UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 1998
Commission File Number: 0-17007
Republic First Bancorp, Inc.
(Exact name of small business issuer as specified in its charter)
Pennsylvania 23-2486815
(State or other jurisdiction of IRS Employer Identification
incorporation or organization) Number
1608 Walnut Street, Philadelphia, Pennsylvania 19103
(Address of principal executive offices) (Zip code)
215-735-4422
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
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 filing requirements
for the past 90 days.
YES X NO ____
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the Issuer's classes of
common stock, as of the latest practicable date.
5,547,993 shares of Issuer's Common Stock, par value
$0.01 per share, issued and outstanding as of October 31, 1998
Page 1 of 37
Exhibit index appears on page 35
<PAGE>
TABLE OF CONTENTS
Page
Part I: Financial Information
Item 1: Financial Statements 3
Item 2: Management's Discussion and Analysis of Financial Condition and 14
Results of Operations
Part II: Other Information
Item 1: Legal Proceedings 35
Item 2: Changes in Securities 35
Item 3: Defaults upon Senior Securities 35
Item 4: Submission of Matters to a Vote of Security Holders 35
Item 5: Other Information 35
Item 6: Exhibits and Reports on Form 8-K 36
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
Page Number
(1) Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997................................................ 4
(2) Consolidated Statements of Operations for three and nine months ended
September 30, 1998 and 1997...................................... 5
(3) Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1997...................................... 7
(4) Notes to Consolidated Financial Statements....................... 8
3
<PAGE>
Republic First Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
as of September 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
ASSETS: 1998 1997
(unaudited)
<S> <C> <C>
Cash and due from banks $ 9,801,000 $ 5,850,000
Interest - bearing deposits with banks 799,000 476,000
------------- -------------
Total cash and cash equivalents 10,600,000 6,326,000
Securities available for sale, at fair value 148,362,000 2,950,000
Securities held to maturity at amortized cost 40,058,000 145,030,000
(fair value of $40,137,000 and $147,303,000,
respectively)
Loans receivable, (net of allowance for loan losses of
2,324,000 and $2,028,000, respectively) 264,422,000 209,999,000
Premises and equipment, net 3,990,000 2,534,000
Real estate owned 2,673,000 1,944,000
Accrued income and other assets 10,650,000 6,679,000
------------- -------------
Total Assets $ 480,755,000 $ 375,462,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Deposits:
Demand - non-interest-bearing $ 24,550,000 $ 32,885,000
Demand - interest-bearing 13,141,000 8,587,000
Money market and savings 31,536,000 26,341,000
Time 176,688,000 152,014,000
Time over $100,000 25,351,000 28,574,000
------------- -------------
Total Deposits 271,266,000 248,401,000
Other borrowed funds 162,136,000 85,912,000
Accrued expenses and other liabilities 8,634,000 6,527,000
------------- -------------
Total Liabilities $ 442,036,000 $ 340,840,000
------------- -------------
Shareholders' Equity:
Common stock par value $.01 per share, 20,000,000
Shares authorized; shares issued and outstanding
5,545,993 as of September 30, 1998
And 5,515,517 as of December 31, 1997 55,000 55,000
Treasury Stock (17,000) 0
Additional paid in capital 26,409,000 26,364,000
Retained earnings 11,563,000 8,198,000
Accumulated other comprehensive income, net of tax 709,000 5,000
------------- -------------
Total Shareholders' Equity 38,719,000 34,622,000
------------- -------------
Total Liabilities and Shareholders' Equity $ 480,755,000 $ 375,462,000
============= =============
</TABLE>
(See notes to consolidated financial statements)
4
<PAGE>
Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
For the Three and Nine Months Ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
Interest income:
Interest and fees on loans $ 5,737,000 $ 4,364,000 $ 15,841,000 $ 12,316,000
Interest on federal funds sold 7,000 10,000 214,000 300,000
Interest on investments 3,070,000 1,565,000 9,530,000 4,192,000
------------ ------------ ------------ ------------
Total Interest Income 8,814,000 5,939,000 25,585,000 16,808,000
------------ ------------ ------------ ------------
Interest expense:
Demand interest-bearing 84,000 49,000 256,000 159,000
Money market and savings 322,000 233,000 861,000 692,000
Time over $100,000 373,000 390,000 1,155,000 1,214,000
Time 2,609,000 2,285,000 7,496,000 6,373,000
Other borrowed funds 2,031,000 373,000 5,557,000 621,000
------------ ------------ ------------ ------------
Total interest expense 5,419,000 3,330,000 15,325,000 9,059,000
------------ ------------ ------------ ------------
Net interest income 3,395,000 2,609,000 10,260,000 7,749,000
------------ ------------ ------------ ------------
Provision for loan loss 80,000 30,000 290,000 140,000
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 3,315,000 2,579,000 9,970,000 7,609,000
------------ ------------ ------------ ------------
Non-interest income:
Service fees 143,000 129,000 347,000 291,000
Tax Refund Program revenue 0 5,000 2,383,000 2,239,000
Miscellaneous Income 31,000 18,000 82,000 96,000
------------ ------------ ------------ ------------
174,000 152,000 2,812,000 2,626,000
Non-interest expense:
Salaries and benefits 1,390,000 1,056,000 3,788,000 3,083,000
Occupancy/Equipment 369,000 315,000 1,101,000 867,000
Loss from Mortgage Affiliate 1,032,000 0 1,145,000 0
Other expenses 1,057,000 561,000 2,347,000 1,944,000
------------ ------------ ------------ ------------
3,848,000 1,932,000 8,381,000 5,894,000
------------ ------------ ------------ ------------
Income/(loss) before income taxes (359,000) 799,000 4,401,000 4,341,000
Provision/(benefit) for income taxes (118,000) 274,000 1,457,000 1,337,000
------------ ------------ ------------ ------------
Income/(loss) before cumulative effect of a
change in accounting principle (241,000) 525,000 2,944,000 3,004,000
------------ ------------ ------------ ------------
Cumulative effect of a change in accounting 421,000 0 421,000 0
------------ ------------ ------------ ------------
principle (Note 4)
Net income $ 180,000 $ 525,000 $ 3,365,000 $ 3,004,000
============ ============ ============ ============
Net income per share:
Basic:
Income (loss) before cumulative effect
of a change in accounting principle $ (0.04) $ 0.13 $ 0.53 $ 0.73
Cumulative effect of a change in
accounting principle (Note 4) $ 0.07 $ 0.00 $ 0.07 $ 0.00
------------ ------------ ------------ ------------
Net income $ 0.03 $ 0.13 $ 0.60 $ 0.73
============ ============ ============ ============
5
<PAGE>
Diluted:
Income/(loss) before cumulative effect
of a change in accounting principle $ (0.04) $ 0.12 $ 0.50 $ 0.67
Cumulative effect of a change in
accounting principle (Note 4) $ 0.07 $ 0.00 $ 0.07 $ 0.00
------------ ------------ ------------ ------------
Net income $ 0.03 $ 0.12 $ 0.57 $ 0.67
============ ============ ============ ============
Average common shares and common
equivalent shares
Outstanding:
Basic 5,546,553 4,134,371 5,520,810 4,119,811
------------ ------------ ------------ ------------
Diluted 5,882,499 4,497,028 5,893,468 4,465,608
------------ ------------ ------------ ------------
</TABLE>
(See notes to consolidated financial statements)
6
<PAGE>
Republic First Bancorp, Inc. and Subsidiary
Consolidated Statement of Cash Flows
For The Nine Months Ended September 30
(unaudited)
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
------------- -------------
Cash flows from operating activities:
Net income $ 3,365,000 $ 3,004,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 290,000 140,000
Write down of other real estate owned 0 70,000
Depreciation and amortization 482,000 302,000
Proceeds from sale of trading securities 35,143,000 0
Loss from Mortgage Affiliate (1,145,000) 0
Increase in accrued income
and other assets (3,860,000) (147,000)
Increase in accrued expenses
and other liabilities 2,107,000 1,070,000
------------- -------------
Net cash used in operating activities 36,382,000 4,439,000
------------- -------------
Cash flows from investing activities:
Purchase of securities:
Available for Sale (116,664,000) (1,950,000)
Held to Maturity (4,083,000) (37,386,000)
Proceeds from principal receipts, and
maturities of securities 46,021,000 19,074,000
Net increase in loans (55,258,000) (14,715,000)
Net increase/(decrease) in deferred fees 466,000 0
Purchase of other real estate owned 0 (1,406,00)
Premises and equipment expenditures (1,743,000) (1,448,000)
------------- -------------
Net cash used in investing activities (131,261,000) (37,831,000)
------------- -------------
Cash flows from financing activities:
Net increase in demand, money
market, and savings deposits 1,414,000 (1,998,000)
Net increase/(decrease) in borrowed funds less than 90 days (12,476,000) 27,346,000
Net increase in borrowed funds greater than 90 days 88,700,000 0
Net increase (decrease) in time deposits 21,451,000 (157,000)
Purchases of Treasury Stock (17,000) 0
Net proceeds from exercise of stock options 81,000 0
------------- -------------
Net cash provided by financing activities 99,153,000 25,191,000
------------- -------------
Increase in cash and cash equivalents 4,274,000 (8,201,000)
Cash and cash equivalents, beginning of period 6,326,000 15,496,000
------------- -------------
Cash and cash equivalents, end of period $ 10,600,000 $ 7,295,000
============= =============
Supplemental disclosure:
Interest paid $ 8,901,000 $ 8,699,000
============= =============
Non-cash transactions:
Net transfers of loans to real estate owned 718,000 539,000
Changes in unrealized gain on securities available for sale 1,059,000 0
Change in deferred tax liability due to change in unrealized gain
on securities available for sale (348,000) 0
Transfer of securities from held to maturity to available for sale
and trading 138,861,000 0
============= =============
</TABLE>
(See notes to consolidated financial statements)
7
<PAGE>
REPUBLIC FIRST BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Organization
Republic First Bancorp, Inc. ("the Company") is a one-bank holding
company organized and incorporated under the laws of the Commonwealth of
Pennsylvania. Its wholly-owned subsidiary, First Republic Bank (the "Bank"),
offers a variety of banking services to individuals and businesses throughout
the Greater Philadelphia and South Jersey area through its offices and branches
in Philadelphia and Montgomery Counties.
