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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, 1997
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 27, 1998 was approximately $159,963,708.
The number of shares of Registrant's Common Stock outstanding on February 27,
1998 was 6,161,006.
Documents Incorporated by Reference
Portions of the Proxy Statement for the Registrant's 1998 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........................................... 9
Item 3. Legal Proceedings.................................... 9
Item 4. Submission of Matters to a Vote of Security Holders.. 9
Part II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters.......................... 10
Item 6. Selected Financial Data.............................. 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 11
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk.......................................... 28
Item 8. Financial Statements and Supplementary Data.......... 30
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. 54
Part III
Item 10. Directors and Executive Officers of the Registrant... 55
Item 11. Executive Compensation............................... 55
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 55
Item 13. Certain Relationships and Related Transactions....... 55
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.......................................... 56
Signatures...................................................... 57
PART I
Item 1 - Business
Sterling Financial Corporation
Sterling Financial Corporation (the "Corporation") is a registered bank
holding company and a Pennsylvania business corporation, headquartered in
Lancaster, Pennsylvania. The Corporation was organized on February 23, 1987 as a
bank holding company for The First National Bank of Lancaster County, now, by
change of name, Bank of Lancaster County, N.A. (the "Bank").
The Corporation provides a wide variety of commercial banking and trust
services through the Bank.
A major source of operating funds for the Corporation is dividends provided
by the Bank. The Corporation's expenses consist principally of operating
expenses. Dividends paid to stockholders are, in part, obtained by the
Corporation from dividends declared and paid to it by the Bank.
As a bank holding company, the Corporation is registered with the Federal
Reserve Board in accordance with the requirements of the Bank Holding Company
Act of 1956, as amended, and is subject to regulation by the Federal
Reserve Board and by the Pennsylvania Department of Banking.
In addition, the Corporation owns all of the outstanding stock of Sterling
Mortgage Services, Inc., a Pennsylvania corporation and a mortgage service
company formed by the Corporation as a wholly owned subsidiary and is presently
inactive.
Bank of Lancaster County
The Bank 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, the name was changed to The First National Bank
of Lancaster County. At the time of the holding company's organization, on June
30, 1987, the institution's name was changed to its present name, Bank of
Lancaster County, N.A. At December 31, 1997, the Bank had total assets of
$845,311,000 and total deposits of $720,480,000.
The main office of the Bank is located at 1 East Main Street, Strasburg,
Pennsylvania. In addition to its main office, the Bank had twenty-eight (28)
branches in Lancaster County and one (1) branch in Chester County, Pennsylvania
in operation at December 31, 1997.
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, a VISA credit card,
and a full spectrum of personal and commercial lending
activities. The Bank maintains correspondent relationships with major banks
in Philadelphia and Baltimore.
Through these correspondent relationships, the Bank can offer a variety of
collection and international services.
With the installation of three automated teller machines (ATMs) in April,
1983, the Bank was the first financial institution in Lancaster County to join
the MAC (Money Access Center) Network. The Bank now has 25 ATMs in Lancaster
County. The Bank became a participating member of the Plus System in the Fall
of 1984. This membership entitles the Bank's MAC/Plus cardholders to
have access to a nationwide network of over 150,000 ATMs.
The Bank introduced Discount Brokerage Service in July, 1983. This service
is offered in coordination with Fiserv Investor Services, Inc., an affiliate of
BHCM, Inc. and meets the needs of the commission-conscious investor. In 1992,
the Bank began offering mutual funds to customers. The Bank is in the process
of formalizing a product sales agreement with a third party marketer to sell
fixed annuities. As required, the Bank has obtained an insurance license
from the Commonwealth of Pennsylvania. The Bank expects to
begin making this product available during the first quarter of 1998.
Management believes these services are important additions to the Bank's
product line and that these products make a statement about the Bank's
progressive attitude towards the provision of the
Bank's financial services in the future.
The Bank was given permission to open a Trust Department by the Comptroller
of the Currency 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
$379 million at December 31, 1997.
On January 31, 1983, the Bank purchased Town & Country, Inc., a
Pennsylvania corporation and 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, Inc. employs forty-two (42) people.
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 450,000 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's economy.
One of the best agricultural areas in the nation, Lancaster County
continues to be the top agricultural county in the state, leading
Pennsylvania in production of most crops and all livestocks, 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. The unemployment rate
of the county in December 1997 was 2.9%, which was lower than the statewide rate
(4.8%) and the national rate (4.7%). Lancaster County's December unemployment
rate of 2.9% was the best among Pennsylvania's 14 metropolitan areas. 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 has no significant foreign sources and makes no significant
foreign application of funds.
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.
Competition
The financial services industry in the Corporation's service area is
extremely competitive. The Corporation'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 Bank's legal lending limit.
The Bank is subject to intense competition in all respects and areas of its
business from banks and other financial institutions, including savings
and loan associations, finance companies, credit unions and other
providers of financial services. There are 14 full-service commercial banks
with offices in Lancaster County. Some of these banks have branches located
throughout Lancaster County and beyond. The institutions range in asset
size from approximately $233 million to over $57 billion. Four (4) banks in the
trade area exceed $5 billion in assets. Several banks are part of bank
holding company systems. One bank is a subsidiary of a
bank holding company that has assets in excess of $73 billion while two other
banks are subsidiaries of bank holding companies with over $45 billion in
assets.
Due to the Bank's location, the Bank is in direct competition with the larger
banks, as well as, a number of smaller banks. The increased competition has
resulted from a changing legal and regulatory climate, as well as, from the
economic climate. As of December 31, 1997, the Bank ranked, as measured by
total deposits, as the third largest in market share within
Lancaster County of the banks doing business in Lancaster County.
The Bank is not, however, the third largest bank in Lancaster County.
As of December 31, 1997, the Bank had total assets of over $845 million and
ranked ninth on this basis among the commercial banks with offices
located in Lancaster County.
In September 1994, federal legislation was enacted that is expected to have
a significant effect in restructuring the banking industry in the United
States. See "Interstate Banking Legislation" herein. As a result,
the Corporation expects the operating environment for Pennsylvania-based
financial institutions to become increasingly competitive.
Additionally, the manner in which banking institutions conduct their
operations may change materially as the activities increase in which bank
holding companies and their banking and nonbanking subsidiaries are
permitted to engage, and funding and investment alternatives
continue to broaden, although the long-range effects of these changes
cannot be predicted, with reasonable certainty, at
this time. These changes most probably will further narrow the differences and
intensify competition between and among commercial banks, thrift institutions,
and other financial service companies. See "Proposed Legislation and
Regulations" herein.
Neither the Corporation nor the Bank 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
The Corporation is registered as a bank holding company and is subject to
the regulations of the Board of Governors of the Federal Reserve System (the
"Federal Reserve") under the Bank Holding Company Act of 1956, as amended
("BHCA"). 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 BHCA 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, pursuant to such regulations, may require the
Corporation to stand ready to use its resources to provide adequate capital
funds to the Bank during periods of financial stress or adversity.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), a bank holding company is required 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.
Under the BHCA, the Federal Reserve has the authority to require a bank
holding company to terminate any activity or relinquish control of a nonbank
subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious
risk to the financial soundness and stability of any bank
subsidiary of the bank holding company.
The BHCA prohibits the Corporation from acquiring direct or indirect
control of more than 5% of the outstanding shares of any class of voting stock
or substantially all of the assets of any bank or merging or
consolidating with another bank holding company without prior
approval of the Federal Reserve. Such a transaction would also
require approval of the Pennsylvania Department of Banking. Pennsylvania law
permits Pennsylvania bank holding companies to control an unlimited
number of banks.
Additionally, the BHCA prohibits the Corporation from engaging in or from
acquiring ownership or control of more than 5% of the outstanding shares of any
class of voting stock of any company engaged in a nonbanking business unless
such business is determined by the Federal Reserve to be so closely
related to banking as to be a proper incident thereto. The Federal
Reserve can differentiate between nonbanking activities that are
initiated by a bank holding company or subsidiary and activities
that are acquired as a going concern. The BHCA does not place territorial
restrictions on the activities of such nonbanking-related
activities. The Corporation and its subsidiaries are prohibited from
engaging in certain tie-in arrangements in connection with any
extension of credit, lease or sale of property, or
furnishing of services.
The activities that the Federal Reserve has determined by regulation to be
permissible are:
(1) making, acquiring, or servicing loans or other extensions of credit
for its own account or for the account of others;
(2) 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;
(3) 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 investment or accept deposits, except as may be permitted
by the Federal Reserve;
(4) subject to limitations, acting as an investment or financial
advisor (i) to a mortgage or real estate investment trust,
(ii) to certain registered investment companies,
(iii) by providing portfolio investment advice
to other persons, (iv) by furnishing general
economic information and advice, general economic statistical
forecasting services, and industry studies, (v) by providing
financial advice to state and local governments, or (vi) by
providing financial and transaction advice to corporations,
institutions, and certain persons in connection with mergers,
acquisitions, and other financial transactions;
(5) subject to limitations, leasing real or personal property or acting
as agent, broker, or adviser in leasing such property in accordance
with prescribed conditions;
(6) investing in corporations or projects designed primarily to promote
community welfare;
(7) providing to others data processing services and data transmission
services, data bases, and facilities, within certain limitations;
(8) subject to limitations, engaging in certain agency and underwriting
activities with respect to credit insurance, and certain other
insurance activities as permitted by the Federal Reserve;
(9) 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;
(10) providing courier services for certain financial documents;
(11) subject to limitations, providing management consulting advice to
nonaffiliated bank and nonbank depository institutions;
(12) 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;
(13) performing appraisals of real estate and personal property;
(14) 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;
(15) providing certain securities brokerage services;
(16) subject to limitations, underwriting and dealing in government
obligations and certain other instruments;
(17) subject to limitations, providing foreign exchange and transactional
services;
(18) subject to limitations, acting as a futures commission merchant for
nonaffiliated persons;
(19) subject to limitations, providing investment advice on financial
futures and options to futures;
(20) subject to limitations, providing consumer financial counseling;
(21) subject to limitations, tax planning and preparation;
(22) providing check guaranty services;
(23) subject to limitations, operating a collection agency; and
(24) 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.
