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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, 1998
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. |X|
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 26, 1999 was approximately $175,748,981.
The number of shares of Registrant's Common Stock outstanding on February 26,
1999 was 6,447,136.
Documents Incorporated by Reference
Portions of the Proxy Statement for the Registrant's 1999 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............................................. 1
Item 2. Properties........................................... 3
Item 3. Legal Proceedings.................................... 4
Item 4. Submission of Matters to a Vote of Security Holders.. 4
Part II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters.......................... 4
Item 6. Selected Financial Data.............................. 5
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 6
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk.................................... 6
Item 8. Financial Statements and Supplementary Data.......... 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. 50
Part III
Item 10. Directors and Executive Officers of the Registrant... 51
Item 11. Executive Compensation............................... 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 51
Item 13. Certain Relationships and Related Transactions....... 51
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.......................................... 52
Signatures...................................................... 53
PART I
Item 1 - Business
Sterling Financial Corporation
Sterling Financial Corporation is a Pennsylvania business corporation,
based in Lancaster, Pennsylvania. The corporation was organized on
February 23, 1987 and became a bank holding company through the acquisition
on June 30, 1987 of all the outstanding stock of The First National Bank of
Lancaster County, now by change of name, Bank of Lancaster County, N.A.
The corporation provides a wide variety of commercial banking and trust
services through its wholly owned subsidiary, Bank of Lancaster County, N.A.
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 and is subject to regulation by the Federal Reserve Board
and by the Pennsylvania Department of Banking.
On July 21, 1998, Sterling Financial Corporation organized T & C Leasing,
Inc., a Pennsylvania corporation. T & C Leasing, Inc. is a nationwide vehicle
and equipment leasing company operating primarily in Pennsylvania. Its
principal office is located at 1097 Commercial Avenue, East Petersburg,
Pennsylvania.
In addition, the corporation also owns all of the outstanding stock of a
non-bank subsidiary, Sterling Mortgage Services, Inc., a mortgage service
company formed by the corporation as a wholly owned subsidiary that presently is
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, we changed the name to The First National Bank
of Lancaster County. At the time of the holding company reorganization,
on June 30, 1987, the name was changed to its present name,
Bank of Lancaster County, N.A. At December 31, 1998, the bank had total
assets of $918,688,000 and total deposits of $784,422,000.
The main office of the bank is located at 1 East Main Street, Strasburg,
Pennsylvania. In addition to its main office, the bank had 29 branches in
Lancaster County and 1 branch in Chester County, Pennsylvania in operation at
December 31, 1998.
The bank provides a full range of banking services. These include demand,
savings and time deposit services, NOW (Negotiable Order of Withdrawal)
accounts, money market accounts, safe deposit boxes, and a full spectrum of
personal and commercial lending activities. The bank maintains
correspondent relationships with major banks in New York City and
Philadelphia. Through these correspondent relationships, the bank can
offer a variety of collection and international services.
With the installation of 3 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. In mid-year 1998, the Bank of
Lancaster County began offering fixed annuities in addition to mutual funds as
an alternative investment vehicle for appropriate customers.
The annuities are available from 3 insurance companies, AIG,
Jackson National and CIGNA, with BankMark Corporation, Morris Plains, New
Jersey, providing marketing support services. As required, the bank obtained
an insurance license from the Commonwealth of Pennsylvania.
Management believes these services are important
additions to our product line and make a statement about our progressive
attitude in providing financial services for the future.
The Comptroller of the Currency gave the bank permission to open a Trust
Department on May 10, 1971. The Trust Department provides personal and
corporate trust services. These include estate planning, administration of
estates and the management of living and testamentary trusts and investment
management services. Other services available are pension and profit
sharing trusts and self-employed retirement trusts. Trust Department
assets were nearly $531 million at December 31, 1998.
On January 31, 1983, the bank purchased Town & Country, Inc., which is a
vehicle and equipment leasing company operating in Pennsylvania and other
states. Its principal office is located at 1097 Commercial Avenue,
East Petersburg, PA. Town & Country, Inc. employs 50 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 455,000 people. Lancaster's tradition of economic stability
has continued, with agriculture, industry and tourism all contributing
to the overall strength of the economy. Lancaster County has
one of the strongest and most stable economies in the state.
No single sector dominates the county economy.
One of the best agricultural areas in the nation, Lancaster continues to be
the top agricultural county in the state, leading Pennsylvania in production of
most crops and all 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. Lancaster County
ended 1998 with the lowest unemployment rate in Pennsylvania.
The unemployment rate of the county in December 1998 was 2.7% which
was significantly lower than the statewide rate of 3.8% and national rate
of 4.0%. Lancaster County's December unemployment rate of
2.7% tied for the lowest in the state with State College. 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 applications 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. Several of the financial
institutions exceed $20 billion in assets while one is
in excess of $235 billion in assets. The increased competition has
resulted from a changing legal and regulatory climate, as well as, from
the economic climate. As of December 31, 1998, the bank ranked, as measured
by total deposits, as the second largest in market
share within Lancaster County of the banks doing
business in Lancaster County. The bank is not, however, the second largest bank
in Lancaster County. As of December 31, 1998, the bank had total assets of over
$918 million.
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 under
the Bank Holding Company Act. Bank holding companies are required to
file periodic reports with and are subject to examination by the
Federal Reserve. The Federal Reserve has issued regulations under
the Bank Holding Company Act that require a bank holding company to serve
as a source of financial and managerial strength to
its subsidiary banks. As a result, the Federal Reserve, 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, 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 Bank Holding Company Act, 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 Bank Holding Company Act 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 Bank Holding Company Act 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 Bank Holding Company
Act 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:
making, acquiring, or servicing loans or other extensions of
credit for its own account or for the account of others;
operating an industrial bank, Morris Plan bank, or industrial loan
company, in the manner authorized by state law, so long as the
institution is not a bank;
operating as a trust company in the manner authorized by federal
or state law so long as the institution is not a bank and does not
make loans or investment or accept deposits, except as may be
permitted by the Federal Reserve;
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;
subject to limitations, leasing real or personal property or acting
as agent, broker, or adviser in leasing such property in accordance
with prescribed conditions;
investing in corporations or projects designed primarily to promote
community welfare;
providing to others data processing services and data transmission
services, data bases, and facilities, within certain limitations;
subject to limitations, engaging in certain agency and
underwriting activities with respect to credit insurance, and
certain other insurance activities as permitted by the Federal
Reserve;
owning, controlling, or operating a savings association, if the
savings association engages only in deposit-taking activities and
lending and other activities that are permissible for bank holding
companies under Federal Reserve regulations;
providing courier services for certain financial documents;
subject to limitations, providing management consulting advice to
nonaffiliated bank and nonbank depository institutions;
retail selling of money orders and similar consumer-type payment
instruments having a face value of $1,000 or less, selling U.S.
Savings Bonds, and issuing and selling traveler's checks;
performing appraisals of real estate and personal property;
subject to limitations, acting as intermediary for the financing
of commercial or industrial income-producing real estate by
arranging for the transfer of the title, control, and risk of such
a real estate project to one or more investors;
providing certain securities brokerage services;
subject to limitations, underwriting and dealing in government
obligations and certain other instruments;
subject to limitations, providing foreign exchange and
transactional services;
subject to limitations, acting as a futures commission merchant
for nonaffiliated persons;
subject to limitations, providing investment advice on financial
futures and options to futures;
subject to limitations, providing consumer financial counseling;
subject to limitations, tax planning and preparation;
providing check guaranty services;
subject to limitations, operating a collection agency; and
operating a credit bureau.
