)
- ------------------------------------------------------------
these types of impaired loans is determined by the
difference between the present value of the expected cash
flows related to the loan, using the original interest
rate, and its recorded value, or as a practical expedient
in the case of collateralized loans, the difference
between the fair value of the collateral and the recorded
amount of the loans. When foreclosure is probable,
impairment is measured based on the fair value of the
collateral.
Mortgage loans on one-to-four family properties and all
consumer loans are large groups of smaller balance
homogeneous loans and are measured for impairment
collectively. Loans that experience insignificant payment
delays, which are defined as 90 days or less, generally
are not classified as impaired. Management determines the
significance of payment delays on a case-by-case basis,
taking into consideration all circumstances surrounding the
loan and the borrower, including the length of the delay,
the borrower's prior payment record, and the amount of
shortfall in relation to the principal and interest owed.
Premises and Equipment
----------------------
Premises and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation is computed on
the straight-line method over the estimated useful lives of
the assets. Expenditures for maintenance and repairs are
charged against income as incurred. Costs of major
additions and improvements are capitalized.
Employee Benefit Plans
----------------------
Employee benefits include contributions, determined
actuarially, to a retirement plan covering the eligible
employees of Philson. Contributions to the employee
savings plans are made at the discretion of the Board of
Directors.
Income Taxes
------------
Deferred tax assets and liabilities are reflected at
currently enacted income tax rates applicable to the period
in which the deferred tax assets and liabilities are
expected to be realized or settled. As changes in tax laws
or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
Deferred income tax expenses or benefits are based on the
changes in the deferred tax asset or liability from period
to period.
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 for all periods presented. Philson has elected
to report the effects of Statement No. 130 as part of the
Statement of Changes in Stockholders' Equity.
Earnings Per Share
------------------
Philson currently maintains a simple capital structure;
therefore, there are no dilutive effects on earnings per
share. As such, earnings per share are calculated by
dividing net income by the weighted number of shares of
stock outstanding during the year.
Cash Flow Information
---------------------
Philson has defined cash and cash equivalents as those
amounts included in the balance sheet captions Cash and
due from banks and Federal funds sold. Cash payments for
interest in 1998, 1997, and 1996 were $5,857,000,
$5,845,000, and $6,027,000, respectively. Cash payments
for income taxes in 1998, 1997, and 1996 were $1,030,000,
$982,000, and $815,000, respectively.
Pending Accounting Pronouncements
---------------------------------
In June 1998, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging
Activities." The Statement provides accounting and
reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts,
by requiring the recognition of those items as assets or
liabilities in the statement of financial position, recorded
at fair value. Statement No. 133 precludes a held-to-maturity
security from being designated as a hedged item; however, at
the date of initial application of this statement, an entity
is permitted to transfer any held-to-maturity security into
the available-for-sale or trading categories. The unrealized
holding gain or loss on such transferred securities shall
be reported consistant with the requirements of Statement
No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Such transfers do not raise an issue
regarding an entity's intent to hold other debt securities
to maturity in the future. This Statement applies
prospectively for all fiscal quarters of all years
beginning after June 15, 1999. Earlier adoption is
permitted for any fiscal quarter that begins after the
issue date of this Statement.
In March 1998, the Accounting Standards Executive
Committee issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." This SOP, which is
effective for fiscal years beginning after December 15, 1998,
provides guidance on accounting for the costs of computer
software developed or obtained for internal use and
provides guidance for determining whether computer software
is for internal use. Philson will adopt SOP 98-1 in the
first quarter of 1999 and does not believe the effect
of adoption will be material.
Reclassification of Comparative Amounts
---------------------------------------
Certain comparative amounts for prior years have been
reclassified to conform to current year presentations.
Such reclassifications did not effect net income.
11
<PAGE>
2. COMMON STOCK SPLIT
- ------------------------------------------------------------
On August 19, 1997, the Board of Directors approved a
four-for-one stock split. In conjunction therewith, on
October 21, 1997, the stockholders approved an increase in
the number of authorized shares from 500,000 to 10,000,000
and changed the par value from $10.00 to $2.50. All
references to the number of common shares and per share
amounts for 1996 have been restated to reflect the stock
split.
