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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For Fiscal Period Ended: June 30, 1999
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from ________ to _________
Commission File No: 0-18833
Chester Valley Bancorp Inc.
---------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2598554
------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 E. Lancaster Ave., Downingtown PA 19335
------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 269-9700
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered
pursuant to Section 12(g) of the Act:
Common Stock, $1.00 Par Value Per Share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES [ X ] NO [ ]
Indicate by 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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. X
As of September 1, 1999, the aggregate value of the 3,033,917 shares of Common
Stock of the registrant which were issued and outstanding on such date,
excluding 673,822 shares held by all directors and officers of the registrant as
a group, was approximately $50.82 million. This figure is based on the closing
sales price of $16.75 per share of the registrant's Common Stock on September 1,
1999.
Number of shares of Common Stock outstanding as of September 1, 1999: 3,707,739
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference:
(1) Portions of the Annual Report to shareholders for the year ended June
30, 1999, are incorporated into Part II, Items 5 - 8 of this Form 10-K.
(2) Portions of the Definitive Proxy Statement for the 1999 annual meeting
of shareholders are incorporated into Part III, Items 10-13 of this Form
10-K.
PART I.
ITEM 1. BUSINESS
- -----------------
Forward Looking Statements
In this Report, the Company has included certain "forward looking
statements" concerning the future operations of the Company. It is management's
desire to take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. This statement is for the express
purpose of availing the Company of the protections of such safe harbor with
respect to all "forward looking statements" contained in this Report. The
Company has used "forward looking statements" to describe the future plans and
strategies including management's expectations of the Company's Year 2000
readiness and future financial results. Management's ability to predict results
or the effect of future plans and strategy is inherently uncertain. Factors that
could affect results include interest rate trends, competition, the general
economic climate in Chester County, the mid-Atlantic region and the country as a
whole, loan delinquency rates, changes in federal and state regulation, Year
2000 uncertainties and other uncertainties described in the Company's filings
with the Securities and Exchange Commission, including its Form 10-K for the
year ended June 30, 1999. These factors should be considered in evaluating the
"forward looking statements", and undue reliance should not be placed on such
statements.
General
Chester Valley Bancorp Inc. (the "Holding Company") is a unitary thrift
holding company, incorporated in the Commonwealth of Pennsylvania in August
1989. The business of the Holding Company and its subsidiaries (the "Company")
consists of the operations of First Financial Bank ("First Financial" or the
"Bank"), a Pennsylvania-chartered stock savings and loan association founded in
1922 and Philadelphia Corporation for Investment Services ("PCIS"), a full
service investment advisory and securities brokerage firm. The Bank provides a
wide range of banking services to individual and corporate customers through its
eight branch banks in Chester County, Pennsylvania. The Bank provides
residential real estate, commercial real estate, commercial and consumer lending
services and funds these activities primarily with retail deposits and
borrowings. PCIS is a registered broker/dealer in all 50 states and Washington,
DC and it is also registered as an investment advisor with the Securities and
Exchange Commission. PCIS provides many additional services, including
self-directed and managed retirement accounts, safekeeping, daily sweep money
market funds, portfolio and estate valuations, life insurance and annuities, and
margin accounts, to individuals and smaller corporate accounts. PCIS' offices
are located in Wayne and Philadelphia, Pennsylvania.
The Company experienced substantially increased net income of $4.21
million, or $1.13 per diluted share, for the fiscal year ended June 30, 1999,
compared to $3.63 million or $.98 per diluted share for fiscal 1998. This
represents a 16.0% increase in net income.
The Company's earnings depend primarily on the difference between the
yield earned on its loan and securities portfolios and its cost of funds,
consisting primarily of the interest paid on deposits and, to a lesser extent,
on borrowings ("interest rate spread"). During fiscal year 1999 the Company's
interest rate spread averaged 3.03% compared to 3.28% and 3.37% in fiscal years
1998 and 1997, respectively. Net interest income, on a fully tax equivalent
basis, increased 12.0% or $1.54 million to $14.33 million in fiscal 1999 from
$12.80 million in 1998, compared to a 12.1% or $1.39 million increase from
fiscal 1997 to fiscal 1998. Net interest margin, on a fully tax equivalent
basis, was 3.64% for the fiscal year ended June 30, 1999, compared to 3.94% in
fiscal 1998 and 4.03% in fiscal 1997.
Total other income increased $579,000 or 12.5% to $5.20 million for the
year ended June 30, 1999 as compared to fiscal 1998. Investment services income
increased $460,000 or 16.5% to $3.26 million as the result of PCIS' increased
commission income due to the increase in the stock market activity, an increase
in advisory fee income due to the strategic plan of PCIS to focus on advisory
services as it provides a more stable revenue stream for PCIS and stabilizes
expenses for the customer, and an increase in money market fund fees due to an
increase in customer balances. The growth in the Bank's Investment Services and
Trust Division (the "Trust Division") also contributed to the increase in
investment services income for fiscal 1999. An increase in checking account
fees, as the result of an increased number of accounts, and an increase in the
fees earned on the Bank's debit card, due to both increased usage and an
increased number of cardholders, contributed to the increase of $354,000 or
31.7% in service charges and fees in fiscal 1999. The Company recognized gains
on trading account securities of $171,000 during fiscal 1999 compared to
$338,000 during fiscal 1998.
Total other income increased $968,800 or 26.6% to $4.62 million for the
year ended June 30, 1998 as compared to fiscal 1997. Investment services income
increased $488,400 or 21.2% to $2.80 million as the result of increases in
revenue generated by PCIS and the Trust Division. Service charges and fees
increased $139,700 in fiscal 1998. The Company recognized gains on trading
account securities or $337,500 during fiscal 1998 compared to $15,700 during
fiscal 1997.
Total operating expenses increased $1.09 million or 9.4% to $12.73
million for the year ended June 30, 1999 as compared to fiscal 1998. The
increase in operating expenses over the prior fiscal year was primarily due to a
$1.04 million or 17.6% increase in salaries and employee benefits related to
general salary increases and increased number of staff associated with the
Bank's Call Center and its Trust Division established during the Summer and Fall
of 1997, respectively. Also, in the winter of 1999, the Bank opened its eighth
branch office in Devon, Pennsylvania which further contributed to an increase in
operating expenses. Occupancy and equipment expenses increased $190,000 or 10.1%
to $2.08 million for the year ended June 30, 1999, compared to the same period
in 1998 as a result of the opening of the Banks branch office in Devon and
capital expenditures associated with technology upgrades and enhancements.
During fiscal 1998, the Bank made a $291,000 donation in connection with a
project located in Honey Brook, PA to provide low income housing for the
2
elderly. As an offset to the donation, the Bank received a state tax credit in
the amount of $146,000 through the Neighborhood Assistance Act which was
recorded as a reduction to income tax expense in fiscal 1998.
Total operating expenses increased $1.78 million or 18.1% to $11.64
million for the year ended June 30, 1998 from the comparable prior period,
excluding the $1.39 million one-time SAIF assessment levied in fiscal 1997. The
increase in operating expenses over the fiscal 1997 year was primarily due to a
$632,500 or 12.0% increase in salaries and employee benefits related to general
salary increases and increased number of staff associated with the addition of
the Bank's new Call Center and its new Investment Services and Trust Division.
In addition, occupancy and equipment expenses increased $246,900 or 15.1% to
$1.89 million for the year ended June 30, 1998, from the comparable prior period
related to the refurbishment of the Bank's new Call Center and Trust Department.
Also contributing to the increase in operating expenses during fiscal 1998 was
the previously mentioned $291,000 donation to a project to provide low income
housing for the elderly.
The Company's assets totaled $451.16 million at June 30, 1999, as
compared with $377.01 million at June 30, 1998. This 19.7% increase in assets
was primarily funded by an increase in deposits of $61.32 million or 20.6% from
$298.19 million at June 30, 1998, to $359.51 million at June 30, 1999, and an
increase in Federal Home Loan Bank ("FHLB") advances of $9.44 million from
$40.94 million to $50.38 million at June 30, 1998 and 1999, respectively. The
increase in deposits and advances was used in part to fund loan originations
during the period, which contributed to an increase in net loans receivable from
$273.13 million at June 30, 1998, to $291.39 million at June 30, 1999. In
addition, the Company's securities portfolios along with its interest-bearing
deposits increased, in the aggregate, from $86.12 million to $140.03 million at
June 30, 1998 and 1999, respectively.
