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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________
Commission file number 0-16276
STERLING FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2449551
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 North Pointe Boulevard
Lancaster, Pennsylvania 17601-4133
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 581-6030
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $5.00 Per Share
(Title of class)
Indicate by a check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or
any amendment to this
Form 10-K. | |
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at February 29, 2000 was approximately $122,528,000.
The number of shares of Registrant's Common Stock outstanding on February 29,
2000 was 8,931,568.
Documents Incorporated by Reference
Portions of the Proxy Statement for the Registrant's 2000 Annual Meeting of
Shareholders are incorporated by reference into Part III of this report.
Sterling Financial Corporation
Table of Contents
Page
Part I
Item 1. Business............................................. 3
Item 2. Properties........................................... 16
Item 3. Legal Proceedings.................................... 17
Item 4. Submission of Matters to a Vote of Security Holders.. 17
Part II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters.......................... 18
Item 6. Selected Financial Data.............................. 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 20
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk.................................... 46
Item 8. Financial Statements................................. 49
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. 86
Part III
Item 10. Directors and Executive Officers of the Registrant... 86
Item 11. Executive Compensation............................... 86
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 86
Item 13. Certain Relationships and Related Transactions....... 86
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.......................................... 87
Signatures...................................................... 90
PART I
The management of Sterling Financial Corporation has made forward-looking
statements in this annual report on Form 10-K. These forward-looking statements
may be subject to risks and uncertainties. Forward-looking statements include
the information concerning possible or assumed future results of operations of
Sterling Financial Corporation and its subsidiaries, Bank of Lancaster County,
N.A., Northeast Bancorp, Inc., The First National Bank of North East, T&C
Leasing, Inc. Sterling Mortgage Services, Inc. and Town & Country, Inc. When
words such as "believes", "expects", "anticipates" or similar expressions occur
in this annual report, management is making forward-looking statements.
Shareholders should note that many factors, some of which are discussed
elsewhere in this annual report, could affect the future financial results of
Sterling Financial Corporation and its subsidiaries, both individually and
collectively, and could cause those results to differ materially from those
expressed in the forward-looking statements contained in this annual report on
Form 10-K. These factors include the following:
operating, legal and regulatory risks;
economic, political and competitive forces affecting our banking,
securities, asset management and credit service businesses; and
the risk that our analysis of these risks and forces could be
incorrect and/or that the strategies developed to address them could
be unsuccessful.
Sterling undertakes no obligation to publicly revise or update these
forward-looking statements to reflect events or circumstances that arise after
the date of this report. Readers should carefully review the risk factors
described in other documents Sterling files periodically with the Securities and
Exchange Commission, including Quarterly Reports on Form 10-Q to be filed by
Sterling Financial Corporation, and any Current Reports on Form 8-K.
Item 1 - Business
Sterling Financial Corporation
Sterling Financial Corporation is a Pennsylvania business corporation,
based in Lancaster, Pennsylvania. Sterling was organized on
February 23, 1987 and became a bank holding company on June 30, 1987 through
the acquisition of all the outstanding stock of Bank of Lancaster
County, N.A., formerly The First National Bank of Lancaster County.
Sterling provides a wide variety of commercial banking and trust services
through its wholly owned subsidiaries, Bank of Lancaster County, N.A. and The
First National Bank of North East.
Sterling's major source of operating funds is dividends that it receives
from its subsidiary banks. Sterling's expenses consist principally of operating
expenses. Dividends that Sterling pays to stockholders consist, in part, of
dividends declared and paid to Sterling by the subsidiary banks.
As a bank holding company, Sterling is registered with the Federal Reserve
Board under the Bank Holding Company Act. The Federal Reserve Board and the
Pennsylvania Department of Banking, both regulate Sterling's operations.
On July 21, 1998, Sterling organized T & C Leasing, Inc., a Pennsylvania
corporation. T & C Leasing, Inc. is a nationwide vehicle and equipment leasing
company operating primarily in Pennsylvania. Its principal office is located at
1097 Commercial Avenue, East Petersburg, Pennsylvania.
On June 15, 1999, Sterling completed its acquisition of Northeast Bancorp,
Inc., the parent company of The First National Bank of North East, based in
North East, Maryland.
In addition, Sterling also owns all of the outstanding stock of a non-bank
subsidiary, Sterling Mortgage Services, Inc. which Sterling organized. Sterling
Mortgage Services, Inc. is presently inactive.
The common stock of Sterling is listed on The Nasdaq Stock Market under the
symbol SLFI.
Bank of Lancaster County, N.A.
The Bank of Lancaster County, N.A. is a full service commercial bank
operating under charter from the Comptroller of the Currency. On July 29, 1863,
the Comptroller of the Currency authorized The First National Bank of Strasburg
to commence the business of banking. On September 1, 1980, we changed the name
to The First National Bank of Lancaster County. On June 30, 1987, the date the
bank reorganized as a bank holding company, the bank changed its name to Bank of
Lancaster County, N.A. At December 31, 1999, the bank had total assets of
$975,647,000 and total deposits of $815,706,000.
The main office of the bank is located at 1 East Main Street, Strasburg,
Pennsylvania. In addition to its main office, the bank had 28 branches in
Lancaster County and one (1) branch in Chester County, Pennsylvania in operation
at December 31, 1999.
The bank provides a full range of banking services. These include demand,
savings and time deposit services, NOW (Negotiable Order of Withdrawal)
accounts, money market accounts, safe deposit boxes, and a full spectrum
of personal and commercial lending activities. The bank maintains
correspondent relationships with major banks in New York City and
Philadelphia. Through these correspondent relationships, the bank
can offer a variety of collection and international services.
With the installation of three automated teller machines in April, 1983,
the bank was the first financial institution in Lancaster County
to join the MAC Network. The bank now has 27 ATM
locations located in Lancaster County. Additionally, Bank of Lancaster
County customers can use their personal computers for services such as bill
paying, loan applications and transfer of funds through BLC OnLine.
The bank introduced Discount Brokerage Service in July, 1983. The bank
offers this service in coordination with Fiserv Investor Services, Inc. and
meets the needs of the commission-conscious investor. In 1992, the bank
began offering mutual funds to customers. In mid-year 1998,
the Bank of Lancaster County began offering fixed annuities in addition
to mutual funds as an alternative investment vehicle for appropriate
customers. The annuities are available from three insurance companies,
AIG, Jackson National and CIGNA, with BankMark Corporation,
Morris Plains, New Jersey, providing marketing support services. As required,
the bank obtained an insurance license from the Commonwealth of Pennsylvania.
Management believes these services are important additions to our product line
and make a statement about our progressive attitude in providing financial
services for the future.
The Comptroller of the Currency gave the bank permission to open a Trust
Department on May 10, 1971. The Trust Department provides personal and
corporate trust services. These include estate planning, administration
of estates and the management of living and testamentary trusts and
investment management services. Other services available are pension and
profit sharing trusts and self-employed retirement trusts. Trust Department
assets were over $611.5 million at December 31, 1999.
On January 31, 1983, the bank purchased Town & Country, Inc., which is a
vehicle and equipment leasing company operating in Pennsylvania and other
states. Its principal office is located at 1097 Commercial
Avenue, East Petersburg, PA. Town & Country employs 55 people.
On May 18, 1999, Bank of Lancaster County, N.A. and Murray Insurance
Associates, Inc. formed the Lancaster Insurance Group, L.L.C., a limited
liability company under the laws of the Commonwealth of Pennsylvania.
Regulatory approval was received July 27, 1999 to commence business.
Lancaster Insurance Group offers comprehensive personal insurance coverage
as well as a complete range of business insurance programs.
The bank's principal market area is Lancaster County, Pennsylvania.
Lancaster County is the sixth largest county in Pennsylvania, in terms of
population, behind Philadelphia, Allegheny, Montgomery, Delaware and Bucks.
Lancaster County, with an area of 949 square miles, has a population of
approximately 455,000 people. Lancaster's tradition of economic stability has
continued, with agriculture, industry and tourism all contributing to the
overall strength of the economy. Lancaster County has one of
the strongest and most stable economies in the state. No single sector
dominates the county economy.
One of the best agricultural areas in the nation, Lancaster continues to be
the top agricultural county in the state, leading Pennsylvania in production of
most crops and all livestock, with the exception of sheep. Lancaster County is
also one of the leading industrial areas in the state. The county is considered
a prime location for manufacturing, away from congested areas, yet close to
major east coast markets. Diversification of industry has
helped to maintain the economic stability of the county. Lancaster County
ended 1999 with the second lowest unemployment rate in Pennsylvania.
The unemployment rate of the county in December 1999 was 2.6%
which was significantly lower than the statewide and national rate of 4.1%.
Lancaster County's December unemployment rate of 2.6%
continued to trail only State College among the 14 metropolitan areas in
Pennsylvania. Lancaster County, with its many historic sites, well-kept
farmlands and the large Amish community has become very attractive to tourists
and is one of the top tourist attractions in the United States.
The bank does not depend on foreign sources of funds, nor does it make
foreign loans.
The bank is subject to regulation and periodic examination by the
Comptroller of the Currency. The bank's deposits are insured by the Federal
Deposit Insurance Corporation, as provided by law.
Northeast Bancorp, Inc.
Northeast Bancorp, Inc. is a Delaware bank holding company based in Newark,
Delaware. The corporation was organized in 1983 and is parent company of The
First National Bank of North East, North East, Maryland.
A major source of operating funds for Northeast Bancorp, Inc., is dividends
provided by The First National Bank of North East.
Northeast Bancorp, Inc. is a one-bank holding company and is registered
with the Federal Reserve Board in accordance with the requirements
of the Bank Holding Company Act and is subject to regulation
by the Federal Reserve Board.
On June 15, 1999, Sterling Financial Corporation acquired Northeast
Bancorp, Inc. Under the terms of the agreement, Northeast Bancorp
shareholders received two shares of Sterling common stock for
each share of Northeast Bancorp's common stock in a tax-free
exchange. The transaction was accounted for under the
pooling-of-interests method of accounting
The First National Bank of North East
On December 12, 1903, the Comptroller of the Currency authorized The First
National Bank of North East to commence the business of banking. The main
office of the bank is located at 14 South Main Street,
North East, Maryland. In addition to the main office, there are
three branches located in Cecil County, Maryland. At December 31, 1999,
the bank had total assets of nearly $87.0 million and total deposits
of $78.5 million.
The bank does not depend on foreign sources of funds, nor does it make
foreign loans.
The bank is subject to regulation and periodic examination by the
Comptroller of the Currency. The bank's deposits are insured by the Federal
Deposit Insurance Corporation, as provided by law.
Under the merger agreement between Sterling Financial Corporation and the
Northeast Bancorp, Inc., The First National Bank of North East continues to
operate as a separate commercial bank.