In the opinion of the Company, the accompanying unaudited financial
statements contain all adjustments (including normal recurring accruals)
necessary to present fairly the financial position as of September 30, 1998, the
results of operations for the quarter and nine months ended September 30, 1998
and 1997, and the cash flows for the nine months ended September, 1998 and 1997.
The interim results of operations may not be indicative of the results of
operations for the full year. The accompanying unaudited financial statements
should be read in conjunction with the Company's audited financial statements,
and the notes thereto, included in the Company's 1997 annual report.
Note 2: Summary of Significant Accounting Policies:
Principles of Consolidation
The consolidated financial statements of the Company include the
accounts of Republic First Bancorp. Inc. and its wholly-owned subsidiary, First
Republic Bank. All significant intercompany accounts and transactions have been
eliminated in the consolidated financial statements.
Risks and Uncertainties and Certain Significant Estimates
The earnings of the Company depend on the earnings of the Bank. The
Bank is dependent primarily upon the level of net interest income, which is the
difference between interest earned on its interest-earning assets, such as loans
and investments, and the interest paid on its interest-bearing liabilities, such
as deposits and other borrowed funds. Accordingly, the operations of the Bank
are subject to risks and uncertainties surrounding its exposure to changes in
the interest rate environment.
Additionally, the Company derives fee income from the Bank's
participation in a Tax Refund Program, which indirectly funds consumer loans
collateralized by federal income tax refunds. Approximately $2.4 million and
$2.2 million in gross revenues were collected on these loans during the nine
months ended September 30, 1998 and 1997, respectively. The Company expects to
participate in the program again in 1999, however, tax code changes, banking
regulations, as well as business decisions by the parties involved in the
program may affect the Company's participation in the program in 1999.
Subsequently, the Company does not expect to participate in the program in 2000.
8
<PAGE>
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make significant estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Significant estimates are made by management in determining the
allowance for loan losses and carrying values of real estate owned and carrying
value of the Company's equity investment. In determining the allowance for loan
losses, consideration is given to a variety of factors in establishing these
estimates including current economic conditions, diversification of the loan
portfolio, delinquency statistics, results of internal loan reviews, borrowers'
perceived financial and managerial strengths, the adequacy of underlying
collateral, if collateral dependent, or present value of future cash flows and
other relevant factors. Since the allowance for loan losses and carrying value
of real estate owned are dependent, to a great extent, on the general condition
of the local economy and other conditions that may be beyond the Company's
control, it is at least reasonably possible that the estimates of the allowance
for loan losses and the carrying values of the real estate owned could differ
materially in the near term. An allowance for the future deterioration of the
market value of puchased mortage servicing rights owned by the Company's
mortgage banking affiliate has been established as of September 30, 1998, in the
amount of $688,000. No such reserves were established as of September 30, 1997.
The market value of mortgage servicing rights fluctuates with interest rate
changes, prepayment speeds of the underlying collateral, and market demand. The
Company established a reserve, since it is resonably possible that changes in
interest rate, prepayment speeds of underlying collateral and general market
conditions could impair the value of its equity investment.
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers
all cash and due from banks, interest-bearing deposits with an original maturity
of ninety days or less and federal funds sold to be cash and cash equivalents.
The Bank is required to maintain certain average reserve balances as established
by the Federal Reserve Board. The amounts of those balances for the reserve
computation periods, which included September 30, 1998 and December 31, 1997,
were $801,000 and $850,000, respectively. These requirements were satisfied
through the restriction of vault cash and a balance at the Federal Reserve Bank
of Philadelphia.
Loans
Loans are stated at the principal amount outstanding, net of deferred
loan fees and costs. The amortization of deferred loan fees and costs are
accounted for by a method, which approximates level yield. Any unamortized fees
or costs associated with loans, which pay down in full, are immediately
recognized in the Company's operations. Income is accrued on the principal
amount outstanding.
Loans, including impaired loans, are generally classified as nonaccrual
if they are past due as to maturity or payment of principal and/or interest for
a period of more than 90 days, unless such loans are well-secured and in the
process of collection. Loans that are on a current payment status or past due
less than 90 days may also be classified as nonaccrual if repayment in full of
principal and/or interest is in doubt.
9
<PAGE>
Loans may be returned to accrual status when all principal and interest
amounts contractually due are reasonably assured of repayment within an
acceptable period of time, and there is a sustained period of repayment
performance (generally a minimum of six months) by the borrower, in accordance
with the contractual terms of interest and principal.
While a loan is classified as nonaccrual or as an impaired loan and the
future collectibility of the recorded loan balance is doubtful, collections of
interest and principal are generally applied as a reduction to principal
outstanding. When the future collectibility of the recorded loan balance is
expected, interest income may be recognized on a cash basis. In the case where a
nonaccrual loan had been partially charged off, recognition of interest on a
cash basis is limited to that which would have been recognized on the recorded
loan balance at the contractual interest rate. Cash interest receipts in excess
of that amount are recorded as recoveries to the allowance for loan losses until
prior charge-offs have been fully recovered.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for
loan losses charged to operations. Loans are charged against the allowance when
management believes that the collectibility of the loan principal is unlikely.
Recoveries on loans previously charged off are credited to the allowance.
The allowance is an amount that management believes will be adequate to
absorb loan losses on existing loans that may become uncollectible, based on
evaluations of the collectibility of loans and prior loan loss experience. The
evaluations take into consideration such factors as changes in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, the results of the most recent regulatory examination, current
economic conditions and trends that may affect the borrower's ability to pay.
The Company considers residential mortgage loans and consumer loans,
including home equity lines of credit, to be homogeneous loans. These loan
categories are collectively evaluated for impairment. Impaired commercial
business loans and commercial real estate loans are individually measured for
impairment based on the present value of expected future cash flows discounted
at the historical effective interest rate, except that all collateral dependent
loans are measured for impairment based on the fair market value of the
collateral.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation of furniture and equipment is calculated over the
estimated useful life of the asset using the straight-line method. Leasehold
improvements are amortized over the shorter of their estimated useful lives or
terms of their respective leases, using the straight-line method.
Repairs and maintenance are charged to current operations as incurred,
and renewals and betterments are capitalized.
10
<PAGE>
Real Estate Owned
Real estate owned consists of foreclosed assets and is stated at the
lower of cost or estimated fair market value less estimated costs to sell the
property. Costs to maintain other real estate owned, or deterioration on value
of the properties is recognized as period expenses. There is no valuation
allowance associated with the Company's other real estate portfolio for those
periods presented.
Income Taxes
Deferred income taxes are established for the temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities at the tax rates expected to be in effect when the temporary
differences are realized or settled. In addition, a deferred tax asset is
recorded to reflect the future benefit of net operating loss carryforwards. The
deferred tax assets may be reduced by a valuation allowance if it is probable
that some portion or all of the deferred tax assets will not be realized. No
such valuations exist for the periods presented herein.
Reclassifications
Certain items in the 1997 financial statements were reclassified to
conform to 1998 presentation format. These reclassifications had no impact on
net income.
Earnings Per Share
In February 1997, the FASB issued SFAS Statement No. 128, "Earnings Per
Share". This Statement establishes standards for computing and presenting
earnings per share ("EPS") and applies to entities with publicly held common
stock or potential common stock. This Statement simplifies the standards for
computing EPS previously found in APB Opinion No. 15, "Earnings Per Share", and
makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator
and denominator of the diluted EPS computation. This Statement requires
restatement of all prior period EPS data presented upon adoption. The Company
adopted SFAS Statement No. 128 effective December 31, 1997. All prior period
earnings per share presentations have been restated to conform to this
pronouncement.
EPS consists of two separate components, basic EPS and diluted EPS.
Basic EPS is computed by dividing net income by the weighted average number of
common shares outstanding for each period presented. Diluted EPS is calculated
by dividing net income by the weighted average number of common shares
outstanding plus common stock equivalents. Common stock equivalents consist of
dilutive stock options granted through the Company's stock option plan. The
following table is a reconciliation of the numerator and denominator used in
calculating basic and diluted EPS.
11
<PAGE>
The following table is a comparison of EPS for the nine months ended
September 30, 1998 and 1997.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Quarter to Date | Year to Date
1998 1997 | 1998 1997
-------------------------------------------|----------------------------------------------------
Income/(loss) before cummulative |
effect of a change in accounting $(241,000) $525,000 | $2,944,000 $3,004,000
principle (numerator for both |
calculations) |
-------------------------------------------|----------------------------------------------------
|
Shares Per Share Shares Per Share | Shares Per Share Shares Per Share
Weighted average shares |
for period 5,546,553 4,134,371 | 5,520,810 4,119,811
Basic EPS $(0.04) $ 0.13 | $ 0.53 $ 0.73
Add common stock equivalents |
|
Representing dilutive stock options 335,946 362,657 | 372,658 345,797
Effect on basic EPS and CSE $ 0.00 $( 0.01)| $(0.03) $(0.06)
Equals total weighted average |
Shares and CSE (diluted) 5,882,499 4,497,028 | 5,893,468 4,465,608
Diluted EPS $(0.04) $ 0.12 | $ 0.50 $ 0.67
</TABLE>
Investment Securities
Debt and equity securities are classified in one of three categories,
as applicable, and are accounted for as follows: debt securities which the
Company has the positive intent and ability to hold to maturity are classified
as "securities held to maturity" and are reported at amortized cost; debt and
equity securities that are bought and sold in the near term are classified as
"trading" and are reported at fair market value with unrealized gains and losses
included in earnings; and debt and equity securities not classified as either
held to maturity and/or trading securities are classified as "securities
available for sale" and are reported at fair market value with net unrealized
gains and losses, net of tax, reported as a separate component of shareholders'
equity. Securities are adjusted for amortization of premiums and accretion of
discounts over the life of the related security on a level yield method.
Securities available for sale include those management intends to use as part of
its asset-liability matching strategy or that may be sold in response to changes
in interest rates or other factors. Realized gains and losses on the sale of
investment securities are recognized using the specific identification method.
As described in Note 4, the Company transferred $127.8 million of securities
from held to maturity to available for sale and $50.4 million of securities from
held to maturity to the trading category. The Company sold the securities
transferred to the trading category during the third quarter and realized a gain
on the sale of these securities of $421,000, net of income taxes, as a
cumulative effect of a change in accounting.