In September 1998 and 1997 the Company paid 5% common stock dividends
in the amounts of 116,034 and 102,606 shares, respectively, from authorized but
unissued common stock, with fractional shares paid in the form of cash. In
December 1998 and March 1997 the Company paid a three-for-two and five-for-four
stock split, effected in the form of a dividend in the amount of 1,224,980 and
414,188 shares, respectively. Fractional shares were paid in the form of cash.
The Bank's primary market area includes Chester County and sections of
the four contiguous counties (Delaware, Montgomery, Berks, and Lancaster) in
Pennsylvania. Chester County, in which all of the Bank's offices are located,
continues to grow in terms of economic development and population growth.
Customer deposits with First Financial are insured to the maximum
extent provided by law by the Federal Deposit Insurance Corporation ("FDIC")
through the SAIF. The Bank is subject to examination and comprehensive
regulation by the FDIC, the Office of Thrift Supervision ("OTS"), and the
Pennsylvania Department of Banking ("Department"). It is a member of the FHLB of
Pittsburgh ("FHLBP"), which is one of the 12 regional banks comprising the FHLB
3
System. The Bank is further subject to regulations of the Board of Governors of
the Federal Reserve System ("Federal Reserve Board") governing reserves required
to be maintained against deposits and certain other matters.
Lending Activities
Loan Portfolio Composition. The Company's net loan portfolio (net of
undisbursed proceeds, deferred fees and allowance for loan losses) totaled
$291.39 million at June 30, 1999, representing approximately 64.6% of the
Company's total assets of $451.16 million at that date.
4
The following table presents information regarding the Company's loan portfolio
by type of loan indicated.
(Dollars in Thousands)
At June 30,
---------------------------------------------------------------------------------------------
1999 1998 1997 1996
-------------------- ------------------- ------------------- --------------------
% of % of % of % of
Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans
-------- ----- -------- ----- -------- ----- -------- -----
Real estate loans:
Residential:
Single-family $156,514 50.8% $154,755 53.3% $158,537 58.4% $147,274 62.6%
Multi-family 828 .3 873 0.3 893 0.3 1,256 0.5
Commercial 55,197 17.9 41,002 14.1 33,981 12.5 22,552 9.6
Construction and land
acquisition(1) 29,339 9.5 30,646 10.5 22,907 8.5 17,028 7.2
-------- ----- -------- ----- -------- ----- -------- -----
Total real estate loans 241,878 78.5 227,276 78.2 216,318 79.7 188,110 79.9
Commercial business loans(2) 14,708 4.8 11,437 3.9 7,863 2.9 5,701 2.4
Consumer loans(3) 51,416 16.7 51,829 17.9 47,343 17.4 41,486 17.7
-------- ----- -------- ----- -------- ----- -------- -----
Total loans receivable 308,002 100.0% 290,542 100.0% 271,524 100.0% 235,297 100.0%
===== ===== ===== =====
Less:
Loans in process (11,393) (12,380) (10,092) (7,134)
Allowance for loan losses (3,651) (3,414) (2,855) (2,667)
Deferred loan fees (1,571) (1,620) (1,537) (1,533)
-------- -------- -------- --------
Net loans receivable 291,388 273,128 257,040 223,963
Loans held for sale, single-family
residential mortgages -- 1,101 106 --
-------- -------- -------- --------
Net loans receivable and loans held
for sale $291,388 $274,229 $257,146 $223,963
======== ======== ======== ========
--------------------
1995
--------------------
% of
Total
Amount Loans
-------- -----
Real estate loans:
Residential:
Single-family $150,639 66.0%
Multi-family 1,359 0.6
Commercial 22,433 9.8
Construction and land
acquisition(1) 13,120 5.7
-------- -----
Total real estate loans 187,551 82.1
Commercial business loans(2) 4,039 1.8
Consumer loans(3) 36,634 16.1
-------- -----
Total loans receivable 228,224 100.0%
=====
Less:
Loans in process (3,385)
Allowance for loan losses (2,449)
Deferred loan fees (1,574)
--------
Net loans receivable 220,816
Loans held for sale, single-family
residential mortgages 142
--------
Net loans receivable and loans held
for sale $220,958
========
(1) Includes construction loans for both residential and commercial real
estate properties.
(2) Consists primarily of secured equipment
loans.
(3) Consists primarily of home equity loans and lines of credit, home
improvement, automobile and other personal loans.
5
Contractual Maturities. The following table sets forth the contractual
principal repayments of the total loan portfolio, including loans in process, of
the Company as of June 30, 1999, by categories of loans. All loans are included
in the period in which they mature. Loans held for sale are not included.
Principal Repayments
Contractually Due in Year(s) Ended
June 30,
-----------------------------------
(Dollars in Thousands)
Total
Outstanding
at 2005
June 30, 2001- and
1999 2000 2004 Thereafter
-------- ------- ------- --------
Real estate loans:
Residential(1) $157,342 $24,456 $27,434 $105,452
Commercial 55,197 5,190 37,299 12,708
Construction and land acquisition 29,339 16,368 7,957 5,014
Commercial business loans 14,708 9,416 4,448 844
Consumer loans 51,416 7,300 16,018 28,098
-------- ------- ------- --------
Total loans $308,002 $62,730 $93,156 $152,116
======== ======= ======= ========
(1) Includes mortgages on both single-family and multi-family (more than four
units) residential properties.
6
The following table sets forth, as of June 30, 1999, the dollar amount of all
loans contractually due after June 30, 2000, which have fixed interest rates and
floating or adjustable rates.
Contractual Obligations
Due After June 30, 2000
---------------------------
Floating/
Fixed Adjustable
Rates Rates
-------- -------
(Dollars in Thousands)
Real estate loans:
Residential $100,976 $31,910
Commercial 10,142 39,865
Construction and land acquisition 3,506 9,465
Commercial business loans 4,923 369
Consumer loans 44,099 17
-------- -------
Total loans $163,646 $81,626
======== =======
Contractual principal repayments of loans do not necessarily reflect
the actual term of the Company's loan portfolio. The average life of mortgage
loans is substantially less than their contractual terms because of loan
prepayments and because of enforcement of due-on-sale clauses, which give the
Company the right to declare a loan immediately due and payable in the event,
among other things, that the borrower sells the real property subject to the
mortgage and the loan is not repaid. The average life of mortgage loans tends to
increase, however, when current mortgage loan rates substantially exceed rates
on existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans substantially exceed current mortgage loan rates. The Company
experienced significant refinancings of its loan portfolio during fiscal 1999
due to the declining interest rate environment and leveling of the yield curve.
Origination, Purchase and Sale of Loans. As a Pennsylvania-chartered
savings institution, First Financial has general authority pursuant to the
Savings Association Code of 1967, as amended ("State Code"), to originate and
purchase loans secured by real estate located throughout the United States. Due
to the Company's strong community orientation, substantially all of the
Company's total mortgage loan portfolio is secured by real estate located in its
primary market area.
Residential and commercial real estate loans are originated directly by
the Bank through salaried loan officers. In addition, from time to time the Bank
utilizes third-party originators who use the same credit guidelines and
standards as the Bank to originate residential loans. Residential and commercial
real estate loan originations are normally attributable to referrals from real
estate brokers and builders and other financial institutions, mortgage brokers,
depositors and walk-in customers. Consumer loan originations are primarily
attributable to existing customers and referrals, as well as third party auto
loans originated through dealers.
7
The Bank periodically identifies certain loans as held for sale at the
time of origination. These loans consist primarily of fixed-rate, single-family
residential mortgage loans which meet the underwriting characteristics of
certain government-sponsored enterprises (conforming loans). The majority of
conforming loans sold to date have consisted of sales to Freddie Mac ("FHLMC")
of fixed-rate mortgage loans in furtherance of the Company's goal of better
matching the maturities and interest-rate sensitivity of its assets and
liabilities. In selling conforming loans, the Bank has retained the servicing
thereon in order to increase its non-interest income. At June 30, 1999, the Bank
serviced $26.74 million of mortgage loans for others. Sales of loans produce
future servicing income and provide funds for additional lending and other
purposes. The Bank is a qualified servicer for FHLMC, Fannie Mae ("FNMA"), and
Ginnie Mae ("GNMA").
The following table shows total loans and loans held for sale originated,
purchased, sold and repaid during the periods indicated.