Competition
The financial services industry in Sterling's service area is extremely
competitive. Sterling's competitors within its service area include multi-bank
holding companies, with resources substantially greater than those of the
corporation. Many competitor financial institutions have legal lending limits
substantially higher than the subsidiary banks' legal lending limits. The
subsidiary banks are subject to intense competition in all respects and areas of
their business from commercial banks, savings banks, credit unions, finance
companies and other nonbank providers of financial services. Several of the
financial institution competitors exceed $15 billion in assets while one is in
excess of $230 billion in assets. The increased competition has resulted from a
changing legal and regulatory climate, as well as, from the economic climate.
As of December 31, 1999, the Bank of Lancaster County ranked, as
measured by total deposits, as the second largest in market
share within Lancaster County of the banks doing business
in Lancaster County, Pennsylvania. The bank is not, however, the second
largest bank in Lancaster County. As of December 31, 1999,
The First National Bank of North East ranked, as measured by total deposits, as
the fourth largest in market share within Cecil County, Maryland.
Neither Sterling nor the subsidiary banks rely on a single customer or a
few customers, including federal, state or local governments and
agencies thereunder the loss of which would have a material adverse
effect on the business of the bank.
Supervision and Regulation
Bank Holding Company Regulation
Sterling Financial Corporation and Northeast Bancorp, Inc. are subject to
the regulations of the Board of Governors of the Federal Reserve System under
the Bank Holding Company Act. Bank holding companies are required
to file periodic reports with and are subject to examination
by the Federal Reserve. The Federal Reserve has issued regulations
under the Bank Holding Company Act that require a bank holding company
to serve as a source of financial and managerial strength to
its subsidiary banks. As a result, the Federal Reserve may require the
corporations to stand ready to use its resources to provide adequate capital
funds to the banks during periods of financial stress or adversity.
Under the Bank Holding Company Act, the Federal Reserve may require a bank
holding company to end a non-banking business if the non-banking business
constitutes a serious risk to the financial soundness and stability of any bank
subsidiary of the bank holding company.
The Bank Holding Company Act prohibits a bank holding company from
acquiring a bank or merging or consolidating with another bank holding
company without prior approval of the Federal Reserve. The Pennsylvania
Department of Banking must also approve acquisitions and mergers.
Pennsylvania law permits Pennsylvania bank holding companies to control
an unlimited number of banks.
Additionally, the Bank Holding Company Act prohibits a bank holding company
from engaging in most non-banking businesses or from owning more than 5% of the
voting shares of most non-bank businesses.
The Federal Reserve has determined that the following activities are
permissible:
making, acquiring, or servicing loans or other extensions of
credit for its own account or for the account of others;
operating an industrial bank, Morris Plan bank, or industrial loan
company, in the manner authorized by state law, so long as the
institution is not a bank;
operating as a trust company in the manner authorized by federal
or state law so long as the institution is not a bank and does not
make loans or investments or accept deposits, except as may be
permitted by the Federal Reserve;
subject to limitations, acting as an investment or financial
advisor:
to a mortgage or real estate investment trust;
to certain registered investment companies;
by providing portfolio investment advice to
other persons;
by furnishing general economic information and
advice, general economic statistical forecasting services,
and industry studies;
by providing financial advice to state
and local governments; or
by providing financial and transaction advice to
corporations, institutions, and persons in the
areas of mergers, acquisitions, and other
financial transactions;
subject to limitations, leasing real or personal property or
acting as agent, broker, or adviser in leasing such property in
accordance with prescribed conditions;
investing in corporations or projects designed primarily to
promote community welfare;
providing to others data processing services and data transmission
services, data bases, and facilities, within certain limitations;
subject to limitations, engaging in agency and underwriting
activities concerning credit insurance, and certain other insurance
activities as permitted by the Federal Reserve;
owning, controlling, or operating a savings association, if the
savings association engages only in deposit-taking activities and
lending and other activities that are permissible for bank holding
companies under Federal Reserve regulations;
providing courier services for certain financial documents;
subject to limitations, providing management consulting advice to
nonaffiliated bank and nonbank depository institutions;
retail selling of money orders and similar consumer-type payment
instruments having a face value of $1,000 or less, selling U.S.
Savings Bonds, and issuing and selling traveler's checks;
performing appraisals of real estate and personal property;
subject to limitations, acting as intermediary for the financing
of commercial or industrial income-producing real estate by
arranging for the transfer of the title, control, and risk of such
a real estate project to one or more investors;
providing certain securities brokerage services;
subject to limitations, underwriting and dealing in government
obligations and certain other instruments;
subject to limitations, providing foreign exchange and
transactional services;
subject to limitations, acting as a futures commission merchant
for nonaffiliated persons;
subject to limitations, providing investment advice on financial
futures and options to futures;
subject to limitations, providing consumer financial counseling;
subject to limitations, tax planning and preparation;
providing check guaranty services;
subject to limitations, operating a collection agency; and
operating a credit bureau.
Federal Reserve approval may be required before the corporation or its
nonbank subsidiaries may begin to engage in any such activity and before
any such business may be acquired.
The Federal Deposit Insurance Corporation Improvement Act requires a bank
holding company to guarantee the compliance of any insured depository
institution subsidiary that may become "undercapitalized", as defined by
regulations, with the terms of any capital restoration plan
filed by such subsidiary with its appropriate federal
banking agency, up to specified limits.
Financial Services Modernization Legislation
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999, the Financial Services Modernization Act,
which repealed provisions of the Depression-era Glass-Steagall Act.
The Glass-Steagall Act prohibited banks from engaging in securities
and insurance business.
The general effect of the law is to establish a comprehensive framework to
permit affiliations among commercial banks, insurance companies, securities
firms and other financial service providers.
Generally, the Financial Services Modernization Act:
repeals historical restrictions on, and eliminates many federal and
state law barriers to, affiliations among banks, securities firms,
insurance companies and other financial service providers;
provides a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding companies;
broadens the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries to include banking, insurance and securities activities,
but also merchant banking and additional activities that the Federal
Reserve, in consultation with the Secretary of the Treasury,
determines;
provides an enhanced framework for protecting the privacy of consumer
information;
adopts a number of provisions related to the capitalization,
membership, corporate governance and the other measures designed to
modernize the Federal Home Loan Bank system;
modifies the laws governing the implementation of the Community
Reinvestment Act;
addresses a variety of other legal and regulatory issues affecting
both day-to-day operations and long-term activities of financial
institutions; and
expressly preempts state insurance laws.
In order for Sterling to take advantage of the new law, it must become a
financial holding company. To become a financial holding company, Sterling
would file a declaration with the Federal Reserve, electing to engage
in activities permissible for financial holding companies and certifying
that it is eligible to do so because all of its insured depository
institution subsidiaries are well-capitalized and well-managed. In addition,
the Federal Reserve must determine that each insured depository
institution subsidiary of Sterling has at least a
"satisfactory" CRA rating. Sterling currently meets the requirements to make an
election to become a financial holding company. Sterling's management has not
determined at this time whether it will seek an election to become a financial
holding company. Sterling is examining its strategic business plan to determine
whether, based on market conditions, the relative financial conditions of the
company and its subsidiaries, regulatory capital requirements, general economic
conditions and other factors, Sterling desires to utilize any of its expanded
powers provided in the Financial Service Modernization Act.
The Financial Services Modernization Act also permits banks to engage in
expanded activities through the formation of financial subsidiaries. A national
bank may have a subsidiary engaged in any activity authorized for national banks
directly or any financial activity, except for insurance underwriting, insurance
investments, real estate investment or development or merchant banking, which
may only be conducted through a subsidiary of a financial holding company.
Financial activities include all activities permitted under
new sections of the Bank Holding Company Act or permitted
by regulation.
A national bank seeking to have a financial subsidiary, and each of its
depository institution affiliates, must be "well-capitalized" and
"well-managed". The total assets of all financial subsidiaries may not
exceed the lesser of 45% of a bank's total assets or $50 billion. A
national bank must exclude from its assets and equity all
equity investments, including retained earnings, in a financial
subsidiary. The assets of the subsidiary may not be consolidated with
the bank's assets. The bank must also have policies and procedures to assess
financial subsidiary risk and protect the bank from such risks and potential
liabilities.
Sterling and its subsidiary banks do not believe that the Financial
Services Modernization Act will have a material effect on our
operations in the near-term. However, to the extent that it permits
banks, securities firms and insurance companies to affiliate,
the financial services industry may experience further
consolidation. The Financial Service Modernization Act is intended to
grant to community banks certain powers as a matter of right that
larger institutions have accumulated on an ad hoc basis.
Nevertheless, this act may have the result of increasing the amount of
competition that the company and the banks face from
larger institutions and other types of companies offering financial products,
many of which may have substantially more financial resources than Sterling and
its subsidiary banks.
Dividend Restrictions
Sterling is a legal entity separate and distinct from the subsidiary banks
and nonbank subsidiaries. Sterling's revenues, on a parent company only basis,
result almost entirely from dividends paid to the corporation by its
subsidiaries.
Federal and state laws regulate the payment of dividends by Sterling's
subsidiaries. See "Supervision and Regulation - Regulation of the Banks",
below.
Further, it is the policy of the Federal Reserve that bank holding
companies should pay dividends only out of current earnings. Federal banking
regulators also have the authority to prohibit banks and bank holding companies
from paying a dividend if they should deem such payment to be an unsafe or
unsound practice.
Capital Adequacy
The Federal Reserve requires bank holding companies to comply with its
risk-based capital guidelines. The required minimum ratio of total capital to
risk-weighted assets, including certain off-balance sheet activities, such as
standby letters of credit, is 8%. At least half of the total capital is
required to be "Tier 1 capital," consisting principally of:
common shareholders' equity,
noncumulative perpetual preferred stock,
a limited amount of cumulative perpetual preferred stock,
minority interests in the equity accounts of consolidated
subsidiaries, and
a deduction for certain intangible assets.
The remainder, "Tier 2 capital", may consist of:
a limited amount of subordinated debt and intermediate-term
preferred stock,
certain hybrid capital instruments and other debt securities,
perpetual preferred stock, and
a limited amount of the general loan loss allowance.
In addition to the risk-based capital guidelines, the Federal Reserve
requires a bank holding company to maintain a minimum "leverage ratio." This
requires a minimum level of Tier 1 capital, as determined under the risk-based
capital rules, to average total consolidated assets of 3% for those bank holding
companies that have the highest regulatory examination ratings and are not
contemplating or experiencing significant growth or expansion. All other bank
holding companies are expected to maintain a ratio of at least 1% to 2% above
the stated minimum. Further, the Federal Reserve has indicated
that it will consider a "tangible Tier 1 capital leverage ratio",
deducting all intangibles, and other indicia of capital strength
in evaluating proposals for expansion or new activities. The Federal Reserve
has not advised Sterling of any specific minimum leverage ratio applicable
to the corporation.
Under the Federal Deposit Insurance Corporation Insurance Act, the federal
banking agencies have specified, by regulation, the levels at which an nsured
institution is considered "wellcapitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," or "critically
undercapitalized." Under these regulations, an institution is considered "well
capitalized" if it has a total risk-based capital ratio of 10% or greater, a
Tier 1 risk-based capital ratio of 6% or greater, a leverage ratio of
5% or greater, and is not subject to any order or written
directive to meet and maintain a specific capital level. Sterling
and the subsidiary banks, at December 31, 1999,
qualify as "well capitalized" under these regulatory standards.