Federal Reserve approval may be required before the corporation or its
nonbank subsidiaries may begin to engage in any such activity and before any
such business may be acquired.
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 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, 1998, qualify as "well capitalized" under these regulatory
standards.
FDIC Insurance
The bank is subject to Federal Deposit Insurance Corporation assessments.
The FDIC has adopted a risk-related premium assessment system for both the Bank
Insurance Fund for banks and the Savings Association Insurance Fund for savings
associations. Under this system, FDIC insurance premiums are assessed based on
capital and supervisory measures.
Under the risk-related premium assessment system, the FDIC, on a semiannual
basis, assigns each institution to one of three capital groups, well
capitalized, adequately capitalized, or undercapitalized, and further
assigns such institution to one of three subgroups within a
capital group corresponding to the FDIC's judgment of its
strength based on supervisory evaluations, including examination
reports, statistical analysis, and other information relevant to gauging the
risk posed by the institution. Only institutions with a
total risk-based capital to risk-adjusted assets ratio of 10% or greater,
a Tier 1 capital to risk-adjusted assets ratio of 6% or greater,
and a Tier 1 leverage ratio of 5% or greater, are
assigned to the well-capitalized group.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 to recapitalize the Savings Association Insurance Fund
administered by the Federal Deposit Insurance Corporation 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 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 1 year would exceed the bank's net profits,
as defined and interpreted by regulation, for the 2 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 availability of funds for lending and
investment.
Interstate Banking Legislation
In September 1994, the Riegle-Neal Interstate Banking and Branching
Efficiency Act was enacted. The Interstate Banking Act facilitates the
interstate expansion and consolidation of banking organizations:
by permitting bank holding companies that are adequately
capitalized and adequately managed, beginning September 29, 1995,
to acquire banks located in states outside their home states
regardless of whether such acquisitions are authorized under the
law of the host state;
by permitting the interstate merger of banks after June 1, 1997,
subject to the right of individual states to "opt in" or "opt out" of
this authority before that date;
by permitting banks to establish new branches on an interstate
basis provided that such action is specifically authorized by the
law of the host state;
by permitting, beginning September 29, 1995, a bank to engage in
certain agency relationships (i.e., to receive deposits, renew time
deposits, close loans (but not including loan approvals or
disbursements), service loans, and receive payments on loans and other
obligations) as agent for any bank or thrift affiliate, whether the
affiliate is located in the same state or a different state than the
agent bank; and
by permitting foreign banks to establish, with approval of the
regulators in the United States, branches outside their "home" states
to the same extent that national or state banks located in the home
state would be authorized to do so.
One effect of this legislation will be to permit 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:
eliminates the "reciprocity" requirement previously applicable to
interstate commercial bank acquisitions by bank holding companies,
authorizes interstate bank mergers and reciprocal interstate branching
into Pennsylvania by interstate banks, and
permits Pennsylvania institutions to branch into other states with the
prior approval of the Pennsylvania Department of Banking.
Overall, this federal and state legislation 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, 1998, there were 468 persons employed by the bank, of
which 352 were full-time and 116 were part-time employees. These figures do not
include employees of Town & Country, Inc. which employed 50 persons.
Item 2 - Properties
The bank, in addition to its main office, had, at December 31, 1998, a
branch network of 30 offices and 2 off-site electronic MAC/ATM installations.
All branches are located in Lancaster County with the exception of 1 office
located in Chester County. Branches at 20 locations are occupied under leases
and at 3 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 1 or more renewal options. During 1998, aggregate annual rentals for
real estate paid did not exceed 3% of the bank's operating expenses.
On December 4, 1996, the bank purchased a property located at 1097
Commercial Avenue, East Petersburg, PA, situated on 12.7 acres with a building
containing approximately 123,000 square feet. The building is used to house the
bank'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. At December 31, 1998, approximately 24,000 square feet of this
building was leased to outside parties. The building is owned in fee by the
bank, free and clear of encumbrances. 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 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 39,281 square feet while nearly 13,719
square feet has been leased to other tenants.
The building is owned in fee by the bank, free and clear of
encumbrances.
Item 3 - Legal Proceedings
As of December 31, 1998, 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 1998.
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 26, 1999, 6,447,136 shares were outstanding.
As of February 26, 1999, the corporation had approximately
3,245 stockholders of record. There is no other
class of stock authorized or outstanding. 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. These dividends
are restated to give effect to the 5% stock dividend paid
in June, 1998. 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 1998 Consolidated Financial Statements.
The following table reflects the quarterly high and low prices of the
corporation's common stock for the periods indicated and the cash dividends
declared on the common stock for the periods indicated. All information has
been restated to give effect to the 5% stock dividend paid in June, 1998.
Price Range Per Share Per Share
1998 High Low Dividend
First Quarter $34.76 $29.76 $.20
Second Quarter 57.00 33.81 .21
Third Quarter 49.88 35.00 .21
Fourth Quarter 44.00 39.63 .21
Price Range Per Share Per Share
1997 High Low Dividend
First Quarter $24.76 $24.29 $.18
Second Quarter 24.52 24.29 .18
Third Quarter 24.88 24.29 .23
Fourth Quarter 30.24 24.76 .19
The corporation maintains a Dividend Reinvestment and Stock Purchase Plan
for eligible shareholders who elect to participate in the plan. You may obtain
a copy of the prospectus for the plan by writing to: Bank of
Lancaster County, N.A.
Dividend Reinvestment and Stock Purchase Plan, 101 North Pointe Boulevard,
Lancaster, Pennsylvania 17601-4133.
As of December 31, 1998, the following firms made a market in the
corporation's common stock:
Hopper Soliday & Co.
F.J. Morrissey & Co., Inc.
Prudential Securities, Inc.
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 1998 1997 1996 1995 1994
Interest income............. $60,066 $ 56,499 $ 52,558 $ 48,850 $ 41,931
Interest expense............ 27,925 25,326 22,823 21,153 14,926
------ ------ ------ ------ ------
Net interest income......... 32,141 31,173 29,735 27,697 27,005
Provision for loan losses... 896 1,129 580 534 1,081
------ ------ ------ ------ ------
Net interest income after
provision for loan losses.. 31,245 30,044 29,155 27,163 25,924
Other income................ 14,187 11,930 9,442 7,397 6,222
Other expenses.............. 30,188 28,082 25,639 22,527 21,232
------ ------ ------ ------ ------
Income before income taxes.. 15,244 13,892 12,958 12,033 10,914
Applicable income taxes..... 3,643 3,491 3,147 3,039 2,637
------ ------ ------ ------ ------
NET INCOME..................$ 11,601 $ 10,401 $ 9,811 $ 8,994 $ 8,277
====== ====== ====== ====== ======
Per Common Share:*
Net income - basic..........$ 1.80 $ 1.60 $ 1.50 $ 1.38 $ 1.29
Net Income - diluted........ 1.79 1.60 1.50 1.38 1.29
Cash dividends declared**... .83 .78 .70 .85 .55
Book value.................. 12.63 11.46 10.59 10.28 9.30
Book value (excluding
SFAS 115)................. 11.90 11.01 10.34 10.01 9.23
Average shares outstanding -
basic.................... 6,456,896 6,511,742 6,545,925 6,513,333 6,433,385
Average shares outstanding -
diluted...................6,478,290 6,514,984 6,546,002 6,513,333 6,433,385
Ratios:
Return on average assets.. 1.33% 1.32% 1.34% 1.36% 1.38%
Return on average equity.. 15.63% 14.89% 15.01% 15.02% 15.47%
Financial Condition at
Year-End:
Assets.................... $ 919,264 $ 845,488 $ 764,072 $ 711,154 $ 633,395
Loans (net of unearned)... 534,209 511,637 473,832 426,312 392,649
Deposits.................. 781,383 718,661 647,036 610,105 537,002
Stockholders' Equity...... 81,313 73,987 69,179 63,909 57,285
Average Assets............ 874,640 789,314 732,226 659,335 600,263
*Figures prior to 1998 were restated for stock dividends of 5% paid in
1998 and 5% paid in 1996, 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. Both have been restated
to give effect to the 5% stock dividends paid in 1998 and 1996.