Year Ended June 30,
----------------------------------
1999 1998 1997
-------- -------- --------
(In Thousands)
Total loans receivable and loans held for sale
at beginning of period $291,643 $271,630 $235,297
Real estate loan originations:
Residential(1) 31,705 39,329 31,031
Commercial 18,914 9,398 10,018
Construction and land acquisition(2) 21,852 21,057 21,740
-------- -------- --------
Total real estate
loan originations 72,471 69,784 62,789
Consumer loans(2) 24,540 24,771 19,163
Commercial business loans 17,312 11,896 5,150
-------- -------- --------
Total loan
originations 114,323 106,451 87,102
-------- -------- --------
Principal loan repayments 96,487 77,481 45,846
Sales of loans 1,477 8,957 4,923
-------- -------- --------
Total principal
repayments
and sales 97,964 86,438 50,769
-------- -------- --------
Net increase in
loans and loans
held for sale 16,359 20,013 36,333
-------- -------- --------
Total loans receivable and loans
held for sale at end of period $308,002 $291,643 $271,630
======== ======== ========
(1) Includes both single-family and multi-family residential loans.
(2) Includes construction loans for both residential and commercial real estate
properties.
8
Loans on Existing Single-Family Residential Properties. The Bank
currently offers adjustable-rate mortgages ("ARMs") which have up to 30-year
terms and interest rates which adjust either annually or every three years, or
which are fixed initially for the first three years, five years, seven years, or
ten years, and adjust annually thereafter, based upon changes in an index based
on the weekly average yield on United States Treasury securities adjusted to a
constant maturity of one year or three years, respectively, as made available by
the Federal Reserve Board plus a margin. The amount of any increase or decrease
in the interest rate for ARMs is limited to 1% or 2% per year and 6% over the
life of the loan. Although the Bank has originated a small amount of ARMs which
include the ability to be converted to a fixed-rate loan, substantially all of
the ARMs originated cannot be converted to fixed-rate loans. The interest rates
of ARMs may not adjust as rapidly as changes in the Company's cost of funds. In
order to minimize risk, ARM borrowers are qualified at the rate which would be
in effect after the first interest rate adjustment, if that rate is higher than
the initial rate. The Bank's adjustable rate loans require that any payment
adjustment resulting from a change in the interest rate of an adjustable-rate
loan be sufficient to result in full amortization of the loan by the end of the
loan term and, thus, do not permit any of the increased payment to be added to
the principal amount of the loan, or so-called negative amortization. Due to the
declining interest rate environment and leveling of the yield curve, the Bank
experienced significant refinancings of its adjustable rate portfolio into its
fixed rate mortgage products.
Fixed-rate residential mortgage loans currently originated generally
have 30-year terms, although some have 15-year terms with commensurately lower
interest rates. The Bank also offers a bi-weekly mortgage which is a fixed-rate
loan with bi-weekly payments. Based on current interest rates, it is repaid in
approximately 22 years. Substantially all of the Bank's long-term, fixed-rate
residential mortgage loans and ARMs include "due on sale" clauses.
The Bank also makes second mortgage loans and home equity loans. See
"Lending Activities - Consumer Loans."
Loans on Existing Commercial and Multi-Family Properties. During the
past several years, the Bank has originated permanent loans secured by
multi-family and income-producing properties such as condominiums, apartment
buildings, office buildings and, to a lesser extent, hotels and small shopping
centers. The Bank intends to increase its emphasis on the origination of
commercial real estate loans and, accordingly, has increased its commercial
lending staff. The Bank's Commercial Loan Department consists of seven loan
officers, all but one of whom joined the Bank's staff with substantial prior
commercial lending experience. The origination of multi-family residential and
commercial real estate loans has resulted in the shortening of the average
maturity and an increase in the interest rate sensitivity of the Bank's loan
portfolio as well as to generated increased fee income. All of the Bank's
multi-family residential and commercial real estate loan portfolio is secured by
properties located in the Company's primary market area. As of June 30, 1999,
commercial and multi-family real estate loans, excluding construction loans for
such properties, amounted to $56.03 million, or 18.2% of the total loan
portfolio.
9
A substantial majority of commercial real estate loans have interest
rates which adjust annually after an initial three- or five-year term by a
margin over the corresponding United States Treasury yield for securities with
the same term. These loans typically have amortization periods of up to 20
years, but occasionally provide that the loans can be called by the Bank prior
to the end of the amortization period, generally at three, five, seven or ten
years after origination.
Commercial and multi-family residential real estate lending entails
significant additional risks as compared with single-family residential property
lending. Commercial and multi-family residential real estate loans typically
involve large loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans is typically dependent on the successful
operation of the business or real estate project. The success of such projects
is sensitive to changes in supply and demand conditions in the market for
commercial and multi-family residential real estate as well as economic
conditions generally.
The Bank seeks to ensure that the property securing these loans will
generate sufficient cash flow to adequately cover operating expenses and debt
service payments. To this end, permanent commercial and multi-family residential
real estate loans generally are made with a loan-to-value ratio of 75% or less.
In underwriting commercial and multi-family residential real estate loans,
consideration is given to the property's operating history, future operating
projections, current and projected occupancy, position in the local and regional
market, location and physical condition. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower. The Bank
usually obtains full or partial loan guarantees from the principal(s) involved.
Construction Loans. The Bank also offers both fixed-rate and
adjustable-rate residential and commercial construction loans. Residential
construction loans are offered to individuals building their primary or
secondary residence as well as to selected local developers to construct up to
four-family dwellings. Advances are made on a percentage of completion basis,
usually consisting of six draws. Residential construction loans convert to
permanent loans at the end of 12 months or upon completion of construction,
whichever occurs first. At June 30, 1999, $24.26 million or 7.9% of the
Company's total loan portfolio consisted of construction loans including loans
in process. Loans in process related to such loans totaled $10.75 million at
June 30, 1999.
The Bank has been active in construction lending for many years and
intends to continue its involvement in such lending in the future. Construction
lending is generally considered to involve a higher degree of risk of loss than
long-term financing on improved, occupied real estate. Risk of loss on
construction loans is dependent largely upon the accuracy of the initial
appraisal of the property's projected value at completion of construction as
well as the estimated cost, including interest, of construction. During the
construction phase, a number of factors could result in delays and cost
overruns. If either estimate proves to be inaccurate and the borrower is unable
to provide additional funds, the lender may be required to advance funds
10
beyond the amount originally committed to permit completion of the project
and/or be confronted at the maturity of the construction loan with a project
whose value is insufficient to assure full repayment.
Land Acquisition and Development Loans. The Bank also offers land
acquisition and development loans. These types of loans are generally provided
only to local developers with strong financial positions and with whom the Bank
is familiar. These loans typically have terms of one to three years and carry a
floating interest rate normally indexed to the Wall Street Journal Prime. The
Bank will lend up to 75% of the appraised value of the project. At June 30,
1999, $5.08 million, or 1.6% of the Company's total loan portfolio consisted of
land acquisition and development loans, including loans in process. Loans in
process on such loans totaled $627,000 at June 30, 1999. Like construction
lending, these loans generally are considered to involve a higher degree of risk
of loss than long-term financing on approved occupied real estate. The Bank is
actively pursuing developers who can both demonstrate the ability to meet cash
flow projections in order to repay loans through a very strong financial
position and have a reputation for successfully completing such projects in
similar situations with the Bank.
Consumer Loans. The Bank offers a wide variety of consumer loans,
including home equity loans, home improvement loans, equity lines of credit,
secured and unsecured personal loans and automobile loans. The Bank has
aggressively marketed consumer loans in order to provide a wider range of
financial services to its customers and because of the shorter terms and
normally higher interest rates on such loans. As of June 30, 1999, consumer
loans amounted to $51.42 million or 16.7% of the total loan portfolio.
The Bank's home equity lines of credit currently provide for terms of
up to 10 years. The interest rate on the "Prime Line" adjusts monthly to the
Prime Rate. The regular equity line of credit adjusts monthly at 1.50% above the
Prime Rate. The limit of such loan is the borrower's equity in his residence,
subject to certain income qualifications. The Bank also makes fixed-rate,
fixed-term home equity loans on which it takes a first- or second-mortgage lien
on the borrower's property. These loans have terms of up to 15 years. The
balance of the fixed-rate mortgages on the properties cannot exceed in the
aggregate 80% of the appraised value of the properties. Home equity lines of
credit and fixed-rate home equity loans amounted to $5.51 million and $40.05
million, respectively, as of June 30, 1999. The Bank also originates fixed-rate
bridge loans with loan-to-value ratios of no greater than 80% of the value of
the secured real estate and at a maximum term of twelve months. At June 30,
1999, the balance on these loans totaled $455,000.