Dividend Restrictions
The Corporation is a legal entity separate and distinct from the Bank and
the Corporation's nonbank subsidiaries. The Corporation's revenues (on a parent
Company only basis) result almost entirely from dividends paid to the
Corporation by its subsidiaries. The right of the company, and consequently
the right of creditors and shareholders of the Corporation,
to participate in any distribution of the assets or earnings of any subsidiary
through the payment of such dividends or otherwise is necessarily
subject to the prior claims of creditors of the subsidiary (including
depositors, in the case of the Bank), except to the extent
that claims of the Corporation in its capacity as a creditor may be recognized.
Federal and state laws regulate the payment of dividends by the
Corporation's subsidiaries. See "Supervision and Regulation - Regulation of the
Bank" herein.
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
Bank holding companies are required to comply with the Federal Reserve's
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 (4%) 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, and minority interests in the equity accounts of
consolidated subsidiaries, less 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 the
Corporation of any specific minimum leverage ratio applicable to
the Corporation.
Pursuant to FDICIA, the federal banking agencies have specified, by
regulation, the levels at which an insured institution is considered "well
capitalized," "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. The Corporation
and the Bank, at December 31, 1997, qualify as "well capitalized"
under these regulatory standards.
FDIC Insurance
The Bank is subject to Federal Deposit Insurance Corporation ("FDIC")
assessments. The FDIC has adopted a risk-related premium assessment system for
both the Bank Insurance Fund ("BIF") for banks and the Savings Association
Insurance Fund ("SAIF") 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.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 to recapitalize the Savings Association Insurance Fund
("SAIF") administered by the Federal Deposit Insurance Corporation
("FDIC") and to provide for repayment of the FICO
(Financial Institution Collateral Obligation) bonds
issued by the United States Treasury Department. The FDIC levied a one-time
special assessment on SAIF deposits equal to 65.7 cents per $100 of the
SAIF-accessible deposit base as of March 31, 1995. During 1997, 1998, and
1999, the Bank Insurance Fund ("BIF") will pay $322 million of FICO debt
service, and SAIF will pay $458 million. During 1997,
1998, and 1999, the average regular annual deposit insurance assessment
is estimated to be about 1.29 cents per $100 of deposits for BIF
deposits and 6.44 cents per $100 of deposits for SAIF deposits.
Individual institution's assessments will continue to vary according to their
capital and management ratings. As always, the FDIC will be able to raise the
assessments as necessary to maintain the funds at their target capital ratios
provided by law. After 1999, BIF and SAIF will share the FICO costs equally.
Under current estimates, BIF and SAIF assessment bases would each be assessed at
the rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will
mature in 2018-2019, ending the interest payment obligation.
Regulation of the Bank
The operations of the Bank 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 Bank's operations are also subject to regulations
to the OCC, the Federal Reserve, and the FDIC.
The OCC, which has primary supervisory authority over the Bank, 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 Bank's depositors rather than the Corporation's
shareholders. The Bank must furnish annual and quarterly reports to the OCC,
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 law
permits statewide branching.
Under the National Bank Act, as amended, the Bank is required to obtain the
prior approval of the OCC for the payment of dividends if the total of all
dividends declared by the Bank in one year would exceed the Bank's net profits
(as defined and interpreted by regulation) for the two preceding years, less any
required transfers to surplus. In addition, the Bank may only pay dividends to
the extent that its retained net profits (including the portion transferred to
surplus) exceed statutory bad debts (as defined by regulation). Under FDICIA,
any depository institution, including the Bank is prohibited from paying any
dividends, making other distributions or paying any management fees if, after
such payment, it would fail to satisfy its minimum capital requirements.
A subsidiary bank of a bank holding company, such as the Bank, is subject
to certain restrictions imposed by the Federal Reserve Act on any extensions of
credit to the bank holding company or its subsidiaries, on investments in the
stock or other securities of the bank holding company or its subsidiaries, and
on taking such stock or securities as collateral for loans. The Federal
Reserve Act and Federal Reserve 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 such principal shareholders. In addition,
such legislation and regulations may affect the terms upon which any
person becoming a principal shareholder of a holding company may obtain credit
from banks with which the subsidiary bank maintains a correspondent
relationship.
The Bank, 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 unavailability of funds for lending and
investment.
Interstate Banking Legislation
In September 1994, the Riegle-Neal Interstate Banking and Branching
Efficiency Act (the "Interstate Banking Act") was enacted. The Interstate
Banking Act facilitates the interstate expansion and consolidation of banking
organizations (i) 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; (ii) 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;
(iii) 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; (iv) 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 (v) 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 the Corporation 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 (i) eliminates the "reciprocity" requirement previously applicable
to interstate commercial bank acquisitions by bank holding companies,
(ii) authorizes interstate bank mergers and reciprocal interstate branching
into Pennsylvania by interstate banks, and (iii) permits Pennsylvania
institutions to branch into other states with the prior approval of the
Pennsylvania Department of Banking.
Overall, this federal and state legislation has, as was predicted, 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
the Corporation and the Bank, or otherwise change the business environment.
Management cannot predict whether any of this legislation, if enacted, will
have a material effect on the business of the Corporation.
Employees
As of December 31, 1997, there were 469 persons employed by the Bank, of
which 350 were full-time and 119 were part-time employees. These figures do not
include employees of Town & Country, Inc. which employed 42 persons.
Item 2 - Properties
The Bank, in addition to its main office, had, at December 31, 1997, a
branch network of 29 offices and 2 off-site electronic MAC/ATM installations.
All branches are located in Lancaster County with the exception of one office,
located in Chester County. Branches at nineteen (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 Corporation owns no real estate.
The leases expire intermittently over the years through 2022 and most are
subject to one or more renewal options. During 1997, aggregate annual rentals
for real estate did not exceed three percent 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's Administrative Service Center as well as other departments of the Bank.
Town & Country, Inc., a wholly owned subsidiary of the Bank, also occupies this
building. The building is owned in fee by the Bank, free and clear of
encumbrances. The Bank sold the building which previously housed the
Administrative Service Center. Settlement took place on February 21, 1997.
Town & Country, Inc. sold the building it formerly occupied on April 1,
1997.
In 1995, the Bank completed construction of a new headquarters building
including a branch banking office. The building also serves as headquarters for
the Corporation. Occupancy took place in July of 1995. The three-story
building contains approximately 53,000 square feet. The Bank and the
Corporation occupy approximately 43,000 square feet. Nearly 10,000 square
feet has been leased to other tenants. The building is owned in
fee by the Bank, free and clear of encumbrances.
Item 3 - Legal Proceedings
As of December 31, 1997, there were no material pending legal proceedings,
other than ordinary routine litigation incidental to the business, to which the
Corporation 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 1997.
PART II
Item 5 - Market for the Registrant's Common Equity and Related Stockholder
Matters
As of January 29, 1998, the common stock of the Corporation began trading
on the NASDAQ National Market. The trading symbol for Sterling Financial
Corporation is SLFI. There are 35,000,000 shares of common stock
authorized and at February 27, 1998, 6,161,006 shares were outstanding.
As of February 27, 1998, the Corporation had approximately 3,081
stockholders of record. There is no other class of stock authorized
or outstanding. During 1997, the price range of the
common stock known by management to have traded was $25.00 to $32.00 per share.
A regular $.20 per share dividend, as well as a $.04 per share "Special
Dividend," was declared in the third quarter of 1997 and is reflected in the
table below. The Corporation is restricted as to the amount of dividends
that it can pay to stockholders by virtue of the
restrictions on the Bank's ability to pay dividends to the
Corporation. See Note 19 to the 1997 Consolidated Financial
Statements. The Corporation paid a 5% stock dividend in July 1996. The
following table reflects the bid and asked prices reported for the Corporation's
common stock at the end of the period 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 1996.
In the absence of an active market, these prices may not
reflect the actual market value of the
Corporation's stock for the periods reported.
1997 Bid Ask Dividend
First Quarter $25.25 $25.75 $.19
Second Quarter 25.375 25.625 .19
Third Quarter 25.75 26.125 .24
Fourth Quarter 30.50 32.00 .20
1996 Bid Ask Dividend
First Quarter $25.18 $26.13 $.18
Second Quarter 26.36 26.60 .18
Third Quarter 26.25 26.75 .19
Fourth Quarter 25.25 26.25 .19
The prices used in the previous table represent bid and asked prices
furnished by F.J. Morrissey & Company; Hopper Soliday & Co., Inc.; Legg Mason
Wood Walker, Inc.; Prudential Securities; Ryan, Beck & Company; or The National
Quotation Bureau. These quotations reflect inter-dealer prices, without retail
markup, markdown or commission.
The Corporation maintains a Dividend Reinvestment and Stock Purchase Plan
for eligible stockholders who elect to participate in the plan. A copy of the
Prospectus for this plan can be obtained by writing to: Bank of Lancaster
County, N.A. Dividend Reinvestment and Stock Purchase Plan, 101 North
Pointe Boulevard, Lancaster, Pennsylvania 17601-4133.
Item 6 - Selected Financial Data
The following selected financial data should be read in conjunction with
the Corporation's consolidated financial statements and the
accompanying notes presented elsewhere herein.