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., T & C Leasing,
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 1998 was $11,601,000, an increase of $1,200,000 or 11.5%
over the $10,401,000 earned in 1997. The results of 1997 were $590,000 or 6%
higher than the $9,811,000 reported in 1996. Basic earnings per share on
net income amounted to $1.80, $1.60 and $1.50 for the years ended
1998, 1997 and 1996.
Basic earnings per share were computed by dividing net income by the weighted
average number of shares of common stock outstanding, which were 6,456,896,
6,511,742 and 6,545,925 for 1998, 1997 and 1996. Diluted earnings per share on
net income amounted to $1.79, $1.60 and $1.50 for the years ending 1998, 1997
and 1996. The weighted number of common shares and dilutive potential
common stock
used in calculating the diluted earnings per share were 6,478,290, 6,514,984 and
6,546,002 for 1998, 1997 and 1996. Figures prior to 1998 were restated to
reflect a 5% stock dividend paid in June, 1998.
Return on average total assets was 1.33% in 1998 compared to 1.32% in 1997
and 1.34% in 1996. Return on average stockholders' equity was 15.63%, in 1998
compared to 14.89% in 1997 and 15.01% in 1996.
Growth in earning assets was the primary factor contributing to the
increased earnings in 1998 and 1997. As of December 31, 1998, earning assets
were approximately $810 million compared to $747 million at December 31, 1997,
and $673 million at December 31, 1996. Average earning assets for 1998
increased over $74 million, to approximately $773 million, up 10.6% from the
prior year. Similarly, in 1997, average earning assets
increased over $51 million, up 7.9% from 1996. The current year increase,
as well as the increase in 1997, was primarily due to increases
in both loans and investments.
Average interest bearing liabilities increased over $68 million or 10.9% in
1998, compared to an increase of nearly $48 million, or 8.3% in 1997.
The increase in average earning assets exceeded the increase in average
interest-bearing liabilities in both 1998 and 1997.
Provision for loan losses decreased to $896,000 in 1998 from $1,129,000 in
1997. The provision in 1996 was $580,000.
Non-interest income increased $2,257,000 in 1998, compared to an increase
of $2,488,000 in 1997.
Non-interest expenses increased $2,106,000 or 7.5% in 1998 compared to an
increase of $2,443,000 or 9.5% in 1997 over 1996.
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
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 1998 and 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 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
ready. On December 31, 1998, approximately 71% of the corporation's systems
were ready, with all systems expected to be ready by June 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 year to have a material
effect on its financial position or results of operations.
On February 10, 1999, the corporation entered into an agreement to acquire
Northeast Bancorp, Inc., the parent company of First National Bank of North
East, based in Maryland. Northeast Bancorp is an $82 million bank
holding company for First National Bank of North East,
with 4 branches located in Cecil County,
Maryland. Under the terms of the agreement, Northeast Bancorp shareholders will
receive 2 shares of Sterling Financial Corporation common stock for each
share of Northeast Bancorp's common stock in a tax-free exchange. The
purchase, which is subject to regulatory approval, will give Sterling
Financial its first banking presence outside of Pennsylvania.
The transaction is expected to be completed in
mid 1999 and the acquisition is expected to be accounted for as a pooling of
interests. First National Bank of North East will continue to operate as a
separate bank after the acquisition.
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 1998, 1997 and 1996.
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 1998 and 1997 resulted from increased
volumes in average earning assets. Average earning assets increased 10.6% in
1998 and 7.9% in 1997. These increases were primarily funded with interest
bearing liabilities which increased 10.9% in 1998 and 8.3% in 1997.
Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity
Interest Rates and Interest Differential-Tax Equivalent Yields
(Unaudited)
Years ended December 31,
1998 1997 1996
Average Annual Average Annual Average Annual
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest bearing deposits
with banks..............$ 170 $ 10 5.70% $ 214 $ 13 5.90% $ 103 $ 6 5.72%
Federal Funds sold......... 18,077 985 5.45% 13,110 730 5.57% 7,376 398 5.39%
Investment securities:
U.S. Treasury securities. 32,581 1,910 5.86% 28,330 1,679 5.93% 28,789 1,686 5.86%
U.S. Government agencies. 37,607 2,318 6.16% 33,508 2,100 6.27% 33,895 2,192 6.47%
State and Municipal
securities.............. 68,457 5,180 7.57% 60,324 4,702 7.79% 57,966 4,615 7.96%
Other securities......... 86,540 5,301 6.13% 66,207 4,131 6.24% 57,189 3,535 6.18%
------ ----- ----- ------- ------ ------ ------- ------ ------
Total investment securities225,185 14,709 6.53% 188,369 12,612 6.70% 177,839 12,028 6.76%
Loans:
Commercial...............292,666 25,750 8.80% 265,638 24,021 9.04% 245,018 22,276 9.09%
Consumer.................131,084 11,615 8.86% 133,125 11,927 8.96% 130,044 11,401 8.77%
Mortgages................ 51,278 4,012 7.82% 47,983 3,814 7.95% 41,046 3,330 8.11%
Leases................... 55,004 5,463 9.93% 50,811 5,221 10.28% 46,420 4,865 10.48%
------ ------ ----- ------- ------- ------- ------- ------- ------
Total loans................530,032 46,840 8.84% 497,557 44,983 9.04% 462,528 41,872 9.05%
------- ------ ----- ------- ------- ------ ------- ------- ------
Total earning assets.......773,464 62,544 8.09% 699,250 58,338 8.34% 647,846 54,304 8.38%
Allowance for loan losses.. (7,894) (7,863) (7,863)
Cash and due from banks.... 27,625 32,409 30,238
Other non-earning assets... 81,445 65,518 62,005
------- ------- -------
Total non-earning assets...101,176 90,064 84,380
------- ------- ------ ------- ------- ------ ------- ------- ------
Total assets..............$874,640 $62,544 7.15% $789,314 $ 58,338 7.39% $732,226 $54,304 7.42%
======== ======= ====== ======== ======= ====== ======= ====== =====
Liabilities and Stockholders' Equity
Deposits:
Demand deposits
Noninterest-bearing....$ 83,972 $ 0 0.00% $ 74,332 $ 0 0.00% $ 72,052 $ 0 0.00%
Demand deposits
Interest-bearing........289,062 7,289 2.52% 267,987 6,931 2.59% 257,622 6,726 2.61%
Savings deposits......... 57,615 1,131 1.96% 58,149 1,188 2.04% 58,232 1,288 2.21%
Time deposits............313,963 17,522 5.58% 262,681 14,805 5.64% 229,835 12,695 5.52%
------- ------ ----- ------- -------- ------ -------- ------- ------
Total deposits.............744,612 25,942 3.48% 663,149 22,924 3.46% 617,741 20,709 3.35%
Other borrowed funds....... 31,549 1,983 6.29% 35,316 2,402 6.80% 30,578 2,114 6.91%
Other liabilities.......... 20,684 18,894 17,122
Stockholders' equity....... 77,795 71,955 66,785
------ ------ ----- ------- ------- ------ -------- ------- ------
Total liabilities and
Stockholders' equity....$874,640 $ 27,925 3.19% $789,314 $ 25,326 3.21% $732,226 $22,823 3.12%
======== ======= ====== ======== ======== ====== ======== ======= ======
Net interest income/
Average total assets...... $ 34,619 3.96% $ 33,012 4.18% $31,481 4.30%
Net interest income/
Average earning assets.... $ 34,619 4.48% $ 33,012 4.72% $31,481 4.86%
Net interest income on a fully taxable equivalent basis increased by
$1,607,000 in 1998 compared to an increase of $1,531,000 in 1997. Table 2
indicates that of the increase in 1998, $2,507,000 was the result of increased
volumes. This figure was reduced by $900,000 due to changes in interest rates.