At June 30, 1999, the balance was $487,700 for fixed-rate loans
secured by certificates of deposit or marketable securities. Unsecured personal
loans amounted to $443,400 at June 30, 1999 and consisted of fixed-rate loans
with maximum loan balances of $5,000 and terms no greater than 48 months. The
Bank also originates fixed-rate loans on new and used automobiles. The terms of
such loans do not exceed 60 months on new cars and 48 months on used cars.
Automobile loans amounted to $3.43 million at June 30, 1999. The Bank's current
line of credit
11
provides for unsecured loans of up to $1,000 for terms of up to 36 months with
an interest rate set at 6.0% over the Prime Rate adjusted monthly. Such loans
have a floor of 10.0% and a ceiling of 18.0% and totaled $238,000 at June 30,
1999. In addition, the Bank originates Visa and MasterCard credit card loans
with up to $5,000 lines of credit and at an interest rate set at 6.0% over the
Prime Rate. At June 30, 1999, the Company had $365,900 in credit card loans
outstanding.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss, divorce, illness and personal bankruptcy. In
most cases, any repossessed collateral for a defaulted consumer loan will not
provide an adequate source of repayment of the outstanding loan balance because
of improper repair and maintenance of the underlying security. The Bank believes
that the generally higher yields earned on consumer loans compensate for the
increased credit risk associated with such loans and that consumer loans are
important to its efforts to increase the interest rate sensitivity and shorten
the average maturity of its loan portfolio.
Commercial Business Loans. The Bank makes commercial business loans
directly to businesses located in its market area. The Bank targets small and
medium sized businesses with the majority of the loans being less than $750,000.
Applications for commercial business loans are obtained primarily from existing
customers, branch referrals and direct inquiry. As of June 30, 1999, commercial
business loans totaled $14.71 million or 4.8% of the total loan portfolio.
Commercial business loans originated by the Bank generally have terms
of five years or less and fixed interest rates or adjustable interest rates tied
to the Wall Street Journal Prime plus a margin. Such loans are generally secured
by real estate, receivables, equipment, or inventory and are generally backed by
the personal guarantees of the principals of the borrower. Commercial business
loans generally have shorter terms to maturity and provide higher yields than
residential mortgage loans. Although commercial business loans generally are
considered to involve greater credit risk than certain other types of loans,
management intends to continue to offer commercial business loans to small
medium sized businesses in an effort to better serve our community's needs,
obtain core non-interest bearing deposits, and increase the Company's interest
rate spread.
Regulatory Requirements and Underwriting Policies. Under the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") and
pursuant to the parity provisions of the State Code, the aggregate loans that
the Company may make to any borrower and its affiliates is limited to 15% of
unimpaired capital for unsecured loans and 25% of capital for loans secured by
readily marketable collateral. At June 30, 1999, pursuant to such provisions,
the Bank was permitted to extend credit to any one borrower totaling $4.94
million. Special rules applicable to savings associations' provide authority to
develop domestic residential
12
housing units up to the lesser of 30% of the savings association's unimpaired
capital and unimpaired surplus or $30.0 million, if: (a) the purchase price of a
single-family unit does not exceed $500,000; (b) the savings association is in
compliance with the fully phased-in capital standards; (c) the OTS director, by
order, authorizes the higher limit; (d) the loans made to all borrowers in the
aggregate do not exceed 150% of the savings association's unimpaired capital and
unimpaired surplus; and (e) all loans comply with applicable loan-to-value
requirements. At June 30, 1999, the Bank's largest loan or group of loans to one
borrower, including related entities, aggregated $4.50 million, and is in
conformity with the current loans to one borrower regulations described above.
The Bank is currently permitted to lend up to 100% of the appraised
value of the real property securing a loan; however, if the amount of a
residential loan originated or refinanced exceeds 90% of the appraised value,
the Bank is required by federal regulations, the State Code and Department
regulations to obtain private mortgage insurance on the portion of the principal
amount of the loan that exceeds 80% of the appraised value of the security
property. Pursuant to underwriting guidelines adopted by the Board of Directors,
private mortgage insurance must be obtained on all residential loans whose
loan-to-value ratios exceed 80%. The Bank will generally lend up to 97% of the
appraised value of one-to four-family owner-occupied residential dwellings when
the required private mortgage insurance is obtained. The Bank generally
originates loans of up to 75% of the appraised value of the properties securing
its commercial real estate and commercial business loans and 75% of the
appraised value upon completion or sale price, whichever is lower, for
construction loans. With respect to construction loans for owner-occupied
properties made in connection with the providing of the permanent financing, the
Bank will lend up to 90% of the appraised value when the required private
mortgage insurance is obtained.
In the loan approval process, the Bank assesses both the borrower's
ability to repay the loan and the adequacy of the proposed security. In
connection therewith, the Bank obtains an appraisal of the security property and
information concerning the income, financial condition, employment and credit
history of the applicant. Loans must be approved at various management levels,
including the Board of Directors, depending on the amount of the loan.
Residential mortgage loans, commercial business and commercial real estate
loans, and consumer loans in excess of $1.00 million require approval by the
Board of Directors. In addition, any loan in excess of $500,000 which exhibits
certain characteristics concerning the borrower or the project requires approval
by the Board of Directors.
For mortgage loans the Bank requires title insurance insuring the
priority of its lien, as well as fire and extended coverage casualty insurance,
in order to protect the properties securing its real estate loans. Borrowers
must also obtain flood insurance policies where the property is in a flood plain
as designated by the Federal Emergency Management Agency. Borrowers may be
required to advance funds on a monthly basis together with each payment of
principal and interest to a mortgage loan account from which the Company makes
disbursements for items such as real estate taxes, hazard insurance premiums and
private mortgage insurance premiums as they fall due.
13
Loan Fee and Servicing Income. In addition to interest earned on loans,
the Bank receives income through servicing of loans and fees in connection with
loan originations, loan modifications, late payments, prepayments, repayments
and changes of property ownership and for miscellaneous services related to its
loans. Income from these activities varies from period to period with the volume
and type of loans made.
Loan origination fees and certain related direct loan origination costs
are offset and the resulting net amount is deferred and amortized over the life
of the related loans as an adjustment to the yield of such related loans.
However, in the event the related loan is sold, any deferred loan fees or costs
remaining with respect to such loan should be taken into income.
The Bank currently charges loan origination fees which are calculated
as a percentage of the amount of the loan. The fees received in connection with
the origination of commercial real estate loans have generally amounted to two
points (one point being equivalent to 1% of the principal amount of the loan).
In addition, the Bank typically receives fees from two to three points in
connection with the origination of new, conventional, one-to four-family
mortgages and 3.5 points in connection with the origination of construction
loans.
At June 30, 1999, the Bank was servicing $26.74 million of loans for
others, substantially all of which were whole loans sold by the Bank to the
FHLMC. The Bank receives a servicing fee of approximately 1/4 or 3/8 of 1% on
such loans.
Non-Performing Loans and Real Estate Owned ("REO"). When a borrower
fails to make a required loan payment, the Bank attempts to cause the default to
be cured by contacting the borrower. In general, contacts are made after a
payment is more than 15 days past due, at which time a late charge is assessed.
Defaults are cured promptly in most cases. If the delinquency on a mortgage loan
exceeds 90 days and is not cured through the Bank's normal collection
procedures, or an acceptable arrangement is not worked out with the borrower,
the Company will institute measures to remedy the default, including commencing
a foreclosure action or, in special circumstances, accepting from the mortgagor
a voluntary deed of the secured property in lieu of foreclosure. The remedies
available to the Bank in the event of a default or delinquency with respect to
certain residential mortgage loans, and the procedures by which such remedies
may be exercised, are subject to Pennsylvania law and regulations. Under
Pennsylvania law, a lender is prohibited from accelerating the maturity of a
residential mortgage loan, commencing any legal action (including foreclosure
proceedings) to collect on such loan, or taking possession of any loan
collateral until the lender has first provided the delinquent borrower with at
least 30 days prior written notice specifying the nature of the delinquency and
the borrower's right to correct such delinquency. In addition, the lender's
ability to exercise any remedies it may have with respect to loans for one- or
two-family principal residences located in Pennsylvania is further restricted
(including the lender's right to foreclose on such property) until the lender
has provided the delinquent borrower with written notice detailing the
borrower's rights to seek consumer credit counseling and state financial
assistance and until the borrower has
14
exhausted or failed to pursue such rights. These provisions of Pennsylvania law
may delay for several months the Bank's ability to foreclose upon residential
loans secured by real estate located in the Commonwealth of Pennsylvania. In
addition, the uniform FNMA/FHLMC lending documents used by the Bank, as well as
most other residential lenders in Pennsylvania, requires notice and a right to
cure similar to that provided under Pennsylvania law.