3. INVESTMENT SECURITIES
- -------------------------------------------------------------
The amortized cost and estimated market values of
investment securities available for sale and held to
maturity are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
AVAILABLE
FOR SALE
U. S.
Treasury
securities $ 998 $ 12 $ - $ 1,010
U. S.
Government
agency
securities 8,557 125 (12) 8,670
Obligations
of states
and
political
subdivisions 3,696 54 (2) 3,748
Corporate
notes 27,274 352 (35) 27,591
--------- ---------- ---------- ---------
Total debt
securities 40,525 543 (49) 41,019
Equity
securities 1,519 176 (24) 1,671
--------- ---------- ---------- ---------
Total debt
and
equity
securities $ 42,044 $ 719 $ (73) $ 42,690
========= ========== ========== =========
<CAPTION>
1997
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
AVAILABLE
FOR SALE
U. S.
Treasury
securities $ 995 $ 7 $ - $ 1,002
U. S.
Government
agency
securities 5,052 30 (1) 5,081
Obligations
of states
and
political
subdivisions 1,284 6 - 1,290
Corporate
notes 11,580 74 (5) 11,649
--------- ---------- ---------- ---------
Total debt
securities 18,911 117 (6) 19,022
Equity
securities 929 232 - 1,161
--------- ---------- ---------- ---------
Total debt
and
equity
securities $ 19,840 $ 349 $ (6) $ 20,183
========= ========== ========== =========
</TABLE>
12
<PAGE>
3. INVESTMENT SECURITIES (Continued)
- -------------------------------------------------------------
<TABLE>
<CAPTION>
1998
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
HELD TO
MATURITY
U. S.
Treasury
securities $ 5,996 $ 76 $ - $ 6,072
U. S.
Government
agency
securities 21,212 136 (23) 21,325
Obligations of
states and
political
subdivisions 9,100 223 - 9,323
Corporate
notes 4,205 60 - 4,265
Mortgage-
backed
securities 6,041 27 (47) 6,021
--------- ---------- ---------- ---------
Total debt
securities $ 46,554 $ 522 $ (70) $ 47,006
========= ========== ========== =========
<CAPTION>
1997
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
HELD TO
MATURITY
U. S.
Treasury
securities $ 6,988 $ 15 $ (9) $ 6,994
U. S.
Government
agency
securities 32,187 107 (96) 32,198
Obligations of
states and
political
subdivisions 9,876 251 (1) 10,126
Corporate
notes 7,748 25 (3) 7,770
Mortgage-
backed
securities 649 30 - 679
--------- ---------- ---------- ---------
Total debt
securities $ 57,448 $ 428 $ (109) $ 57,767
========= ========== ========== =========
</TABLE>
The amortized cost and estimated market value of debt
securities at December 31, 1998, by contractual maturity,
are shown below (dollars in thousands). Expected
maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
-------------------- --------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Due in one
year or less $ 4,297 $ 4,333 $ 10,317 $ 10,392
Due after one
year through
five years 33,552 33,994 24,703 24,973
Due after five
years through
ten years 2,432 2,449 9,313 9,363
Due after
ten years 244 243 2,221 2,278
---------- --------- ---------- ---------
Total debt
securities $ 40,525 $ 41,019 $ 46,554 $ 47,006
========== ========= ========== =========
</TABLE>
Investment securities with an amortized cost of $26,007,000
and $24,966,000 and an estimated market value of $26,198,000
and $25,025,000 were pledged to secure public deposits and
other purposes as required by law at December 31, 1998 and
1997, respectively.