Treasury Stock
During 1998, the Company purchased 2,000 shares of its own stock as
part of the buyback program. The purchased stock is accounted for as a deduction
to common stock, paid in capital and retained earnings.
12
<PAGE>
Comprehensive Income
On January 1, 1998, the Company adopted SFAS Statement No. 130,
"Reporting Comprehensive Income." The following table displays net income and
the components of other comprehensive income to arrive at total comprehensive
income. For the Company, the only components of other comprehensive income are
those related to SFAS Statement No. 115 available for sale securities.
<TABLE>
<CAPTION>
(amount in thousands) Three months ended Nine months ended
September 30 September 30
1998 1997 1998 1997
---------------- ---------------- --------------- --------------
<S> <C> <C> <C> <C>
Net income $ 180,000 $ 525,000 $3,365,000 $3,004,000
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains during the period 704,000 $ (3,000) 704,000 0
Less: Reclassification adjustment for gains
Included in net income 0 0 0 0
---------------- ---------------- --------------- --------------
Comprehensive income $ 884,000 $ 522,000 $4,069,000 $3,004,000
================ ================ =============== ==============
</TABLE>
Note: 3 Legal Proceedings
The Company, along with a number of other financial institutions, has
been made a party to a lawsuit brought by a New Jersey bank claiming damages of
approximately $200,000 arising out of a series of mortgage loans made to a
borrower who apparently procured one or more of these loans fraudulently. The
Company believes that it has a valid defense to this claim. In addition, one of
these loans in the amount of $612,000, was sold by the Bank to a mortgage banker
who is now alleging that the Company breached its warranty obligations when it
sold this loan to the mortgage banker because the lien of the loan is possibly
inferior to other mortgages. The Company believes its actions were proper, that
the lien is enforceable as a first lien, and it intends to vigorously defend
these claims and, to the extent necessary, seek recourse from other parties who
may have participated in this allegedly fraudulent scheme.
The Company and the Bank are from time to time a party (plaintiff or
defendant) to lawsuits that are in the normal course of business. While any
litigation involves an element of uncertainty, management, after reviewing
pending actions with its legal counsel, is of the opinion that the liability of
the Company and the Bank, if any, resulting from such actions will not have a
material effect on the financial condition or results of operations of the
Company and the Bank.
13
<PAGE>
Note: 4 Cumulative Change in Accounting Principle
The Company adopted SFAS Statement No. 133 "Accounting for Derivative
Instruments and Hedging Activities" on July 1, 1998. As permitted by SFAS
Statement No. 133, the company transferred $106.4 million of securities from
held to maturity to available-for-sale and $32.5 million of securities from held
to maturity to the trading category. The Company sold the securities transferred
to the trading category during the third quarter and realized a gain on the sale
of these securities of $421,000, net of income taxes, as a cumulative effect of
a change in accounting principle. The Company sold these securities as part of a
portfolio-restructuring program, which reduced the Company's risk of prepayment
on its mortgage-backed securities portfolio due to the sharp decline in interest
rates during the third quarter.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Quarter Ended September 30, 1998 Compared to September 30, 1997
Results of Operations:
Overview
The Company's net income decreased $345,000, or 65.7%, to $180,000 for
the quarter ended September 30, 1998, from $525,000 for the quarter ended
September 30, 1997. The earnings decreased primarily due to a loss from the
Company's mortgage banking affiliate of approximately $1.0 million, including
the Company's estimate of the impact of the devaluation of the affiliate's
servicing portfolio, resulting from a decline in market rates. Partially
offsetting this loss was a gain of $628,000 from the sale of investment
securities, as part of a portfolio restructuring program, which reduced the
Company's exposure to rapid repayment risk on its mortgage backed securities
portfolio. Diluted earnings per share for the quarter ended September 30, 1998
was $0.03 compared to $0.12, for the quarter ended September 30, 1997, due to
the decrease in net income, and the effect of the stock offering during the
fourth quarter of 1997, by which 1,150,000 additional shares were issued
resulting in a materially larger number of average shares outstanding for the
quarter ended September 30, 1998, compared to the quarter ended September 30,
1997.
Analysis of Net Interest Income
Historically, the Company's earnings have depended primarily upon the
Bank's net interest income, which is the difference between interest earned on
interest-earning assets and interest paid on interest-bearing liabilities. Net
interest income is affected by changes in the mix of the volume and rates of
interest-earning assets and interest-bearing liabilities.
The Company's net interest income increased $786,000, or 30.1%, to $3.4
million for the quarter ended September 30, 1998 from $2.6 million for the
quarter ended September 30, 1997. The increase in net interest income was
primarily due to an increase in average interest-earning assets due to the
purchase of investment securities primarily funded by borrowings, and also in
part to increased business development.
14
<PAGE>
The Company's total interest income increased $2.9 million, or 48.4%, to $8.8
million for the quarter ended September 30, 1998 from $5.9 million for the
quarter ended September 30, 1997. Interest and fees on loans increased $1.4
million, or 31.5%, to $5.7 million for the quarter ended September 30, 1998 from
$4.4 million for the quarter ended September 30, 1997. This increase was due
primarily to an increase in average loans outstanding for the period of $72.2
million. Also contributing to the increase in total interest income was an
increase in interest and dividend income on securities of $1.5 million, or
96.2%, to $3.1 million for the quarter ended September 30, 1998 from $1.6
million for the quarter ended September 30, 1997. This increase in investment
income was the result of an increase in the average balance of securities owned
of $90.9 million, or 98.3%, to $183.4 million for the quarter ended September
30, 1998 from $92.5 million for the quarter ended September 30, 1997.
The increase in the average balance of securities is the result of
leveraged funding programs employed by the Company that utilize Federal Home
Loan Bank ("FHLB") advances to fund securities purchases. The purpose of these
programs is to target growth in net interest income while managing liquidity,
credit, market and interest rate risk. From time to time, a specific leveraged
funding program may attempt to achieve current earnings benefits by funding
security portfolio increases partially with short-term FHLB advances with the
expectation that future growth in deposits will replace the FHLB advances at
maturity.
The decrease in average yield on interest-earning assets from 8.61% for
the quarter ended September 30, 1997 to 8.04% for the same period in 1998, was
largely the result of the Company's strategy to increase its position in
investment securities which have an incrementally lower yield than the existing
interest earning asset base. Therefore, as a result, the total yield on interest
earning assets declined. However, net interest income is benefited by this
strategy, as net interest income increases due to increased volume of investment
securities, net of other borrowings.
The Company's total interest expense increased $2.1 million, or 62.7%,
to $5.4 million for the quarter ended September 30, 1998 from $3.3 million for
the quarter ended September 30, 1997. This increase was due to an increase in
the volume of average interest-bearing liabilities of $128.8 million, or 48.5%,
to $394.2 million for the quarter ended September 30, 1998 from $265.4 million
for the quarter ended September 30, 1997. The average rate paid on
interest-bearing liabilities increased 48 basis points to 5.51% for the quarter
ended September 30, 1998 from 5.03% for the quarter ended September 30, 1997 due
primarily to the increase in average FHLB advances of $124.2 million which were
borrowed at higher incremental rate than the Company's existing interest-bearing
liability base.
Interest expense on time deposits increased $307,000 or 11.4%, to $3.0
million for the quarter ended September 30, 1998 from $2.7 million for the
quarter ended September 30, 1997. This increase was primarily due to an increase
in the average volume of certificates of deposit in the amount of $17.3 million,
or 9.8%, to $193.8 million for the quarter ended September 30, 1998 from $176.5
million for the quarter ended September 30, 1997.
Interest expense on FHLB advances and overnight federal funds purchased
was $2.0 million for the quarter ended September 30, 1998. At September 30,
1998, FHLB advances funded purchases of securities and origination of loans as
part of an ongoing leveraged funding program designed to increase earnings while
also managing interest rate risk and liquidity.
15
<PAGE>
Provision for Loan Losses
The provision for loan losses is charged to operations to bring the
total allowance for loan losses to a level considered appropriate by management.
The level of the allowance for loan losses is determined by management based
upon its evaluation of the known as well as inherent risks within the Company's
loan portfolio. Management's periodic evaluation is based upon an examination of
the portfolio, past loss experience, current economic conditions, the results of
the most recent regulatory examinations and other relevant factors. The
provision for loan losses were $80,000 and $30,000 for the quarters ended
September 30, 1998 and 1997, respectively. This increase is due primarily to an
increase in loans outstanding of $80.0 million from September 30, 1997 to
September 30, 1998.
Non-Interest Income
Total non-interest income increased $22,000 or 14.5%, to $174,000 for
the quarter ended September 30, 1998 from $152,000 for the quarter ended
September 30, 1997. This was mainly attributable to an increase from service fee
income related to loans.
Non-Interest Expenses
Total non-interest expenses increased $1.9 million, to $3.8 million for
the quarter ended September 30, 1998 from $1.9 million for the quarter ended
September 30, 1997. Salaries and benefits increased $334,000, or 31.6%, to $1.4
million for the quarter ended September 30, 1998 from $1.1 million for the
quarter ended September 30, 1997. The increase was due primarily to an increase
in staff as a result of the expansion of the branches. Also included in salary
expense for the quarter ended September 30, 1998 was non-recurring executive
severance costs of approximately $258,000.
Occupancy and equipment expenses increased $54,000, or 17.1%, to
$369,000 for the quarter ended September 30, 1998 from $315,000 for the quarter
ended September 30, 1997 as a result of opening an additional branch office,
during the fourth quarter of 1997.
Other non-interest expense increased $1.5 million, to $2.1 million for
the quarter ended September 30, 1998 from $561,000 for the same period in 1997.
The mortgage servicing portfolio of the Company's mortgage banking affiliate was
impacted by rapid refinancing of mortgages due to declining interest rates,
causing the Company to record a $1.0 million loss to reflect its share of the
loss recorded by the affiliate in the third quarter as well as the Company's
reserve for the estimate of the impact of the devaluation of the affiliate's
servicing portfolio resulting from the decline in market rates. The Company
believes that the reserve is adequate to fully address this impact.
Additionally, legal and real estate costs associated with non-performing assets,
as well as higher advertising expenses contributed to the overall increase.