Non-accrual loans are loans on which the accrual of interest ceases
when the collection of principal or interest payments is determined to be
doubtful by management. It is the policy of the Company to discontinue the
accrual of interest when principal or interest payments are delinquent 90 days
or more (unless the loan principal and interest are determined by management to
be fully secured and in the process of collection), or earlier, if the financial
condition of the borrower raises significant concern with regard to the ability
of the borrower to service the debt in accordance with the current loan term.
Interest income is not accrued until the financial condition and payment record
of the borrower once again demonstrate the ability to service the debt. When a
loan is placed on non-accrual status, previously accrued but unpaid interest is
deducted from interest income. Non-real estate consumer loans more than 120 days
delinquent are required to be written off in accordance with federal
regulations.
If foreclosure is effected, the property is sold at a public auction in
which the Company may participate as a bidder. If the Company is the successful
bidder, the acquired real estate property is then included in the Company's
"real estate owned" account until it is sold. When property is acquired, it is
recorded at the lower of carrying or fair value at the date of acquisition and
any write-down resulting therefrom is charged to the allowance for loan losses.
Interest accrual ceases on the date of acquisition and all costs incurred in
maintaining the property from that date forward are expensed. Costs incurred for
the improvement or development of such property are capitalized to the extent
they do not exceed the property's fair value. No loss reserves are maintained on
REO and future write-downs for cost beyond the fair value are expensed. The
Company is permitted under Department and OTS regulations to finance sales of
REO by "loans to facilitate," which may involve more favorable interest rates
and terms than generally would be granted under the Bank's underwriting
guidelines. However, at June 30, 1999, the Company did not have any loans to
facilitate.
For purposes of applying the measurement criteria for impaired loans,
the Company excludes large groups of smaller-balance homogeneous loans,
primarily consisting of residential real estate loans and consumer loans as well
as commercial loans with balances of less than $100,000. For applicable loans,
the Company evaluates the need for impairment recognition when a loan becomes
non-accrual or earlier if, based on management's assessment of the relevant
facts and circumstances, it is probable that the Company will be unable to
collect all proceeds due according to the contractual terms of the loan
agreement. At and during the year ended June 30, 1999, the average recorded
investment in impaired loans was $262,000. If these impaired loans had been
current in accordance with their original terms and had been outstanding
throughout the period, the gross interest income for fiscal 1999 that would have
been recorded for these loans was $13,000. Interest income on these impaired
loans included in income for
15
fiscal 1999 amounted to $3,000. The Company's policy for the recognition of
interest income on impaired loans is the same as for non-accrual loans discussed
above. Impaired loans are charged off when the Company determines that
foreclosure is probable and the fair value of the collateral is less than the
recorded investment of the impaired loan.
The following table sets forth information regarding non-accrual loans and REO
held by the Company at the dates indicated. The Company did not have any (i)
loans which are 90 days or more delinquent but on which interest is being
accrued or (ii) loans which were classified as restructured troubled debt at any
of the dates presented.
Year Ended June 30,
--------------------------------------------------
1999 1998 1997 1996 1995
---- ------ ---- ------ ------
(Dollars In Thousands)
Non-accrual loans:
Residential real estate loans $568 $ 771 $417 $1,166 $2,029
Commercial real estate loans -- -- -- -- 28
Construction and land loans -- 55 -- 737 294
Commercial business loans 258 -- -- 18 10
Consumer loans 107 420 331 297 549
---- ------ ---- ------ ------
Total non-accrual loans $933 $1,246 $748 $2,218 $2,910
==== ====== ==== ====== ======
Total non-accrual loans
to total assets .21% .33% .23% .81% 1.10%
Total REO -- -- -- $ 121 $ 157
Total non-accrual loans and
REO to total assets .21% .33% .23% .85% 1.16%
At June 30, 1999, non-accrual real estate loans included six
residential mortgage loans aggregating $568,000, all secured by single-family
residential properties.
The total amount of non-performing loans was $933,000, $1.25 million
and $748,000 at June 30, 1999, 1998 and 1997, respectively. If these
non-performing loans had been current in accordance with their original terms
and had been outstanding throughout the period, the gross amount of interest
income for fiscal 1999, 1998, and 1997 that would have been recorded for these
loans was $75,200, $111,800, and $71,400. Interest income on these
non-performing loans included in income for fiscal 1999, 1998, and 1997 amounted
to $26,100, $57,560, and $35,200, respectively.
Allowances for Losses on Loans and Classified Assets. The allowance for
loan losses is maintained at a level that management considers adequate to
provide for potential losses based upon an evaluation of known and inherent
risks in the loan portfolio. Management's evaluation
16
is based upon, among other things, delinquency trends, the volume of
non-performing loans, prior loss experience of the portfolio, current economic
conditions and other relevant factors. Although management believes it has used
the best information available to it in making such determinations, and that the
present allowance for loan losses is adequate, future adjustments to the
allowance may be necessary, and net income may be adversely affected if
circumstances differ substantially from the assumptions used in determining the
level of the allowance. Management may in the future further increase the level
of its allowance for loan losses as a percentage of total loans and
non-performing loans in the event the level of multi-family residential and
commercial real estate loans (which generally are considered to have a greater
risk of loss than single-family residential mortgage loans) as a percentage of
its total loan portfolio continues to increase. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for losses on loans. Such agencies may require the
Company to recognize additions to the allowance based on their judgments about
information available to them at the time of their examination. The allowance is
increased by the provision for loan losses which is charged to operations. Loan
losses, other than those incurred on loans held for sale, are charged directly
against the allowance and recoveries on previously charged-off loans are
generally added to the allowance. At June 30, 1999, the Bank's allowance for
loan losses was $3.65 million or 1.24% of total net loans receivable and 391.3%
of total non-performing loans compared to $3.41 million or 1.23% of net loans
and 274.0% of total non-performing loans at June 30, 1998.
The Company monitors the quality of its assets on a regular basis.
Under regulations of the OTS, all of the Company's assets are subject to being
classified under a classification system that has three categories: (i)
substandard, (ii) doubtful and (iii) loss. An asset may fall within more than
one category and a portion of the asset may remain unclassified. The Company is
required to review the classification of its assets on a regular basis. In
addition, in connection with the examinations of First Financial by the OTS, the
FDIC, and the Department, the examiners have the authority to identify problem
assets and, if appropriate, classify them and/or require adjustments to the
carrying value of such assets.
Assets classified substandard are considered inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Assets so classified must have a well-defined weakness or
weaknesses. They are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Assets classified doubtful are considered to have all the weaknesses
inherent in those classified substandard with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions, and values, highly questionable and improbable.
Assets classified loss are considered uncollectable and of such little
value that their continuance as assets without establishment of a specific
reserve is not warranted. This classification does not mean that an asset has
absolutely no recovery or salvage value, but rather,
17
that it is not practical or desirable to defer writing off a basically worthless
asset even though partial recovery may be affected in the future.
At June 30, 1999 and 1998, the Company's classified assets, which
consisted of assets classified as substandard or doubtful, totaled $1.24 million
and $1.47 million, respectively. The Company did not have any REO at June 30,
1999 and 1998. Included in the assets classified substandard at June 30, 1999
and 1998, were all loans 90 days past due and loans which are less than 90 days
delinquent but inadequately protected by the current paying capacity of the
borrower or of the collateral pledged, and have a well-defined weakness that may
jeopardize the liquidation of the debt. The majority of loans which are
classified but otherwise performing are residential mortgage loans.
Other loans designated as special mention by the Company amounted to
$4.37 million and $971,700 at June 30, 1999 and 1998, respectively. Included in
the special mention category at June 30, 1999 was one loan with a balance of
$4.37 million to an extended term healthcare provider which was performing in
accordance with the terms and conditions of the loan but had characteristics
which warranted management to classify it special mention. Although these loans
are not considered or classified as substandard, doubtful or loss, they do have
a potential weakness which may, if not corrected, result in increased risk at
some future date.
18
The following table summarizes activity in the Company's allowance for loan
losses during the periods indicated.