13
<PAGE>
4. LOANS
- -------------------------------------------------------------
Major classifications of loans are summarized as follows
(dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
Percent Percent
Amount of Total Amount of Total
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Commercial,
financial, and
agricultural $ 19,213 17.86% $ 19,244 18.28%
Real estate -
mortgage:
Residential 61,376 57.07 61,616 58.52
Commercial 11,994 11.15 11,412 10.84
Installment loans
to individuals 14,972 13.92 13,021 12.36
-------- --------- -------- ---------
Total loans 107,555 100.00% 105,293 100.00%
========= =========
Less allowance
for loan losses 2,731 2,729
-------- --------
Net loans $104,824 $102,564
======== ========
</TABLE>
Loan maturities and rate sensitivity of the loan portfolio,
exclusive of real estate mortgage loans, and consumer
installment loans, at December 31, 1998, are as follows
(dollars in thousands):
<TABLE>
<CAPTION>
Within One to After
One Year Five Years Five Years Total
-------- ---------- ---------- -------
<S> <C> <C> <C> <C>
Commercial,
financial, and
agricultural $ 10,897 $ 4,987 $ 3,329 $19,213
======== ========== ========== =======
Loans at fixed
interest rates $ 2,593 $ 4,987 $ 3,329 $10,909
Loans at variable
interest rates 8,304 - - 8,304
-------- ---------- ---------- -------
$ 10,897 $ 4,987 $ 3,329 $19,213
======== ========== ========== =======
</TABLE>
Included in the table above are loans at fixed
interest rates of $8,316,000 that mature or reprice
after one year. Generally, loans with maturities of one
year or less consist of funds drawn on commercial lines
of credit, short-term notes written with maturities of 90
to 180 days, and demand notes written without alternative
maturity schedules. All lines of credit and demand loans
are subject to an annual review where the account may be
approved for up to one year. Short-term notes are
generally permitted two renewals, prior to being placed
on a fixed payment schedule.
Loans of $60,000 or more extended to executive officers,
directors, and corporations in which they are beneficially
interested as stockholders, executive officers, or
directors were $573,000 at December 31, 1998. An
analysis of these related party loans for 1998 follows
(dollars in thousands):
Balance Amounts Balance
1997 Additions Collected 1998
---------- ----------- ----------- ----------
$ 736 $ 470 $ 633 $ 573
Philson's primary business activity is with customers
located within its local trade area. Commercial,
residential, personal, and agricultural loans are granted.
Philson also selectively funds residential loans
originated outside of its trade area provided such loans
meet Philson's credit policy guidelines. Although
Philson has a diversified loan portfolio at December 31,
1998 and 1997, loans outstanding to individuals and
businesses are dependent upon the local economic conditions
in its market area.
14
<PAGE>
5. ALLOWANCE FOR LOAN LOSSES
- -------------------------------------------------------------
Changes in the allowance for loan losses for the years
ended December 31, 1998, 1997, and 1996 are as follows
(dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance, January 1 $ 2,729 $ 3,017 $ 2,882
Add:
Provisions charged
to operations 44 20 -
Recoveries 568 290 379
Less loans charged off 610 598 244
-------- -------- --------
Balance, December 31 $ 2,731 $ 2,729 $ 3,017
======== ======== ========
</TABLE>
6. PREMISES AND EQUIPMENT, NET
- -------------------------------------------------------------
Major classifications of premises and equipment are
summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Land and land improvements $ 552 $ 153
Premises 3,673 3,367
Furniture and equipment 3,418 3,535
---------- ----------
7,643 7,055
Less accumulated depreciation 4,131 4,047
---------- ----------
Total $ 3,512 $ 3,008
========== ==========
</TABLE>
Depreciation expense amounted to $387,000, $298,000, and
$301,000 in 1998, 1997, and 1996, respectively.
7. DEPOSITS
- --------------------------------------------------------------
Time deposits include certificates of deposit in
denominations of $100,000 or more. Such deposits
aggregated $7,056,000 and $5,226,000 at December 31, 1998
and 1997, respectively. Interest expense on certificates
of deposit of $100,000 or more was $339,000, $292,000,
and $315,000 in 1998, 1997, and 1996, respectively.