Provision for Income Taxes
The provision for income taxes decreased $185,000, or 67.5%, to $89,000
for the quarter ended September 30, 1998 from $274,000 for the quarter ended
September 30, 1997. This decrease is mainly the result of the decrease in
pre-tax income from 1997 to 1998.
16
<PAGE>
Cumulative Effect of a Change in Accounting Principle
The Company adopted SFAS No. 133 "Accounting for Derivative Instruments
and Hedging Activities" on July 1, 1998. As permitted by SFAS No. 133, the
company transferred $106.4 million of securities from held to maturity to
available-for-sale and $32.5 million of securities from held to maturity to the
trading category. The Company sold the securities transferred to the trading
category during the third quarter and realized a gain on the sale of these
securities of $421,000, net of income taxes, as a cumulative effect of a change
in accounting principle. The Company sold these securities as part of a
portfolio-restructuring program, which reduced the Company's risk of prepayment
on its mortgage-backed securities portfolio due to the sharp decline in interest
rates during the third quarter.
Nine months ended September 30, 1998 Compared to September 30, 1997
Results of Operations:
Overview
The Company's net income increased $361,000 or 12.0%, to $3.4 million
for the nine months ended September 30, 1998, from $3.0 million for the nine
months ended September 30, 1997. The earnings increased primarily due to an
increase in the Company's net interest income. Included in the results of
operation for the nine months ended September 30, 1998 was a loss from the
Company's mortgage banking affiliate of approximately $1.0 million, including
the Company's estimate of the impact of the devaluation of the affiliate's
servicing portfolio, resulting from a decline in market rates. Partially
offsetting this loss was a gain of $628,000 from the sale of investment
securities, as part of a portfolio restructuring program, which reduced the
Company's exposure to rapid repayment risk on its mortgage backed securities
portfolio. Diluted earnings per share for the nine months ended September 30,
1998 was $0.57 compared to $0.67, for the nine months ended September 30, 1997,
due to the increase in net income, partially offset by the effect of the stock
offering during the fourth quarter of 1997, by which 1,150,000 additional shares
were issued resulting in a materially larger number of average shares
outstanding for the nine months ended September 30, 1998.
Analysis of Net Interest Income
Historically, the Company's earnings have depended primarily upon the
Company's net interest income, which is the difference between interest earned
on interest-earning assets and interest paid on interest-bearing liabilities.
Net interest income is affected by changes in the mix of the volume and rates of
interest-earning assets and interest-bearing liabilities.
The Company's net interest income increased $2.5 million, or 32.4%, to
$10.3 million for the nine months ended September 30, 1998 from $7.7 million for
the nine months ended September 30, 1997. The increase in net interest income
was primarily due to an increase in average interest-earning assets due to the
purchase of investment securities funded by borrowings, and also in part to
increased business development. The Company's total interest income increased
$8.8 million, or 52.2%, to $25.6 million for the nine months ended September 30,
1998 from $16.8 million for the nine months ended September 30, 1997. Interest
and fees on loans increased $3.5 million, or 28.6%, to $15.8 million for the
nine months ended September 30, 1998 from $12.3 million for the nine months
ended September 30, 1997. This
17
<PAGE>
increase was due primarily to an increase in average loans outstanding for the
period of $46.5 million. Also contributing to the increase in total interest
income was an increase in interest and dividend income on securities of $5.3
million, to $9.5 million for the nine months ended September 30, 1998 from $4.2
million for the nine months ended September 30, 1997. This increase in
investment income was the result of an increase in the average balance of
securities owned of $94.1 million, to $177.6 million for the nine months ended
September 30, 1998 from $83.5 million for the nine months ended September 30,
1997. The average yield on interest-earning assets of 8.13% for the nine months
ended September 30, 1998 was unchanged for the same period in 1997.
The increase in the average balance of securities is the result of
leveraged funding programs employed by the Company that use Federal Home Loan
Bank ("FHLB") advances to fund securities purchases. The purpose of these
programs is to target growth in net interest income while managing liquidity,
credit, market and interest rate risk. From time to time, a specific leveraged
funding program may attempt to achieve current earnings benefits by funding
security portfolio increases partially with short-term FHLB advances with the
expectation that future growth in deposits will replace the FHLB advances at
maturity.
The Company's total interest expense increased $6.3 million, or 69.2%,
to $15.3 million for the nine months ended September 30, 1998 from $9.1 million
for the nine months ended September 30, 1997. This increase was due to an
increase in the volume of average interest-bearing liabilities of $139.1
million, or 60.5%, to $368.9 million for the nine months ended September 30,
1998 from $229.8 million for the nine months ended September 30, 1997. The
average rate paid on interest-bearing liabilities increased 29 basis points to
5.62% for the nine months ended September 30, 1998 from 5.33% for the nine
months ended September 30, 1997 due primarily to the increase in average FHLB
advances of $120.3 million which were borrowed at higher incremental rate than
the Company's existing interest-bearing liability base.
Interest expense on time deposits increased $1.1 million, or 14.0%, to
$8.7 million for the nine months ended September 30, 1998 from $7.6 million for
the nine months ended September 30, 1997. This increase was primarily due to an
increase in the average volume of certificates of deposit in the amount of $15.3
million, or 8.8%, to $189.0 million for the nine months ended September 30, 1998
from $173.7 million for the nine months ended September 30, 1997.
Interest expense on FHLB advances was $5.6 million for the nine months
ended September 30, 1998. At September 30, 1998, FHLB advances funded purchases
of securities and origination of loans as part of an ongoing leveraged funding
program designed to increase earnings while also managing interest rate risk and
liquidity. Additionally, the Company utilized FHLB borrowings to fund the Tax
Refund Program during the first quarter in 1998.
Provision for Loan Losses
The provision for loan losses is charged to operations to bring the
total allowance for loan losses to a level considered appropriate by management.
The level of the allowance for loan losses is determined by management based
upon its evaluation of the known as well as inherent risks within the Company's
loan portfolio. Management's periodic evaluation is based upon an examination of
the portfolio, past loss experience, current economic conditions, the results of
the most recent regulatory examinations and other relevant factors. The
provision for loan losses increased $150,000, to $290,000 for the nine months
ended September 30, 1998 from $140,000 for the nine months ended September 30,
1997 primarily due to an increase in loans outstanding of $80.0 million from
September 30, 1997 to September 30, 1998. Non-Interest Income
Total non-interest income increased $186,000 or 7.1%, to $2.8 million
for the nine months ended September 30, 1998 from $2.6 million for the nine
months ended September 30, 1997. The increase was due primarily to a $144,000
increase in Tax Refund Program income associated with an increase in Tax Refund
Product sales in 1998. Additionally, there was an increase in service fees of
$56,000 to $347,000 for the nine months ended September 30, 1998 from $291,000
for the nine months ended September 30, 1997, due to an average increase in core
deposits of $3.9 million.
18
<PAGE>
Non-Interest Expenses
Total non-interest expenses increased $2.5 million, to $8.4 million for
the nine months ended September 30, 1998 from $5.9 million for the nine months
ended September 30, 1997. Salaries and benefits increased $705,000, or 22.9%, to
$3.8 million for the nine months ended September 30, 1998 from $3.1 million for
the nine months ended September 30, 1997. The increase was due primarily to an
increase in staff as a result of the expansion of the branches. Also included in
salary expense for the quarter ended September 30, 1998 was non-recurring
executive severance costs of approximately $258,000.
Occupancy and equipment expenses increased $234,000, or 27.0%, to $1.1
million for the nine months ended September 30, 1998 from $867,000 for the nine
months ended September 30, 1997 as a result of opening four additional branch
offices, during 1997 and 1998.
Other non-interest expense increased $1.6 million, to $3.5 million for
the nine months ended September 30, 1998 from $1.9 million for the same period
in 1997. The mortgage servicing portfolio of the Company's mortgage banking
affiliate was impacted by rapid refinancing of mortgages due to declining
interest rates, causing the Company to record a $1.0 million loss to reflect its
share of the loss recorded by the affiliate in the third quarter as well as the
Company's reserve for the estimate of the impact of the devaluation of the
affiliate's servicing portfolio resulting from the decline in market rates. The
company believes that the reserve is adequate to fully address this impact.
Additionally, legal and real estate cost associated with non-performing assets,
higher advertising expenses, as well as, insurance deductible costs related to a
branch robbery and customer fraud, contributed to the overall increase.
Provision for Income Taxes
The provision for income taxes increased $327,000, or 24.4%, to $1.7
million for the nine months ended September 30, 1998 from $1.3 million for the
nine months ended September 30, 1997. This increase is mainly the result of the
increase in pre-tax income from 1997 to 1998. The effective tax rate in 1998
increased to 33.1% from 30.8% in 1997 primarily due to an increase in permanent
tax difference items, compared to the same period in 1997.
Cumulative Effect of a Change in Accounting Principle
The Company adopted SFAS No. 133 "Accounting for Derivative Instruments
and Hedging Activities" on July 1, 1998. As permitted by SFAS No. 133, the
company transferred $106.4 million of securities from held to maturity to
available-for-sale and $32.5 million of securities from held to maturity to the
19
<PAGE>
trading category. The Company sold the securities transferred to the trading
category during the third quarter and realized a gain on the sale of these
securities of $421,000, net of income taxes, as a cumulative effect of a change
in accounting principle. The Company sold these securities as part of a
portfolio-restructuring program, which reduced the Company's risk of prepayment
on its mortgage-backed securities portfolio due to the sharp decline in interest
rates during the third quarter.
Financial Condition:
September 30, 1998 Compared to December 31, 1997
Total assets increased $105.3 million, or 28.0%, to $480.8 million at
September 30, 1998 from $375.5 million at December 31, 1997. The increase in
assets was the result of higher levels of loans and securities, which were
funded by the increase in deposits and a net increase in other borrowed funds.
Net loans increased $54.4 million, or 25.9%, to $264.4 million at September 30,
1998 from $210.0 million at December 31, 1997. This increase in loans was mainly
attributable to the growth in residential mortgages of $45.2 million. Investment
securities increased $40.4 million, or 27.3%, to $188.4 million at September 30,
1998 from $148.0 million at December 31, 1997. The increase was due primarily to
the purchase of $50.0 million in securities from funds generated through other
borrowed funds as part of the Company's leveraged funding strategy, which is
intended to increase earnings.