FDIC Insurance
The subsidiary banks are subject to Federal Deposit Insurance Corporation
assessments. The FDIC has adopted a risk-related premium assessment system for
both the Bank Insurance Fund for banks and the Savings Association Insurance
Fund for savings associations. Under this system, FDIC insurance
premiums are assessed based on capital and supervisory measures.
Under the risk-related premium assessment system, the FDIC, on a semiannual
basis, assigns each institution to one of three capital groups, well
capitalized, adequately capitalized, or undercapitalized, and further
assigns such institution to one of three subgroups within a capital
group corresponding to the FDIC's judgment of its strength
based on supervisory evaluations, including examination
reports, statistical analysis, and other information relevant to gauging
the risk posed by the institution. Only institutions with a total
risk-based capital to risk-adjusted assets ratio of 10% or greater,
a Tier 1 capital to risk-adjusted assets ratio of 6% or
greater, and a Tier 1 leverage ratio of 5% or greater, are
assigned to the well-capitalized group.
Regulation of Banks
The operations of the subsidiary banks are subject to federal and state
statutes applicable to banks chartered under the banking laws of the United
States, to members of the Federal Reserve System, and to banks whose deposits
are insured by the FDIC. The banks' operations are also subject
to regulations of the Office of the Comptroller of the Currency,
the Federal Reserve, and the FDIC.
The Office of the Comptroller of the Currency, which has primary
supervisory authority over the subsidiary banks, regularly examines banks
in such areas as reserves, loans, investments, management
practices, and other aspects of operations. These examinations are
designed for the protection of the banks' depositors rather than
Sterling's shareholders. The subsidiary banks must
furnish annual and quarterly reports to the Office of the Comptroller of the
Currency, which has the authority under the Financial Institutions Supervisory
Act to prevent a national bank from engaging in an unsafe or unsound practice in
conducting its business.
Federal and state banking laws and regulations govern, among other things:
the scope of a bank's business,
the investments a bank may take,
the reserves against deposits a bank must maintain,
the types and terms of loans a bank may make and
the collateral it may take,
the activities of a bank with respect to mergers and
consolidations, and
the establishment of branches.
Pennsylvania and Maryland laws permit statewide branching.
The National Bank Act requires the subsidiary banks to obtain the prior
approval of the Office of the Comptroller of the Currency for the payment of
dividends if the total of all dividends declared by the banks in one year would
exceed the banks' net profits, as defined and interpreted by regulation, for the
two preceding years, less any required transfers to surplus. In addition, the
banks may only pay dividends to the extent that their retained net profits,
including the portion transferred to surplus, exceed statutory bad debts, as
defined by regulation. Under the Federal Deposit Insurance Corporation
Insurance Act, any depository institution, including the banks are
prohibited from paying any dividends, making other distributions or
paying any management fees if, after such payment, it would
fail to satisfy their minimum capital requirements.
A subsidiary bank of a bank holding company, such as the Bank of Lancaster
County and The First National Bank of North East, is subject to certain
restrictions imposed by the Federal Reserve Act, including:
extensions of credit to the bank holding company or its
subsidiaries,
investments in the stock or other securities of the bank
holding company or its subsidiaries,
taking such stock or securities as collateral for loans.
The Federal Reserve Act and Federal Reserve regulations also place certain
limitations and reporting requirements on extensions of credit by a bank to the
principal shareholders of its parent holding company, among others, and to
related interests of principal shareholders. In addition, such legislation and
regulations may affect the terms upon which any person becoming a principal
shareholder of a holding company may obtain credit from banks with which the
subsidiary bank maintains a correspondent relationship.
The subsidiary banks, and the banking industry in general, are affected by
the monetary and fiscal policies of government agencies, including the Federal
Reserve. Through open market securities transactions and changes in its discount
rate and reserve requirements, the Board of Governors of the Federal Reserve
exerts considerable influence over the cost and availability of funds for
lending and investment.
Interstate Banking Legislation
In September 1994, Congress enacted the Riegle-Neal Interstate Banking and
Branching Efficiency Act. The Interstate Banking Act facilitates the interstate
expansion and consolidation of banking organizations:
by permitting bank holding companies that are adequately
capitalized and adequately managed, beginning September 29, 1995,
to acquire banks located in states outside their home states
regardless of whether such acquisitions are authorized under the
law of the host state;
by permitting the interstate merger of banks after June 1, 1997,
subject to the right of individual states to "opt in" or "opt out" of
this authority before that date;
by permitting banks to establish new branches on an interstate
basis provided that such action is specifically authorized by the
law of the host state;
by permitting, beginning September 29, 1995, a bank to engage in
certain agency relationships (i.e., to receive deposits, renew time
deposits, close loans (but not including loan approvals or
disbursements), service loans, and receive payments on loans and
other obligations) as agent for any bank or thrift affiliate, whether
the affiliate is located in the same state or a different state than
the agent bank; and
by permitting foreign banks to establish, with approval of the
regulators in the United States, branches outside their "home" states
to the same extent that national or state banks located in the home
state would be authorized to do so.
One effect of this legislation will be to permit Sterling to acquire banks
and bank holding companies located in any state and to permit qualified banking
organizations located in any state to acquire banks and bank holding companies
located in Pennsylvania, irrespective of state law.
In July 1995, the Pennsylvania Banking Code was amended to authorize full
interstate banking and branching under Pennsylvania law. Specifically, the
legislation:
eliminates the "reciprocity" requirement previously applicable to
interstate commercial bank acquisitions by bank holding companies,
authorizes interstate bank mergers and reciprocal interstate
branching into Pennsylvania by interstate banks, and
permits Pennsylvania institutions to branch into other states with
the prior approval of the Pennsylvania Department of Banking.
Overall, this federal and state legislation had the effect of increasing
consolidation and competition and promoting geographic diversification in the
banking industry.
Proposed Legislation and Regulations
From time to time, various federal and state legislation is proposed that
could result in additional regulation of, and restrictions on, the business of
Sterling and the subsidiary banks, or otherwise change the business environment.
Bank stocks also may be depressed in the future by a new accounting rule
which is expected to become effective on January 1, 2001, by constraining or
eliminating the merger premium currently reflected in bank stock prices. The
new rule will eliminate the pooling-of-interests accounting method
and mandate the use of purchase accounting for all business
combinations. Pooling-of-interests has always been the
method of choice for financial services sector combinations
because it is simple to apply and avoids recognition of expense associated
with the intangible asset goodwill. An overview of the new accounting
rule can be found in "New Financial Accounting Standards" located
in item 7 of this Annual Report.
Management cannot predict whether any of this legislation, if enacted, will
have a material effect on the business of Sterling.
Employees
As of December 31, 1999, there were 455 persons employed by the Bank of
Lancaster County, of which 326 were full-time and 129 were part-time employees.
The First National Bank of North East had 45 persons employed at December 31,
1999, of which 39 were full-time and 6 were part-time. These figures do not
include employees of Town & Country, Inc. which employed 55 persons.
Item 2 - Properties
The Bank of Lancaster County, in addition to its main office, had a branch
network of 29 offices and 4 off-site electronic MAC/ATM installations at
December 31, 1999. All branches are located in Lancaster County with the
exception of one office located in Chester County. Branches
at 19 locations are occupied under leases and at three branches,
the bank owns the building, but leases the land. One off-site MAC/ATM
installation is occupied under lease. All other properties
were owned in fee. All real estate and buildings owned by the bank are free and
clear of encumbrances.
The leases expire intermittently over the years through 2022 and most are
subject to one or more renewal options. During 1999, aggregate annual rentals
for real estate paid did not exceed 3% of the bank's operating expenses.
On December 4, 1996, the bank purchased a property located at 1097
Commercial Avenue, East Petersburg, PA, situated on 12.7 acres with a building
containing approximately 123,000 square feet. The building is used to house the
Bank of Lancaster County's Administrative Service Center as well as other
departments of the bank. Town & Country, Inc. also occupies this building. At
December 31, 1999, approximately 24,000 square feet of this building was leased
to outside parties. The building is owned in fee by the bank, free and clear of
encumbrances.
In 1995, the bank completed construction of a new headquarters building
including a branch banking office. The building also serves as headquarters for
Sterling. Occupancy took place in July of 1995. The three-story building
contains approximately 53,000 square feet. Bank of Lancaster County and
Sterling Financial Corporation occupy approximately 39,281 square feet
while nearly 13,719 square feet has been leased to other tenants.
The building is owned in fee by the bank, free and
clear of encumbrances.
Sterling Financial Corporation owns no real estate.
In addition to it main office located at 14 South Main Street, North East,
Maryland, The First National Bank of North East operated three additional
branches at December 31, 1999. All branches are located in Cecil County. All
properties are owned in fee by the bank, free and clear of encumbrances.
Item 3 - Legal Proceedings
As of December 31, 1999, there were no material pending legal proceedings,
other than ordinary routine litigation incidental to the business, to which
Sterling or its subsidiaries are a party or by which any of their property is
the subject.
Item 4 - Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the
fourth quarter of 1999.
PART II
Item 5 - Market for the Registrant's Common Equity and Related Stockholder
Matters
Sterling Financial Corporation's common stock trades on The NASDAQ Stock
Market under the symbol SLFI. There are 35,000,000 shares of common stock
authorized and at December 31, 1999, there were 8,931,568 shares outstanding.
As of December 31, 1999, Sterling had approximately 3,300
stockholders of record. There is no other class of stock authorized
or outstanding. Dividends are restated to give effect
to a 5% stock dividend paid in June, 1998 and a 5-for-4
stock split effected on the form of a 25% stock dividend, paid in
November 1999. Sterling Financial Corporation is restricted as to the
amount of dividends that it can pay to stockholders by virtue of
the restrictions on the subsidiary banks' ability to pay dividends
to Sterling Financial Corporation.
The following table reflects the quarterly high and low prices of the
Sterling Financial Corporation's common stock for the periods indicated and the
cash dividends declared on the common stock for the periods indicated. All
information has been restated to give effect to the 5% stock dividend paid in
June, 1998 and the 5-for-4 stock split, effected in the form of a 25% stock
dividend, paid in November 1999.
Price Range Per Share Per Share
1999 High Low Dividend
First Quarter $36.80 $26.80 $.176
Second Quarter 29.80 26.00 .176
Third Quarter 32.48 24.70 .184
Fourth Quarter 32.00 25.00 .185
Price Range Per Share Per Share
1998 High Low Dividend
First Quarter $27.81 $23.81 $.160
Second Quarter 45.60 27.05 .168
Third Quarter 39.90 28.00 .168
Fourth Quarter 35.20 31.70 .168
Sterling Financial Corporation maintains a Dividend Reinvestment and Stock
Purchase Plan for eligible shareholders who elect to participate in the plan.
You may obtain a copy of the prospectus for the plan by writing to: Bank of
Lancaster County, N.A., Dividend Reinvestment and Stock Purchase Plan, 101 North
Pointe Boulevard, Lancaster, Pennsylvania 17601-4133.