The increase in 1997 resulted in $1,788,000 from increased volumes and a
reduction of $257,000 due to changes in interest rates.
For the year 1998 compared to 1997, loan volumes, on average, increased
over $32 million and income earned on loans increased $1,857,000,
tax adjusted. This compares to a volume increase of over $35
million in 1997 over 1996 with an increase in income
earned on loans amounting to $3,111,000. As a result of
increased volumes in 1998, nearly $3 million contributed to the increase in
income on loans. Rates charged on loans decreased in 1998. The decrease in
rates reduced interest $1,079,000 in income earned on loans. Increased
volume in loans in 1997 contributed nearly $3.2 million to the increase
in income, while a decrease in interest rates reduced
income earned on loans by $60,000.
Total investment securities, on average, increased over $36.8 million in
1998 over 1997 compared to an increase of over $10.5 million in 1997 over 1996.
Increased volume in both periods was responsible for the increase in interest
income on securities. Table 2 indicates that, of the increase in interest
income in 1998, $2,465,000 was the result of increased volume while a
decrease in interest rates caused a $368,000 reduction.
Increased volume in securities in 1997 contributed nearly $712,000 to the
increase while a decrease in rates caused a $128,000 reduction.
Interest income on federal funds sold contributed $255,000 to the increase
in net income in 1998 over 1997. Increased volumes generated an increase of
$277,000 which was reduced by $22,000 due to a decrease in rates.
Interest bearing deposits, on average, grew over $71.8 million in 1998. The
major portion of the increase in interest expense on deposits was generated on
time deposits, as a result of increased volumes. Although there were increased
volumes on the other deposits, with the exception of savings deposits, the
decrease in rates paid on these deposits reduced the total interest expense by
$406,000. Interest expense on interest bearing deposits increased over $2.2
million in 1997 over 1996. Increased volumes generated an increase of
$2,083,000 while an increase in income of $132,000 resulted from
increased rates.
Interest expense on borrowed funds decreased $419,000 in 1998 over 1997
compared to an increase of $288,000 in 1997 over 1996. A decrease in volume as
well as a decrease in interest rates generated the decrease in 1997. The major
portion of the increase in 1997 over 1996 was a result of increased volume.
Table 2 - Analysis of Changes in Net Interest Income
The rate-volume variance analysis set forth in the table below, which is
computed on a tax equivalent basis, compares changes in net interest income for
the periods indicated by their rate and volume components.
1998 Versus 1997 1997 Versus 1996
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
Volume Rate Total Volume Rate Total
Interest Income
Interest on deposits
with banks...........$ (3) 0 $ (3) $ 6 $ 1 $ 7
Interest on federal
funds sold........... 277 (22) 255 309 23 332
Interest on investment
securities........... 2,465 (368) 2,097 712 (128) 584
Interest and fees on
loans................ 2,936 (1,079) 1,857 3,171 (60) 3,111
------- -------- ------ ------ ------- -------
Total interest income...$ 5,675 $ (1,469) $ 4,206 $ 4,198 $ (164) $ 4,034
------- -------- ------ ------ ------- -------
Interest Expense
Interest on
interest-bearing
demand deposits......$ 545 (187) 358 $ 271 $ (66) $ 205
Interest on
savings deposits...... (11) (46) (57) (2) (97) (99)
Interest on
time deposits......... 2,890 (173) 2,717 1,814 295 2,109
Interest on
borrowed funds........ (256) (163) (419) 327 (39) 288
------- -------- ------ ------- ------- -------
Total interest expense.. $ 3,168 $ (569) $ 2,599 $ 2,410 $ 93 $ 2,503
------- -------- ------ ------- ------- -------
Net interest income..... $ 2,507 $ (900) $ 1,607 $ 1,788 $ (257) $ 1,531
======= ======== ======= ======= ======= =======
Provision for Loan Losses
The provision for loan losses charged against earnings was $896,000 in 1998
compared to $1,129,000 in 1997 and $580,000 in 1996. 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 $1,008,000 in 1998, $1,199,000 in 1997 and
$560,000 in 1996. Gross charge-offs for 1998 were $1,269,000, a 15% decline
from the $1,502,000 reported in 1997. The decline in the provision for
loan losses, gross and net charge-offs was a result of
improvement in credit quality,
particularly in the consumer portfolio. Management instituted certain
underwriting criteria during 1997 and 1998 that had a positive effect on the
quality of the consumer portfolio. Personal bankruptcies continue to play a
significant role in the losses. Management expects further improvement in 1999
in the consumer portfolio. Loan quality remains high in the commercial loan
portfolio. The net losses to average loans and leases in 1998 were in line with
the bank's peers.
The allowance for loan losses as a percent of loans at December 31, 1997
was 1.51%, while at December 31, 1998 it was 1.43%.
Non-Interest Income
Table 3 - Non-Interest Income
1998/1997 1997/1996
Increase Increase
(Decrease) (Decrease)
1998 Amount % 1997 Amount % 1996
Income from fiduciary activities.$ 1,879 $ 366 24.2% $ 1,513 $ 374 32.8% $1,139
Service charges on deposit
accounts....................... 2,908 (1) ---- 2,909 424 17.1% 2,485
Other service charges, commissions
and fees....................... 1,729 273 18.8% 1,456 512 54.2% 944
Mortgage banking income........... 1,811 506 38.8% 1,305 113 9.5% 1,192
Income from sale of assets........ 1,338 1,338 ---- none none ---- none
Other operating income............ 4,522 (17) (.4%) 4,539 1,015 28.8% 3,524
Investment securities gains or
(losses)....................... none (208)(100.0%) 208 50 31.7% 158
------ ------ ------ ------ ------ ------ ------
Total............................$14,187 $2,257 18.9% $11,930 $ 2,488 26.4% $9,442
======= ======= ====== ====== ====== ====== ======
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. Reflected in
non-interest income is the sale of the bank's credit card portfolio.
Income from fiduciary activities in the amount of $1,879,000 in 1998 was
$366,000 or 24.2% greater than the $1,513,000 recorded in 1997. Income in 1997
was $374,000 or 32.8% greater than the $1,139,000 recorded in 1996. Fees
increased primarily due to increased transaction volumes.
Service charges on deposit accounts decreased to $2,908,000, a decrease of
$1,000 over the $2,909,000 reported for 1997. Service charges on deposit
accounts in 1997 was $424,000 more than the $2,485,000 reported for 1996.
General increases in service charges on various accounts, as well as,
transaction volume produced the increase in 1997 over 1996. Management
continuously monitors the fee structure and makes
changes where appropriate.