Summary of Operations
(Dollars in thousands, except per share data)
Years Ended 1997 1996 1995 1994 1993
Interest income.............. $ 56,499 $ 52,558 $ 48,850 $ 41,931 $ 40,092
Interest expense............. 25,326 22,823 21,153 14,926 15,042
------ ------ ------ ------ ------
Net interest income.......... 31,173 29,735 27,697 27,005 25,050
Provision for loan losses.... 1,129 580 534 1,081 2,430
------ ------ ------ ------ ------
Net interest income after
provision for loan losses... 30,044 29,155 27,163 25,924 22,620
Other income................. 11,930 9,442 7,397 6,222 8,107
Other expenses............... 28,082 25,639 22,527 21,232 20,176
------ ------ ------ ------ ------
Income before income taxes... 13,892 12,958 12,033 10,914 10,551
Applicable income taxes...... 3,491 3,147 3,039 2,637 2,749
------ ------ ------ ------ ------
NET INCOME................... $ 10,401 $ 9,811 $ 8,994 $ 8,277 $ 7,802
====== ====== ====== ====== ======
Per Common Share:*
Net income (basic and diluted)$ 1.68 $ 1.57 $ 1.45 $ 1.35 $ 1.30
Cash dividends declared**.... .82 .74 .89 .58 .54
Book value................... 12.03 11.12 10.79 9.76 8.58
Book value (excluding
SFAS 115)................. 11.56 10.86 10.51 9.69 8.58
Average shares outstanding 6,202,696 6,235,257 6,204,212 6,128,058 6,013,937
Ratios:
Return on average assets.... 1.32% 1.34% 1.36% 1.38% 1.41%
Return on average equity.... 14.89% 15.01% 15.02% 15.47% 16.90%
Financial Condition at
Year-End:
Assets...................... $ 845,488 $ 764,072 $ 711,154 $ 633,395 $ 587,883
Loans (net of unearned)..... 511,637 473,832 426,312 392,649 359,365
Deposits.................... 718,661 647,036 610,105 537,002 505,680
Stockholders' Equity........ 73,987 69,179 63,909 57,285 49,467
Average Assets.............. 789,314 732,226 659,335 600,263 555,216
*Figures prior to 1996 were restated for stock dividends of 5% paid in 1996 and 5%
paid in 1993, a two-for-one stock split paid on September 1, 1994 and for
comparative purposes.
**The 1997 dividend includes a $.04 per share "Special Dividend," declared in the
third quarter. The 1995 dividend includes a $.25 per share "Special Dividend"
declared in the second quarter.
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 the Corporation and its
subsidiaries, the Bank and its subsidiary, Town & Country, Inc.
and Sterling Mortgage Services, Inc. Management's discussion and
analysis should be read in conjunction with the audited financial statements
and footnotes appearing elsewhere in this report.
(All dollar amounts presented in the tables are in thousands, except per
share data.)
Results of Operations Summary
Net income for 1997 was $10,401,000, an increase of $590,000 or 6% over
the $9,811,000 earned in 1996. The results of 1996 were $817,000 or 9.1%
higher than the $8,994,000 reported in 1995. Basic earnings per share
and diluted earnings per share on net income amounted to $1.68, $1.57
and $1.45 for the years ended 1997, 1996 and 1995, respectively.
Basic earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding, which
were 6,202,696, 6,235,257 and 6,204,212 for 1997, 1996 and 1995,
respectively. The weighted number of common shares and dilutive
potential common stock used in calculating the diluted earnings per
share were 6,205,784, 6,235,330 and 6,204,212, respectively for 1997, 1996
and 1995. Figures prior to 1997 were restated to reflect a 5%
stock dividend paid in July, 1996.
Return on average total assets was 1.32% in 1997 compared to 1.34%
in 1996 and 1.36% in 1995. Return on average stockholders' equity was 14.89%,
in 1997 compared to 15.01% in 1996 and 15.02%, in 1995.
Growth in earning assets was the primary factor contributing to the
increased earnings in 1997 and 1996. As of December 31, 1997, earning assets
were approximately $747 million compared to $673 million at
December 31, 1996, and $629 million at December 31, 1995.
Average earning assets for 1997 increased nearly $51 million,
to approximately $699 million, up 7.9% from the prior year.
Similarly, in 1996, average earning assets increased
approximately $61 million, up 10.4% from 1995. The current year increase,
as well as the increse in 1996, was primarily due to increases
in both loans and investments.
Average interest bearing liabilities increased nearly $48
million or 8.3% in 1997, compared to an increase of nearly $59 million,
or 11.3% in 1996.
The increase in average earning assets exceeded the increase in average
interest-bearing liabilities in both 1997 and 1996.
Provision for loan losses increased to $1,129,000 in 1997 from $580,000
in 1996. The provision in 1995 was $534,000.
Non-interest income increased $2,488,000 in 1997, compared to an
increase of $2,045,000 in 1996. In 1997, all categories of non-interest
income increased over the previous year.
Non-interest expenses increased $2,443,000 or 9.5% in 1997 compared
to an increase of $3,112,000 or 13.8% in 1996 over 1995.
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. The level of inflation over the
last few years has been declining.
During 1997, 1998 and 1999, the Federal Deposit Insurance Corporation
(the "FDIC") estimates that the average regular annual deposit insurance
assessment will be about 1.29 cents per $100 of deposits for
BIF deposits and 6.44 cents per $100 of deposits for SAIF
deposits. Individual institution's assessments will continue to vary
according to their capital and management ratings. As always, the FDIC
will be able to raise the assessments as necessary to maintain
the funds at their target capital ratios provided by law.
Based on the above legislation, the Bank experienced an increase in the
FDIC assessment in 1997 over 1996.
The passage of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 and the Riegle Community Development and Regulatory
Improvement Act has not yet, but may have a significant impact upon
the Corporation. The key provisions pertain to interstate banking
and interstate branching as well as a reduction in the regulatory burden on
the banking industry. Since September 1995, bank holding companies may
acquire banks in other states without regard to state law. In addition,
banks could merge with other banks in another state beginning in June
1997. States may adopt laws preventing interstate branching but, if
so, no out-of-state bank can establish a branch in such state and no
bank in such state may branch outside the state. Pennsylvania recently
amended the provisions of its Banking Code to authorize full interstate banking
and branching under Pennsylvania law and to facilitate
the operations of interstate banks in Pennsylvania. As a result of legal
and industry changes, management predicts that consolidation will
continue as the financial services industry strives for
greater cost efficiencies and market share. Management believes that
such consolidation may enhance its competitive position as a community bank.
There are numerous proposals before Congress to modify the
financial services industry and the way commercial banks operate.
However, it is difficult to determine at this time what effect
such provisions may have until they are enacted into law. Except as
specifically described above, management believes that the effect
of the provisions of the aforementioned legislation on the
liquidity, capital resources and results of operations of the Corporation
will be immaterial. Management is not aware of any other current
specific recommendations by regulatory authorities or proposed legislation,
which if they were implemented, would have a material adverse effect
upon the liquidity, capital resources or results of operations,
although the general cost of compliance with numerous and multiple federal
and state laws and regulations does have and in the future may have a
negative impact on the Corporation's results of operations.
In addition to historical information, this Annual Report on Form 10-K
Annual Report contains forward-looking statements. The forward-looking
statements contained herein are subject to certain risks and
uncertainties that could cause actual results to differ
materially from those projected in the forward-looking statements.
Important factors that might cause such a difference include, but are
not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of
Operations." Readers are cautioned not to place undue reliance on
these forward-looking statements, which reflect management's analysis only as
of the date hereof. The Corporation undertakes no obligation
to publicly revise or update these forward-looking statements to
reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors described in other
documents the Corporation files from time to time with the Securities and
Exchange Commission, including the Quarterly Reports on Form 10-Q to
be filed by the Corporation, and any Current Reports on Form 8-K filed by the
Corporation.
Management has initiated an enterprise-wide program to prepare the
Corporation's computer systems and applications for the year 2000. In
January 1997, the Corporation began converting its
computer systems to be year 2000 compliant. On December 31, 1997,
approximately 59 percent of the Corporation's systems were compliant,
with all systems expected to be compliant by May of 1999. The Corporation
continues to evaluate appropriate courses of corrective action,
including replacement of certain systems whose associated costs
would be recorded as assets and amortized. The total cost of the project is
being funded through operating cash flows. Accordingly, the Corporation
does not expect the amounts required to be expensed over the
next two years to have a material effect on its financial
position or results of operations.
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.
Net Interest Income
The primary component of the 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 basis. 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 34% for 1997, 1996 and 1995.
Table 1 presents average balances, taxable equivalent interest income
and expense and the yields earned or paid on these assets and
liabilities. The increase in net interest income during
1997 and 1996 resulted from increased volumes in average earning assets.
Average earning assets increased 7.9% in 1997 and 10.4% in 1996.
These increases were primarily funded with interest-bearing
liabilities which increased 8.3% in 1997 and 11.3% in 1996.
Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity
Interest Rates and Interest Differential-Tax Equivalent Yields
(Unaudited)
Years ended December 31,
1997 1996 1995
Average Annual Average Annual Average Annual
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest bearing deposits
with banks..............$ 214 $ 13 5.90% $ 103 $ 6 5.72% $ 30 $ 2 6.78%
Federal Funds sold......... 13,110 730 5.57% 7,376 398 5.39% 7,583 449 5.92%
Investment securities:
U.S. Treasury securities. 28,330 1,679 5.93% 28,789 1,686 5.86% 28,696 1,675 5.84%
U.S. Government agencies. 33,508 2,100 6.27% 33,895 2,192 6.47% 27,999 1,761 6.29%
State and Municipal
securities.............. 60,324 4,702 7.79% 57,966 4,615 7.96% 48,884 4,083 8.35%
Other securities......... 66,207 4,131 6.24% 57,189 3,535 6.18% 66,990 4,294 6.41%
------- ------- ------ -------- ------- ------ -------- ------- -----
Total investment securities188,369 12,612 6.70% 177,839 12,028 6.76% 172,569 11,813 6.85%
Loans:
Commercial...............265,638 24,021 9.04% 245,018 22,276 9.09% 226,032 21,284 9.42%
Consumer.................133,125 11,927 8.96% 130,044 11,401 8.77% 106,171 9,766 9.20%
Mortgages................ 47,983 3,814 7.95% 41,046 3,330 8.11% 32,739 2,771 8.46%
Leases................... 50,811 5,221 10.28% 46,420 4,865 10.48% 41,974 4,350 10.36%
------- ------- ------ -------- ------- ------ -------- ------- -----
Total loans................497,557 44,983 9.04% 462,528 41,872 9.05% 406,916 38,171 9.38%
------- ------- ------ -------- ------- ------ -------- ------- -----
Total earning assets.......699,250 58,338 8.34% 647,846 54,304 8.38% 587,098 50,435 8.59%
Allowance for loan losses.. (7,863) (7,863) (7,155)
Cash and due from banks.... 32,409 30,238 27,763
Other nonearning assets.... 65,518 62,005 51,629
------- -------- --------
Total nonearning assets.... 90,064 84,380 72,237
------- ------- ------ -------- -------- ------ -------- -------- -----
Total assets..............$789,314 $ 58,338 7.39% $732,226 $ 54,304 7.42% 659,335 $ 50,435 7.65%
======== ======= ====== ======== ======== ====== ======== ======= ======
Liabilities and Stockholders' Equity
Deposits:
Demand deposits
Noninterest bearing....$ 74,332 $ 0 0.00% $ 72,052 $ 0 0.00% $66,133 $ 0 0.00%
Demand deposits
Interest bearing........267,987 6,931 2.59% 257,622 6,726 2.61% 239,036 7,181 3.00%
Savings deposits......... 58,149 1,188 2.04% 58,232 1,288 2.21% 54,982 1,333 2.42%
Time deposits............262,681 14,805 5.64% 229,835 12,695 5.52% 194,512 10,579 5.44%
------- -------- ------ -------- ------- ------ -------- ------- -----
Total deposits.............663,149 22,924 3.46% 617,741 20,709 3.35% 554,663 19,093 3.44%
Other borrowed funds....... 35,316 2,402 6.80% 30,578 2,114 6.91% 29,143 2,060 7.07%
Other liabilities.......... 18,894 17,122 14,856
Stockholders' equity....... 71,955 66,785 60,673
------- -------- ------ -------- ------- ------ -------- ------- -----
Total liabilities and
Stockholders' equity....$789,314 $ 25,326 3.21% $732,226 $ 22,823 3.12% $659,335 $ 21,153 3.21%
======== ======== ====== ======== ======== ====== ======== ======= =====
Net interest income/
Average total assets...... $ 33,012 4.18% $ 31,481 4.30% $ 29,282 4.44%
Net interest income/
Average earning assets.... $ 33,012 4.72% $ 31,481 4.86% $ 29,282 4.99%
Net interest income on a fully taxable equivalent basis increased by
$1,531,000 in 1997 compared to an increase of $2,199,000 in 1996. Table 2
indicates that of the increase in 1997, $1,788,000 was the result
of increased volumes. This figure was reduced by $257,000
due to changes in interest rates. The increase in 1996 resulted in
$2,910,000 from increased volumes while a reduction of $711,000 was
realized due to changes in interest rates.
For the year 1997 compared to 1996, loan volumes, on average, increased
over $35 million and income earned on loans increased $3,111,000,
tax adjusted. This compares to a volume increase of nearly $56 million in
1996 over 1995 with an increase in income earned on loans amounting
to $3,701,000. As a result of increased volumes in 1997,
nearly $3.2 million contributed to the increase in income on loans.
Rates charged on loans decreased in 1997. The decrease in rates
reduced interest $60,000 in income earned on loans.
Increased volume in loans in 1996 contributed over $5.2 million to
the increase in income, while a decrease in interest rates reduced
income earned on loans by $1.5 million.
Total investment securities, on average, increased over $10.5 million in
1997 over 1996 compared to an increase of over $5.2 million in 1996 over
1995. Increased volume in both periods was primarily responsible
for the increase in interest income on securities. Table 2 indicates
that, of the increase in interest income in 1997, $712,000 was the result
of increased volume while a decrease in interest rates caused a
$128,000 reduction. Increased volume in securities in 1996 contributed
nearly $361,000 to the increase while a decrease in rates
caused a $146,000 reduction.
Interest income on federal funds sold contributed $332,000 to the
increase in net income in 1997 over 1996. Increased volume, as well
as increased rates, combined to produce this increase.
Interest bearing deposits, on average, grew over $43 million in 1997.
The major portion of the increase in interest expense on deposits was
generated on time deposits, as a result of increased volume
and rates paid for these deposits. Although there were
increased volumes on the other deposits, the decrease in rates
paid on these deposits reduced the total interest expense by $163,000.
Interest expense on interest bearing deposits increased over
$1.6 million in 1996 over 1995. Increased volumes generated an
increase of $2,558,000 while a reduction in income of $942,000 resulted
from decreased rates.
Interest expense on borrowed funds increased $288,000 in 1997 over 1996
compared to an increase of $54,000 in 1996 over 1995. The major portion
of the increase in these periods was a result of increased volume.
Table 2 - Analysis of Changes in Net Interest Income
The rate-volume variance analysis set forth in the table below, which is
computed on a tax equivalent basis, compares changes in net interest
income for the periods indicated by their rate and volume components.
,caption>
1997 Versus 1996 1996 Versus 1995
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
Volume Rate Total Volume Rate Total
Interest Income
Interest on deposits
with banks...........$ 6 $ 1 $ 7 $ 5 $ (1) $ 4
Interest on federal
funds sold........... 309 23 332 (12) (39) (51)
Interest on investment
securities........... 712 (128) 584 361 (146) 215
Interest and fees on
loans................ 3,171 (60) 3,111 5,216 (1,515) 3,701
------- -------- --------- -------- -------- -------
Total interest income...$ 4,198 $ (164) $ 4,034 $ 5,570 $ (1,701) $ 3,869
------- -------- --------- -------- -------- -------
Interest Expense
Interest on
interest-bearing
demand deposits......$ 271 $ (66) $ 205 $ 558 $ (1,013) $ (455)
Interest on
savings deposits...... (2) (97) (99) 79 (124) (45)
Interest on
time deposits......... 1,814 295 2,109 1,921 195 2,116
Interest on
borrowed funds........ 327 (39) 288 102 (48) 54
------- -------- -------- -------- -------- --------
Total interest expense..$ 2,410 $ 93 $ 2,503 $ 2,660 $ (990) $ 1,670
------- -------- -------- -------- -------- --------
Net interest income.....$ 1,788 $ (257) $ 1,531 $ 2,910 $ (711) $ 2,199
======= ======== ======== ======== ======== ========
Provision for Loan Losses
The provision for loan losses charged against earnings was $1,129,000
in 1997 compared to $580,000 in 1996 and $534,000 in 1995. The provision
reflects the amount deemed appropriate by management to produce
an adequate reserve to meet the present and foreseeable 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 $1,199,000 in 1997, $560,000 in 1996 and
$394,000 in 1995. Gross charge-offs for 1997 were $1,502,000, an
increase over the $703,000 reported in 1996. The increases in the
provision for loan losses, gross and net charge-offs were a result of a
reduction in asset quality in the consumer loan portfolio,
particularly the installment and credit card portfolios.
Personal bankruptcies played a significant role in the losses.
Management has instituted certain changes in underwriting criteria in an
effort to reduce the risk of similar increases in the future.
Management does not expect to experience a similar
increase in losses in 1998 in the consumer portfolio. Management
believes that despite the increase in the losses in 1997, the percentage of
net losses to average loans and leases is
comparable to the Bank's peers.
The allowance for loan losses as a percent of loans at December 31, 1996
was 1.65%, while at December 31, 1997 it was 1.51%.
Non-Interest Income
Table 3 - Non-Interest Income
1997/1996 1996/1995
Increase Increase
(Decrease) (Decrease)
1997 Amount % 1996 Amount % 1995
Income from fiduciary activities.$ 1,513 $ 374 32.8% $1,139 $ 283 33.1% $ 856
Service charges on deposit
accounts....................... 2,909 424 17.1% 2,485 475 23.6% 2,010
Other service charges, commissions
and fees....................... 1,456 512 54.2% 944 124 15.1% 820
Mortgage banking income........... 1,305 113 9.5% 1,192 667 127.0% 525
Other operating income............ 4,539 1,015 28.8% 3,524 338 10.6% 3,186
Investment securities gains or
(losses)....................... 208 50 31.7% 158 158 .0% 0
------ ------ ------ ------ ------- ------ ------
Total............................$11,930 $ 2,488 26.4% $9,442 $ 2,045 27.7% $7,397
======= ======= ====== ====== ======= ====== ======
Non-interest income, recorded as other operating 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.
Income from fiduciary activities in the amount of $1,513,000 in 1997
was $374,000 or 32.8% greater than the $1,139,000 recorded in 1996.
Income in 1996 was $283,000 or 33.1% greater than the $856,000
recorded in 1995. Fees increased primarily due to increased transaction
volumes.