Maturities on time deposits of $100,000 or more are as
follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Three months or less $ 886 $ 754
Three to six months 2,233 1,079
Six to twelve months 2,441 1,509
Over one year 1,496 1,884
---------- ----------
Total $ 7,056 $ 5,226
========== ==========
</TABLE>
8. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
- ------------------------------------------------------------
The outstanding balances and related information for
securities sold under agreements to repurchase are
summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
Amount Rate Amount Rate
------ ------ ------ ------
<S> <C> <C> <C> <C>
Balance at year end $1,807 3.45% $1,674 3.97%
Average balance
outstanding
during the year 1,995 3.80 1,553 4.03
Maximum amount
outstanding
at any month end 4,154 3,719
</TABLE>
Average amounts outstanding during the year represent daily
average balances and average interest rates represent
interest expense divided by the related average balance.
Investments in U.S. Government agency securities with market
values in excess of outstanding balances of securities sold
under agreements to repurchase have been pledged at December
31, 1998 and 1997.
15
<PAGE>
9. INCOME TAXES
- --------------------------------------------------------------
The provision for income taxes consists of the following
(dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Currently payable $ 1,019 $ 968 $ 838
Deferred 20 60 5
-------- -------- --------
Total provision $ 1,039 $ 1,028 $ 843
======== ======== ========
</TABLE>
The components of the net deferred tax asset at December
31, 1998 and 1997, are as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 720 $ 691
Other, net 10 11
---------- ----------
Total deferred tax assets 730 702
---------- ----------
Deferred tax liabilities:
Deferred loan origination
fees, net 29 25
Unrealized gain on
securities 220 117
Employee benefit plans 80 54
Premises and equipment, net 18 -
---------- ----------
Total deferred tax
liabilities 347 196
---------- ----------
Net deferred tax asset $ 383 $ 506
========== ==========
</TABLE>
No valuation allowance was established at December 31,
1998, in view of Philson's ability to carry back taxes
paid in previous years and certain tax strategies and
anticipated future taxable income as evidenced by
Philson's earnings potential.
The reconciliation of the statutory rate and the effective
income tax rate is as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
----------------- -----------------
<S> <C> <C> <C> <C>
% of % of
Pre-tax Pre-tax
Amount Income Amount Income
------- ------- ------- -------
Provision
at statutory
rate $1,299 34.0% $1,278 34.0%
Effect of tax-
free income (283) (7.4) (276) (7.3)
Other 23 0.6 26 0.7
------- ------- ------- -------
Actual tax
expense and
effective rate $1,039 27.2% $1,028 27.4%
======= ======= ======= =======
<CAPTION>
1996
-----------------
<S> <C> <C>
% of
Pre-tax
Amount Income
------- -------
Provision
at statutory
rate $1,099 34.0%
Effect of tax-
free income (290) (9.0)
Other 34 1.1
------- -------
Actual tax
expense and
effective rate $ 843 26.1%
======= =======
</TABLE>
10. EMPLOYEE BENEFITS
- ------------------------------------------------------------
Defined Benefit Pension Plan
----------------------------
Philson sponsors a trusteed, non-contributory benefit
pension plan covering all eligible employees and officers.
The plan calls for benefits to be paid to eligible
employees at retirement based primarily upon years of
service and compensation rates near retirement. Philson's
funding policy is to make annual contributions, if needed,
based upon the funding formula developed by the plan's
actuary.
16
<PAGE>
10. EMPLOYEE BENEFITS (Continued)
- ------------------------------------------------------------
The following table sets forth the change in plan assets
and benefit obligation at December 31(dollars in
thousands):
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Plan assets at fair value,
beginning of year $ 683 $ 504
Actual return on plan
assets 81 43
Employer contribution 150 154
Benefits paid (3) (18)
---------- ----------
Plan assets at fair value,
end of year 911 683
---------- ----------
Benefit obligation,
beginning of year 599 514
Service cost 81 74
Interest cost 48 38
Actuarial adjustments 176 (9)
Benefits paid (3) (18)
---------- ----------
Benefit obligation,
end of year 901 599
---------- ----------
Funded status 10 84
Prior service cost - -
Unrecognized transition asset (39) (43)
Unrecognized net loss from
past experience different
from that assumed 229 82
---------- ----------
Prepaid pension cost $ 200 $ 123
========== ==========
</TABLE>
The plan assets are invested in U. S. Government agency
securities, obligations of states and political subdivisions,
corporate notes, and equity securities under the control of
the plan's trustees as of December 31, 1998.