Other service charges, commissions and fees were $1,729,000 in 1998
compared to $1,456,000 in 1997 and $944,000 in 1996. The increase in 1998 over
1997 was $273,000 or 18.8%. The significant increase in 1997 is attributable to
the introduction of ATM charges. Other contributors to the increase in 1998 as
well as 1997 were the fees received on mutual funds transactions and fees on the
bank's debit card.
Income from mortgage banking activities increased to $1,811,000 in 1998
from $1,305,000 in 1997. Mortgages sold in the secondary market in 1998
increased to approximately $88.9 million from $40.9 million in 1997. All
mortgages sold were originated by the bank's mortgage operation and branch
network. No mortgages were acquired from third parties, nor have servicing
rights been purchased from third parties. A low interest rate environment in
1998 and 1997, as well as an expansion in mortgage products and services
resulted in the increase in volume in 1998 and 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
totaled $221 million as of December 31, 1998 compared to $175
million on December 31, 1997.
Another component of the mortgage banking increase in income was a result
of the implementation of FASB 122, subsequently replaced by FASB 125, which
required that mortgage servicing rights be recognized for their economic value,
beginning January 1, 1996. Mortgage servicing has an economic value because of
future servicing income to be received over the life of the mortgage. The value
of servicing rights is available through third party purchasers in private
transactions. The bank has developed a business relationship with an
independent consultant to determine the values of mortgage servicing rights.
In 1998, the amount recognized to income was $839,880. 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, 1998
and 1997 amounted to $1,382,000 and $892,000. The market value of all mortgage
servicing assets is also determined by the independent consultant. The market
valuation, or impairment, of all the mortgage assets was $41,000 as of December
31, 1998. This impairment was charged against earnings and is carried as a
valuaion allowance for mortgage servicing assets.
Other operating income decreased $17,000 to $4,522,000 in 1998 from
$4,539,000 in 1997. Other income was $3,524,000 in 1996. Income generated from
operating leases was a major contributor to the increase in 1997. 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 in 1997. Income on operating leases increased nearly
$415,000 in 1998 over 1997.
The major contributor to the increase in total other operating income
was a one-time earnings gain of $1,338,507 as a result of the sale of the
bank's credit card portfolio in the second quarter of 1998.
Investment securities transaction reflect a gain of $208,000 in 1997
compared to $158,000 in 1996 on securities sold from the available-for-sale
securities. There were no securities sold in 1998.
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 $2,257,000 in 1998 over 1997 compared to
an increase of $2,448,000 in 1997 over 1996.
Non-Interest Expense
Table 4 - Non-Interest Expense
1998/1997 1997/1996
Increase Increase
(Decrease) (Decrease)
1998 Amount % 1997 Amount % 1996
Salaries and employee benefits...$17,638 $ 1,240 7.6% $16,398 $ 1,371 9.1% $15,027
Net occupancy expense............. 2,088 (202) (8.8%) 2,290 181 8.6% 2,109
Furniture & equipment expense..... 2,755 275 11.1% 2,480 436 21.3% 2,044
FDIC insurance assessment......... 87 6 7.4% 81 79 --- 2
Other operating expense........... 7,620 787 11.5% 6,833 376 5.8% 6,457
----- ------ ----- ------ ------ ----- -------
Total............................$30,188 $ 2,106 7.5% $28,082 $2,443 9.5% $25,639
======= ======= ===== ======= ====== ===== =======
Non-interest expense consists of salaries and employee benefits, net
occupancy expense, furniture and equipment expense and other operating expenses.
Total operating expenses for 1998 were $30,188,000 compared to $28,082,000
in 1997. This represents an increase of $2,106,000 or 7.5%. This compares to
an increase of $2,443,000 or 9.5% in 1997.
The largest component of the corporation's other operating expense is
salaries and employee benefits which increased to $17,638,000 in 1998 or
$1,240,000 or 7.6% over the $16,398,000 reported in 1997. In 1997, expenses
increased $1,371,000 or 9.1% over the $15,027,000 reported in 1996. The increase
in 1997 was primarily due to increases in staff as well as increases in wages
and the increased cost of employee benefits. The increase in 1998 was
related more to increases in wages and the increased cost of employee
benefits. The full-time equivalent employees in 1998 rose to 436
from 431 in 1997. The full-time equivalent in 1996 was 400.
Occupancy expenses decreased $202,000 or 8.8% to $2,088,000 in 1998 from
$2,290,000 in 1997. By comparison, during 1997, there was an increase of
$181,000 or 8.6%. 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, PA 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 along with expenses relating to
occupancy such as real estate taxes, insurance, utilities,
maintenance and janitor services contributed to the increase in
occupancy expense in 1997. One new branch facility was opened in
1997 as well as 1998. At December 31, 1998, approximately
24,000 square feet of the building at 1097 Commercial Avenue was leased to
outside parties.
Furniture and equipment expenses were $2,755,000 in 1998 and $2,480,000 in
1997. This represents an increase of $275.000 or 11.1%. The increase in 1997
over 1996 was $436,000 or 21.3%. Reflected in this increase is a $159,000
increase in depreciation expense in 1998. Service contracts on equipment also
contributed to the increase in 1998.
The FDIC insurance assessment reflects an increase of $6,000 in 1998 over
1997. On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 to recapitalize the Savings Association
Insurance Fund
administered by the Federal Deposit Insurance Corporation 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 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 of $79,000 in the 1997 FDIC assessment over the
1996 assessment.
Other operating expenses increased $787,000 or 11.5% in 1998 compared to
an increase of $376,000 in 1997. The 1998 increase is consistent with rising
costs associated with acquiring services covered 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 1998 were increases in Pennsylvania Shares Tax, professional
services, MAC fees, telephone expense, stationery and supplies, other real
estate expenses and losses associated with a limited partnership.
Income Taxes
Income tax expense was $3,643,000 in 1998 compared to $3,491,000 in 1997
and $3,147,000 in 1996. These increases were a result of higher
levels of taxable income and increased earnings each year. The corporation's
effective tax rate was 23.9% in 1998 compared with 25.1% in 1997
and 24.3% in 1996. Use of tax credits in 1998 and an
increase in tax exempt interest resulted in a lower
effective tax rate than 1997 even though income taxes increased. Additional
information related to income taxation is presented in the Notes to Consolidated
Financial Statements.
Financial Condition
Investment Portfolio
Table 5 - Investment Securities at Cost
The following table shows the amortized cost of the held-to-maturity
securities owned by the corporation as of the dates indicated. Investment
securities are stated at cost adjusted for amortization of premiums and
accretion of discounts.
December 31,
1998 1997 1996
U.S. Treasury securities................$ 2,508 $ 6,537 $ 12,888
Obligations of other U.S. Government
agencies and corporations............. 2,208 9,696 11,607
Obligations of states and political
subdivisions.......................... 44,465 45,816 37,584
Mortgage-backed securities.............. 1,219 1,575 2,076
Other bonds, notes and debentures....... 10,808 18,574 27,269
--------- --------- ---------
Subtotal................................ 61,208 82,198 91,424
Non-marketable securities............... 3,201 2,957 2,798
--------- --------- ---------
Total...................................$ 64,409 $ 85,155 $ 94,222
========= ========= =========
The following table shows the amortized cost and fair value of the
available-for-sale securities owned as of the dates indicated.