As of June 30,
---------------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(Dollars in Thousands)
Allowance at beginning of period $ 3,414 $ 2,855 $ 2,667 $ 2,449 $ 2,199
Loans charged off against the allowance:
Residential real estate (58) (12) (117) (101) (54)
Construction and land -- -- (177) -- (5)
Commercial business -- -- (1) (2) (201)
Consumer (119) (69) (82) (43) (69)
------- ------- ------- ------- -------
(177) (81) (377) (146) (329)
Recoveries:
Residential real estate -- 21 37 -- --
Construction and land -- -- 4 16 --
Commercial business -- -- -- -- 93
Consumer 24 13 1 8 31
------- ------- ------- ------- -------
24 34 42 24 124
Net charge-offs (153) (47) (335) (122) (205)
Provision for loan losses
charged to operating expenses 390 606 523 340 455
------- ------- ------- ------- -------
Allowance at year end $3,651 $ 3,414 $ 2,855 $ 2,667 $ 2,449
======= ======= ======= ======= =======
Ratio of net charge-offs to
average loans outstanding .05% .02% .13% .05% .10%
======= ======= ======= ======= =======
Ratio of allowance to period-end
net loans 1.24% 1.23% 1.10% 1.18% 1.10%
======= ======= ======= ======= =======
19
The following table presents information regarding the Company's total allowance
for losses on loans as well as the allocation of such amounts to the various
categories of the loan portfolio.
(Dollars in Thousands)
At June 30,
-----------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------------- --------------- ---------------- ---------------- -----------------
% of % of % of % of % of
Loans Loans Loans Loans Loans
to Total to Total to Total to Total to Total
-------- -------- -------- -------- --------
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Residential real estate loans $ 638 51.1% $ 789 53.6% $ 778 58.7% $ 898 63.1% $1,077 66.6%
Commercial real estate loans 1,415 17.9 1,050 14.1 871 12.5 585 9.6 428 9.8
Construction and land loans 194 9.5 201 10.5 139 8.5 280 7.2 309 5.7
Commercial business loans 726 4.8 357 3.9 278 2.9 207 2.4 105 1.8
Consumer loans 678 16.7 1,017 17.9 789 17.4 697 17.7 530 16.1
Total allowance for loan losses $3,651 100.0% $3,414 100.0% $2,855 100.0% $2,667 100.0% $2,449 100.0%
Total allowance for loan losses
to total non-performing loans 391.3% 274.0% 381.7% 120.2% 84.2%
===== ===== ===== ===== ====
Total non-performing loans $ 933 $1,246 $ 748 $2,218 $2,910
====== ====== ====== ====== ======
20
Securities Activities
Historically, interest and dividends on securities have provided the
Company with a significant source of revenue. At June 30, 1999, the Company's
securities portfolio and interest-bearing deposits aggregated $140.03 million or
31.04% of its total assets. First Financial's securities and interest-bearing
deposits are used to meet certain federal liquidity ratios. The liquidity ratios
are met in part by investing in securities that qualify as liquid assets under
OTS regulations. (See "Regulation - Regulation of the Bank - Liquidity
Requirements"). Such securities include obligations issued or fully guaranteed
by the United States Government, certain federal agency obligations, certain
time deposits and negotiable certificates of deposit issued by commercial banks
and other specified investments, including commercial paper and other
securities. Investment decisions are made by members of senior management within
guidelines approved by the Company's Board of Directors.
The Company divides its securities portfolio into three segments: (a)
held to maturity; (b) available for sale; and (c) trading. Securities in the
held to maturity category are accounted for at amortized cost. Trading
securities are accounted for at quoted market prices with changes in market
values being recorded as gain or loss in the income statement. All other
securities are included in the available for sale category and are accounted for
at fair value with unrealized gains or losses, net of taxes, being reflected as
adjustments to equity. At June 30, 1999, the Company had a net unrealized loss
on securities available for sale, net of taxes, of $1.55 million.
21
The following table sets forth the Company's securities portfolio and
interest-earning deposits at carrying value at the dates indicated.
At June 30,
--------------------------------
1999 1998 1997
-------- ------- -------
(Dollars in Thousands)
Interest-bearing deposits $ 13,409 $11,861 $ 7,901
Trading account securities 9,221 20,352 252
Investment securities held to maturity:
U.S. Government and agency obligations -- 4,500 5,500
Municipal notes and bonds 3,229 7,394 10,986
Mortgage-backed securities 791 1,123 1,473
Other 3,781 2,583 1,510
-------- ------- -------
Total investment securities held to
maturity 7,801 15,600 19,469
-------- ------- -------
Investment securities available for sale:
U.S. Government and agency obligations 47,242 12,296 18,217
Municipal notes and bonds 27,378 15,173 4,128
Mortgage-backed securities 15,817 9,431 5,054
Equity securities 1,336 1,096 167
Debt securities 15,430 307 --
Other 2,397 -- --
-------- ------- -------
Total investment securities available for sale 109,600 38,303 27,566
======== ======= =======
Total securities and interest-bearing
deposits $140,031 $86,116 $55,188
======== ======= =======
The contractual maturity or repricing characteristics of the Company's
investment portfolio is considerably more interest rate sensitive than that of
its loan portfolio. Consequently, the investment portfolio provides a
significant source of liquidity and protection against interest rate risk. The
weighted average term to maturity or repricing of the Company's investment
securities held to maturity was 3.1 years at June 30, 1999 and 5.5 years at June
30, 1998.
22
The amortized cost and estimated fair value of investment securities at June 30,
1999, by contractual maturity, are shown below.
Estimated Weighted
Amortized Fair Average
Cost Value Yield
-------- -------- ------
(Dollars in Thousands)
Held to Maturity
Due in one year or less $ 1,840 $ 1,848 7.22%
Due after one year through five years 1,087 1,088 6.27
Due after five years through ten years -- -- --
Due after ten years 1,093 1,098 6.96
No stated maturity 3,781 3,782 6.50
-------- -------- ----
Total held to maturity $ 7,801 $ 7,816 6.70%
======== ======== ====
Available for Sale
Due in one year or less $ 340 $ 341 5.52%
Due after one year through five years 25,805 25,528 6.28
Due after five years through ten years 27,983 27,313 6.36
Due after ten years 56,551 55,081 6.97
No stated maturity 1,450 1,337 2.46
-------- -------- ----
Total available for sale $112,129 $109,600 6.60%
======== ======== ====
The weighted average yield, based on amortized cost, is presented on a
taxable equivalent basis.
As of June 30, 1999, investments in the debt and/or equity securities
of any one issuer (excluding U.S. Government and federal agencies) did not
exceed 10% of the Company's stockholders' equity.
Sources of Funds
General. Deposits obtained through branch offices have traditionally
been the principal source of the Company's funds for use in lending and for
other general business purposes. The Company also derives funds from
amortization and prepayments of outstanding loans and sales of loans. From time
to time, the Company also may borrow funds from the FHLBP and other sources.
Borrowings may be used on a short-term basis to compensate for seasonal or other
reductions in deposits or other inflows at less than projected levels, as well
as on a longer term basis to support expanded lending and investment activities.
Deposits. The Company obtains deposits primarily from residents of
Chester County, and to a lesser extent Berks, Delaware, Lancaster and Montgomery
Counties, Pennsylvania. Currently, the principal methods used by First Financial
to attract deposit accounts include the offering of services and accounts,
competitive interest rates, and convenient office locations and service hours.
Other than during times of inverse or flat yield curves, the Bank has adopted a
pricing program for its certificate accounts which provides for higher rates of
interest on its
23
longer term certificates in order to encourage depositors to invest in
certificates with longer maturities, thus reducing the interest rate sensitivity
of the Company's deposit portfolio. First Financial also offers a tiered money
market account that pays higher interest on higher balances so as to maintain a
relatively stable core of deposits even when its certificate accounts mature.
Market conditions have caused First Financial to rely primarily on
short-term certificate accounts and other deposit alternatives that are more
responsive to market interest rates than passbook accounts and regulated
fixed-rate, fixed-term certificates that were historically the Company's primary
sources of deposits. First Financial's current deposit products include
non-interest-bearing accounts, passbook/statement savings accounts, NOW checking
accounts, money market deposit accounts, certificates of deposit ranging in
terms from 30 days to five years and certificates of deposit in denominations of
$100,000 or more ("jumbo certificates"). Included among these deposit products
are individual retirement account certificates ("IRA certificates") and Keogh
accounts.