As of December 31, 1999, the following firms made a market in Sterling
Financial Corporation's common stock:
Legg Mason Wood Walker, Inc.
F.J. Morrissey & Co., Inc.
Prudential Securities, Inc.
Tucker Anthony Cleary Gull (division of Tucker Anthony Incorporated)
Item 6 - Selected Financial Data
The following selected financial data should be read in conjunction with
Sterling's consolidated financial statements and the accompanying notes
presented elsewhere herein.
(Dollars in thousands, except per share data)
Years Ended 1999 1998 1997 1996 1995
Results of Operations:
Interest income...........$ 67,714 $ 65,763 $ 61,784 $ 57,530 $ 53,807
Interest expense........... 29,797 30,215 27,338 24,781 23,140
------ ------ ------ ------ ------
Net interest income........ 37,917 35,548 34,446 32,749 30,667
Provision for loan losses.. 420 956 1,129 540 276
------ ------ ------ ------ ------
Net interest income after
provision for loan losses. 37,497 34,592 33,317 32,209 30,391
Noninterest income......... 29,497 27,193 22,928 19,166 16,246
Noninterest expenses....... 48,831 45,250 41,120 37,220 33,538
------ ------ ------ ------ ------
Income before income taxes. 18,163 16,535 15,125 14,155 13,099
Applicable income taxes.... 4,924 4,193 3,969 3,648 3,356
------ ------ ------ ------ ------
NET INCOME..............$ 13,239 $ 12,342 $ 11,156 $ 10,507 $ 9,743
====== ====== ====== ====== ======
Per Common Share:(1)
Net income - basic.......$ 1.48 $ 1.38 $ 1.24 $ 1.16 $ 1.08
Net income - diluted...... 1.48 1.38 1.24 1.16 1.08
Cash dividends declared(2) .721 .664 .625 .550 .650
Book value................ 10.08 9.91 9.02 8.34 7.66
Realized book value (3)... 10.24 9.39 8.70 8.17 7.49
Average shares outstanding:
Basic................... 8,912,120 8,922,343 8,997,973 9,082,046 9,041,306
Diluted..................8,934,945 8,949,086 9,002,026 9,082,143 9,041,306
Ratios:
Return on average assets.. 1.29% 1.29% 1.30% 1.31% 1.34%
Return on average equity.. 14.86% 14.59% 14.23% 14.17% 14.47%
Return on average
realized equity (3)..... 15.17% 15.23% 14.62% 14.69% 14.87%
Dividend payout ratio..... 48.05% 46.16% 47.55% 44.62% 56.57%
Average equity to average
assets................... 8.69% 8.87% 9.11% 9.17% 9.18%
Financial Condition at
Year-End:
Assets....................$1,059,374 $ 997,882 $ 915,173 $ 829,283 $ 776,593
Loans, net................ 654,834 584,590 558,737 511,967 459,374
Deposits.................. 892,432 855,056 783,297 707,252 671,418
Borrowed money............ 59,291 35,661 35,312 33,175 23,757
Stockholders' equity...... 90,018 88,191 80,468 75,581 69,821
(1) Per common share data has been restated to reflect all stock dividends and splits.
(2) The 1997 dividend includes a $.031 per share "Special Dividend", declared in the third quarter.
The 1995 dividend includes an $.18 per share "Special Dividend" declared in the second quarter.
(3) Excluding unrealized gain (loss) on securities available-for-sale.
Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion provides management's analysis of the
consolidated financial condition and results of operations of Sterling
Financial Corporation and its subsidiaries, Bank of Lancaster County, N.A.
and its subsidiary, Town & County, Inc., T & C Leasing, Inc., Northeast
Bancorp, Inc and its subsidiary, The First National Bank of North East
and Sterling Mortgage Services, Inc., which is presently inactive.
Management's discussion and analysis should be read in conjunction with
the audited financial statements and footnotes appearing
elsewhere in this report.
In addition to historical information, the Management's Discussion
and Analysis contains forward-looking statements. The forward-looking
statements are subject to certain risks and uncertainties.
Forward-looking statements include the information concerning possible
or assumed future results of operations of Sterling, and its
subsidiaries, or the combined company. When we use words such
as "believes", "expects", "anticipates" or similar expressions, we are
making forward-looking statements.
Shareholders should note that many factors, some of which are
discussed elsewhere in this document and in the documents that we
incorporate by reference, could affect the future financial results
of Sterling and its subsidiaries or the combined company and
could cause those results to differ materially from those expressed
in our forward-looking statements contained or incorporated by
reference in this document. These factors include
the following:
operating, legal and regulatory risks;
economic, political and competitive forces affecting
our banking, securities, asset management
and credit services businesses; and
the risk that our analyses of these risks and forces could
be incorrect and/or that the strategies developed
to address them could be unsuccessful.
Sterling undertakes no obligation to publicly revise or update
these forward-looking statements to reflect events or circumstances that
arise after the date of this report. Readers should carefully review
the risk factors described in other documents Sterling files periodically
with the Securities and Exchange Commission, including Quarterly
Reports on Form 10-Q to be filed by Sterling Financial Corporation, and
any Current Reports on Form 8-K.
On June 15, 1999, Sterling completed the acquisition of Northeast
Bancorp, Inc., the parent company of The First National Bank of North
East, based in North East, Maryland. Northeast Bancorp is an
$86 million bank holding company for The First National Bank of
North East, with four branches located in Cecil County, Maryland. The
First National Bank of North East will continue to operate as
a separate bank.
Under the terms of the agreement, Northeast Bancorp shareholders
received two (2) shares of Sterling common stock for each share of
Northeast Bancorp's common stock in a tax-free exchange. The transaction
was accounted for under the pooling-of-interests method of accounting.
Accordingly, the consolidated financial statements have been
restated to include the consolidated accounts for Northeast Bancorp for
all periods presented.
On January 25, 2000, Sterling entered into an agreement with
Hanover Bancorp, Inc., based in Hanover, Pennsylvania, in which Hanover
Bancorp would merge with Sterling. Hanover Bancorp is the
holding company of Bank of Hanover and Trust Company. It had
assets of $504 million at December 31, 1999, and ten full-service offices
located in York and Adams County, Pennsylvania. Under the terms of the
agreement, Hanover Bancorp shareholders will receive .93 shares
of Sterling common stock for each share of Hanover
Bancorp's common stock in a tax-free stock exchange. The merger,
which is subject to shareholder and regulatory approvals, is expected
to be accounted for as a pooling of interests. The transaction is
expected to be completed in mid 2000. Bank of Hanover will
continue to operate as a separate subsidiary after the merger.
The majority of assets and liabilities of a financial institution
are monetary in nature and, therefore, differ greatly from most
commercial and industrial companies that have significant
investments in fixed assets or inventories. However, inflation does have
an important impact on the growth of total assets and on non-interest
expenses, which tend to rise during periods of general inflation.
Inflationary pressures over the last few years have been modest,
although the potential for future inflationary pressure is always
present given changing trends in the economy. The rate of inflation in
1999 was 2.7%.
At its meeting held on June 29-30, 1999, the Federal Open Market
Committee adopted a directive that called for a slight tightening of conditions
in reserve markets consistent with an increase of 1/4 percentage point
in the federal funds rate to an average of 5%. At its meeting in
August 1999, the Committee adopted a directive that called for an
increase of 1/4 percentage point in the federal funds rate, to an average
of 5 1/4 % and at its November 1999 meeting, the Committee
adopted a directive that called for increasing the federal funds
rate by 25 basis points to 5 1/2%. These rate increases resulted in
corresponding increases in the prime lending rate during the same time
period. Long term, which is defined as five years, market
rates began the year at approximately 5 1/2% and ended the year at
nearly 7%. This trend in interest rates has yielded a market
expectation that interest rates will continue to increase during
the year 2000.
Aside from those matters described above, management does not believe
that there are any trends or uncertainties which would have a
material impact on future operating results, liquidity or
capital resources nor is it aware of any current recommendations by
the regulatory authorities which, if they were to be implemented,
would have such an effect.
Results of Operations
Overview
Sterling's net income for 1999 totaled $13.2 million, a 7.3%
increase from the $12.3 million earned in 1998. The results of 1998
were 10.6% greater than the $11.2 million reported in 1997. The 1999
net income performance produced a return on realized average
stockholders' equity of 15.17% compared to 15.23 % in 1998 and 14.62%
in 1997. The return on average assets was 1.29% in 1999 and 1998
compared to 1.30% in 1997. Basic and diluted earnings per share
was $1.48 in 1999 compared to $1.38 in 1998 and $1.24 in 1997.
During 1999, Sterling incurred $374,000 (net of tax) of merger
costs related to the acquisition of Northeast Bancorp,
Inc. Excluding the impact of these nonrecurring charges, net income
for 1999 totaled $13.6 million, an increase of 10.30% from 1998.
Basic and diluted earnings per share, excluding nonrecurring charges,
totaled $1.52, a 10.14% increase from 1998's basic and diluted earnings
per share of $1.38. Excluding the merger related charges, return
on average realized equity was 15.60% while return on
average assets was 1.33%.
While conducting its year-end closing process in the fourth
quarter of 1999, management reviewed its accounting policies to
ensure conformity with generally accepted accounting principles,
including recent pronouncements by the American Institute of
Certified Public Accountants and the SEC concerning audit differences
and materiality. Upon completion of this review, management
determined that appropriate consideration had not been given
to origination costs for loans and leases, investments in affordable
housing projects, director deferred compensation arrangements and
income taxes. Management has restated Sterling's consolidated
financial statements to reflect the impact of the adjustments
made due to the interpretations of accounting principles related to
these items. Management believes that the overall result of the
adjustments has not had a material impact on Sterling's
financial statements.
The impact of the restatements was a $592,000 reduction at
January 1, 1997 of retained earnings and $48,000 and $81,000 reduction
in net income from the years ended December 31, 1998 and 1999.
This resulted in a decrease in earnings per share of $.01 for
each of the years ended December 31, 1998 and 1997 from amounts
previously reported.
Growth in interest earning assets was the primary factor
contributing to the increased earnings in 1999 and 1998. As of
December 31, 1999, interest earning assets were approximately
$922 million compared to $877 million at December 1998. Average
interest earning assets for 1999 increased nearly $60 million to
over $905 million, up 7.1% from the prior year. In 1998, average
interest earning assets increased nearly $82 million, up 10.7%
from 1997. The current year increase, as well as the increase in 1998,
was primarily due to increases in both loans and investment securities.
Average interest bearing liabilities increased approximately
$52 million, or 6.9%, in 1999 compared to an
increase of approximately $73 million, or 10.9% in 1998.
The increase in interest earning assets and interest bearing
liabilities during 1999 and 1998 was a direct result of Sterling's
ability to attract new customers and relationships from
some competitors. These competitors have been experiencing a decline
in customer service due to merger integration issues, which has led to
their customers seeking financial services from
alternative institutions.
The provision for loan losses decreased to $420,000 in 1999 from
$956,000 in 1998. The provision for loan losses in 1997 was $1,129,000.