December 31,
1998 1997 1996
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- -------- -------- ----------- --------
U.S. Treasury securities............$ 29,265 $ 29,930 $ 24,435 $ 24,625 $ 13,611 $ 13,598
Obligations of other U.S. Government
agencies and corporations.......... 37,713 38,285 26,821 27,008 18,800 18,718
Obligations of states and political
subdivisions....................... 36,938 37,986 21,840 22,571 20,488 20,819
Mortgage-backed securities........... 461 461 832 829 1,125 1,117
Other bonds, notes and debentures.... 66,215 67,312 42,955 43,178 22,752 22,771
-------- --------- -------- -------- --------- --------
Subtotal............................. 170,592 173,974 116,883 118,211 76,776 77,023
Equity securities.................... 174 3,904 174 3,263 171 2,352
-------- --------- -------- -------- --------- --------
Total................................$170,766 $ 177,878 $117,057 $121,474 $ 76,947 $ 79,375
======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields)
The following table shows the maturities of held-to-maturity debt
securities at amortized cost as of December 31, 1998 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....$ 2,005 6.03% $ 503 5.84% $ --- ---% $ --- ---% $ 2,508 5.99%
Obligations of
other U.S.
Government
agencies and
corporations.. 252 6.69% 1,956 6.08% --- ---% --- ---% 2,208 6.15%
Obligations of
states and
political sub-
divisions..... 2,499 5.41% 11,738 5.23% 22,943 5.12% 7,285 4.90% 44,465 5.13%
Mortgage-backed
securities.... 260 8.54% 646 8.52% 200 8.33% 113 7.41% 1,219 8.39%
Other bonds,
notes and
debentures.... 5,047 6.61% 5,761 5.82% --- ---% --- ---% 10,808 6.19%
------- ----- ------- ------ -------- ----- ------- ----- ------- -----
$10,063 6.25% $20,604 5.59% $ 23,143 5.15% $ 7,398 4.94% $61,208 5.45%
======= ===== ======= ====== ======== ===== ======= ===== ======= =====
The following table shows the maturities of available-for-sale debt
securities at amortized cost as of December 31, 1998 and approximate weighted
average yields of such securities. Yields are shown on a tax equivalent basis,
assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 7,568 4.91% $ 21,697 5.82%$ --- ---% $ --- ---% $ 29,265 5.58%
Obligations of
other U.S.
Government
agencies and
corporations.. 3,424 6.37% 23,325 6.05% 10,964 6.17% --- ---% 37,713 6.11%
Obligations of
states and
political sub-
divisions..... 1,142 5.70% 9,127 5.30% 15,134 5.12% 11,535 4.57% 36,938 5.01%
Mortgage-backed
securities.... 189 5.65% 272 5.65% --- ---% --- ---% 461 5.65%
Other bonds,
notes and
debentures.... 11,885 6.48% 54,330 6.15% --- ---% --- ---% 66,215 6.21%
------- ------ ------- ------ ------- ----- ------- ----- -------- ------
$24,208 5.93% $108,751 5.99% $26,098 5.56% $11,535 4.57% $170,592 5.82%
======= ====== ======= ====== ======= ===== ======= ===== ======== ======
Loans
Table 7 - Loan Portfolio
The following table sets forth the composition of the corporation's loan
portfolio as of the dates indicated:
December 31,
1998 1997 1996 1995 1994
Commercial, financial and
agricultural..............$ 290,619 $ 271,605 $ 239,701 $ 228,058 $ 208,918
Real estate-construction... 6,053 6,045 5,608 6,378 8,542
Real estate-mortgage....... 48,381 49,438 45,373 33,124 30,505
Consumer................... 131,939 132,778 136,989 116,210 106,921
Lease financing (net of
unearned income)......... 57,327 52,207 47,346 43,904 38,771
---------- ---------- ---------- ---------- ---------
Total loans.................$ 534,319 $ 512,073 $ 475,017 $ 427,674 $ 393,657
========== ========== ========== ========== =========
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, 1998:
After one
Within but within After
one year five years five years Total
Commercial, financial and
agricultural....................$ 104,041 $ 146,505 $ 40,073 $ 290,619
Real estate-construction........ 5,111 289 653 6,053
--------- --------- -------- ---------
$ 109,152 $ 146,794 $ 40,726 $ 296,672
========= ========= ======== =========
Loans due after one year totaling $107,980,000 have variable interest
rates. The remaining $79,540,000 in loans have fixed rates.
Table 9 - Nonaccrual, Past Due and Restructured Loans
The following table presents information concerning the aggregate amount of
nonaccrual, past due and restructured loans:
December 31,
1998 1997 1996 1995 1994
Nonaccrual loans...........$ 812 $ 1,314 $ 1,193 $ 1,010 $ 2,127
Accruing loans, past due
90 days or more......... 613 787 737 330 1,127
Restructured loans........ 1,993 2,105 none none none
------- -------- -------- -------- --------
Total non-performing loans. 3,418 4,206 1,930 1,340 3,254
Other real estate owned.... 180 341 81 252 759
------- -------- -------- -------- --------
Total non-performing assets $ 3,598 $ 4,547 $ 2,011 $ 1,592 $ 4,013
======= ======== ======= ======== ========
Ratios:
Non-performing loans to
total loans.......... .64% .82% .41% .31% .83%
Non-performing assets to
total loans and other
real estate owned.... .67% .89% .42% .37% 1.02%
Non-performing assets to
total assets.......... .39% .54% .26% .22% .63%
Allowance for loan losses to
non-performing loans.. 222.9% 183.8% 404.1% 580.6% 234.8%
The economic conditions within the corporation's market area remained
healthy in 1998. This is reflected in the unemployment rate for Lancaster
County, which is the bank's primary market area. The jobless rate during 1998
hovered close to 3%, staying the lowest or second lowest in the state. The
county's unemployment rate has not exceeded 3% since November of 1997.
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 average national and state
average unemployment figures of 4.4% and 4.6% respectively. The
unemployment rate for 1999 is expected to mirror that of 1998
with little movement in either direction. Lancaster's labor market is expected
to remain one of the tightest in the state.
The strength in the employment sector in Lancaster County was also seen at
the national level. The U.S. unemployment rate stood at 4.5% in December 1998
compared to 4.7% in December 1997. Economists aren't looking for much change
this year in the health of labor markets. Indications are that the job market
remains robust.
The bank's loan delinquency as a percent of loans outstanding declined
during 1998. At December 31, 1998, this rate stood at .44% compared to .83% and
.96% for December 31, 1997 and December 31, 1996. The average delinquency rate
for 1998 of .56% declined from .99% in 1997. The decline in the average
delinquency rate was primarily attributed to improvement in the consumer
portfolio. The bank, however, is not immune to the significant role that
bankruptcies have on losses. During 1998, the bank's credit card portfolio was
sold, which, is believed, will have a positive effect on delinquencies and
losses. While management believes delinquency rates could rise during 1999,
expectations are that they will not approach the national delinquency rates.
The .44% remains well below the accepted level established by management
and that of its peers. During the year, total nonaccrual
loans and other real estate owned declined to $992,000 from $1,655,000
at December 31, 1997. Total non-performing
assets declined to $3,598,000 compared to $4,547,000 for December 31, 1997
representing a 21% decrease. The restructured loans are a series of loans to
one borrower involving $1,993,000. 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 such 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 continues.
The bank's reserve coverage increased during the year as reserves as a
percent of non-performing loans increased to 223% compared to 184% for December
31, 1997.
A portion of the bank's loan portfolio consists of loans to
agricultural-related borrowers. These loans consist of loans 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 latter part of 1998, milk prices
increased significantly. While the bank continues to pursue quality loans to
the dairy industry and the agricultural community in general, it
should be noted that these loans are susceptible to a variety of
external factors such as adverse climate, economic conditions, etc.,
in addition to factors common to other industries.
The residential real estate market in 1998 for Lancaster County enjoyed a
strong year. The county recorded a record year for sales of existing homes.