Service charges on deposit accounts increased to $2,909,000, an increase of
$424,000 or 17.1% over the $2,485,000 reported for 1996. Service charges on
deposit accounts in 1996 were $475,000 more than the $2,010,000 reported
for 1995. General increases in service charges on various accounts,
as well as, transaction volume produced the increases for
the periods reported. Management continuously monitors fee
structure and makes changes where they believe appropriate.
Other service charges, commissions and fees were $1,456,000 in 1997
compared to $944,000 in 1996 and $820,000 in 1995. The increase in 1997
over 1996 was $512,000 or 54.2%. The significant increase in 1997 is
attributable to the introduction of ATM charges. Other contributors
to the increase were fees received on mutual fund transactions and
fees on the Bank's debit card.
Income from mortgage banking activities increased to $1,305,000 in 1997
from $1,192,000 in 1996. Mortgages sold in the secondary market in
1997 increased to approximately $40.9 million from $33.2 million
in 1996. All mortgages sold were originated by the Bank's
mortgage department or the branch network. No mortgages were
acquired from third parties, nor have servicing rights been purchased
from third parties. A low interest rate environment in 1997, as well
as an expansion in mortgage products and services
resulted in the increase in volume in 1997. The Bank retains
mortgage servicing rights on the majority of mortgages originated and
sold on the secondary market. The Bank's mortgage servicing
portfolio was $175 million as of December 31, 1997 compared
to $155 million on December 31, 1996.
Another component of the mortgage banking increase in profit was caused
by implementation of FASB 122 (subsequently replaced by FASB 125)
which required that mortgage servicing rights be
recognized for their economic value, as of January 1,
1996. Mortgage servicing has a value because of the value of the
future servicing income to be recieved over the life of a mortgage.
The value of servicing rights is available through third
party purchasers in private transactions. The Bank has
developed business relationships with a third party mortgage company,
which sets the values of mortgage servicing rights based upon the mortgage
company's price offerings. The Bank recognized $470,805 in
mortgage servicing values in 1996 for its originated
servicing portfolio, when in previous years no value was recognized.
In 1997, the amount recognized was $549,756. Mortgage servicing rights are
recorded as an asset and recognized directly to income as if
the servicing had been sold. The asset is amortized as a charge to
earnings over the estimated servicing life of the associated
mortgage. Mortgage servicing assets, as of December 31, 1997, and 1996
were $892,000 and $442,000, respectively. Actual pay-off of mortgages
serviced with a recorded asset value are immediately charged against earnings.
Other operating income increased $1,015,000 to $4,539,000 in 1997 from
$3,524,000 in 1996. Other income was $3,186,000 in 1995. Income generated
from operating leases was a major contributor to this increase.
Income on operating leases increased approximately $400,000 in
1997 over 1996. Gains realized on the sale of real estate
and equipment, which amounted to $456,000, also added to the increase.
Investment securities transactions reflect a gain of $208,000 in 1997
compared to a gain of $158,000 in 1996 on securities sold from
the available-for-sale securities. There were no securities sold in 1995.
The Bank does not engage in trading activities. Therefore, the adoption
of SFAS 115 did not impact current year earnings.
As a result of these changes in the components of non-interest income,
total other operating income increased $2,488,000 in 1997 over 1996
compared to an increase of $2,045,000 in 1996 over 1995.
Non-Interest Expense
Table 4 - Non-Interest Expense
1997/1996 1996/1995
Increase Increase
(Decrease) (Decrease)
1997 Amount % 1996 Amount % 1995
Salaries and employee benefits...$16,398 $ 1,371 9.1% $15,027 $1,987 15.2% $13,040
Net occupancy expense............. 2,290 181 8.6% 2,109 388 22.5% 1,721
Furniture & equipment expense..... 2,480 436 21.3% 2,044 439 27.4% 1,605
FDIC insurance assessment......... 81 79 --- 2 (620) (99.7%) 622
Other operating expense........... 6,833 376 5.8% 6,457 918 16.6% 5,539
----- ------ ----- ------ ----- ----- -------
Total............................$28,082 $ 2,443 9.5% $25,639 $3,112 13.8% $22,527
======= ======= ===== ====== ====== ===== =======
Non-interest expense consists of salaries and employee benefits,
net occupancy expense, furniture and equipment expense and other operating
expenses.
Total operating expenses for 1997 were $28,082,000 compared to
$25,639,000 in 1996. This represents an increase of $2,443,000 or 9.5%. This
compares to an increase of $3,112,000 of 13.8% in 1996.
The largest component of the Corporation's other operating expense is
salaries and employee benefits, which increased to $16,398,000 in 1997
or $1,371,000 (9.1%) over the $15,027,000 reported
in 1996. In 1996, expenses increased $1,987,000 (15.2%)
over the $13,040,000 reported in 1995. The increases in 1997 and 1996
were primarily due to increases in staff as well as increases in wages
and the increased cost of employee benefits. During 1996,
four branch offices were opened. In December 1995,
two branch offices were acquired from another financial institution.
Each of these acquisitions contributed to the increase in 1996.
Three of the branches opened in 1996 were opened in the last quarter of 1996.
Occupancy expense increased $181,000 or 8.6% to $2,290,000 in 1997 from
$2,109,000 in 1996. By comparison, during 1996, there was an increase of
$388,000 or 22.5%. Three new branch offices were opened in the last
quarter of 1996. In addition, on December 4, 1996, the Bank
purchased property located at 1097 Commercial Avenue,
East Petersburg, Pennsylvania situated on 12.7 acres with a building
containing approximately 123,000 square feet. The building now
houses the Bank's Administrative Service Center, as well as other
departments of the Bank. Town & Country, Inc., a
wholly owned subsidiary of the Bank, also occupies this building.
These additions contributed to the increase in occupancy expense in 1997.
As noted, the Bank added four branch facilities to its
network in 1996. In addition, the Bank completed
construction of a new headquarters building in 1995 that also includes
branch banking facilities and two branch offices were acquired from
another financial institution in December 1995. These additions and expenses
relating to occupancy such as real estate taxes, insurance, utilities,
maintenance and janitor services contributed to the increase in occupancy
expense.
Furniture and equipment expenses were $2,480,000 in 1997 and $2,044,000
in 1996. This represents an increase of $436,000 or 21.3%. The increase
in 1996 over 1995 was $439,000 or 27.4%. Reflected in this increase is a
$244,000 increase in depreciation expense in 1997. Service contracts on
equipment also contributed to the increase in 1997.
The FDIC insurance assessment reflects an increase of $79,000 in 1997
over 1996. On September 30, 1996, the President signed into law the
Deposit Insurance Funds Act of 1996 to recapitalize the Savings
Association Insurance Fund ("SAIF") administered by
the Federal Deposit Insurance Corporation ("FDIC") and to provide
for repayment of the FICO (Financial Institution Collateral Obligation)
bonds issued by the United States Treasury Department. The FDIC levied a
one-time special assessment on SAIF deposits equal to 65.7 cents per $100
of the SAIF-assessable deposit base as of March 31, 1995.
During 1997, 1998 and 1999, the Bank Insurance Fund ("BIF")
will pay $322 million of FICO debt service, and SAIF will pay $458
million. During 1997, 1998 and 1999, the average regular annual
deposit insurance assessment is estimated to be about 1.29 cents
per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits
for SAIF deposits. Individual institution's assessments will
continue to vary according to their capital and management ratings.
As always, the FDIC will be able to raise the assessments as necessary to
maintain the funds at their target capital ratios provided
by law. After 1999, BIF and SAIF will share the FICO costs equally.
Under current estimates, BIF and SAIF assessment bases would each
be assessed at the rate of approximately 2.43
cents per $100 of deposits. The FICO bonds will mature in 2018-2019, ending
the interest payment obligation. The legislation caused the Bank to
experience an increase in the 1997 FDIC assessment over the 1996 assessment.
Other operating expense increased $376,000 or 5.8% in 1997 compared to an
increase of $918,000 in 1996. The 1997 increase is consistent with rising costs
associated with the acquisition of services in this category of expense.
Expenses in this category include postage, Pennsylvania Shares Tax,
advertising and marketing, professional services, telephone,
stationery and forms, ATM fees, insurance premiums, expense of other real
estate owned and other expense categories not specifically
identified on the income statement. Contributing to the increase in
1997 were increases in Pennsylvania Shares Tax, professional
services, postage, MAC fees and telephone expense.
Income Taxes
Income tax expense was $3,491,000 in 1997 compared to $3,147,000 in
1996 and $3,039,000 in 1995. These increases were a result of higher
levels of taxable income and increased earnings each year. The Corporation's
effective tax rate was 25.1%, in 1997, compared with 24.3%,
in 1996, and 25.3%, in 1995. Use of tax credits in 1997 and
1996 resulted in a lower effective tax rate than 1995 even though income
before taxes increased. Additional information relating to income
taxation is presented in the Notes to Consolidated Financial Statements.
Financial Condition
Investment Portfolio
Table 5 - Investment Securities at Cost
The following table shows the amortized cost of the held-to-maturity
securities owned by the Corporation as of the dates indicated. Investment
securities are stated at cost adjusted for amortization of
premiums and accretion of discounts.
December 31,
1997 1996 1995
U.S. Treasury securities................$ 6,537 $ 12,888 $ 18,837
Obligations of other U.S. Government
agencies and corporations............. 9,696 11,607 18,473
Obligations of states and political
subdivisions.......................... 45,816 37,584 40,212
Mortgage-backed securities.............. 1,575 2,076 3,854
Other bonds, notes and debentures....... 18,574 27,269 38,944
--------- --------- ---------
Subtotal................................ 82,198 91,424 120,320
Non-marketable securities............... 2,957 2,798 2,565
--------- --------- ---------
Total...................................$ 85,155 $ 94,222 $ 122,885
========= ========= =========
The following table shows the amortized cost and fair value of the
available-for-sale securities owned as of the dates indicated.