Cash and due from banks, interest-bearing deposits, which are held at
the Federal Home Loan Bank of Pittsburgh, and federal funds sold are all liquid
funds. The aggregate amount in these three categories increased by $4.3 million,
or 67.5%, to $10.6 million at September 30, 1998 from $6.3 million at December
31, 1997. This increase is mainly due to the funding related to the Bank's
off-site Automated Teller Machines (ATM) network deployment of 103 throughout
Pennsylvania and New Jersey.
Premises and equipment, net of accumulated depreciation, increased $1.5
million to $4.0 million at September 30, 1998 from $2.5 million at December 31,
1997. The increase was attributable mainly to the renovations of the second
floor at 1608 Walnut Street for the Company's Operations Department, in addition
to renovations to the 1601 Market Street Branch, which replaced the 1515 Market
Street Branch and the addition of the 1818 Market Street Branch, in Philadelphia
PA.
Total liabilities increased $101.2 million, or 29.7%, to $442.0 million
at September 30, 1998 from $340.8 million at December 31, 1997. Deposits, the
Company's primary source of funds, increased $22.8 million, or 9.2% to $271.2
million at September 30, 1998 from $248.4 million at December 31, 1997. The
aggregate of transaction accounts, which include demand, money market and
savings accounts, increased $1.4 million, or 2.1%, to $69.2 million at September
30, 1998 from $67.8 million at December 31, 1997. Certificates of deposit
increased by $21.5 million, or 11.9%, to $202.0 million at September 30, 1998
from $180.6 million at December 31, 1997.
Other borrowed funds were $162.1 million at September 30, 1998 as
compared to $85.9 million at December 31, 1997. The increase was primarily the
result of the Company's leveraged funding strategy of utilizing short-term and
long-term FHLB advances to purchase investment securities and to fund new loan
originations.
20
<PAGE>
Interest Rate Risk Management
Interest rate risk management involves managing the extent to which
interest-sensitive assets and interest-sensitive liabilities are matched. The
Company typically defines interest-sensitive assets and interest-sensitive
liabilities as those that reprice within one year or less. Maintaining an
appropriate match is a method of avoiding wide fluctuations in net interest
margin during periods of changing interest rates.
The difference between interest-sensitive assets and interest-sensitive
liabilities is known as the "interest-sensitivity gap" ("GAP"). A positive GAP
occurs when interest-sensitive assets exceed interest-sensitive liabilities
repricing in the same time periods, and a negative GAP occurs when
interest-sensitive liabilities exceed interest-sensitive assets repricing in the
same time periods. A negative GAP ratio suggests that a financial institution
may be better positioned to take advantage of declining interest rates rather
than increasing interest rates and a positive GAP suggests the converse.
Static Gap analysis describes interest rate sensitivity at a point in
time. However, it alone does not accurately measure the magnitude of changes in
net interest income since changes in interest rates do not impact all categories
of assets and liabilities equally or simultaneously. Interest rate sensitivity
analysis also involves assumptions on certain categories of assets and deposits.
For purposes of interest rate sensitivity analysis, assets and liabilities are
stated at their contractual maturity, estimated likely call date, or earliest
repricing opportunity. Mortgage-backed securities and amortizing loans are
scheduled based on their anticipated cash flow, which also considers
prepayments, based on historical data and current market trends. Savings
accounts, including passbook, statement savings, money market, and NOW accounts,
do not have a stated maturity or repricing term and can be withdrawn or repriced
at any time. This may impact the Company's margin if more expensive alternative
sources of deposits are required to fund loans or deposit runoff. Management
projects the repricing characteristics of these accounts based on historical
performance and assumptions that it believes reflect their rate sensitivity.
Therefore, for purposes of the gap analysis, these deposits are not considered
to reprice simultaneously. Accordingly, portions of the deposits are moved into
time periods exceeding one year.
Shortcomings are inherent in a simplified and static GAP analysis that
may result in an institution with a negative GAP having interest rate behavior
associated with an asset-sensitive balance sheet. For example, although certain
assets and liabilities may have similar maturities or periods to repricing, they
may react in different degrees to changes in market interest rates. Furthermore,
repricing characteristics of certain assets and liabilities may vary
substantially within a given time period. In the event of a change in interest
rates, prepayment and early withdrawal levels could also deviate significantly
from those assumed in calculating GAP in the manner presented in the table
below.
The Company attempts to manage its assets and liabilities in a manner
that stabilizes net interest income under a broad range of interest rate
environments. Adjustments to the mix of assets and liabilities are made
periodically in an effort to provide dependable and steady growth in net
interest income regardless of the behavior of interest rates.
Management presently believes that the effect on the Company of any
future rise in interest rates would be beneficial since the Company has
generally more interest sensitive assets repricing during the next year, than
interest bearing liabilities. However, a decrease in interest rates generally
could have a detrimental effect on the Company, due to the timing difference
between repricing the Company's liabilities, primarily certificates of deposit,
and other borrowings, and the largely automatic repricing of
21
<PAGE>
its existing interest-earning assets.
Since the assets and liabilities of the Company have diverse repricing
characteristics that influence net interest income, management analyzes interest
sensitivity through the use of gap analysis and simulation models. Interest rate
sensitivity management seeks to minimize the effect of interest rate changes on
net interest margins and interest rate spreads, and to provide growth in net
interest income through periods of changing interest rates. The Finance
Committee is responsible for managing interest rate risk and for evaluating the
impact of changing interest rate conditions on net interest income. The
Company's Finance Committee acts as its asset/liability committee.
The following table presents a summary of the Company's interest rate
sensitivity GAP at September 30, 1998. For purposes of these tables, the Company
has used assumptions based on industry data and historical experience to
calculate the expected maturity of loans because, statistically, certain
categories of loans are prepaid before their maturity date, even without regard
to interest rate fluctuations. Additionally certain prepayment assumptions were
made with regard to investment securities based upon the expected prepayment of
the underlying collateral of the mortgage-backed securities.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
First Republic Bank
Interest Sensitive Gap
September 30, 1998
- ----------------------------------------------------------------------------------------------------------------------------------
0 - 90 91 - 180 181 - 365 1 - 5 5 YRS &
Days Days Days Years Over Total
Interest Sensitive Assets:
Interest Bearing Balances
Due From Banks $ 799 $ 0 $ 0 $ 0 $ 0 $ 799
Federal Funds Sold 0 0 0 0 0 0
Investment Securities 53,537 9,910 19,113 52,325 53,514 188,399
Loans 83,419 11,359 21,133 114,162 36,666 266,739
Totals 137,755 21,269 40,246 166,487 90,180 455,937
Cumulative Totals $ 137,755 $ 159,024 $ 199,270 $ 365,757 $ 455,937
Interest Sensitive Liabilities:
Demand Interest Bearing $ 8,044 $ 760 $ 1,520 $ 2,755 $ 127 $ 13,206
Savings Accounts 640 61 121 968 1,254 3,044
Money Market Accounts 11,887 875 1,750 13,945 0 28,457
FHLB Borrowings 14,736 0 7,400 90,000 50,000 162,136
Time Deposits 34,689 29,959 56,380 81,011 0 202,039
Totals $ 69,996 $ 31,655 $ 67,171 $ 188,679 $ 51,381 $ 408,899
Cumulative Totals $ 69,996 $ 101,651 $ 168,822 $ 357,501 $ 408,882
GAP $ 67,759 $ (10,386) $ (26,925) $ (22,192) $ 38,799 $ 47,055
Cumulative GAP $ 67,759 $ 57,373 $ 30,448 $ 8,256 $ 47,055 $ 0
Interest Sensitive Assets/
Interest Sensitive Liabilities 2.0 x 1.6 x 1.2 x 1.0 x 1.1 x
Cumulative GAP/
Total Earning Assets 14.9% 12.6% 6.7% 1.8% 10.3%
Total Earning Assets $ 455,937
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
Capital Resources
Shareholders' equity in the Company as of September 30, 1998 totaled
$38,736,000 compared to $34,622,000 as of December 31, 1997.
Book value per share of the Company's common stock increased to $6.98
as of September 30, 1998 from $6.28 as of December 31, 1997.
The Company has implemented a stock repurchase program in which an
aggregate amount not exceeding 4.9% or approximately 270,000 shares of the
Company's stock will be repurchased from time to time through June 30, 1999. The
Company will execute the program through open market purchases. As of September
30, 1998, the Company has repurchased 2,000 shares of stock at a cost of $8.50
per share, or $17,000.
Regulatory Capital Requirements
The Bank is required to comply with certain "risk-based" capital
adequacy guidelines issued by the Federal Reserve Bank (the "FRB") and the
Federal Deposit Insurance Corporation (the "FDIC"). The risk-based capital
guidelines assign varying risk weights to the individual assets held by a bank.
The guidelines also assign weights to the "credit-equivalent" amounts of certain
off-balance sheet items, such as letters of credit and interest rate and
currency swap contracts. Under these guidelines, banks are expected to meet a
minimum target ratio for "qualifying total capital" to weighted risk assets of
8%, at least one-half of which is to be in the form of "Tier 1 capital".
Qualifying total capital is divided into two separate categories or "tiers".
"Tier 1 capital" includes common stockholders' equity, certain qualifying
perpetual preferred stock and minority interests in the equity accounts of
consolidated subsidiaries, less goodwill. "Tier 2 capital" components (limited
in the aggregate to one-half of total qualifying capital) includes allowances
for credit losses (within limits), certain excess levels of perpetual preferred
stock and certain types of "hybrid" capital instruments, subordinated debt and
other preferred stock. Applying the federal guidelines, the ratio of qualifying
total capital to weighted-risk assets was 11.55% and 12.56% at September 30,
1998 and December 31, 1997, respectively, and as required by the guidelines, at
least one-half of the qualifying total capital consisted of Tier l capital
elements. Tier l risk-based capital ratios on September 30, 1998 and December
31, 1997 was 10.70% and 11.65%, respectively. At September 30, 1998, and
December 31, 1997, the Bank exceeded the requirements for risk-based capital
adequacy under both federal and Pennsylvania guidelines.