Residential construction contracts, however, increased at a much slower pace,
suggesting that the building boom in recent years may be over. Reasonably low
interest rates, a continuing strong economy, and minimal inflation accounted for
the sales performance. Non-residential contracts broke even with 1997,
which had experienced a significant increase over 1996.
Most of the bank's business activity is with customers located within the
bank's defined market area. Since the majority of the bank's real estate loans
are located within this area, a substantial portion of the debtor's ability to
honor their obligations and increases and decreases in the market value of the
real estate collateralizing such loans may be affected by the level of economic
activity in the market area.
The bank recognizes that the potential Year 2000 problems, relating to
computers, hardware, microchips, software and additional software applications
utilized by the bank's borrowers in their businesses, or by their suppliers,
vendors and their customers, may result in unexpected and material adverse
changes in borrowers' businesses or financial condition. In order to reduce the
potential risk to the bank from its borrowers, the bank has substantially
completed an assessment of the Year 2000 risk posed by its borrowers. Based on
this assessment, management does not believe that the Year 2000 risks from its
borrowers pose a material risk or threat to the safety and soundness of the
bank. Management believes that the provision for loan losses is adequate
to meet the present and forseeable risk characteristics
of the loan portfolio including the potential Year 2000
risks posed by its borrowers.
The general policy has been to cease accruing interest on loans when it is
determined 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 amounted to $812,000 at
December 31, 1998 compared to $1,314,000 at December 31, 1997. If interest
income had been recorded on all such loans for the years indicated, such
interest income would been been increased by approximately $85,667 and
$152,755 for 1998 and 1997. Interest income recorded on
nonaccrual loans amounted to $561 and $20,020 for 1998 and 1997.
Potential problem loans are loans which are included
as performing loans, but for which possible credit problems of the borrower
causes management to have doubts as to the ability of such borrower to comply
with present repayment terms and which may eventually result in disclosure as a
non-performing loan. At December 31, 1998, there were no such loans that had to
be disclosed 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 impairement 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:
1998 1997
Gross impaired loans which have allowances..........$2,805 $3,419
Less: Related allowances for loan losses......... (140) (410)
------ ------
Net impaired loans..................................$2,665 $3,009
====== ======
The decline in impaired loans is primarily attributed to a reduction in
non-accrual loans. A large portion of the impaired loans is attributed to the
restructure of a series of loans to one borrower. A loan is categorized as
restructured if the original interest rate on such loan, repayment terms, or
both are restructured due to a deterioration in the financial
condition of the borrower that otherwise would not have been
granted. In the case of the above referenced loans,
the bank is fully secured with real estate. The loans are
current and have performed in accordance with the contractural term, both prior
to and after the restructure. Accrual of interest on these loans continues.
At December 31, 1998, there were no concentrations exceeding 10% of loans.
A concentration is defined as amounts loaned to a multiple number of borrowers
engaged in similar activities which would cause them to be similarly affected by
changes in economic or other conditions. There were no foreign loans
outstanding at December 31, 1998.
Allowance for Loan Losses
Table 10 - Summary of Loan Loss Experience
Years ended December 31,
1998 1997 1996 1995 1994
Allowance for Loan Losses:
Beginning balance.............$ 7,730 $ 7,800 $ 7,780 $ 7,640 $ 7,180
Loans charged off during year:
Commercial, financial and
agricultural.............. 447 43 37 50 157
Real estate mortgage........ 268 419 184 252 235
Consumer.................... 500 919 458 360 360
Lease financing............. 54 121 24 14 10
------- ------- ------- ------- -------
Total charge-offs........... 1,269 1,502 703 676 762
------- ------- ------- ------- -------
Recoveries:
Commercial, financial and
agricultural.............. 34 4 5 117 61
Real estate mortgage........ 72 112 42 72 2
Consumer.................... 127 122 88 91 77
Lease financing............. 28 65 8 2 1
------- ------- ------- ------- -------
Total recoveries............ 261 303 143 282 141
------- ------- ------- ------- -------
Net loans charged off......... 1,008 1,199 560 394 621
Additions charged to
operations.................. 896 1,129 580 534 1,081
------- ------- ------- ------- -------
Balance at end of year........$ 7,618 $ 7,730 $ 7,800 $ 7,780 $ 7,640
======= ======= ======= ======= =======
Ratio of net loans charged
off to average loans
outstanding................. .19% .24% .12% .10% .17%
Ratio of net loans charged
off to loans at end of year. .19% .23% .12% .09% .16%
Net loans charged off to
allowance for loan losses.. 13.23% 15.51% 7.18% 5.06% 8.13%
Net loans charged off to
provision for loan losses.. 112.50% 106.20% 96.55% 73.78% 57.45%
Allowance for loan losses as a
percent of average loans... 1.44% 1.55% 1.69% 1.91% 2.04%
Allowance for loan losses
as a percent of loans at
end of year................ 1.43% 1.51% 1.65% 1.82% 1.95%
Allowance for loan losses
as a percent of
non-performing loans....... 222.9% 183.8% 404.1% 580.6% 234.8%
The corporation experienced a 15% decline in gross charge-offs, while net
charge-offs declined 16%. The decline in charge offs was a result of
improvement in the consumer loan portfolios. During 1998, the bank sold
its credit card portfolio, which had a positive
effect on losses. Personal bankruptcies continue
to play a significant role in the losses. Management instituted certain
underwriting criteria in 1997 and 1998 which is believed to also have had a
positive effect on losses. For the year, the corporation recorded net
charge-offs of $1,008,000 or .19% of average loans outstanding compared to
$1,199,000 or .24% of average loans in 1997 and $560,000 or .12% of
average loans in 1996.
The provision for loan losses charged to operating expense reflects the
amount deemed appropriate by management to produce an adequate reserve to meet
the present risk and inherent risk in the loan portfolio, including the
potential Year 2000 risks posed by its borrowers. Management
performs a quarterly assessment of the loan portfolio to
determine the appropriate level of the
allowance. The factors considered in this evaluation include, but are not
limited to, estimated loan losses identified through a loan review process,
general economic conditions, deterioration in pledged collateral, past loan
experiences and trends in delinquencies and non-accruals. Managment uses
available information to determine the appropriate level of the allowance for
possible loan losses. However, the allowance may be affected in the future
based upon changes in the economic conditions and other factors.
While there can be no assurance that material amounts of additional
loan loss provisions will not be required in the future,
management believes that, based upon information
presently available, the amount of the allowance for possible loan losses is
adequate.
Management has not targeted any specific coverage ratio of nonperforming
loans by the allowance for loan losses and the coverage ratio may fluctuate
based on loans placed into or removed from nonperforming status.