Assumptions used in determining net periodic pension cost are
as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Discount rate 6.50% 7.50% 7.00%
Expected return on
plan assets 8.25% 8.25% 8.25%
Rate of compensation
increase 4.00% 4.00% 4.00%
</TABLE>
The plan utilizes the straight-line method of amortization for
unrecognized gains and losses.
Net periodic pension cost includes the following components
(dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Service cost of the
current period $ 81 $ 74 $ 67
Interest cost on
projected benefit
obligation 48 38 29
Actual return on
plan assets (81) (43) (23)
Net amortization
and deferral 25 - (18)
-------- -------- --------
Net periodic
pension cost $ 73 $ 69 $ 55
======== ======== ========
</TABLE>
Savings and Investment Plan
---------------------------
Philson currently sponsors a Section 401(k) employee
savings and investment plan for substantially all employees
and officers. Philson's contribution to the plan is based
on 50 percent matching of voluntary contributions of up to
8 percent of individual compensation. Employee contributions
are vested at all times, and Philson's contributions are
fully vested after seven years. The 1998, 1997, and 1996
expense related to this plan was $83,000, $74,000, and
$68,000, respectively.
Employee Stock Ownership Plan
-----------------------------
Philson sponsors an Employee Stock Ownership Plan
which enables qualifying employees to acquire shares of
Philson's common stock. At December 31, 1998, 159,743
shares, or 9.17 percent, of Philson's stock were held by
the plan. Contributions to the plan are made at the
discretion of the Board of Directors. Philson made no
contribution for the years ended December 31, 1998,
1997, and 1996.
17
<PAGE>
11. OTHER EXPENSES
- -------------------------------------------------------------
Other expenses for the years ended December 31, 1998,
1997, and 1996 consist of the following (dollars in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Professional fees $ 114 $ 167 $ 184
Pennsylvania bank
shares tax 181 170 163
Postage 134 145 166
Other 1,555 1,443 1,295
-------- -------- --------
Total $ 1,984 $ 1,925 $ 1,808
======== ======== ========
</TABLE>
12. COMMITMENTS AND CONTINGENT LIABILITIES
- -------------------------------------------------------------
Commitments
-----------
In the normal course of business, there are various
outstanding commitments and certain contingent liabilities
which are not reflected in the accompanying consolidated
financial statements. These commitments and contingent
liabilities represent financial instruments with off-
balance sheet risk. The contract or notional amounts of
those instruments reflect the extent of involvement in
particular types of financial instruments which were
comprised of the following (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Commitments to extend credit $ 15,326 $ 15,352
Standby letters of credit 1,196 1,005
---------- ----------
Total $ 16,522 $ 16,357
========== ==========
</TABLE>
The instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount
recognized in the balance sheet. The same credit policies
are used in making commitments and conditional obligations
as for on-balance sheet instruments. Generally, collateral
is required to support financial instruments with credit
risk. The terms are typically for a one year period with
an annual renewal option subject to prior approval by
management.
Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition
established in the loan agreement. These commitments are
comprised primarily of available commercial and personal
lines of credit and unfunded real estate loans. Standby
letters of credit written are conditional commitments
issued to guarantee the performance of a customer to a
third party.
The exposure to loss under these commitments is limited
by subjecting each commitment to credit approval and
monitoring procedures. Substantially all commitments
to extend credit are contingent upon customers
maintaining specific credit standards at the time of the
loan funding. Management assesses the credit risk
associated with certain commitments to extend credit in
determining the level of the allowance for loan losses.
Since many of the commitments are expected to expire
without being drawn upon, the contractual amounts do not
necessarily represent future funding requirements.
13. REGULATORY MATTERS
- -------------------------------------------------------------
The approval of the Comptroller of the Currency is
required before any dividends are declared if the total
of all dividends declared by a national bank in any
calendar year would exceed net profits, as defined for
that year, combined with its retained net profits for
the two preceding calendar years less any required
transfers to surplus. Under this formula, the amount
available for payment of dividends by the Bank to
Philson in 1999, without the approval of the Comptroller,
is $2,743,000 plus 1999 profits retained up to the date
of the dividend declaration.