Under FRB and FDIC regulations, a bank is deemed to be "well
capitalized" when it has a "leverage ratio" ("Tier l capital to total quarterly
average assets") of at least 5%, a Tier l capital to risk-weighted assets ratio
of at least 4%, and a total capital to weighted-risk assets ratio of at least
8%. At September 30, 1998 and December 31, 1997, the Bank's leverage ratio was
6.27% and 7.86% respectively. At September 30, 1998 and December 31, 1997, the
consolidated company's leverage ratio was 8.13% and 10.40%, respectively.
Accordingly, at September 30, 1998 and December 31, 1997, the Bank was
considered "well capitalized" under FRB and FDIC regulations.
Federal banking agencies impose three minimum capital requirements on
the Bank's risk-based capital ratios based on total capital, Tier 1 capital, and
a leverage capital ratio. The risk-based capital ratios measure the adequacy of
a bank's capital against the riskiness of its assets and off-balance sheet
activities.
23
<PAGE>
Failure to maintain adequate capital is a basis for "prompt corrective action"
or other regulatory enforcement action. In assessing a bank's capital adequacy,
regulators also consider other factors such as interest rate risk exposure;
liquidity, funding and market risks; quality and level of earnings;
concentrations of credit, quality of loans and investments; risks of any
nontraditional activities; effectiveness of bank policies; and management's
overall ability to monitor and control risks.
The following table presents the Bank's capital regulatory ratios at
September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
To be well
For capital capitalized under FRB
Actual adequacy purposes capital guidelines
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
As of September 30, 1998:
Total risk based capital $31,452 11.55% $21,779 8.00% $27,224 10.00%
Tier I capital 29,128 10.70% 10,889 4.00% 16,335 6.00%
Tier I (leveraged) capital 29,128 6.27% 23,227 5.00% 23,227 5.00%
As of December 31, 1997:
Total risk based capital $28,003 12.56% $17,831 8.00% $22,289 10.00%
Tier I capital 25,975 11.65% 8,916 4.00% 13,374 6.00%
Tier I (leveraged) capital 25,975 7.86% 16,525 5.00% 16,525 5.00%
</TABLE>
The Bank's ability to maintain the required levels of capital is
substantially dependent upon the success of the Bank's capital and business
plans, the impact of future economic events on the Bank's loan customers, the
Bank`s ability to manage its interest rate risk and control its growth and other
operating expenses.
In addition to the above minimum capital requirements, the FRB approved
a rule that became effective on December 19, 1992 implementing a statutory
requirement that federal banking regulators take specified "prompt corrective
action" when an insured institution's capital level falls below certain levels.
The rule defines five capital categories based on several of the above capital
ratios. The Bank currently exceeds the levels required for a bank to be
classified as "well capitalized". However, the Federal Reserve Bank may consider
other criteria when determining such classifications which consideration could
result in a downgrading in such classifications.
Liquidity
Financial institutions must maintain liquidity to meet day-to-day
requirements of depositors and borrowers, take advantage of market
opportunities, and provide a cushion against unforeseen needs. Liquidity needs
can be met by either reducing assets or increasing liabilities. Sources of asset
liquidity are provided by cash and amounts due from banks, interest-bearing
deposits with banks, and federal funds sold. The Company's liquid assets totaled
$10.6 million at September 30, 1998 compared to $6.3 million at December 31,
1997. Maturing and repaying loans and securities are another source of asset
liquidity, as well as securities designated as available for sale.
24
<PAGE>
Liability liquidity can be met by attracting deposits with competitive
rates, buying federal funds or utilizing the facilities of the Federal Reserve
System or the Federal Home Loan Bank System. The Company utilizes a variety of
these methods of liability liquidity. At September 30, 1998, the Company had
$81.4 million in unused lines of credit available to it under arrangements with
correspondent banks compared to $50.1 million at December 31, 1997. These lines
of credit enable the Company to purchase funds for short-term needs at current
market rates.
At September 30, 1998, the Company had outstanding commitments
(including unused lines of credit and letters of credit) of $16.7 million.
Certificates of deposit which are scheduled to mature within one year totaled
$121.0 million at September 30, 1998, and other borrowed funds that are
scheduled to mature within the same period amounted to $22.1 million. The
Company anticipates that it will have sufficient funds available to meet its
current commitments.
The Company's target and actual liquidity levels are determined and
managed based on management's comparison of the maturities and marketability of
the Company's interest-earning assets with its projected future maturities of
deposits and other liabilities. Management currently believes that floating rate
commercial loans, short-term market instruments, such as 2-year United States
Treasury Notes, adjustable rate mortgage-backed securities issued by government
agencies, and federal funds, are the most appropriate approach to satisfy the
Company's liquidity needs. The Company has established collateralized lines of
credit from correspondents to assist in managing the Company's liquidity
position. These lines of credit total $7.0 million in the aggregate.
Additionally, the Company has established a line of credit with the Federal Home
Loan Bank of Pittsburgh with a maximum borrowing capacity of approximately
$236.0 million. An aggregate of $162.1 million was outstanding on the
aforementioned lines of credit at September 30, 1998. The Company's Board of
Directors has appointed a Finance Committee to assist Management in establishing
parameters for investments.
Operating cash flows are primarily derived from cash provided from net
income during the year. Cash used in investment activities for the years ended
September 30, 1998 and December 31, 1997 were primarily due to the investing of
excess and borrowed funds into investment securities. Cash was provided by
financing activities during 1998 and 1997, as the Company has grown its deposit
base and increased its other borrowed funds to fund anticipated loan growth.
The Company's Finance Committee also acts as an Asset/Liability
Management Committee, which is responsible for managing the liquidity, position
and interest sensitivity of the Company. Such committee's primary objective is
to maximize net interest margin in an ever changing rate environment, while
balancing the Company's interest-sensitive assets and liabilities and providing
adequate liquidity for projected needs.
Securities Portfolio
The Company classifies its securities under one of these categories:
"held-to-maturity" which is accounted for at historical cost, adjusted for
accretion of discounts and amortization of premiums; "available-for-sale" which
is accounted for at fair market value, with unrealized gains and losses reported
as a separate component of shareholders' equity; or "trading" which is accounted
for at fair market value, with unrealized gains and losses reported as a
component of net income.
25
<PAGE>
At September 30, 1998, the Company had identified certain investment
securities that are being held for indefinite periods of time, including
securities that will be used as part of the Company's asset/liability management
strategy and that may be sold in response to changes in interest rates,
prepayments and similar factors. These securities are classified as
available-for-sale and are intended to increase the flexibility of the Company's
asset/liability management. Available-for-sale securities consist of US
Government Agency securities and other investments. The book and market values
of securities available-for-sale were $147.3 million and $148.4 million as of
September 30, 1998. The net unrealized gain on securities available-for-sale, as
of this date, was $1,059,000.
The following table represents the carrying and estimated fair values
of Investment Securities at September 30, 1998.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Gross Gross
Amortized Unrealized Unrealized
Available-for-Sale Cost Gain Loss Fair Value
------------ ------------ ------------ ------------
Mortgage-backed $133,679,000 $ 991,000 $ (99,000) $134,571,000
U.S. Government Agencies 13,624,000 175,000 (8,000) 13,791,000
------------ ------------ ------------ ------------
Total Available-for-Sale $147,303,000 $ 1,166,000 $ (107,000) $148,362,000
============ ============ ============ ============
Gross Gross
Amortized Unrealized Unrealized
Held-to-Maturity Cost Gain Loss Fair Value
------------ ------------ ------------ ------------
Mortgage-backed $ 5,091,000 $ 21,000 $ (13,000) $ 5,099,000
US Government Agencies 25,277,000 73,000 (2,000) 25,348,000
Other 9,690,000 0 0 9,690,000
------------ ------------ ------------ ------------
Total Held-to-Maturity $ 40,058,000 $ 94,000 $ (15,000) $ 40,137,000
============ ============ ============ ============
</TABLE>
The Company adopted SFAS Statement No. 133 "Accounting for Derivative
Instruments and Hedging Activities" on July 1, 1998. As permitted by SFAS
Statement No. 133, the company transferred $106.4 million of securities from
held to maturity to available-for-sale and $32.5 million of securities from held
to maturity to the trading category. The Company sold the securities transferred
to the trading category during the third quarter and realized a gain on the sale
of these securities of $421,000, net of income taxes, as a cumulative effect of
a change in accounting principle. The Company sold these securities as part of a
portfolio-restructuring program, which reduced the Company's risk of prepayment
on its mortgage-backed securities portfolio due to the sharp decline in interest
rates during the third quarter.
Loan Portfolio
The Company's loan portfolio consists of commercial loans, commercial
real estate loans, commercial loans secured by one-to-four family residential
property, as well as residential, home equity loans and consumer loans.
Commercial loans are primarily term loans made to small-to-medium-sized
businesses and professionals for working capital purposes. The majority of these
commercial loans are collateralized by real estate and further secured by other
collateral and personal guarantees. The Company's
26
<PAGE>
commercial loans generally range from $250,000 to $750,000 in amount.
The Company's net loans increased $54.4 million, or 25.9%, to $264.4
million at September 30, 1998 from $210.0 million at December 31, 1997, which
were primarily funded by an increase in other borrowed funds.
The following table sets forth the Company's gross loans by major
categories for the periods indicated:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
As of September 30, 1998 As of December 31, 1997
Balance % of Total Balance % of Total
-------------------- ----------------- -------------------- -----------------
Real Estate:
1-4 Family $110,398,000 41.4% $ 71,241,000 33.6%
Multi-Family 20,997,000 7.9% 7,125,000 3.4%
Commercial Real Estate 95,593,000 35.8% 87,701,000 41.4%
-------------------- ----------------- -------------------- -----------------
Total Real Estate 226,988,000 85.1% 166,067,000 78.4%
Commercial 38,406,000 14.4% 42,519,000 20.0%
Other 1,352,000 .5% 3,441,000 1.6%
-------------------- ----------------- -------------------- -----------------
Total Loans $266,746,000 100.0% $212,027,000 100.0%
</TABLE>
Credit Quality
The Company's written lending policies require underwriting, loan
documentation, and credit analysis standards to be met prior to funding. In
addition, a senior loan officer reviews all loan applications. The Board of
Directors reviews the status of loans monthly to ensure that proper standards
are maintained.