Table 11 - Allocation of Allowance for Loan Losses
December 31,
1998 1997
Commercial, financial and agricultural..........$ 4,705 $ 3,529
Real estate - mortgage.......................... 107 25
Consumer........................................ 660 910
Leases.......................................... 527 599
Unallocated..................................... 1,619 2,667
------- -------
Total...........................................$ 7,618 $ 7,730
======= =======
Deposits
Table 12 - Average Deposit Balances and Rates Paid
The average amounts of deposits and rates paid for the years indicated are
summarized below:
1998 1997 1996
Amount Rate Amount Rate Amount Rate
Demand deposits.....................$ 83,972 --- $ 74,332 --- $ 72,052 ---
Interest bearing demand deposits.... 289,062 2.52% 267,987 2.59% 257,622 2.61%
Savings deposits.................... 57,615 1.96% 58,149 2.04% 58,232 2.21%
Time deposits....................... 313,963 5.58% 262,681 5.64% 229,835 5.52%
-------- ----- -------- ----- -------- -----
$744,612 3.48% $663,149 3.46% $617,741 3.35%
======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity
The maturities of time deposits of $100,000 or more are summarized below:
December 31,
1998 1997
Three months or less..........................$ 7,352 $ 11,058
Over three thru six months.................... 7,262 6,541
Over six thru twelve months................... 9,676 9,209
Over twelve months............................ 8,469 10,357
------- -------
Total.........................................$ 32,759 $ 37,165
======= =======
Capital
Total stockholders' equity increased over $7.3 million or 9.9% in 1998 to
$81,313,000. Total stockholders' equity at December 31, 1997 in the amount of
$73,987,000 represented an increase of over $4.8 million or 7% over the
$69,179,000 reported at December 31, 1996. A major portion of the increase for
1998 was the difference between net income of $11.6 million less dividends
declared of approximately $5.4 million. Adding to the increase in stockholders'
equity was an increase in net unrealized gains on available-for-sale securities,
accumulated other comprehensive income, in the amount of $1.8 million. Treasury
stock purchased during the period was $2.5 million. The corporation issued $1.8
million in treasury shares. The major portion of the increase in 1997 was due
to net income of $10.4 million less dividends declared of approximately $5.1
million. Adding to the increase in 1997 was an increase in accumulated other
comprehensive income in the amount of $1.3 million. These increases were offset
by the repurchase of outstanding stock throughout the year. 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.
During 1998, the Board of Directors
authorized the repurchase of up to 250,000 shares of the outstanding common
stock. During 1998, the Corporation repurchased 70,266 shares for $2.5
million. The Corporation used, during 1998, 79,332 shares for a
portion of the common stock issued for a 5% stock dividend, 36,448 shares
for the Dividend Reinvestment
Plan, 7,414 shares for the Employee Stock Plan, 2,000 shares for the Directors'
Compensation Plan and 1,400 shares for stock options exercised. Effective
December 1998, the Board of Directors of the corporation terminated the common
stock repurchase program that was approved in 1998.
Federal regulatory authorities promulgate risk-based capital guidelines
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 holding gains and losses 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, 1998, 1997
and 1996 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, 1998 was 9.73% and the total
risk-based capital ratio was 10.94%, which exceeds the minimum capital
guidelines. Tier 1 capital ratio was 10.23% and the total risk-based capital
ratio was 11.38% at December 31, 1997 while Tier 1 capital ratio was 10.68% and
the total risk-based capital ratio was 11.93% at December 31, 1996. At December
31, 1998, 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:
1998 1997 1996
Return on average assets...................... 1.33% 1.32% 1.34%
Return on average equity...................... 15.63% 14.89% 15.01%
Dividend payout ratio......................... 46.17% 48.79% 45.95%
Average total equity to average assets........ 8.54% 8.89% 8.95%
Total equity to assets at year end............ 8.40% 8.45% 8.87%
Primary capital ratio......................... 9.16% 9.28% 9.80%
Tier 1 risk-based capital ratio............... 9.73% 10.23% 10.68%
Total risk-based capital ratio................ 10.94% 11.38% 11.93%
Liquidity and Interest Rate Sensitivity
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 amounted to $34,221,000 at December 31, 1998 compared to
$34,585,000 at December 31, 1997. Interest bearing deposits with banks were
$557,000 at December 31, 1998 compared to $15,000 at December 31, 1997. Federal
funds sold totaled $26,850,000 at December 31, 1998 compared to $28,150,000 at
December 31, 1997. Securities available-for-sale as of December 31, 1998 were
$177,878,000 compared to $121,474,000 as of December 31, 1997.
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 $88.9 million in 1998 and
$40.9 million in 1997, 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 of $87
million during the next 12 months.
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, 1998 was $17,300,000 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 changes in levels of
deposits and in the demand for loans. Management believes that these mentioned
sources of funds provide sufficient liquidity.
YEAR 2000
The following section contains forward-looking statements which involve
risks and uncertainties. The actual impact on the corporation of the Year 2000
issue could materially differ from that which is anticipated in the
forward-looking statements as a result of certain factors identified below.
The Year 2000 issue ("Y2K") is the result of computer programs being
written using two digits rather than four to define the applicable year.
It is anticipated that most systems may recognize a date using "00"
as the year "1900" rather than "2000". This could result in system
failures, miscalculations, and
disruptions of normal business operations including, among other things, a
temporary inability to process transactions, send statements, or engage in
similar day to day business activities. At Sterling Financial Corporation, we
recognize the Year 2000 problem is more than just a systems issue. It is a
business issue, and we are dealing with it in that manner.
Corporation's State of Readiness
Sterling Financial Corporation is committed to ensuring that the
corporation's daily operations suffer little or no impact from the century date
change. The corporation has applied due diligence throughout the Y2K process,
following the guidelines contained in the series of Federal Financial
Institutions Examination Council's Interagency Guidelines. These guidelines
include the following five phases:
awareness,
assessment,
renovation or remediation,
testing or validation and
implementation.
Management has initiated an enterprise-wide program to prepare the
corporation's computer systems and applications for the Year 2000. The
corporation has developed a comprehensive inventory of all mainframe and PC
based applications, third-party relationships, environmental (bank
vaults, VCRs, security systems, etc.) and proprietary programs.
This assessment identified 224
systems or processes and 448 proprietary programs, which could be
impacted by the century date change.
The 448 proprietary programs consist of management reporting, interface
programs, and bridge programs. As of December 31, 1998, the corporation has
remediated 324 or 72% of these programs.
In January of 1997, the corporation began converting its computer systems
to be Year 2000 ready. As of December 31, 1998, approximately
71% of the corporation's systems were ready, with all systems
expected to be ready by June 1999.
Vendor Type Total# # Y2K Ready % Y2K Ready
PC Based Applications 125 81 65%
Mainframe Applications 49 36 73%
Third-Party Relationships 25 12 48%
Environmental 25 24 96%
Proprietary Programs 448 324 72%
Total 672 477 71%
The corporation has acquired its core mission-critical systems from a
highly regarded third-party vendor. Thus, even though the corporation
does not have direct control over the renovation process, it is
monitoring the progress of its third-party vendors to assess the status
of their Y2K readiness efforts. However, because most computer
systems are, by their very nature, independent, it
is possible that noncompliant third-party computers could impact the
corporation's computer systems. The corporation could be adversely affected by
the Y2K problem if it or unrelated parties fail to successfully address the
problem. Steps have been taken to communicate with the unrelated parties with
whom it deals to coordinate Year 2000 readiness. Additionally, we are dependent
on external suppliers, such as, wire transfer systems, telephone systems,
electric companies, and other utility companies for continuation of service. The
corporation is also assessing the impact, if any, the century date change may
have on its credit risk. The corporation is contacting its large commercial
loan customers concerning their level of readiness for Year 2000.
Formal communications have been initiated with all of its
vendors and large commercial customers to determine the extent to which the
corporation is vulnerable to those third-parties' failure to remedy
their own Year 2000 issues. The Y2K Project
Manager has available each vendors' Y2K readiness efforts which includes their
remediation plan, renovation approach, testing methodologies and target dates.
A comprehensive testing plan has been developed. The corporation has
prioritized all mainframe and PC based applications, third-party relationships,
environmental and proprietary programs to be tested. Separate environments for
testing have been defined and established. Beginning in the fourth quarter of
1998, the corporation performed a variety of testing to include limited unit
testing (aging dates forward on files), system testing (advancing the computer
system date forward) and combined system integration (running applications<