The decline in the provision for loan losses is a result of
improvement in credit quality, particularly within the consumer
loan portfolio.
Noninterest income increased $2,304,000 in 1999 compared to an
increase of $4,265,000 in 1998. The increase in 1998 included $1,338,000
income from the sale of the credit card portfolio. Noninterest
expense increased to nearly $48.8 million in 1999 from $45.2
million 1998. Contributing to the increase in 1999 was the merger
related expenses involved with Northeast Bancorp, Inc. and increased
depreciation on operating lease assets.
Net Interest Income
The primary component of Sterling Financial Corporation's net
earnings is net interest income, which is the difference between
interest and fees earned on interest-earning assets and interest paid on
deposits and borrowed funds. For presentation and analytical purposes,
net interest income is adjusted to a taxable equivalent bases. For
purposes of calculating yields on tax-exempt interest income, the
taxable equivalent adjustment equates tax-exempt interest rates to taxable
interest rates as noted in Table 1. Adjustments are made using a
statutory federal tax rate of 35% for 1999, 1998 and 1997.
Tax equivalent net interest income was $40.8 million in 1999
compared to $38.2 million in 1998, an increase of $2.6 million or 6.9%. This
was an increase from the $1.8 million or 4.8% increase realized
in 1998. As depicted in Table 2, the increase in 1999
was primarily the result of increased volumes which generated $2.4
million of additional net interest income, supplemented by $.2 million
due to changes in interest rates. The net interest margin
was 4.51% compared to 4.52% in 1998 and 4.77% in 1997. Table 1-
Distribution of Assets, Liabilities and Stockholders' Equity - Interest
Rates and Interest Differential - Tax Equivalent Yields and Table 2 -
Analysis of Changes in Net Interest Income summarize the components
of net interest income and illustrate variances as a
result of changes in interest rates versus growth in assets and liabilities.
During 1999, Sterling's net interest margin remained fairly stable,
as management was able to reprice its interest bearing liabilities in a manner
that offset the decline in the yield earned on interest earning
assets. The decline in the yield earned on interest
earning assets was primarily the result of the continual decline
in the yields earned on the loan portfolio, which declined from 8.81% in
1998 to 8.42% in 1999. This decline can be attributed to competitive
pressures within Sterling's market territory, in which
financial institutions are pricing quality credits in a manner which
attracts new customers.
Although there can be no assurances, management believes there
will be pressure to maintain its net interest margin at its
historical levels as interest rates have increased over the last third
of 1999, which will increase the cost of funding sources. We believe
it will be difficult to gain similar increases on yields in interest bearing
assets due to competitive pressures discussed above.
Interest income increased over $2.2 million or 3.3% from $68.4
million in 1998. Of this increase, $4.9 million was a result of a $59.9
million or 7.1% increase in average interest earning assets. This
increase was offset by a $2.7 million decrease due to a drop in the
average yield from 8.09% in 1998 to 7.80% in 1999. The increase in interest
income in 1998 over 1997 was $4.6 million. Of this increase, $6.3 million
was a result of increased volumes in average interest earning
assets, offset by a $1.7 million decrease due to a drop in
the average yield from 8.35% in 1997 to 8.09% in 1998. Average loans
increased $39.8 million in 1999 compared to an increase of $39.5 million
in 1998. Securities increased $25.2 million in 1999 compared
to the $32.8 increase in 1998. The average for federal funds sold was $17.9
million, $23.0 million and $13.6 million for 1999, 1998 and 1997.
Interest expense decreased $418,000 or 1.4% in 1999 from $30.2
million in 1998. Increased volumes increased interest expense by $2.4
million but this was offset by a decrease of $2.9 million as a result of a
decline in rates from 4.04% in 1998 to 3.73% in 1999. Interest expense
increased $2.9 million in 1998 over 1997. Increased volumes
generated an increase of $3.4 million which was offset by a decrease
of $.5 million as a result of a decline in rates from 4.05%
in 1997 to 4.04% in 1998. Average interest bearing deposits
increased $40.3 million in 1999 over 1998 compared to an increase of
$77.2 in 1998 over 1997. Other borrowed funds, on average, increased
$11.5 million in 1999 compared to a decrease of $3.8 in 1998.
The average rate on other interest bearing liabilities was
6.03%, 6.29% and 6.80% in 1999, 1998 and 1997.
Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity
Interest Rates and Interest Differential-Tax Equivalent Yields
(Unaudited)
Years ended December 31,
1999 1998 1997
Average Annual Average Annual Average Annual
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets:
Federal funds sold........$ 17,871 $ 891 4.98% $ 22,967 $ 1,243 5.41% $ 13,600 $ 770 5.66%
-------- ------ ----- ------- ------ ------ ------- ------ ------
Securities:
U.S. Treasury securities. 29,807 1,720 5.77% 32,581 1,910 5.86% 28,330 1,679 5.93%
U.S. Government agencies. 52,171 3,232 6.19% 43,630 2,682 6.15% 43,193 2,771 6.42%
State and municipal
securities.............. 82,195 6,194 7.54% 70,469 5,395 7.66% 62,775 4,941 7.87%
Other securities......... 95,496 5,758 6.03% 87,814 5,374 6.12% 67,360 4,166 6.18%
-------- ------ ----- ------- ------ ------ ------- ------ ------
Total securities........... 259,669 16,904 6.51% 234,494 15,361 6.55% 201,658 13,557 6.72%
-------- ------ ----- ------- ------ ------ ------- ------ ------
Loans:
Commercial............... 319,407 27,101 8.48% 303,826 26,858 8.84% 274,738 24,913 9.07%
Consumer................. 147,652 12,092 8.19% 137,966 12,097 8.77% 138,675 12,337 8.90%
Mortgages................ 95,568 7,597 7.95% 91,028 7,603 8.35% 84,129 7,164 8.52%
Leases................... 65,008 6,043 9.30% 55,004 5,238 9.52% 50,811 5,022 9.88%
--------- ------ ------ ------- ------- ------- ------- ------- ------
Total loans................ 627,635 52,833 8.42% 587,824 51,796 8.81% 548,353 49,436 9.02%
--------- ------ ----- ------- ------- ------ ------- ------- ------
Total interest earning
assets................... 905,175 70,628 7.80% 845,285 68,400 8.09% 763,611 63,763 8.35%
--------- ----- ------- ----- ------- -----
Allowance for loan losses.. (8,141) (8,335) (8,298)
Cash and due from banks.... 34,970 31,708 29,841
Other assets............... 93,756 85,294 75,265
--------- ------- -------
Total non interest
earning assets........... 120,585 108,667 96,808
--------- ------- ------- ------- ------- -------
Total assets..............$1,025,760 $70,628 $953,952 $ 68,400 $860,419 $63,763
========== ======= ======== ======= ======= =======
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Demand deposits.........$ 321,769 $ 7,279 2.26% $302,062 $ 7,562 2.50% $280,197 $ 7,205 2.57%
Savings deposits........ 70,733 1,223 1.73% 73,082 1,580 2.16% 73,549 1,638 2.23%
Time deposits........... 363,872 18,699 5.14% 340,969 19,089 5.60% 285,191 16,093 5.64%
Other borrowed funds...... 43,022 2,596 6.03% 31,550 1,984 6.29% 35,317 2,402 6.80%
--------- ------ ----- ------- -------- ------ -------- ------- ------
Total interest bearing
liabilities.............. 799,396 29,797 3.73% 747,663 30,215 4.04% 674,254 27,338 4.05%
--------- ------ ----- ------- -------- ------ -------- ------- ------
Demand deposits .......... 113,208 98,957 87,248
Other liabilities......... 24,046 22,729 20,527
Stockholders' equity...... 89,110 84,603 78,390
--------- ------ ------- ------- -------- -------
Total liabilities and
stockholders' equity.....$1,025,760 $29,797 $953,952 $ 30,215 $860,419 $27,338
========== ======= ======== ======== ======== =======
Interest rate spread....... 4.07% 4.05% 4.30%
===== ===== =====
Net interest income/
Average earning assets.... $40,831 4.51% $ 38,185 4.52% $36,425 4.77%
Yields on tax-exempt assets have been computed on a fully taxable equivalent
basis assuming a 35% tax rate.
For yield calculation purposes, nonaccruing loans are included
in the average loan balance.
Table 2 - Analysis of Changes in Net Interest Income
The rate-volume variance analysis set forth in the table below,
which is computed on a taxable equivalent basis, compares changes
in net interest income for the periods indicated by their
rate and volume components. The change in interest income/expense due
to both volume and rate has been allocated to change in rate.
1999 Versus 1998 1998 Versus 1997
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
Volume Rate Total Volume Rate Total
Interest income:
Federal funds sold.....$ (276) $ (76) $ (352) $ 530 $ (57) $ 473
Securities............. 1,649 (106) 1,543 2,206 (402) 1,804
Loans.................. 3,507 (2,470) 1,037 3,577 (1,217) 2,360
------- ------- ------ ------ ------- -------
Total interest income... 4,880 (2,652) 2,228 6,313 (1,676) 4,637
------- ------- ------ ------ ------- -------
Interest expense:
Interest-bearing demand$ 494 (777) (283) $ 562 $ (205) $ 357
Savings deposits....... (51) (306) (357) (11) (47) (58)
Time deposits.......... 1,282 (1,672) (390) 3,148 (152) 2,996
Borrowed funds......... 721 (109) 612 (256) (162) (418)
------- ------- ------ ------- ------- -------
Total interest expense.. 2,446 (2,864) (418) 3,443 (566) 2,877
------- ------- ------ ------- ------- -------
Net interest income..... $ 2,434 $ 212 $ 2,646 $ 2,870 $ (1,110) $ 1,760
======= ======= ======= ======= ======= =======
For yield calculation purposes, nonaccruing loans are included in the average
loan balances.
Provision for Loan Losses
The provision for loan losses charged against earnings was $420,000 in
1999 compared to $956,000 in 1998 and $1,129,000 in 1997. The provision
reflects the amount deemed appropriate by management to produce an
adequate reserve to meet the present risk characteristics of the
loan portfolio. Management's judgement is based on the evaluation
of individual loans and their overall risk characteristics, past loan
loss experience, and other relevant factors. Net charge-offs amounted
to $316,000 in 1999, $1,028,000 in 1998 and $1,246,000 in 1997.
Gross charge-offs for 1999 were $521,000, a 60% decline from the
$1,311,000 reported in 1998. The decline in the provision for loan losses,
gross and net charge-offs was a result of improvement in credit
quality, particularly in the consumer portfolio. A strong economy, a tightening
of certain underwriting criteria during 1997 and 1998 and strong
collection efforts contributed to the improvement. Loan quality remains
high in the commercial loan portfolio as evidenced by the continuing low
levels of delinquency, charge-offs and non-accruals. The net
losses to average loans and leases in 1999 were significantly
lower than the bank's peer group.
The allowance for loan losses as a percent of loans at
December 31, 1998 was 1.36%, while at December 31, 1999 it was 1.23%.