Federal law prevents Philson from borrowing from the Bank
unless loans are secured by specific obligations. Further,
such secured loans are limited in amount to ten percent of
the Bank's capital.
Included in cash and due from banks are required federal
reserves of $1,271,000 and $1,189,000 at December 31,
1998 and 1997, respectively, for facilitating the
implementation of monetary policy by the Federal Reserve
System. The required reserves are computed by applying
prescribed ratios to the classes of average deposit
balances. These are held in the form of cash on hand
and/or balances maintained directly with the Federal
Reserve Bank.
14. REGULATORY CAPITAL REQUIREMENTS
- -------------------------------------------------------------
Philson (on a consolidated basis) and the Bank are
subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary actions
by the regulators that, if undertaken, could have a direct
material effect on Philson's and the Bank's financial
statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, Philson
and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets,
liabilities, and certain off-balance sheet items as
calculated under regulatory accounting practices. The
capital amounts and classification are also subject to
qualitative judgments by the regulators about components,
risk weightings, and other factors.
18
<PAGE>
14. REGULATORY CAPITAL REQUIREMENTS (Continued)
- -------------------------------------------------------------
Quantitative measures established by the regulatory capital
standards to ensure capital adequacy require Philson and
the Bank to maintain minimum amounts and ratios of Total
and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined), and of Tier I capital to
average assets (as defined). Management believes, as of
December 31, 1998, that Philson and the Bank meet all
capital adequacy requirements to which they are subject.
As of December 31, 1998, the most recent notification from
the Federal Reserve Board and the Office of the Comptroller
of the Currency have categorized Philson and the Bank
as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well
capitalized they must maintain minimum Total risk-based,
Tier I risk-based, and Tier I leverage ratios of at least
100 to 200 basis points above those ratios set forth in
the table. There have been no conditions or events since
that notification that management believes have changed
Philson's and the Bank's category.
The following table reflects Philson's capital ratios
and minimum requirements at December 31 (dollars in
thousands). The Bank's capital ratios are substantially
the same as Philson.
<TABLE>
<CAPTION>
1998 1997
---------------- ----------------
Amount Ratio Amount Ratio
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Total Capital (to
Risk-weighted
Assets)
-------------------
Actual $26,880 19.72% $24,770 20.51%
For Capital
Adequacy Purposes 10,906 8.00 9,662 8.00
To Be Well
Capitalized 13,632 10.00 12,077 10.00
Tier I Capital (to
Risk-weighted
Assets)
-------------------
Actual $25,163 18.46% $23,245 19.25%
For Capital
Adequacy Purposes 5,453 4.00 4,831 4.00
To Be Well
Capitalized 8,179 6.00 7,246 6.00
Tier I Capital (to
Average Assets)
-------------------
Actual $25,163 11.68% $23,245 11.40%
For Capital
Adequacy Purposes 8,617 4.00 8,153 4.00
To Be Well
Capitalized 10,771 5.00 10,192 5.00
</TABLE>
15. FAIR VALUE DISCLOSURE
- --------------------------------------------------------------
The estimated fair values of Philson's financial
instruments are as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- ---------- --------- ---------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and due
from banks,
interest-
bearing
deposits in
other banks,
and federal
funds sold $ 13,001 $ 13,001 $ 15,793 $ 15,793
Investment
securities 89,244 89,585 77,631 77,950
Net loans 104,824 105,983 102,564 102,367
Accrued interest
receivable 1,886 1,886 1,849 1,849
--------- ---------- --------- ---------
Total financial
assets $208,955 $ 210,455 $197,837 $197,959
========= ========== ========= =========
FINANCIAL
LIABILITIES
Deposits $185,130 $186,344 $174,243 $173,812
Securities
sold under
agreements to
repurchase 1,807 1,807 1,674 1,674
U. S. Treasury
demand notes 134 134 1,674 1,674
Accrued interest
payable 553 553 546 546
--------- ---------- --------- ---------
Total financial
liabilities $187,624 $188,838 $178,137 $177,706
========= ========== ========= =========
</TABLE>
19
<PAGE>
Financial instruments are defined as cash, evidence of
an ownership interest in an entity, or a contract which
creates an obligation or right to receive or deliver cash
or another financial instrument from/to a second entity
on potentially favorable or unfavorable terms.