24
The following table shows the balances of the Company's deposits as of the dates
indicated:
At June 30,
---------------------------------------------------------------------------------
1999 1998 1997
--------------------- --------------------- ------------------------
(Dollars in Thousands)
% of % of % of
Amount Deposits Amount Deposits Amount Deposits
------ -------- ------ -------- ------ --------
Non-interest-bearing accounts $ 33,007 9.2% $ 32,361 10.9% $ 21,493 8.2%
NOW checking accounts 36,011 10.0 31,770 10.6 27,625 10.6
Savings accounts 29,033 8.1 27,164 9.1 29,887 10.2
Money market accounts 47,464 13.2 35,610 11.9 26,474 11.5
Certificates of deposit less than
$100,000 137,559 38.2 133,801 44.9 124,636 47.8
Certificates of deposit with
$100,000 minimum balance 76,439 21.3 37,485 12.6 30,635 11.7
-------- ----- -------- ----- -------- -----
Total deposits $359,513 100.0% $298,191 100.0% $260,750 100.0%
======== ===== ======== ===== ======== ======
The following table shows the weighted average interest rate of the Company's
deposits by type of account at June 30, 1999:
Weighted
Amount Avg. Rate
-------- ---------
(Dollars in Thousands)
Non-interest-bearing accounts $ 33,007 0.00%
NOW checking accounts 36,011 1.47
Savings accounts 29,033 1.87
Money market accounts 47,464 3.82
Certificates of deposit less than
$100,000 137,559 5.36
Certificates of deposit with
$100,000 minimum balance 76,439 5.07
-------- ----
Total deposits $359,513 3.93%
======== ====
The following table sets forth the net deposit flows of the Company for the
periods indicated:
Year Ended June 30,
---------------------------------
1999 1998 1997
------- ------- -------
(Dollars in Thousands)
Increase before interest credited $50,465 $27,568 $23,848
Interest credited
10,857 9,873 8,696
------- ------- -------
Net deposit increase $61,322 $37,441 $32,544
======= ======= =======
25
The following table shows the balances of certificates of deposit with balances
of $100,000 or greater which mature during the periods indicated and the balance
at June 30, 1999.
Balances at June 30, 1999, Maturing
----------------------------------------------------
(Dollars in Thousands)
At Within Three Six to After
June 30, Three to Six Twelve Twelve
1999 Months Months Months Months
---- ------ ------ ------ ------
Certificates of deposit with $100,000
minimum balance $76,439 $17,994 $8,270 $7,184 $42,991
======= ======= ====== ====== =======
The following table presents the average balance by type of deposit and the
average rate paid by type of deposit for the periods indicated.
Year Ended June 30,
-----------------------------------------------------------------------------------
1999 1998 1997
------------------------- ----------------------- -----------------------
(Dollars in Thousands)
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
------- ---- ------- ---- ------- ----
NOW checking accounts $ 33,278 1.48% $ 29,328 1.81% $ 23,986 1.92%
Savings accounts 31,392 1.81 25,991 2.67 25,067 2.87
Money market accounts 43,147 3.65 29,847 3.57 26,084 3.42
Certificates of deposit
less than $100,000 149,713 5.55 126,286 5.90 119,679 5.81
Certificates of deposit with
$100,000 minimum balance 52,917 5.17 35,725 4.94 26,990 4.91
The greater variety of deposit accounts offered by First Financial has
increased its ability to retain deposits and has allowed it to be more
competitive in obtaining new funds, although the threat of disintermediation
(the flow of funds away from savings institutions into direct investment
vehicles such as government and corporate securities) still exists. However,
these types of accounts have been and continue to be more costly than
traditional accounts during periods of high interest rates. In addition, First
Financial has become much more susceptible to short-term fluctuations in deposit
flows, as customers have become more rate conscious and willing to move funds
into higher-yielding accounts. Thus, both the ability of First Financial to
attract and maintain deposits as well as its cost of funds have been, and will
continue to be, affected significantly by economic market conditions.
In an effort to attract increasing amounts of non-interest-bearing
deposits, First Financial offers a basic checking account which features no-fee
checking with a minimum balance of $50.
26
First Financial also offers a business checking account which grants
credits against service charges based on the average daily balance. It is
management's belief that such accounts represent an excellent source of deposits
that are not affected by interest rates.
First Financial attempts to control the flow of deposits by pricing its
accounts to remain generally competitive with other financial institutions in
its primary market area, but does not necessarily seek to match the highest
rates paid by competing institutions.
First Financial's deposits are obtained primarily from persons who are
residents of Pennsylvania. First Financial does not advertise for deposits
outside of Pennsylvania or accept brokered deposits, and management believes
that an insignificant amount of First Financial's deposits were held by
non-residents of Pennsylvania at June 30, 1999.
Borrowings. First Financial may obtain advances from the FHLBP upon the
security of the common stock it owns in that bank and certain of its residential
mortgage loans, provided certain standards related to credit worthiness have
been met. See "Regulation - Regulation of the Bank - Federal Home Loan Bank
System." Such advances are made pursuant to several different credit programs,
each of which has its own interest rate and range of maturities. FHLBP advances
are generally available to meet seasonal and other withdrawals of deposit
accounts and to expand lending and investment activities, as well as to aid the
efforts of members to establish better asset and liability management through
the extension of maturities of liabilities. At June 30, 1999, the Company had
$50.38 million in FHLBP advances outstanding. The Company has available to it
from an unaffiliated financial institution an annually renewable line of credit
not to exceed 10% of the Company's maximum borrowing capacity. The line of
credit was $13.13 million at the time the commitment was executed. The Company,
from time to time, has used the line of credit to meet liquidity needs. At June
30, 1999, there was no balance outstanding on the line of credit.
27
The following tables present certain information regarding short-term
borrowings (borrowings with a maturity of one year or less) for the periods
indicated:
Year Ended June 30,
---------------------------------------------------
1999 1998 1997
---- ---- ----
(Dollars in Thousands)
Short-term borrowings:
Balance outstanding at end
of period $16,731 $17,601 $18,325
Weighted average interest rate
at end of period 5.43% 5.28% 5.91%
Average balance outstanding $18,596 $16,417 $6,152
Maximum amount outstanding
at any month-end
during the period $35,320 $25,323 $19,046
Weighted average interest rate
during the period 5.51% 5.58% 5.97%
Yields Earned and Rates Paid
The largest components of the Company's total income and total expense
are interest income and interest expense. As a result, the Company's earnings
are dependent primarily upon net interest income, which is determined by the
Company's net interest rate spread (i.e., the difference between the yields
earned on interest-earning assets and the rates paid on interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities.
28
Interest Income and Interest Spread Analysis
The following table sets forth, for the periods indicated, information
regarding (i) the total dollar amount of interest income of the Company from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average cost; (iii) net interest income; (iv) interest rate spread; and (v) net
interest-earning assets and their net yield.
Average balances are determined on a monthly basis which are representative of
operations.
Year Ended June 30,
--------------------------------------------------------------------------------
1999 1998
-------------------------------------- ---------------------------------------
(Dollars in Thousands)
Average Yield/ Average Yield/
Balance(2) Interest(1) Rate(1) Balance(2) Interest(1) Rate(1)
---------- ----------- ------- ---------- ----------- -------
Assets:
Loans and loans
held for sale $280,544 $22,875 8.15% $264,106 $22,298 8.44%
Securities and
other investments $113,110 $ 7,137 6.31% $ 60,777 $ 3,906 6.43%
-------- ------- -------- -------
Total interest-
earning assets $393,654 $30,012 7.62% $324,883 $26,204 8.07%
Non-interest earning assets $ 18,092 $ 15,141
Total assets $411,746 $340,024
======== ========
Liabilities and Stockholders' Equity:
Deposits and repurchase agreements $287,627 $12,711 4.42% $247,903 $11,476 4.63%
FHLB advances and
other borrowings $ 53,595 $ 2,971 5.54% $ 31,813 $ 1,933 6.08%
-------- ------- -------- -------
Total interest-
bearing liabilities $341,222 $15,682 $279,716 $13,409 4.79%
Non-interest-bearing liabilities $ 36,962 4.60% $ 30,167
Stockholders' equity $ 33,562 $ 30,141
Total liabilities and stockholders' equity $411,746 $340,024
======== ========
Net interest income/interest rate spread $14,330 3.03% $12,795 3.28%
======= ==== ======= ====
Net interest-earning assets/net yield on
interest-earning assets $ 52,432 3.64% $ 45,167 3.94%
======== ==== ======== ====
Ratio of average interest-earning assets to
interest-bearing liabilities 115% 116%
=== ===
June 30,
---------------------------------------
1997
--------------------------------------
Average Yield/
Balance(2) Interes(1) Rate(1)
Assets:
Loans and loans
held for sale $240,858 $20,452 8.49%
Securities and
other investments $ 42,566 $ 2,465 5.79%
-------- -------
Total interest-
earning assets $283,424 $22,917 8.09%
Non-interest earning assets $ 11,388
Total assets $294,812
========
Liabilities and Stockholders' Equity:
Deposits and repurchase agreements $223,048 $10,338 4.63%
FHLB advances and
other borrowings $ 20,942 $ 1,169 5.58%
-------- -------
Total interest-
bearing liabilities $243,990 $11,507 4.72%
Non-interest-bearing liabilities $ 23,603
Stockholders' equity $ 27,219
Total liabilities and stockholders' equity $294,812
========
Net interest income/interest rate spread $11,410 3.37%
======= ====
Net interest-earning assets/net yield on
interest-earning assets $ 39,434 4.03%
======== ====
Ratio of average interest-earning assets to
interest-bearing liabilities 116%
=========
(1) The indicated interest and annual yield and rate are presented on a taxable
equivalent basis using the Federal marginal income tax rate of 34% adjusted
for the 20% interest expense disallowance (27.2%) for 1999, 1998, and 1997.