Noninterest Income
Table 3 - Noninterest Income
1999/1998 1998/1997
Increase Increase
(Decrease) (Decrease)
1999 Amount % 1998 Amount % 1997
Income from fiduciary activities.$ 2,349 $ 470 25.0% $ 1,879 $ 366 24.2% $ 1,513
Service charges on deposit
accounts....................... 3,380 167 5.2% 3,213 18 0.6% 3,195
Other service charges, commissions
and fees....................... 1,978 84 4.4% 1,894 438 30.1% 1,456
Mortgage banking income........... 1,291 (520) (28.7%) 1,811 506 38.8% 1,305
Income from sale of credit card
portfolio...................... --- (1,338)(100.0%) 1,338 1,338 100.0% ---
Rental income on operating leases. 18,469 2,504 15.7% 15,965 2,348 17.2% 13,617
Other operating income............ 1,200 107 9.8% 1,093 (534) (32.8%) 1,627
Securities gains.................. 830 830 100.0% none (215)(100.0%) 215
------ ------ ------ ------ ------ ------ ------
Total............................$ 29,497 $2,304 8.5% $27,193 $ 4,265 18.6% $22,928
====== ====== ====== ====== ====== ====== ======
Noninterest income consists of income from fiduciary activities,
service charges on deposit accounts, other service charges, commissions and
fees, mortgage banking income and other income such as safe deposit box rents
and income from operating leases. Investment securities gains are
also reflected in noninterest income.
Income from fiduciary activities, which is investment management and
trust services income, reached a record level of over $2.3 million, an
increase of nearly $.5 million or 25.0%. This follows an increase of 24.2%
in 1998 over 1997. Fees increased primarily due to increased transaction
volumes and growth in assets under management, which increased
from $379 million in 1997, to $531 million in 1998, to $611 million in 1999.
This growth in assets resulted from new relationships developed, as
well as market appreciation on existing assets under management.
Management continues to feel that the wealth management division, or
trust services, represents a significant growth opportunity for the
corporation. Sterling will continue its concerted efforts to expand
the business, which includes marketing activities and the
hiring of experienced professionals. Although wealth management
professionals can continue to generate new business, the value of assets
under management is directly related to the stock market.
Declines in the stock market could have an adverse impact on
income from fiduciary activities.
Service charges on deposit accounts increased $167,000 or 5.2%
during 1999. This follows an increase of $18,000 or .6% in 1998.
General increases in service charges on various accounts, as
well as transaction volume produced the increase in 1999 over 1998.
Management continuously monitors the fee structure and makes changes
where appropriate. Other service charges, commissions and fees
increased $84,000 or 4.4% in 1999 compared to 1998. The increase
in 1998 over 1997 was $438,000 or 30.1%. Contributing to the increase
in 1999 as well as 1998 were the fees received on mutual funds
transactions and fees on the debit card product
offered by subsidiary banks.
Income from mortgage banking activities was $1.3 million, $1.8
million and $1.3 million for the years ended December 31, 1999,
1998 and 1997. The fluctuation in mortgage banking income
is directly related to the residential mortgage interest rate
environment and the mortgage products offered. In 1998, the
relatively low residential mortgage interest rate environment
combined with an expansion of products and services
offered resulted in an increase in the volume of loans sold on
the secondary market, from $40.9 million in 1997 to $88.9 million
in 1998. During 1999, residential mortgage interest rates increased
resulting in a slow down in mortgage loan originations as
evidenced by $58.8 million in loans sold in the secondary market. As a
result of this volume, gains on sales of mortgage loans
totaled $418,000, $642,000 and $319,000 for the
years ended December 31, 1999, 1998 and 1997.
Another component of the decrease in mortgage banking income is
mortgage servicing rights capitalized and included as mortgage
banking income. Amounts capitalized are directly related
to the volume of loans sold in the secondary market. Mortgage servicing
rights capitalized for the years ended December 31, 1999, 1998 and 1997
totaled $569,000, $840,000 and $563,000. Sterling originated
all mortgages sold on the secondary market. No mortgages were
acquired from third parties, nor have servicing rights been purchased
from third parties. The mortgage servicing portfolio totaled $244
million as of December 31, 1999 compared to $221 million
on December 31, 1998.
During 1998, the Bank of Lancaster County sold its credit card
portfolio for a gain of $1.3 million.
Rental income on operating leases has increased 15.7% from $15,965,000
in 1998 to $18,469,000 in 1999. This follows an increase
of 17.2% in 1998 over 1997. The increase in rental income
is primarily due to an increase in the number of units under operating
leases which totaled 4,648, 3,826 and 3,205 as of December 31, 1999, 1998
and 1997. Sterling recognizes that leasing operations represent
a growth opportunity for the corporation and has committed resources
to expand this business. These resources include increased marketing
efforts, not only in developing new customer relationships, but also
in maintaining existing customer relationships. With the hiring of
additional employees to perform operational functions, salesmen
are able to devote more of their time to business development
and less time performing operational activities. Additionally, the
strong national and local economy has led to our clients expanding
their business operations, resulting in an increase in the number
of new units leased within our customer base.
Other operating income totaled $1.2 million in 1999, which was
consistent with $1.1 million earned in 1998. Other operating income
declined 32.8% in 1998 compared to the $1.6 million earned
in 1997 due primarily to a $450,000 gain recognized on the sale of
real estate in 1997. The corporation was able to sell this real estate,
which formerly housed the leasing operations, with the purchase of the
123,000 square foot administrative service center in 1996.
Investment securities gains totaled $830,000 in 1999, $0 in 1998
and $215,000 in 1997. The securities sold in 1999 and 1997 were equity
securities from the available-for-sale securities portfolio.
Sterling does not engage in trading activities.
Noninterest Expenses
Table 4 - Noninterest Expenses
1999/1998 1998/1997
Increase Increase
(Decrease) (Decrease)
1999 Amount % 1998 Amount % 1997
Salaries and employee benefits...$19,302 $ 674 3.6% $18,628 $ 1,185 6.8% $17,443
Net occupancy .................... 2,143 (213) (9.0%) 2,356 (185) (7.3%) 2,541
Furniture & equipment............. 3,242 244 8.1% 2,998 293 10.8% 2,705
Professional services............. 1,089 106 10.8% 983 291 42.1% 692
Depreciation on operating lease
assets...........................14,641 2,000 15.8% 12,641 1,943 18.2% 10,698
Merger related costs.............. 423 423 100.0% --- --- --- ---
Other operating expense........... 7,991 347 4.5% 7,644 603 8.6% 7,041
----- ------ ----- ------ ------ ----- -------
Total............................$48,831 $ 3,581 7.9% $45,250 $ 4,130 10.0% $41,120
======= ======= ===== ======= ====== ===== =======
Operating expense levels are often measured by the efficiency ratio,
which expresses noninterest expense as a percentage of tax-equivalent
net interest income and total fees and other income. Operating leases
significantly impact Sterling's consolidated efficiency ratio, which
tends to drive the ratio higher than is typically acheived on
financial institutions with no similar operating lease portfolio. In
order to effectively monitor the efficiency ratio, Sterling monitors this
ratio on its two significant operating segments: 1) community banking and
related services and 2) leasing.
Sterling's efficiency ration for each significant segment has shown
improvement in 1999 compared to the prior two years. Excluding non-recurring
items, the operating efficiency ratio for community banking and related
services moved down to 61.3% in 1999, versus 63.0% in 1998 and 62.8% in
1997. The leasing segment's ratio was reduced to 92.5% in 1999, versus 94.2%
in 1998 and 94.5% in 1997.
The largest component of noninterest expense is salaries and employee
benefits which increased $674,000 or 3.6% to $19.3 million from $18.6
million in 1998, after increasing $1.2 million or 6.8% during 1998.
The number of full-time equivalent employees at year-end 1999 and 1998
was 480. The 1999 salary expense increase was due primarily to normal
merit increases and promotions. Also included in the increase for 1999
and 1998 are the increased costs of benefits such as health
insurance and additional benefit plans.
Net occupancy expense decreased $213,000 or 9% to $2.1 million
in 1999 from $2.4 million in 1998. This compares to a decrease of
$185,000 in 1998 from 1997. Furniture and equipment expense
experienced an increase of $244,000 or 8.1% to $3.2 million in 1999
from $3 million in 1998, compared to an increase of $293,000 or 10.8%
in 1998. Included in the increase of furniture and equipment
expense in 1999 is an increase in depreciation of approximately
$180,000.
Professional services increased $106,000 or 10.8% in 1999 to
$1.1 million after increasing $291,000 or 42.1% in 1998.
The increase in professional services over the last
two years can be attributed to Sterling's increased reliance on
services outsourced to third parties. These third parties bring a
greater degree of knowledge and experience to
the organization than that which can be obtained internally.
Merger related costs incurred in 1999 totaled $423,000 and
was a direct result of Sterling's acquisition of Northeast Bancorp, Inc.
completed during the second quarter of 1999. These merger expenses
consisted entirely of attorney, accountant, investment
advisory and application fees.
Depreciation on operating leases increased $2,000,000 or 15.8%
in 1999 from 1998 compared to $1,943,000 increase or 18.1% from 1998
compared to 1997. The increase is directly related to the increase
in number of units on operating lease to customers discussed above, and the
percent increase each year is consistent with the increase in rental income
on operating leases.
Other expenses increased $346,000 or 4.5% to nearly $8 million
during 1999 after increasing $604,000 or 8.6% during 1998.
The 1999 increase is consistent with rising costs associated
with acquiring services covered in this category of expense. Expenses
in this category include advertising and marketing, postage, telephone,
stationery and forms, ATM fees, insurance premiums, training and
education, Pennsylvania Shares Tax and other expense categories
not specifically identified on the income statement. Contributing to the
increase in 1999 were increases in Pennsylvania Shares Tax, MAC fees,
telephone expense, postage, marketing, and training and education.
Income Taxes
Sterling recognized income tax of $4.9 million, or 27.1% of
pretax income, for the year 1999 compared to $4.2 million, or 25.4% of
pretax income, for the year 1998. The variances from the federal statutory
rate of 35% are generally due to tax exempt income, investments in low
and moderate income housing partnerships (which qualify for federal tax
credits), offset somewhat by certain merger-related expenses in 1999
which are not deductible. The income tax recognized in 1997 was $4
million, or 26.2% of pretax income. Additional information related
to income taxation is presented in the Notes to Consolidated
Financial Statements.
Financial Condition
Investment Portfolio
Table 5 - Investment Securities
The following table shows the amortized cost of the
held-to-maturity securities owned by Sterling as of the dates
indicated. Securities are stated at cost adjusted for
amortization of premiums and accretion of discounts.
December 31,
1999 1998 1997
U.S. Treasury securities................$ 501 $ 2,508 $ 6,537
U.S. Government agencies and corporations 1,460 2,208 9,696
States and political subdivisions....... 41,030 44,465 45,816
Mortgage-backed securities.............. 851 1,219 1,575
Corporate securities.................... 4,757 10,808 18,574
--------- --------- ---------
Subtotal................................ 48,599 61,208 82,198
Non-marketable equity securities........ 3,793 3,547 3,277
--------- --------- ---------
Total...................................$ 52,392 $ 64,755 $ 85,475
========= ========= =========
The following table shows the amortized cost and fair value of the
available-for-sale securities owned as of the dates indicated.