Fair value is defined as the amount at which a financial
instrument could be exchanged in a current transaction
between willing parties other than in a forced or
liquidation sale. If a quoted market price is available
for a financial instrument, the estimated fair value would
be calculated based upon the market price per trading unit
of the instrument.
If no readily available market price exists, the fair
value estimates for financial instruments should be based
upon management's judgment regarding current economic
conditions, interest rate risk, expected cash flows and
future estimated losses, and other factors as determined
through various option pricing formulas or simulation
modeling. As many of these assumptions result from
judgments made by management based upon estimates which
are inherently uncertain, the resulting estimated fair
values may not be indicative of the amount realizable
in the sale of a particular financial instrument. In
addition, changes in the assumptions on which the
estimated fair values are based may have a significant
impact on the resulting estimated fair values.
As certain assets and liabilities such as deferred tax
assets and premises and equipment are not considered
financial instruments, the estimated fair value of
financial instruments would not represent the full value
of Philson.
Philson employed simulation modeling in determining
the estimated fair value of financial instruments for
which quoted prices were not available based upon the
following assumptions:
The fair value of cash and due from banks, interest-
bearing deposits in other banks, federal funds sold,
accrued interest receivable, securities sold under
agreements to repurchase, U. S. Treasury demand notes,
and accrued interest payable is equal to the current
book value.
The fair value of investment securities available for
sale and held to maturity are equal to the available quoted
market price. If no quoted market price is available, fair
value is estimated using the quoted market price for
similar securities.
The fair value of loans is estimated by discounting the
future cash flows using a simulation model which estimates
future cash flows and constructs discount rates that
consider reinvestment opportunities, operating expenses,
non-interest income, credit quality, and prepayment risk.
Demand, savings, and money market deposit accounts are
valued at the amount payable on demand as of year end.
Fair values for time deposits are estimated using
discounted cash flow calculations that apply contractual
cost currently being offered in the existing portfolio to
current market rates being offered for deposits of similar
remaining maturities.
16.CONDENSED FINANCIAL INFORMATION OF FIRST PHILSON
FINANCIAL CORPORATION (PARENT COMPANY ONLY)
- -----------------------------------------------------------
<TABLE>
CONDENSED BALANCE SHEET
(Dollars in thousands)
<CAPTION>
December 31,
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Interest-bearing deposits
in subsidiary $ 117 $ 129
Investment securities
available for sale 1,470 960
Investment in bank
subsidiary 23,583 21,994
Investment in non-bank
subsidiary 494 467
---------- ----------
TOTAL ASSETS $ 25,664 $ 23,550
========== ==========
LIABILITIES
Other liabilities $ 75 $ 79
STOCKHOLDERS' EQUITY 25,589 23,471
---------- ----------
TOTAL LIABILITIES
AND STOCKHOLDERS'
EQUITY $ 25,664 $ 23,550
========== ==========
</TABLE>
20
<PAGE>
16.CONDENSED FINANCIAL INFORMATION OF FIRST PHILSON
FINANCIAL CORPORATION (PARENT COMPANY ONLY) (Continued)
- ------------------------------------------------------------
<TABLE>
CONDENSED STATEMENT OF INCOME
(Dollars in thousands)
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
INCOME
Dividends from
bank subsidiary $ 1,500 $ 1,385 $ 755
Dividend and
interest income 53 42 31
Other income 6 12 -
-------- -------- --------
Total income 1,559 1,439 786
-------- -------- --------
EXPENSE
Other expense 142 82 42
-------- -------- --------
Total expense 142 82 42
-------- -------- --------
Income before equity in
undistributed earnings
of subsidiaries 1,417 1,357 744
Equity in undistributed
earnings of subsidiaries 1,364 1,374 1,646
-------- -------- --------
NET INCOME $ 2,781 $ 2,731 $ 2,390
======== ======== ========
</TABLE>