December 31,
1997 1996 1995
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- -------- -------- ----------- --------
U.S. Treasury securities............$ 24,435 $ 24,625 $ 13,611 $ 13,598 $ 11,046 $ 11,155
Obligations of other U.S. Government
agencies and corporations.......... 26,821 27,008 18,800 18,718 15,489 15,632
Obligations of states and political
subdivisions....................... 21,840 22,571 20,488 20,819 19,622 19,945
Mortgage-backed securities........... 832 829 1,125 1,117 1,249 1,242
Other bonds, notes and debentures.... 42,955 43,178 22,752 22,771 19,013 19,247
-------- --------- -------- -------- --------- --------
Subtotal............................. 116,883 118,211 76,776 77,023 66,419 67,221
Equity securities.................... 174 3,263 171 2,352 88 1,746
-------- --------- -------- -------- --------- --------
Total................................$117,057 $ 121,474 $ 76,947 $ 79,375 $ 66,507 $ 68,967
======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields)
The following table shows the maturities of held-to-maturity debt
securities at amortized cost as of December 31, 1997 and approximate weighted
average yields of such securities. Yields are shown on a tax
equivalent basis, assuming a 34% 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....$ 3,999 5.71% $ 2,538 5.99% $ --- ---% $ --- ---% $ 6,537 5.82%
Obligations of
other U.S.
Government
agencies and
corporations.. 5,452 5.79% 3,256 6.06% 988 6.48% --- ---% 9,696 5.95%
Obligations of
states and
political sub-
divisions..... 3,966 5.96% 11,264 7.40% 21,463 7.62% 9,123 7.58% 45,816 7.41%
Mortgage-backed
securities.... 60 8.62% 1,102 8.68% 226 8.55% 187 7.61% 1,575 8.53%
Other bonds,
notes and
debentures.... 9,476 6.15% 9,098 6.53% --- ---% --- ---% 18,574 6.34%
------- ----- -------- ------ -------- ------ ------- ------ -------- -----
$22,953 5.96% $27,258 6.87% $ 22,677 7.58% $ 9,310 7.58% $82,198 6.89%
======= ===== ======= ====== ======== ===== ======= ====== ======== =====
The following table shows the maturities of available-for-sale debt
securities at amortized cost as of December 31, 1997 and approximate
weighted average yields of such securities. Yields are shown on a
tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 4,500 4.17% $ 19,622 6.13%$ 313 6.21% $ --- ---% $ 24,435 5.77%
Obligations of
other U.S.
Government
agencies and
corporations.. 1,299 5.98% 19,876 6.26% 5,646 6.66% --- ---% 26,821 6.33%
Obligations of
states and
political sub-
divisions..... 603 7.93% 4,119 7.14% 15,308 7.91% 1,810 7.91% 21,840 7.77%
Mortgage-backed
securities.... 278 5.85% 554 5.91% --- ---% --- ---% 832 5.89%
Other bonds,
notes and
debentures.... 4,952 6.13% 38,003 6.49% --- ---% --- ---% 42,955 6.45%
------- ------ ------- ------ ------- ----- ------- ----- -------- ------
$11,632 5.44% $82,174 6.38% $21,267 7.55% $ 1,810 7.91% $116,883 6.52%
======= ====== ======= ====== ======= ===== ======= ===== ======== ======
Loans
Table 7 - Loan Portfolio
The following table sets forth the composition of the Corporation's loan
portfolio as of the dates indicated:
December 31,
1997 1996 1995 1994 1993
Commercial, financial and
agricultural..............$ 271,605 $ 239,701 $ 228,058 $ 208,918 $ 191,431
Real estate-construction... 6,045 5,608 6,378 8,542 10,265
Real estate-mortgage....... 49,438 45,373 33,124 30,505 22,335
Consumer................... 132,778 136,989 116,210 106,921 101,256
Lease financing (net of
unearned income)......... 52,207 47,346 43,904 38,771 35,443
---------- ---------- ---------- ---------- ---------
Total loans.................$ 512,073 $ 475,017 $ 427,674 $ 393,657 $ 360,730
========== ========== ========== ========== =========
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, 1997:
After one
Within but within After
one year five years five years Total
Commercial, financial and agricultural..$ 121,240 $ 129,905 $ 20,460 $ 271,605
Real estate-construction................ 1,009 5,036 none 6,045
--------- --------- -------- --------
$ 122,249 $ 134,941 $ 20,460 $ 277,650
========= ========= ========= =========
Loans due after one year totaling $94,632,000 have variable interest rates.
The remaining $60,769,000 in loans have fixed rates.
Table 9 - Nonaccrual, Past Due and Restructured Loans
The following table presents information concerning the aggregate amount of
nonaccrual, past due and restructured loans:
December 31,
1997 1996 1995 1994 1993
Nonaccrual loans...........$ 1,314 $ 1,193 $ 1,010 $ 2,127 $ 2,960
Accruing loans, past due
90 days or more......... 787 737 330 1,127 522
Restructured loans........ 2,105 none none none none
-------- -------- -------- -------- --------
Total nonperforming loans.. 4,206 1,930 1,340 3,254 3,482
Other real estate owned.... 341 81 252 759 251
-------- -------- -------- -------- --------
Total nonperforming assets.$ 4,547 $ 2,011 $ 1,592 $ 4,013 $ 3,733
======== ======== ======= ======== ========
Ratios:
Non-performing loans to
total loans.......... .82% .41% .31% .83% .97%
Non-performing assets to
total loans and other
real estate owned.... .89% .42% .37% 1.02% 1.04%
Non-performing assets to
total assets.......... .54% .26% .22% .63% .63%
Allowance for loan losses to
non-performing loans.. 183.8% 404.1% 580.6% 234.8% 206.2%
The economic conditions within the Corporation's market area remained
healthy in 1997. The unemployment rate for Lancaster County, which is the
Bank's primary market area was 2.9%. The jobless rate during 1997 hovered
close to 3%, which was the lowest or second lowest in the state.
Lancaster County's unemployment rate has historically been and
continues to be one of the lowest among Pennsylvania's 14
metropolitan regions. It also remains well below the state unemployment
rate of 4.80%, as reported for December 1997. Management believes
that the unemployment rate for 1998 is expected to mirror that of
1997 with little movement in either direction. Management believes that
Lancaster's labor market is expected to remain one of the
tightest in the state.
Lancaster County also was strong compared to the national unemployment
levels. The U.S. unemployment rate was at 4.70% in December 1997
compared to 5.3% in December 1996. The average for the year of 4.9%
was the best since 1973. Unemployment hasn't been lower since 1969.
Economists do not anticipate much change this year in the
health of labor markets and believe the unemployment rate will
drift toward 4.5% or a shade lower before rising late in the
year toward 5%.
The Bank's loan delinquency, as a percent of loans outstanding,
declined during 1997. At December 31, 1997, the rate was at .83%
compared to .96% and .58% for December 31, 1996 and December 31,
1995, respectively. The average delinquency rate
of .99% for 1997 did increase compared to .77% in 1996. The
increase in the average delinquency rate is primarily attributable to increases
in the retail portfolio, particularly in the
installment and credit card portfolios. The Bank is not immune to
the continued rise in the number of bankruptcies that occurred in 1997 and
1996 nationwide. While management believes delinquency rates could
continue an upward trend during 1998, management does not
expect that they will approach the national delinquency rates. The .83%
remains well below the accepted level established by
management and below that of the Bank's peers. During the year,
total nonaccrual loans and other real estate owned increased to $1,655,000
from $1,274,000 at December 31, 1996. Total non-performing assets
increased to $4,547,000 compared to $2,011,000 for
December 31, 1996, representing a 126.1% increase. The increase in the
total non-performing assets is primarily attributed to the restructure of
a series of loans to one borrower involving $2,105,000. There are no
commitments to lend additional funds to this borrower in
relation to the restructured loans. A loan is categorized as
restructured if the original interest rate on the loan, repayment terms
or both are restructured due to a deterioration in the
financial condition of the borrower. In the case of the above referenced
loans, the Bank is secured by real estate. The loans are
current and have performed in accordance with the contractural terms,
both prior to and after the restructure. Accrual of interest on
these loans continues.
The Bank's reserve coverage declined during the year. Reserves, as a
percent of non-performing loans, declined to 184% compared with 404% for
December 31, 1996, and 581% for December 31, 1995.
This decline in reserve coverage is a result of the
restructured loans in 1997 which were not present in 1996 and 1995.
A portion of the Bank's loan portfolio consists of loans to
agricultural-related borrowers. These loans are made for a variety of
purposes within the industry. Lancaster County 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.
Dairy production remains Lancaster County's number one agricultural industry.
The Lancaster County dairy industry suffered in 1997 due to a steep drop
in milk prices. During the later part of 1997, milk prices
edged up slightly. Management hopes that this portion of the loan
portfolio will continue to show growth, but notes that
agricultural loans are susceptible to a variety of external factors
such as adverse climate, economic conditions, etc., in addition to factors
common to other industries.
In 1997, Lancaster County's residental real estate market enjoyed a
strong year. Through November 1997, houses sold countywide were up 5.4%
during the same 11-month period in 1996. Residential construction
contracts, however, dropped 6% between 1996 and 1997,. Reasonably
low interest rates, a continuing strong economy and minimal
inflation accounted for the sales performance. Strong home sales are
predicted through at least the first half of 1998. Non-residential
contracts increased by 25% over 1996.
The year 1998 is expected to be equivalent to 1997.