December 31,
1999 1998 1997
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- -------- -------- ----------- --------
U.S. Treasury securities............$ 28,961 $ 28,758 $ 29,265 $ 29,930 $ 24,435 $ 24,625
U.S. Government agencies and
corporations....................... 50,290 49,017 37,713 38,285 26,821 27,008
States and political subdivisions.... 53,617 51,755 38,671 39,761 23,976 24,726
Mortgage-backed securities........... 4,989 4,829 6,732 6,761 8,603 8,542
Corporate securities................. 70,878 69,711 66,215 67,312 42,955 43,178
-------- --------- -------- -------- --------- --------
Subtotal............................. 208,735 204,070 178,596 182,049 126,790 128,079
Equity securities.................... 704 3,113 174 3,904 174 3,263
-------- --------- -------- -------- --------- --------
Total................................$209,439 $ 207,183 $178,770 $185,953 $ 126,964 $131,342
======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields)
The following table shows the maturities of held-to-maturity debt
securities at amortized cost as of December 31, 1999 and approximate weighted
average yields of such securities. Yields on states and political
subdivision securities are shown on a tax equivalent basis,
assuming a 35% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 501 5.84% $ --- ---% $ --- ---% $ --- ---% $ 501 5.84%
U.S. Government
agencies and
corporations.. 1,000 6.41% 460 5.98% --- ---% --- ---% 1,460 6.28%
States and
political sub-
divisions..... 2,694 5.21% 11,994 5.27% 22,292 5.08% 4,050 4.83% 41,030 5.12%
Mortgage-backed
securities.... 230 8.30% 534 8.39% 51 8.08% 36 7.28% 851 8.30%
Corporate
securities.... 2,156 6.30% 2,601 6.28% --- ---% --- ---% 4,757 6.29%
------- ----- ------- ------ -------- ----- ------- ----- ------- -----
$ 6,581 5.91% $15,589 5.57% $ 22,343 5.07% $ 4,086 4.85% $48,599 5.32%
======= ===== ======= ====== ======== ===== ======= ===== ======= =====
The following table shows the maturities of available-for-sale debt
securities at fair value as of December 31, 1999 and approximate weighted
average yields of such securities. Yields on states and political
subdivision securities are shown on a tax equivalent basis,
assuming a 35% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 6,797 5.59% $ 21,961 5.87% $ --- ---% $ --- ---% $ 28,758 5.80%
U.S. Government
agencies and
corporations.. 8,036 6.17% 27,018 5.98% 13,031 6.29% 932 7.00% 49,017 6.12%
States and
political sub-
divisions..... 1,750 5.73% 12,365 5.31% 18,861 4.80% 18,779 4.61% 51,755 4.88%
Mortgage-backed
securities.... 200 5.44% 170 7.29% 1,130 7.21% 3,329 6.71% 4,829 6.79%
Corporate
securities.... 13,508 6.18% 56,203 6.13% --- ---% --- ---% 69,711 6.14%
------- ------ ------- ------ ------- ----- ------- ----- -------- ------
$30,291 5.91% $117,717 5.96% $33,022 5.48% $23,040 5.00% $204,070 5.78%
======= ====== ======= ====== ======= ===== ======= ===== ======== ======
There is no issuer of securities in which the aggregate book value of
that issuer, other than securities of the U.S. Treasury, U.S. Government
agencies or corporations, exceeds 10% of stockholders' equity.
Loans
Loans outstanding increased $70.3 million or 11.9% in 1999,
compared to an increase of $25.8 million or 4.5% in 1998. All categories
of loans reflect an increase in 1999 over 1998. Commercial loans
increased over $29 million or 9.6% in 1999 while consumer
loans increased $16 million or 11.8%. Lease financing reflects an
increase of $15.4 million or 26.7% in 1999. The loan growth in
1998 was realized mainly in commercial loans which reflects
an increase of $20.2 million or 7.2%.
Table 7 - Loan Portfolio
The following table sets forth the composition of Sterling's
loan portfolio as of the dates indicated:
December 31,
1999 1998 1997 1996 1995
Commercial, financial and
agricultural..............$ 331,510 $ 302,497 $ 282,287 $ 244,538 $ 232,282
Real estate-construction... 7,872 6,633 7,053 6,421 6,628
Real estate-mortgage....... 97,631 89,021 88,212 83,168 66,981
Consumer................... 152,872 136,773 136,760 138,439 117,626
Lease financing (net of
unearned income)......... 73,123 57,736 52,566 47,659 44,181
---------- ---------- ---------- ---------- ---------
Total loans.................$ 663,008 $ 592,660 $ 566,878 $ 520,225 $ 467,698
========== ========== ========== ========== =========
Table 8 - Loan Maturity and Interest Sensitivity
The following table sets forth the maturity and interest
sensitivity of the loan portfolio as of December 31, 1999:
After one
Within but within After
one year five years five years Total
Commercial, financial and agricultural..$ 150,521 $ 165,864 $ 15,125 $ 331,510
Real estate-construction................ 5,545 1,062 1,265 7,872
--------- --------- -------- ---------
$ 156,066 $ 166,926 $ 16,390 $ 339,382
========= ========= ======== =========
Loans due after one year totaling $103,246,000 have variable
interest rates. The remaining $80,070,000 in loans have fixed rates.
Asset Quality
Sterling has policies and procedures designed to manage credit risk
and to maintain the quality of its loan portfolio. These include prudent
underwriting standards for new loan originations and ongoing
monitoring and reporting of asset quality measures and the
adequacy of the allowance for loan losses.
Sterling's commercial, consumer and residential mortgage loans
are principally to borrowers within Lancaster County, Pennsylvania,
Cecil County, Maryland, and surrounding counties. Since the
majority of Sterling's real estate loans are located within this
area, a substantial portion of the debtor's ability to honor their
obligations may be affected by the level of economic
activity in the market area.
The economic conditions within Sterling's market area remained
healthy in 1999. The unemployment rate for Lancaster County,
Pennsylvania and Cecil County, Maryland, Sterling's primary
market area, both remained below than 4%. In fact, Lancaster County
has now had an unemployment rate of less than 3% for 24 consecutive months.
Additionally, reasonably low interest rates, a continuing strong economy
and minimal inflation resulted in a record number of sales of existing homes.
A portion of Sterling's loan portfolio consists of loans to
agricultural-related borrowers. This industry experienced a difficult year
in 1999, with low crop yields as a result of a drought and
low milk prices in late 1999 due to oversupply. While Sterling
continues to pursue quality loans to the dairy industry and the
agricultural community in general, it should be noted that these loans are
susceptible to a variety of external factors such as adverse
climate, economic conditions, etc. in addition to factors common
in other industries.
The loan portfolio is well diversified with no industry
concentrations comprising greater than 10% of total loans outstanding.
A concentration is defined as amounts loaned to multiple number of
borrowers engaged in similar activities which would cause them to be
similarly affected by changes in economic or other conditions. There
were no foreign loans outstanding at December 31, 1999.
Nonperforming assets include nonaccrual and restructured loans,
accruing loans past due 90 days or more and other real estate
owned. Sterling's general policy has been to cease accruing interest
on loans when management determines that a reasonable doubt exists
as to the collectibility of additional interest. When management
places a loan on nonaccrual status, it reverses unpaid
interest credited to income in the current year, and charges unpaid
interest accrued in prior years to the allowance for loan losses.
Sterling recognizes income on these loans only to the extent that
it receives cash payments. Sterling typically returns
nonaccrual loans to performing status when the borrower brings
the loan current and performs in accordance with contractual terms for a
reasonable period of time. Sterling categorizes a loan as restructured
if it changes the terms of the loan such as interest rate,
repayment schedule or both, to terms which it otherwise would
not have granted originally.
Table 9 - Nonaccrual, Past Due and Restructured Loans
The following table presents information concerning the aggregate amount of
nonaccrual, past due and restructured loans:
December 31,
1999 1998 1997 1996 1995
Nonaccrual loans........... $ 325 $ 908 $ 1,314 $ 1,193 $ 1,386
Accruing loans, past due
90 days or more......... 751 654 1,269 752 369
Restructured loans........ 1,961 1,993 2,105 none none
------- -------- -------- -------- --------
Total non-performing loans. 3,037 3,555 4,688 1,945 1,755
Other real estate owned.... 163 180 341 81 252
------- -------- -------- -------- --------
Total non-performing assets $ 3,200 $ 3,735 $ 5,029 $ 2,026 $ 2,007
======= ======== ======== ======== ========
Nonaccrual loans:
Interest income that
would have been
recorded under
original terms......... $ 59 $ 88 $ 173 $ 144 $ 238
Interest income recorded. --- 1 20 28 94
Ratios:
Non-performing loans to
total loans.......... .46% .60% .83% .37% .38%
Non-performing assets to
total loans and other
real estate owned.... .48% .63% .89% .39% .43%
Non-performing assets to
total assets.......... .30% .37% .55% .24% .26%
Allowance for loan losses to
non-performing loans.. 269.1% 227.0% 173.7% 424.6% 474.3%
As of December 31, 1999, total non-performing assets totaled
$3,200,000, a decline of $535,000, or 14%, from the December 31, 1998
balance of $3,735,000. The decline in nonaccrual loans and
accruing loans past due 90 days or more during the year is consistent
with the downward trend Sterling has experienced since 1997. The
restructured loans included in nonperforming loans represents a series
of loans to one borrower in the real estate business. Sterling has
no commitment to lend this customer additional funds
related to the restructured notes. These restructured loans are
fully secured with real estate collateral, are current, and have
performed in accordance with the contractual terms, both prior to
and after the restructuring. Accrual of interest on the restructured
loans continues.
Sterling's loan delinquency (past due greater than 30 days)
as a percent of loans outstanding declined during 1999. At
December 31, 1999, this rate stood at .31% compared
to .49% and .90% for December 31, 1998 and 1997. The average
delinquency rate for 1999 of .41% declined from .56% in 1998. The
decline in the delinquency rate was primarily attributed to
improvement in the consumer loan portfolio, and is partially attributed to
the sale of the credit card portfolio in 1998. The credit card portfolio
tended to have higher delinquencies associated with it
than the remainder of the consumer loan balances.
Potential problem loans are defined as performing loans which
have characteristics that cause management to have serious doubts as to
the ability of the borrower to perform under present loan
repayment terms and which may result in the reporting of these loans as
nonperforming loans in the future. Total potential problem loans
approximated $3 million at December 31, 1999. The majority of these
loans are secured by real estate with acceptable loan-to-value ratios.
Sterling has implemented SFAS No. 118, Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosures, an amendment
of SFAS No. 114, at the beginning of 1995. A loan is considered impaired
when, based on current information and events, it is probable that
Sterling will be unable to collect the scheduled payments of principal or
interest when due according to the original contractual terms of the
loan agreement. Generally, this definition includes all loans on
nonaccrual status and restructured loans, except those specifically
excluded from the scope of SFAS No. 114. Factors considered by
management in determining impairment include payment status,
collateral value and the probability of collecting scheduled
principal and interest payments when due. Impairment is measured on a
loan by loan basis for commercial and construction loans by either the
present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's obtainable market price
or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, Sterling does not
separately identify individual consumer and residential loans
for impairment disclosures.