<TABLE>
CONDENSED STATEMENT OF CASH FLOWS
(Dollars in thousands)
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 2,781 $ 2,731 $ 2,390
Adjustments to reconcile
net income to net
cash provided by
operating activities:
Equity in
undistributed
earnings of
subsidiaries (1,364) (1,374) (1,646)
Other, net 24 - (4)
-------- -------- --------
Net cash provided
by operating
activities 1,441 1,357 740
-------- -------- --------
INVESTING ACTIVITIES
Purchase of investment
securities available
for sale (681) (378) (350)
Proceeds from maturity
of investment
securities available
for sale 91 - -
Maturity of investment
securities held to
maturity - - 99
Purchase of time
deposits in subsidiary - - (100)
Maturity of time deposits - 310 -
Investment in Flex - (500) -
-------- -------- --------
Net cash used for
investing
activities (590) (568) (351)
-------- -------- --------
FINANCING ACTIVITIES
Cash dividends paid (863) (666) (544)
-------- -------- --------
Net cash used
for financing
activities (863) (666) (544)
-------- -------- --------
Increase (decrease)
in cash and cash
equivalents (12) 123 (155)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 129 6 161
-------- -------- --------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 117 $ 129 $ 6
======== ======== ========
</TABLE>
21
<PAGE>
17. AGREEMENT AND PLAN OF MERGER
- --------------------------------------------------------------
On February 23, 1999, the Board of Directors executed a
definitive Agreement and Plan of Merger (Agreement), which
provides for the affiliation of Philson with BT Financial
Corporation (BT Financial) headquartered in Johnstown,
Pennsylvania. The Agreement provides that the affiliation
will be effected by means of a merger of Philson and
BT Financial. In the merger, each stockholder of Philson
will receive 1.667 shares of BT Financial common stock in
exchange for each share of Philson's stock, subject to
certain terms, conditions, and limitations set forth in
the Agreement. Completion of the merger is subject to
appoval by various regulatory agencies and the stockholders
of Philson and BT Financial.
22
<PAGE>
SNODGRASS
Certified Public Accountants and Consultants
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
First Philson Financial Corporation
We have audited the accompanying consolidated balance sheet of
First Philson Financial Corporation and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated
statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility
of Philson's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating
the overall financial statement presentation. We believe our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of First Philson Financial Corporation and subsidiaries
as of December 31, 1998 and 1997, and the consolidated results
of their operations and their cash flows for each of the three
years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
/s/S.R. Snodgrass, A.C.
Wexford, PA
January 22, 1999 except for Note 17,
as to which the date is February 23, 1999
S.R. Snodgrass, A.C.
101 Bradford Road, Suite 100 Wexford, PA 15090-6909 Phone: 724-934-0344
Facsimile: 724-934-0345
23
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 10,301
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 2,700
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 42,690
<INVESTMENTS-CARRYING> 46,554
<INVESTMENTS-MARKET> 47,006
<LOANS> 107,555
<ALLOWANCE> 2,731
<TOTAL-ASSETS> 213,607
<DEPOSITS> 185,130
<SHORT-TERM> 1,941
<LIABILITIES-OTHER> 947
<LONG-TERM> 0
0
0
<COMMON> 4,356
<OTHER-SE> 21,233
<TOTAL-LIABILITIES-AND-EQUITY> 213,607
<INTEREST-LOAN> 9,552
<INTEREST-INVEST> 4,716
<INTEREST-OTHER> 727
<INTEREST-TOTAL> 14,995
<INTEREST-DEPOSIT> 5,753
<INTEREST-EXPENSE> 5,864
<INTEREST-INCOME-NET> 9,131
<LOAN-LOSSES> 44
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 6,292
<INCOME-PRETAX> 3,820
<INCOME-PRE-EXTRAORDINARY> 3,820
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,781
<EPS-PRIMARY> 1.60
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.75
<LOANS-NON> 177
<LOANS-PAST> 50
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,729
<CHARGE-OFFS> 610
<RECOVERIES> 568
<ALLOWANCE-CLOSE> 2,731
<ALLOWANCE-DOMESTIC> 2,731
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