Most of the Bank's business activity is with customers located within
the Bank's defined market area. The majority of the Bank's real estate
loans are located within this area, therefore both a debtor's
ability to honor his obligations and increases and decreases in the market
value of the real estate collateralizing loans are affected by
the level of economic activity in Lancaster County.
The Bank's general policy is to cease accruing interest on loans when
management determines that a reasonable doubt exists as to the
collectibility of additional interest. Interest income on these
loans is only recognized to the extent payments are
received. Loans on a nonaccrual status were $1,314,000 at
December 31, 1997, compared to $1,193,000 at December 31, 1996. If interest
income had been recorded on all such loans for the years indicated, such
interest income would have been increased by approximately $152,755 and
$116,567 for 1997 and 1996 respectively. Interest income
recorded on nonaccrual loans was $20,020 and $27,532 for 1997 and 1996,
respectively. Potential problem loans are included as performing loans,
and are loans with respect to which possible
credit problems of the borrower cause management to doubt the ability of
the borrower to comply with present repayment terms. These loans
may eventually result in disclosure as non-performing loans. At
December 31, 1997, the Bank had no loans to disclose as potential problem
loans.
The Corporation 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.
The Bank defined impaired loans as all loans on nonaccrual status
and restructured, except those specifically excluded from the
scope of SFAS No. 114, regardless of the credit grade assigned by loan
review committee. All impaired loans are measured using the
fair value of the collateral for each loan. When an impaired
loan is measured as less than the recorded investment in the loan,
the Bank compares the impairment measured to the existing
allowance assigned to the loan. If the impairment is greater
than the allowance, the Bank adjusts the existing allowance to
reflect the greater amount or takes a charge to the provision for
loan losses in that amount. If the impairment is less than the existing
allowance for a particular loan, no adjustment to the
allowance or to the provision for loan and lease losses is made.
The Bank was not required to adjust for impaired loans for the periods
indicated.
The following table presents information concerning impaired loans
at December 31:
1997 1996
Gross impaired loans which have allowances..........$3,419 $1,193
Less: Related allowances for loan losses......... (410) (179)
------ ------
Net impaired loans..................................$3,009 $1,014
====== ======
The increase in impaired loans is primarily attributable to the
restructure of a series of loans to one borrower involving $2,105,000.
A loan is categorized as restructured if the original interest
rate on the loan, repayment terms or both are restructured due to a
deterioration in the financial condition of the borrower that
otherwise would not have been granted. In the case of the above
referenced loans, the Bank is fully secured with real estate.
The loans are current and have performed in accordance with the
contractural terms, both prior to and after the restructure.
Accrual of interest on these loans continue.
At December 31, 1997, there were no concentrations exceeding 10% of
total loans. A concentration is defined as amounts loaned to a
multiple number of borrowers engaged in similar activities which
would cause them to be similarly affected by changes in
economic or other conditions. There were no foreign loans outstanding at
December 31, 1997.
Allowance for Loan Losses
Table 10 - Summary of Loan Loss Experience
Years ended December 31,
1997 1996 1995 1994 1993
Allowance for Loan Losses:
Beginning balance.............$ 7,800 $ 7,780 $ 7,640 $ 7,180 $ 5,400
Loans charged off during year:
Commercial, financial and
agricultural.............. 43 37 50 157 194
Real estate mortgage........ 419 184 252 235 392
Consumer.................... 919 458 360 360 290
Lease financing............. 121 24 14 10 14
------- ------- ------- ------- -------
Total charge-offs........... 1,502 703 676 762 890
------- ------- ------- ------- -------
Recoveries:
Commercial, financial and
agricultural.............. 4 5 117 61 157
Real estate mortgage........ 112 42 72 2 8
Consumer.................... 122 88 91 77 63
Lease financing............. 65 8 2 1 12
------- ------- ------- ------- -------
Total recoveries............ 303 143 282 141 240
------- ------- ------- ------- -------
Net loans charged off......... 1,199 560 394 621 650
Additions charged to
operations.................. 1,129 580 534 1,081 2,430
------- ------- ------- ------- -------
Balance at end of year........$ 7,730 $ 7,800 $ 7,780 $ 7,640 $ 7,180
======= ======= ======= ======= =======
Ratio of net loans charged
off to average loans
outstanding................. .24% .12% .10% .17% .18%
Ratio of net loans charged
off to loans at end of year. .23% .12% .09% .16% .18%
Net loans charged off to
allowance for loan losses.. 15.51% 7.18% 5.06% 8.13% 9.05%
Net loans charged off to
provision for loan losses.. 106.20% 96.55% 73.78% 57.45% 26.75%
Allowance for loan losses as a
percent of average loans... 1.55% 1.69% 1.91% 2.04% 2.01%
Allowance for loan losses
as a percent of loans at
end of year................ 1.51% 1.65% 1.82% 1.95% 2.00%
Allowance for loan losses
as a percent of
nonperforming loans........ 183.8% 404.1% 580.6% 234.8% 206.2%
The Corporation experienced a 113.7% increase in gross charge-offs
in 1997. Net charge-offs increased 114.1% in 1997. The increase
in charge offs was a result of a reduction in asset quality
in the consumer loan portfolios, particularly the
installment and credit card portfolios. Personal bankruptcies played a
significant role in the losses. Management has instituted certain changes
in underwriting criteria in an effort to reduce the risk of
increases in the future. For the year, the Corporation recorded
net charge-offs of $1,199,000 or .24% of average loans
outstanding, compared to $560,000 or .12% of average loans in
1996 and $394,000 or .10% of average loans in 1995.
The provision for loan losses charged to operating expense
reflects the amount deemed appropriate by management to produce an
adequate reserve to meet the present risk and inherent risk
in the loan portfolio. Management performs a quarterly
assessment of the loan portfolio to determine the appropriate level of
the allowance. The factors considered in this evaluation include,
but are not limited to, estimated loan losses identified
through a loan review process, general economic conditions,
deterioration in pledged collateral, past loan experience and
trends in delinquencies and nonaccruals. Management uses available
information to determine the appropriate level of the allowance for
possible loan losses. However, the allowance may be affected in the future
based upon changes in the economic conditions and other factors.
While there can be no assurance that material amounts of additional loan loss
provisions will not be required in the future, management believes that,
based upon information presently available, the amount of the allowance
for possible loan losses is adequate.
Management has not targeted any specific coverage ratio of
non-performing loans by the allowance for loan losses and the coverage
ratio may fluctuate based on loans placed into or removed
from non-performing status.
Table 11 - Allocation of Allowance for Loan Losses
December 31,
1997 1996
Commercial, financial and agricultural..........$ 3,529 $ 3,471
Real estate - mortgage.......................... 25 5
Consumer........................................ 910 590
Leases.......................................... 599 620
Unallocated..................................... 2,667 3,114
------- -------
Total...........................................$ 7,730 $ 7,800
======= =======
Deposits
Table 12 - Average Deposit Balances and Rates Paid
The average amounts of deposits and rates paid for the years indicated are
summarized below:
1997 1996 1995
Amount Rate Amount Rate Amount Rate
Demand deposits.....................$ 74,332 --- $ 72,052 --- $ 66,133 ---
Interest-bearing demand deposits.... 267,987 2.59% 257,622 2.61% 239,036 3.00%
Savings deposits.................... 58,149 2.04% 58,232 2.21% 54,982 2.42%
Time deposits....................... 262,681 5.64% 229,835 5.52% 194,512 5.44%
-------- ----- -------- ----- -------- -----
$663,149 3.46% $617,741 3.35% $554,663 3.44%
======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity
The maturities of time deposits of $100,000 or more are summarized below:
December 31,
1997 1996
Three months or less..........................$ 11,058 $ 6,095
Over three thru six months.................... 6,541 6,112
Over six thru twelve months................... 9,209 9,026
Over twelve months............................ 10,357 5,963
------- -------
Total.........................................$ 37,165 $ 27,196
======= =======
Capital
Total stockholders' equity increased over $4.8 million or 7% in 1997 to
$73,987,000. Total stockholders' equity at December 31, 1996 of $69,179,000
represented an increase of nearly $5.3 million or 8.3% over the $63,909,000
reported at December 31, 1995. The increase for 1997 was the difference
between net income of $10.4 million less dividends declared of approximately
$5.1 million. Adding to the increase in stockholders' equity was an
increase in net unrealized gains on available-for-sale securities in the
amount of $1.3 million. These increases were to some
degree offset by the repurchase of outstanding common stock
throughout the year. Treasury stock purchased during the period was $3.3
million. The Corporation issued $1.5 million in treasury shares.
The major portion of the increase in 1996 was due to
net income of $9.8 million less dividends declared $4.5 million.
During 1997, the Corporation announced that the Board of Directors
authorized the repurchase of up to 140,000 shares of the
outstanding common stock. During 1997, the Corporation
repurchased 127,751 shares for $3.3 million. The Corporation used,
during 1997, 55,868 shares of treasury stock for the Dividend
Reinvestment Plan and 1,600 shares for the Director's Compensation Plan.
Federal regulatory authorities promulgate risk-based capital guidelines
that are applicable to banks and bank holding companies in an
effort to make regulatory capital more responsive to the risk
exposure related to various categories of assets and off-balance sheet items.