The following table presents information concerning impaired
loans at December 31, 1999 and 1998:
1999 1998
Impaired loans with a valuation allowance.......$ 2,286 $ 2,901
Impaired loans without a valuation allowance.... --- ---
------ ------
Total impaired loans..........................$ 2,286 $ 2,901
====== ======
Valuation allowance related to impaired loans...$ 111 $ 140
====== ======
The decline in impaired loans is primarily attributed to a $583,000
reduction in non-accrual loans at December 31, 1999 versus December 31, 1998.
A large portion of the impaired loans is attributed to the restructure
of a series of loans to one borrower as previously discussed.
Allowance for Loan Losses
Sterling maintains the allowance for loan losses at a level believed
adequate by management to absorb potential losses in the loan portfolio.
It is established through a provision for loan losses charged to
earnings. Quarterly, the company utilizes a defined methodology in
determining the adequacy of the allowance for loan losses which considers
specific credit reviews, past loan loss historical experience, and
qualitative factors. This methodology, which has remained consistent for
the past several years, results in an allowance consisting of
two components, "allocated" and "unallocated".
Management assigns internal risk ratings to all commercial
relationships with aggregate borrowings or commitments to
extend credit in excess of $100,000. Utilizing migration analysis
for the previous eight quarters, management develops a loss factor test
which it then uses to estimate losses on impaired loans, potential problem
loans and non-classified loans. When management finds loans with uncertain
collectibility of principal and interest, it places those loans on the
"problem list", and evaluates them on a quarterly basis in order to
estimate potential losses. Management's analysis considers:
adverse situations that may affect the borrower's ability to repay;
estimated value of underlying collateral; and
prevailing market conditions.
If management determines that a specific reserve allocation is not
required, it assigns the general loss factor to determine the reserve.
For homogeneous loan types, such as consumer and residential
mortgage loans, management bases specific allocations on the
average loss ratio for the previous two years for each specific loan pool.
Additionally, management adjusts projected loss ratios for other
factors, including the following:
trends in delinquency levels,
trends in non-performing and potential problem loans,
trends in composition, volume and terms of loans,
effects in changes in lending policies or underwriting procedures,
experience ability and depth of management,
national and local economic conditions,
concentrations in lending activities,
other factors that management may deem appropriate.
Management determines the unallocated portion of the allowance for
loan losses based on the following criteria:
risk of error in the specific and general reserve allocations;
other potential exposure in the loan portfolio;
variances in management's assessment of national and local economic
conditions; and
other internal or external factors that management believes
appropriate at that time.
Management feels the above methodology accurately reflects losses
inherent in the portfolio. Management charges actual losses to the
allowance for loan losses. Management periodically updates the methodology
discussed above, which reduces the difference between actual losses
and estimated losses.
Management bases the provision for loan losses, or lack of provision,
on the overall analysis taking into account the methodology discussed above.
A summary of the activity in the allowance for loan losses is as follows:
Table 10 - Summary of Loan Loss Experience
Years ended December 31,
1999 1998 1997 1996 1995
Allowance for Loan Losses:
Beginning balance.............$ 8,070 $ 8,142 $ 8,259 $ 8,324 $ 8,429
------ ------ ------ ------ ------
Loans charged off during year:
Commercial, financial and
agricultural.............. 137 479 198 139 187
Real estate mortgage........ 107 96 122 40 ---
Consumer.................... 246 682 1,125 567 487
Lease financing............. 31 54 121 24 14
------- ------- ------- ------- -------
Total charge-offs........... 521 1,311 1,566 770 688
------- ------- ------- ------- -------
Recoveries:
Commercial, financial and
agricultural.............. 44 63 94 13 157
Real estate mortgage........ --- 32 --- --- ---
Consumer.................... 117 160 161 144 148
Lease financing............. 44 28 65 8 2
------- ------- ------- ------- -------
Total recoveries............ 205 283 320 165 307
------- ------- ------- ------- -------
Net loans charged off......... 316 1,028 1,246 605 381
Provision for loan losses..... 420 956 1,129 540 276
------- ------- ------- ------- -------
Balance at end of year........$ 8,174 $ 8,070 $ 8,142 $ 8,259 $ 8,324
======= ======= ======= ======= =======
Ratio of net loans charged
off to average loans
outstanding................. .05% .17% .23% .12% .09%
Ratio of net loans charged
off to loans at end of year. .05% .17% .22% .12% .08%
Net loans charged off to
allowance for loan losses.. 3.87% 12.74% 15.30% 7.33% 4.58%
Net loans charged off to
provision for loan losses.. 75.24% 107.53% 110.36% 112.04% 138.04%
Allowance for loan losses as a
percent of average loans... 1.30% 1.37% 1.48% 1.63% 1.88%
Allowance for loan losses
as a percent of loans at
end of year................ 1.23% 1.36% 1.44% 1.59% 1.78%
Allowance for loan losses
as a percent of
non-performing loans....... 269.1% 227.0% 173.7% 424.6% 474.3%
The allowance for loan losses increased slightly from $8,070,000 at
December 31, 1998 to $8,174,000 at December 31, 1999. Despite
this increase, the allowance for loan losses as a percent of
outstanding loans continued to decline, and was 1.23% at December 31, 1999
versus 1.36% at December 31, 1998. This decrease is reflective of
Sterling's improving asset quality ratios.
Net charge-offs over the last three years were $316,000,
$1,028,000 and $1,246,000 for the years ended December 31, 1999,
1998 and 1997. The decrease in net charge-offs was a direct result
of a strong economy, the tightening of certain underwriting criteria in
1997 and 1998 along with strong collection efforts in all loan portfolios.
Additionally, the significant improvements in the consumer loan
portfolio were partially the result of Sterling selling
its credit card portfolio in 1998, which consistently had higher
delinquencies and charge-offs than the remainder of the consumer loan
portfolio. As a result, similar improvements were noted in
the allowance for loan losses as a percent of non-performing
loans, which increased from 173.7% in 1997, to 227.0% in 1998, to 269.1% in
1999. Finally, loan delinquencies as percent of loans outstanding
declined to .31% at December 31, 1999, well below the levels of
Sterling's peer group.
Table 11 - Allocation of Allowance for Loan Losses (dollars in thousands)
1999 1998 1997 1996 1995
Loans Loans Loans Loans Loans
% to % to % to % to % to
total total total total total
Amount loans Amount loans Amount loans Amount loans Amount loans
Commercial, financial
and agricultural.......$5,578 50% $4,992 51% $3,802 50% $3,836 47% $4,000 50%
Real estate - mortgage
and construction....... 109 16% 144 16% 60 17% 24 17% 143 16%
Consumer.................. 779 23% 693 23% 923 24% 596 27% 532 25%
Leases.................... 638 11% 527 10% 599 9% 620 9% 600 9%
Unallocated............... 1,070 -- 1,714 -- 2,758 -- 3,183 -- 3,049 --
------ --- ------ --- ----- --- ----- --- ----- ---
Total....................$8,174 100% $8,070 100% $8,142 100% $8,259 100% $8,324 100%
====== === ====== === ===== === ===== === ===== ===
The allocation of the allowance for loan losses between the various
loan portfolios has changed over the past few years, consistent with the
historical net loss experience in each of the portfolios.
The largest reserve allocation is to the commercial, financial
and agricultural loan portfolio and represents 68.21% of the
reserve. Although the reserve allocation to this portfolio has
increased over the last two years, the reserve allocation as a percent of
related loans remained at approximately 1.60% to 1.70%. This nonhomogeneous
loan portfolio continues to represent the greatest risk
exposure to Sterling, as the credits generally are significantly
larger than the remainder of the portfolio and the related
collateral is not as marketable. Additionally, other external factors
such as competition for high rated credits has also been considered
in allocating this reserve balance.
As mentioned previously, Sterling sold its credit card
portfolio in 1998, which resulted in a significant improvement in net
charge-offs within the consumer loan portfolio. The sale of
the credit card portfolio combined with increased collections
efforts also resulted in a decline in the consumer loan delinquencies.
As a result, the allocation of the allowance for loan losses for the
consumer loan portfolio has declined since the 1997 allocation,
and has remained at approximately .51% of the related loan
balance as of December 31, 1999 and 1998.
The increase in the reserve allocation related to the
lease portfolio from 1998 to 1999 is a direct result of the growth in
this portfolio as well as an increase in problem credits within this
portfolio. However, the 1999 reserve allocation as a percent of
average loans outstanding remains below the 1995-1997 levels, consistent
with the decrease in net charge-offs and lower delinquency ratios.
Over the past several years, the allowance for loan losses to
outstanding loans has declined. Similarly, the unallocated portion of the
allowance for loan losses has also shown a steady decline,
both in the dollar amount and as a percent of the total reserve.
The unallocated portion totaled $1,071,000 at December 31, 1999,
or 13.1% of the allowance for loan losses balance. These trends are closely
related to improvements in asset quality ratios, including the following:
An increase in the allowance for loan losses to non-performing
loans from 174% at December 31, 1997 to 269% at December 31, 1999.
A decline in the non-performing loans to total loans from .83% at
December 31, 1997 to .46% at December 31, 1999.
A decline in loan delinquencies as a percent of total loans outstanding
from .90% at December 31, 1997 to .31% at December 31, 1999.
A reduction in the ratio of net loans charged off to average loans
outstanding from .23% for the year ended December 31, 1997 to .05%
for the year ended December 31, 1999.
Based upon the improvements noted above, management feels the decrease
in the allowance for loan losses as a percent of total loans outstanding
as well as the unallocated portion of the reserve is justified. Management
has not targeted any specific coverage ratio of nonperforming loans by
the allowance for loan losses, and this ratio may fluctuate based
on loans placed into or removed from nonperforming status. Based upon
information presently available, management believes that the
allowance for loan losses is adequate.
Deposits
The subsidiary banks of Sterling continue to rely heavily on
deposit growth as the primary source of funds for lending activities.
In 1999, total deposits grew nearly $37.4 million or 4.4% to
$892.4 million. Noninterest bearing deposits grew $9.7 million or 8.9%
while interest bearing deposits grew $27.7 million or 3.7%. The total
deposit growth in 1998 was $71.7 million or 9.2% over the deposits of 1997.
Table 12 - Average Deposit Balances and Rates Paid
The following table summarizes the average amounts of deposits and
rates paid for the years indicated:
1999 1998 1997
Amount Rate Amount Rate Amount Rate
Noninterest-bearing demand deposits. $113,208 --- $ 98,957 --- $ 87,248 ---
Interest bearing demand deposits.... 321,769 2.26% 302,062 2.50% 280,197 2.57%
Savings deposits.................... 70,733 1.73% 73,082 2.16% 73,549 2.23%
Time deposits....................... 363,872 5.14% 340,969 5.60% 285,191 5.64%