Loans, including impaired loans, are generally classified as nonaccrual
if they are past due as to maturity or payment of principal and/or interest for
a period of more than 90 days, unless such loans are well-secured and in the
process of collection. Loans that are on a current payment status or past due
less than 90 days may also be classified as nonaccrual if repayment in full of
principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest
amounts contractually due are reasonably assured of repayment within an
acceptable period of time, and there is a sustained period of repayment
performance (generally a minimum of six months) by the borrower, in accordance
with the contractual terms of the loan.
While a loan is classified as nonaccrual or as an impaired loan and the
future collectability of the recorded loan balance is doubtful, collections of
interest and principal are generally applied as a reduction to principal
outstanding. When the future collectability of the recorded loan balance is
expected, interest income may be recognized on a cash basis. In the case where a
nonaccrual loan had been partially charged off, recognition of interest on a
cash basis is limited to that which would have been recognized on the remaining
recorded loan balance at the contractual interest rate. Cash interest receipts
in excess of that amount are recorded as recoveries to the allowance for loan
losses until prior charge-offs have been fully recovered.
27
<PAGE>
The following summary shows information concerning loan delinquency and
other non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
---------------------------------------------
<S> <C> <C>
Loans accruing, but past due 90 days or more $ 543,000 $ 113,000
Non-accrual loans 1,096,000 1,800,000
---------------------------------------------
Total non-performing loans (1) 1,639,000 1,913,000
Foreclosed real estate 2,673,000 1,944,000
---------------------------------------------
Total non-performing assets (2) $4,312,000 $3,857,000
=============================================
Non-performing loans as a percentage of total
Loans, net of unearned income 0.61% 0.90%
Non-performing assets as a percentage of total
assets 0.90% 1.03%
<FN>
(1) Non-performing loans are comprised of (i) loans that are on a nonaccrual
basis; (ii) accruing loans that are 90 days or more past due and (iii)
restructured loans.
(2) Non-performing assets are composed of non-performing loans and foreclosed
real estate (assets acquired in foreclosure).
</FN>
</TABLE>
Total non-performing loans decreased due to the transfer of a
non-accruing loan to other real estate in the amount of $718,000. This decrease
was partially offset by a group of loans to the same borrower of approximately
$500,000 migrating to a non-accrual status.
At September 30, 1998, the Company had no foreign loans and no loan
concentrations exceeding 10% of total loans except for credits extended to real
estate agents and managers in the aggregate amount of $61.7 million, which
represented 23.1% of gross loans receivable. Loan concentrations are considered
to exist when there are amounts loaned to a multiple number of borrowers engaged
in similar activities that would cause them to be similarly impacted by economic
or other conditions.
Foreclosed real estate is initially recorded at the lower or cost or
fair value, net of estimated selling costs at the date of foreclosure. After
foreclosure, management periodically performs valuations and any subsequent
deteriations in fair value, and all other revenue and expenses are charged
against operating expenses in the period in which they occur.
Potential problem loans consist of loans that are included in
performing loans, but for which potential credit problems of the borrowers have
caused management to have serious doubts as to the ability of such borrowers to
continue to comply with present repayment terms. At September 30, 1998, all
identified potential problem loans are included in the preceding table.
The Company had no credit exposure to "highly leveraged transactions"
at September 30, 1998, as defined by the FRB.
28
<PAGE>
Allowance for Loan Losses
A detailed analysis of the Company's allowance for loan losses for the
nine months ended September 30, 1998, and 1997 and the twelve months ended
December 31, 1997:
<TABLE>
<CAPTION>
For the nine months For the twelve months For the nine months
ended ended ended
September 30,1998 December 31, 1997 September 30 1997
------------- ------------- -------------
<S> <C> <C> <C>
Balance at beginning of period $ 2,028,000 $ 2,092,000 $ 2,092,000
Charge-offs:
Commercial 55,000 383.000 26,000
Real estate 0 67,000 300,000
Consumer 0 31,000 61,000
------------- ------------- -------------
Total charge-offs 55,000 481,000 387,000
------------- ------------- -------------
Recoveries:
Commercial 48,000 18,000 15,000
Real estate 0 67,000 60,000
Consumer 13,000 12,000 11,000
------------- ------------- -------------
Total recoveries 61,000 97,000 86,000
------------- ------------- -------------
Net charge-offs (6,000) 384,000 (301,000)
------------- ------------- -------------
Provision for loan losses 290,000 320,000 140,000
------------- ------------- -------------
Balance at end of period $ 2,324,000 $ 2,028,000 $ 1,931,000
============= ============= =============
Average loans outstanding (1) $ 236,874,000 $ 183,246,000 $ 190,373,000
============= ============= =============
As a percent of average loans (1):
Net charge-offs 0.00% 0.21% 0.17%
Provision for loan losses 0.12% 0.17% 0.07%
Allowance for loan losses 0.98% 1.11% 1.07%
Allowance for possible loan losses to:
Total loans, net of unearned income 0.87% 0.96% 1.04%
Total non-performing loans 141.79% 106.01% 117.24%
(1) Includes nonaccruing loans
</TABLE>
Management makes a monthly determination as to an appropriate provision
from earnings necessary to maintain an allowance for loan losses that is
adequate based upon the loan portfolio composition, classified problem loans,
and general economic conditions. The Company's Board of Directors periodically
reviews the status of all nonaccrual and impaired loans and loans criticized by
the Company's regulators and internal loan review officer. The internal loan
review officer reviews both the loan portfolio and the overall adequacy of the
loan loss reserve. During the review of the loan loss reserve, the Board of
Directors considers specific loans, pools of similar loans, and historical
charge-off activity. The sum of these components is compared to the loan loss
reserve balance. Any additions deemed necessary to the loan loss reserve balance
are charged to operations.
The Company has an existing loan review program, which monitors the
loan portfolio on an ongoing basis. Loan review is conducted by a loan review
officer and is reported quarterly to the Board of Directors. The Board of
Directors reviews the finding of the loan review program on a monthly basis.
29
<PAGE>
Determining the appropriate level of the allowance for loan losses at
any given date is difficult, particularly in a continually changing economy.
However, there can be no assurance that, if asset quality deteriorates in future
periods, additions to the allowance for loan losses will not be required.
The Company's management considers the entire allowance for loan losses
to be adequate, however, to comply with regulatory reporting requirements,
management has allocated the allowance for loan losses as shown in the table
below into components by loan type at each period end. Through such allocations,
management does not intend to imply that actual future charge-offs will
necessarily follow the same pattern or that any portion of the allowance is
restricted.
<TABLE>
<CAPTION>
(At September 30, 1998) (At December 31, 1997)
1998 1997
Percent of Loans Percent of Loans
In Each Category In Each Category
Amount To Loans (1) Amount to Loans (1)
<S> <C> <C> <C> <C>
Allocation of allowance for loan losses:
Commercial $1,560,000 50.09% $1,595,000 61.42%
Residential real estate 290,000 49.12% 41,000 36.96%
Consumer and other 17,000 0.79% 58,000 1.62%
Unallocated 457,000 334,000
------------------ -----------------
Total $2,324,000 $2,028,000
================== =================
</TABLE>
The unallocated allowance increased $123,000 to $457,000 at September
30, 1998 from $334,000 at December 31, 1997.
(1) Gross loans net of unearned income and allowance for loan loss.
The Company had delinquent loans as of September 30, 1998 and December
31, 1997 as follows; (i) 30 to 59 days past due, consisted of commercial and
consumer and home equity loans in the aggregate principal amount of $37,000 and
$2,694,000 respectively; and (ii) 60 to 89 days past due, consisted of
commercial and consumer loan in the aggregate principal amount of $389,000 and
$340,000 respectively. In addition, the Company has classified certain loans as
substandard and doubtful (as those terms are defined in applicable Bank
regulations). At September 30, 1998 and December 31, 1997, substandard loans
totaled approximately $1,573,000 and $2,402,000 respectively; and doubtful loans
totaled approximately $0 and $16,000 respectively.
Deposit Structure
Total deposits at September 30, 1998 consisted of approximately $24.6
million in non-interest-bearing demand deposits, approximately $13.1 million in
interest-bearing demand deposits, approximately $31.5 million in savings
deposits and money market accounts, approximately $176.7 million in time
deposits under $100,000, and approximately $25.4 million in time deposits
greater than $100,000. In general, the Bank pays higher interest rates on time
deposits over $100,000 in principal amount. Due to the nature of time deposits
and changes in the interest rate market generally, it should be expected that
the Company's deposit liabilities may fluctuate from period-to-period.
30
<PAGE>
The following table is a distribution of the balances of the Company's
average deposit balances and the average rates paid therein for the nine months
ended September 30, 1998 and the year ended December 31, 1997.
<TABLE>
<CAPTION>
Average Deposit Table
For the nine months ended For the twelve months ended
September 30, 1998 December 31, 1997
Balance Rate Balance Rate
<S> <C> <C> <C> <C>
Non-interest-bearing balances (1) $ 36,079,000 N/A $ 25,551,000 N/A
======================================================================
Money market and savings deposits 33,377,000 3.28% 34,141,000 2.88%
Time deposits 189,019,000 6.19% 174,887,000 5.92%
Demand deposits, interest-bearing 10,598,000 2.50% 8,428,000 2.50%
----------------------------------------------------------------------
Total interest-bearing deposits $232,993,000 5.61% $217,456,000 5.31%
======================================================================
</TABLE>
(1) Note that approximately $10.2 million of these balances during the nine
months ended September 30, 1998 are related to the Tax Refund Program.
The following is a breakdown, by contractual maturities, of the
Company's time deposits issued in denominations of $100,000 or more as of
September 30, 1998 and December 31, 1997.
September 30, December 31,
1998 1997
----------- -----------
Maturing in:
Three months or less $10,837,000 $ 9,896,000
Over three months through six months 14,514,000 8,726,000
Over six months through twelve months 0 7,233,000
Over twelve months 0 2,719,000
----------- -----------
Total $25,351,000 $28,574,000
=========== ===========
Commitments
In the normal course of its business, the Company makes commitments to
extend credit and issues standby letters of credit. Generally, such commitments
are provided as a service to its customers. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirement. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The type and amount of collateral obtained, if deemed
necessary upon extension of credit, are based on
31
<PAGE>
Management's credit evaluation of the borrower. Standby letters of credit are
conditional commitments issued to guarantee the performance of a customer to a
third party. The credit risk involved in issuing standby letters of credit is
essentially the same as that involved in extending loan facilities to customers
and is based on Management's evaluation of the creditworthiness of the borrower
and the quality of the collateral. At September 30, 1998 and December 31, 1997,
firm loan commitments approximated $16.7 million and $17.3 million respectively
and commitments of standby letters of credit approximated $208,000 and $453,000,
respectively.