These guidelines require that banking organizations meet a
minimum risk-based capital, define the components of capital,
categorize assets into different risk classes and include certain
off-balance sheet items in the calculation of capital requirements. The
components of total capital are called Tier 1 and Tier 2
capital. In the case of the Bank, Tier 1 capital is the shareholders'
equity and Tier 2 capital is the allowance for loan losses. The risk-based
capital ratios are computed by dividing the components of capital by
risk-weighted assets. Risk-weighted assets are determined by
assigning various levels of risk to different categories of assets
and off-balance sheet items. Regulatory authorities have decided to exclude
the net unrealized holding gains and losses on
available-for-sale securities from the definition of common
stockholders' equity for regulatory capital purposes. However,
national banks will continue to deduct unrealized losses on equity
securities in their computation of Tier 1 capital. Therefore, national
banks will continue to report the net unrealized gains
and loses on available-for-sale securities in the reports of
condition and income submitted to federal regulators as required by
SFAS 115 and the financial reports prepared in accordance with generally
accepted accounting principles, but will exclude these amounts
from calculations of Tier 1 capital. In addition, national banks should use
the amortized cost of available-for-sale debt securities (as
opposed to fair value) to determine the average total assets as well as
the risk-weighted assets used in the calculations of the leverage and
risk-based capital ratios. The ratios below and in Table 14
reflect the above definition of common stockholders'
equity which includes common stock, capital surplus and retained earnings,
less net unrealized holding losses on available-for-sale
equity securities with readily determinable fair values.
The Bank's ratios at December 31, 1997, 1996 and 1995 were
above the final risk-based capital standards that require Tier 1
capital of at least 4% and total risk-based capital of 8% of
risk-weighted assets. The Tier 1 capital ratio
at December 31, 1997 was 10.23% and the total risk-based capital
ratio was 11.38%, which exceeds the minimum capital guidelines.
Tier 1 capital ratio was 10.68% and the total risk-based capital
ratio was 11.93% at December 31, 1996 while Tier 1 capital
ratio was 10.95% and the total risk-based capital ratio was
12.21% at December 31, 1995. At December 31, 1997, the Corporation
and the Bank, exceeded all capital
requirements and are considered to be "well capitalized."
Table 14 - Capital and Performance Ratios
The following are selected ratios for the years ended December 31:
1997 1996 1995
Return on average assets...................... 1.32% 1.34% 1.36%
Return on average equity...................... 14.89% 15.01% 15.02%
Dividend payout ratio......................... 48.79% 45.95% 58.48%
Average total equity to average assets........ 8.89% 8.95% 9.10%
Total equity to assets at year end............ 8.45% 8.87% 8.79%
Primary capital ratio......................... 9.28% 9.80% 9.78%
Tier 1 risk-based capital ratio............... 10.23% 10.68% 10.95%
Total risk-based capital ratio................ 11.38% 11.93% 12.21%
Liquidity
Liquidity is the ability to meet the requirements of customers for
loans and deposit withdrawals in the most economical manner. Some
liquidity is ensured by maintaining assets which may be immediately converted
into cash at minimal cost. Liquidity from asset categories
is provided through cash, noninterest-bearing and interest-bearing
deposits with banks, federal funds sold and marketable investment
securities maturing within one year. Investment securities maturing
within one year were $34,585,000 at December 31, 1997
compared to $27,169,000 at December 31, 1996.
Interest-bearing deposits with banks were $643,498 at December 31, 1996
compared to $14,565 at December 31, 1997. Federal funds sold
totaled $28,150,000 at December 31, 1997 compared to $24,150,000
at December 31, 1996. Securities available-for-sale as of
December 31, 1997 were $121,474,497 compared to $79,374,627
as of December 31, 1996.
The loan portfolio also provides an additional source of liquidity due
to the Bank's participation in the secondary mortgage market. Sales of
residential mortgages in the secondary market were approximately
$40.9 million in 1997 and $33.2 million in 1996, which allowed
the Bank to meet the needs of customers for new mortgage financing.
The loan portfolio also provides significant liquidity through repayment of
loans by maturity or scheduled amortization payments.
On the liability side, liquidity is available through customer deposit
growth and short term borrowings. Federal Home Loan Bank
available borrowing capacity as of December 31, 1997 was $16,800,000
with existing capital stock ownership. Federal funds
purchased lines are also in place.
Management monitors liquidity daily because customer deposit levels
fluctuate daily and loan fundings, maturities and investment
purchases occur with irregularity.
The amount of liquidity needed is determined by the changes in levels of
deposits and in the demand for loans. Management believes that these
mentioned sources of funds provide sufficient liquidity.
New Financial Accounting Standard
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125 - "Accounting for
Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." This Statement
amends and extends to all servicing assets and libilities
the accounting standards for mortgage servicing rights now in FASB Statement
No. 65, "Accounting for Certain Mortgage Banking Activities,"
and supercedes FASB Statement No. 122, "Accounting for
Mortgage Servicing Rights." SFAS No. 125 establishes accounting
and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on the
consistent application of the financial-components approach.
This approach requires the recognition of financial assets and
servicing assets that are controlled by the reporting entity,
the derecognition of financial assets when control is surrendered
and the derecognition of liabilities when they are extinguished.
Specific criteria are established for determining when control has
been surrendered in the transfer of financial assets. Liabilities
incurred and deriviatives obtained by transferors in connection
with the transfer of financial assets are measured at fair
value, if practicable. Servicing assets and other retained
interests in transferred assets are measured by allocating any prior
carrying amount between the assets sold, if any, and the interest
retained, if any, based on the relative fair values of the assets
at the date of transfer. Servicing assets retained are then subject
to amortization and assessment for impairment. As issued, this
Statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after
December 31, 1996, and is to be applied prospectively.
The FASB became aware that the volume and variety of certain
transactions and the related changes to information
systems and accounting processes necessary to comply
with the requirements of SFAS No. 125 would make it extremely
difficult, if not impossible, for some affected companies to
comply by January 1, 1997. As a result, in December 1996, the
FASB issued FASB No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125" that defers, for one year,
the effective date of certain provisions, as well as accounting for
transfers and servicing for repurchase agreements, dollar-roll,
securities lending and similar transactions. Therefore, this
Statement shall be effective for such transfers of financial assets
after December 31, 1997. Management does not expect the adoption of
SFAS No. 127 to have a material effect on the financial
position or results of operations of the Corporation.
In February 1997, the FASB issued SFAS No. 128 - "Earnings per Share,"
effective for periods ending after December 15, 1997. SFAS
No. 128 is designed to simplify the computation of
earnings per share and requires disclosure of "basic earnings per share"
and, if applicable, "diluted earnings per share." Earlier application is not
permitted. The Statement requires restatement of all prior period earnings
per share data when adopted. Management does not expect SFAS No. 129
to material impact on the Corporation's reported earnings per share.
In February 1997, SFAS No. 129 - "Disclosure of Information about Capital
Structure" was issued by the FASB, which establishes standards for disclosing
information about an entity's capital structure. It consolidates the disclosure
requirements that were previously covered in APB-10, APB-15 and FAS-47.
The Statement is effective for periods ending after December 15, 1997.
Managemnt does not expect SFAS No. 129 to have a material impact
on the Corporation.
In June 1997, the FASB issued Statement No. 130 - "Reporting Comprehensive
Income," which establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Statement No. 130 requires that all items
that are required to be recognized as components of comprehensive
income be reported in a financial statement that is displayed with the
same prominence as other financial statements. Statement No. 130 is
effective for fiscal years beginning after December 15, 1997. This
Statement will require the Corporation to set forth
additional disclosures in the Corporation's financial statements.
In June 1997, the FASB issued SFAS No. 131 - "Disclosures about
Segments of an Enterprise and Related Information." This Statement
establishes standards for the way that public business enterprises
report information about operating segments in annual financial
statements and requires that those enterprises report selected information
about operating segments in interim financial reports issued to shareholders.
The Statement also establishes standards for related disclosures
about products and services, geographic areas and major
customers. This Statement supersedes FASB No. 14,
- - "Financial Reporting for Segments of a Business Enterprise," but retains
the requirement to report information about major customers.
It amends FASB Statement No. 94 - "Consolidation
of All Majority-Owned Subsidiaries," to remove the special
disclosure requirements for previously unconsolidated subsidiaries.
The Statement is effective for fiscal years beginning after December 15, 1997.
This Statement will require the Corporation to set forth additional
disclosures in the Corporation's financial statements.
Item 7A - Quantitative and Qualitative Disclosures About Market Risk
Discussion of Market Risk and Interest Rate Sensitivity
As a financial institution, the primary component of the Bank's market risk
is interest rate volatility. Changes in interest rates will
ultimately impact the Bank's interest income from earning assets and the
interest expense from funding sources (deposits and debt).
Based upon the Bank's nature of operations, the Bank is not subject to
foreign currency exchange or commodity price risk. The Bank's market
area for loans and deposits is concentrated in Lancaster County,
Pennsylvania and as such is subject to risks associated with the
local economy. The Bank does not own any trading assets.
The Bank does not have any hedging transactions in place such as
interest rate swaps and caps.
Management endeavors to control the exposure of earnings to changes in
interest rates. The Bank's asset/liability committee manages interest rate
risk by various means including '"Gap" management and internally developed
models and reports. In 1997, the Bank also utilized Sheshunoff Interest
Rate Risk management services and IBAA investment portfolio
valuation services to enhance risk exposure review. Interest
repricing of assets and liabilities is measured over future time
periods (interest rate sensitivity gaps). While all time gaps are measured,
management's primary focus is the cumulative gap through six months,
as this time frame directly impacts net interest income in the near
term time horizon and is most difficult to make reactive adjustment
to actual rate movements.
The Bank has various investments structured to change investment yield with
current market conditions. Assets subject to repricing include federal funds
sold (repricing daily), loans floating to "treasury bill" indexes
(repricing monthly) and loans tied to "prime" or other indexes subject
to immediate change. Other factors effecting income are
maturing and contracted repayments and\ prepayments of existing loans
and investments. These cash flows will be re-invested at
current market yields.
The Bank's funding liabilities (customer deposits and borrowed funds) have
more complex repricing characteristics, si