Effects of Inflation
The majority of assets and liabilities of a financial institution are
monetary in nature. Therefore, a financial institution differs greatly from most
commercial and industrial companies that have significant investments in fixed
assets or inventories. Management believes that the most significant impact of
inflation on financial results is the Company's need and ability to react to
changes in interest rates. As discussed previously, management attempts to
maintain an essentially balanced position between rate sensitive assets and
liabilities over a one year time horizon in order to protect net interest income
from being affected by wide interest rate fluctuations.
Year 2000 Issue
The following section contains forward-looking statements which involve risks
and uncertainties. The actual impact on the Company of the year 2000 issue could
materially differ form that which is anticipated in the forward looking
statements as a result of certain factors identified below.
Many existing computer programs use only two digits to identify a year in the
date field. These programs were designed and developed without considering the
impact of the upcoming change in the century. If not corrected, many computer
applications could fail or create erroneous results by or at the Year 2000. The
Year 2000 issue affects virtually all companies and organizations.
The Company is subject to various regulations and oversight by regulatory
authorities, including the Federal Reserve Bank, the Pennsylvania Department of
Banking and the Federal Deposit Insurance Corporation (FDIC). These regulatory
agencies have coordinated various regulatory examinations focusing on the year
2000 issues, and report their findings to the Company's management and the Board
of Directors.
Company's State of Readiness
The Company's management is committed to ensuring that the Company's daily
operations suffer little impact as a result of the date change at the end of the
century. The Company is following the Federal Financial Institutions Examination
Council's (FFIEC), Interagency Guidelines. The guidelines identify a process in
which year 2000 issues are addressed, such as awareness, assessment,
remediation, testing and implementation.
The Company has identified key areas for which management is focusing its
efforts. These areas include data center, desktop environment and networks,
branch environment and services, financial applications, facilities, legal,
insurance, audit and outside services. For each of these areas identified, the
Company is
32
<PAGE>
employing a process which will compile inventories of all identified areas which
could be effected by the year 2000. A testing schedule is defined and the
identified systems are tested, and results evaluated. A remedy process is then
defined, and implemented and testing is performed again. The process is repeated
until repairs are complete.
It is anticipated that all identified critical applications will be tested
before December 31, 1998. Testing validation and repair is scheduled to be
performed and completed during the first quarter of 1999.
The Company has relationships with third parties including its borrowers, which
are also subject to the year 2000 uncertainties. Management has identified
relationships which are considered material, and would have an adverse effect on
the Bank and the Company if such third parties were not year 2000 compliant.
Management has solicited year 2000 certifications from significant vendors, and
have also completed their own year 2000 due diligence. No borrower or third
party vendor has given the Company a response that indicates that they will not
be Year 2000 compliant. It is anticipated that all identified third party
vendors will be compliant, however, no assurance can be given with regard to
their compliance with year 2000. Also, no assurances can be given that a third
party vendor or borrower will not have a material effect on the Company or Bank,
due to their non-compliance with he year 2000 issue.
Costs of Year 2000
The Company has spent approximately $50,000 and estimates that the future dollar
cost to the Company to be in compliance with the year 2000 issue will range from
$175,000 to $250,000 over the next fifteen months. These costs include new
equipment and software purchases, in addition to testing applications prior to
the year 2000.
Risks of the Company's Year 2000 Issues
Management believes that it has addressed the major areas with respect to Year
2000 compliance. Management also believes its progress of remedying year 2000
issues is being completed according to plan. However, there can be no assurances
that the Company will not be impacted by Year 2000 complications.
Contingency Plans
The Company has prepared or is in the process of preparing contingency plans for
each major area of business identified above. The plans will utilize other third
party vendors and manual intervention, to compensate for the loss of certain
computer system. All such plans will be completed by year end 1998.
Recent Accounting Pronouncements:
Operating Segment Disclosure
In June 1997, the Financial Accounting Standard Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") Statement No. 131,
"Disclosures About Segments of an Enterprise and Related Information". Statement
of FASB No. 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. Statement No. 131 is effective for annual
periods beginning after December 15, 1997. The Company will present the required
disclosures in its year end 1998 financial statements.
33
<PAGE>
Employers' Disclosures about Pension and Other Postretirement Benefits
In February 1998, the FASB issued SFAS Statement No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits", which amends the
disclosure requirements of Statement No. 87, "Employers' Accounting for
Pensions", Statement No. 88, "Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pensions Plans and for Termination Benefits",
and Statement No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions". Statement No. 132 is applicable to all entities. This Statement
standardizes the disclosure requirements of Statements No. 87 and No. 106 to the
extent practicable and recommends a parallel format for presenting information
about pensions and other postretirement benefits. Statement No. 132 only
addresses disclosure and does not change any of the measurement or recognition
provisions provided for in Statements No. 87, No. 88, or No. 106. The Statement
is effective for fiscal years beginning after December 15, 1997. Restatement of
comparative period disclosures is required if the information is not readily
available, in which case the notes to the financial statements shall include all
available information and a description of the information not available. The
Company will present the required disclosures in its year end 1998 financial
statements.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This Statement standardizes the accounting
for derivative instruments, including certain derivative instruments embedded in
other contracts, and those used for hedging activities, by requiring that an
entity recognize those items as assets or liabilities in the statement of
financial position and measure them at fair value. The statement categorized
derivatives used for hedging purposes as either fair value hedges, cash flow
hedges, foreign currency fair value hedges, foreign currency cash flow hedges,
or hedges of net investments in foreign operations. The statement generally
provides for matching of gain or loss recognition on the hedging instrument with
the recognition of the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk, so long as the hedge is
effective. Prospective application of Statement 133 is required for all fiscal
years beginning after June 15, 1999, however earlier application is permitted.
The Company has adopted this statement effective July 1, 1998, which permitted
the transfer of certain securities originally designated as held-to-maturity, to
available-for-sale. A portion of these securities was subsequently sold during
the third quarter of 1998. In accordance with SFAS No. 133, the Company recorded
the gross gain of $628,000 as a cumulative change in accounting principle, net
of a $207,000 provision for income tax.
Accounting for Mortgage-backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise
In October 1998, the FASB issued Statement No. 134, "Accounting for
Mortgage-backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise". This statement requires that
after the securitization of a mortgage loan held for sale, and equity engaged in
mortgage banking activities classify any retained mortgage-backed securities
based on the ability and intent to sell or hold those investments, except that a
mortgage banking enterprise must classify as trading any retained
mortgage-backed securities that is commits to sell before or during the
securitization process. This Statement is effective for the first fiscal quarter
beginning after December 15, 1998 with earlier adoption permitted. This
Statement provides a one-time opportunity for an enterprise to reclassify, based
on the
34
<PAGE>
ability and intent on the date of adoption of this Statement, mortgage-backed
securities and other beneficial interests retained after securitization of
mortgage loans held for sale from the trading category, except for those with
sales commitments in place. The Company has not yet determined the impact, if
any, of this Statement, including, if applicable, its provision for the
potential reclassifications of certain investment securities, on earnings,
financial condition or equity.
PART II - OTHER INFORMATION
Item 1: Legal Proceedings
The Company, along with a number of other financial institutions, has
been made a party to a lawsuit brought by a New Jersey bank claiming damages of
approximately $200,000 arising out of a series of mortgage loans made to a
borrower who apparently procured one or more of these loans fraudulently. The
Company believes that it has a valid defense to this claim. In addition, one of
these loans in the amount of $612,000, was sold by the Company to a mortgage
banker who is now alleging that the Company breached its warranty obligations
when it sold this loan to the mortgage banker because the lien of the loan is
possibly inferior to other mortgages. The Company believes its actions were
proper, that the lien is enforceable as a first lien, and it intends to
vigorously defend these claims and, to the extent necessary, seek recourse from
other parties who may have participated in this allegedly fraudulent scheme.
The Company and the Bank are from time to time a party (plaintiff or
defendant) to lawsuits that are in the normal course of business. While any
litigation involves an element of uncertainty, management, after reviewing
pending actions with its legal counsel, is of the opinion that the liability of
the Company and the Bank, if any, resulting from such actions will not have a
material effect on the financial condition or results of operations of the
Company and the Bank.
Item 2: Changes in Securities
None
Item 3: Defaults upon Senior Securities
None
Item 4: Submission of Matters to a Vote of Security Holders
None
Item 5: Other Information
None
35
<PAGE>
Item 6: Exhibits and Reports on Form 8-K
The following Exhibits are filed as part of this report. (Exhibit
numbers correspond to the exhibits required by Item 601 of Regulation S-B for an
annual report on Form 10-KSB)
Exhibit No.
3(a) Amended and Restated Articles of Incorporation of
the Company, as amended.*
3(b) Amended and Restated Bylaws of the Company. *
4(b)(i) Amended and Restated Articles of Incorporation of
the Company, as amended.*
4(b)(ii) Amended and Restated Bylaws of the Company.*
10 Amended and Restated Material Contracts.- None
10(a) Agreement and Plan of Merger by and between the
Company and Republic Bancorporation, Inc. dated
November 17, 1996.*
11 Computation of Per Share Earnings See footnote No.
2 to Notes to Consolidated Financial Statements
under Earnings per Share.
21 Subsidiaries of the Company.
All other schedules and exhibits are omitted because they are not
applicable or because the required information is set out in the financial
statements or the notes hereto.
*Incorporated by reference from the Registration Statement on Form S-4
of the Company, as amended, Registration No. 333-673 filed April 29, 1996.
Reports on Form 8-K
None
36
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Issuer has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Republic First Bancorp, Inc.
/s/ Jere A. Young
Jere A. Young
President and Chief Executive Officer
/s/ George S. Rapp
George S. Rapp
Executive Vice President and Chief Financial Officer
Dated: November 16, 1998
37
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<NAME> REPUBLIC FIRST BANCORP INC.
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