(2) Non-accruing loans are included in the average balance.
29
Rate/Volume Analysis
- --------------------
The following table presents certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
Interest income and the annual rate are calculated on a taxable equivalent basis
using the Federal marginal income tax rate of 34% adjusted for the 20% interest
expense disallowance (27.2%). For each category of interest-earning assets and
interest-bearing liabilities, information is provided with respect to changes
attributable to (1) changes in volume (change in volume multiplied by old rate),
(2) changes in rate (change in rate multiplied by old volume) and (3) changes in
rate/volume (change in rate multiplied by change in volume).
1999 Compared to 1998 1998 Compared to 1997
Increase (Decrease) Due to Increase (Decrease) Due to
-------------------------------------- ---------------------------------------
(Dollars in Thousands)
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ----- ----- ------ ------ ----- ----- ------
Interest income on interest-
earning assets:
Loans and loans
held for sale $1,387 ($765) ($ 48) $ 574 $1,974 ($117) ($ 11) $1,846
Securities and
other investments $3,365 ($ 73) ($ 63) $3,229 $1,055 $ 271 $ 115 $1,441
------ ----- ----- ------ ------ ----- ----- ------
Total interest income $4,752 ($838) ($111) $3,803 $3,029 $ 154 $ 104 $3,287
------ ----- ----- ------ ------ ----- ----- ------
Interest expense on interest-
bearing liabilities:
Deposits and repurchase
agreements $1,839 ($521) ($ 84) $1,234 $1,152 ($ 13) ($ 1) $1,138
FHLB advances and other
borrowings $1,324 ($172) ($118) $1,034 $ 607 $ 103 $ 54 $ 764
------ ----- ----- ------ ------ ----- ----- ------
Total interest expense $3,163 ($693) ($202) $2,268 $1,759 $ 90 $ 53 $1,902
----- ----- ------
Net change in net interest
income $1,589 ($145) $ 91 $1,535 $$1,270 $ 64 $ 51 $1,385
====== ===== ===== ====== ======= ===== ===== ======
30
Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. The Company's market risk arises primarily from the interest rate
risk inherent in its lending and deposit taking activities. To that end,
management actively monitors and manages its interest rate risk exposure.
The Company's profitability is affected by fluctuations in interest
rates. A sudden and substantial change in interest rates may adversely impact
the Company's earnings to the extent that the yields on interest-sensitive
assets and interest-sensitive liabilities do not change at the same speed, to
the same extent, or on the same basis. The Company monitors the impact of
changes in interest rates between assets and liabilities as discussed in the
Company's Interest Rate Sensitivity Analysis under the Asset/Liability
Management caption in the Company's 1999 Annual Report (see Exhibit 13 hereto).
Although interest rate sensitivity gap analysis is a useful measurement tool and
contributes towards effective asset liability management, it is difficult to
predict the effect of changing interest rates based solely on that measure. An
alternative methodology is to estimate the impact on net interest income and on
net portfolio value of an immediate change in interest rates in 100 basis point
increments. Net portfolio value ("NPV") is defined as the net present value of
assets, liabilities, and off-balance sheet contracts. The chart below is the
estimated effect of immediate changes in interest rates at the specified levels
at June 30, 1999, calculated in compliance with Thrift Bulletin No. 13:
Change in Interest Estimate Net Market Value
Rates in Basis Points of Portfolio Equity NPV as % of PV of Average Assets
--------------------- -------------------- ---------------------
(Rate Shock) Amount $ Change % Change NPV Ratio Change
------------ ------ -------- -------- --------- ------
(Dollars in Thousands)
300 $11,975 $(27,443) (70)% 2.86% (580)
200 20,823 (18,595) (47) 4.83 (382)
100 30,107 (9,331) (24) 6.80 (186)
Static 39,418 -- 8.66 --
--
(100) 48,191 8,773 22 10.31 166
(200) 56,700 17,282 44 11.83 318
(300) 66,518 27,100 69 13.51 485
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV require the making of
certain assumptions which may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. In this regard,
the NPV table presented above assumes that the composition of the Company's
interest sensitive assets and liabilities existing at the beginning of a period
remains constant over the period being measured and also assumes that a
particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the NPV table provides an indication of the
Company's interest rate risk exposure at a particular point in
31
time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in market interest rates on the Company's net
interest income and will differ from actual results.
The Company's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset/liability
structure to obtain the maximum yield/cost spread on that structure. The Company
relies primarily on its asset/liability structure to control interest rate risk.
The Company continually evaluates interest rate risk management
opportunities, including the use of derivative financial instruments. Management
believes that hedging instruments currently available are not cost-effective
and, therefore, has focused its efforts on increasing the Company's yield/cost
spread through wholesale and retail opportunities.
32
Ratios
The following table shows certain income and financial condition ratios
for the periods indicated. All averages are based on month-end balances.
Year Ended June 30,
----------------------------
1999 1998 1997
----- ---- ----
Return on average assets (income
excluding the special SAIF
assessment of $832,000 in fiscal
1997 net of taxes divided by
average total assets) 1.02% 1.07% 1.04%
Return on average assets
(income divided by average
total assets) 1.02% 1.07% .76%
Return on average equity
(income excluding the special
SAIF assessment of $832,000
in fiscal 1997 net of taxes divided
by average equity) 12.55% 12.03% 11.28%
Return on average equity
(income divided by average equity) 12.55% 12.03% 8.22%
Equity-to-assets ratio
(average equity divided by
average assets) 8.15% 8.86% 9.23%
Dividend pay-out ratio 27.39% 33.90% 47.46%
Subsidiaries of First Financial
At June 30, 1999, the Bank was permitted by regulations to invest up to
2% of assets in the capital stock of, and secured and unsecured loans to,
subsidiary corporations or service corporations and under certain circumstances
may make conforming loans to service corporations in greater amounts. As a
Pennsylvania-chartered savings institution, the Bank may diversify into any
business activity approved in advance by the Department. In addition, First
Financial could invest up to 30% of its assets in finance subsidiaries. Such
subsidiaries must be limited purpose subsidiaries whose sole purpose is to issue
debt or equity securities that the parent association is authorized to issue
directly and to remit the proceeds of such issuance to the parent association.
The Bank operates (as a wholly owned subsidiary) D & S Service
Corporation ("D & S Service"), which has participated in the development for
sale of residential properties, in particular condominium conversions and also
the development of commercial properties in order for the Bank to expand its
facilities to accommodate its growth. All of such projects have either been
located in or within close proximity to the Bank's primary market area. D & S
Service operates two wholly owned subsidiaries: Wildman Projects and D & F
Projects, Inc.
33
At June 30, 1999, the Bank was authorized to have a maximum investment
of $8.93 million in its one first-tier wholly-owned subsidiary, D & S Service.
As of such date, the Bank had invested $1.19 million in this subsidiary.
Acquisition
On May 29, 1998, the Company acquired Philadelphia Corporation for
Investment Services, a full service investment advisory and securities brokerage
firm. The transaction was accounted for as a pooling of interests and the
shareholders of PCIS received 23.4239 shares of Chester Valley Bancorp Inc.
stock for each share of PCIS stock. Approximately 134,000 shares of CVAL stock
were issued in the exchange.
Competition
First Financial encounters strong competition both in the attraction of
deposits and in the making of real estate and other loans. Its most direct
competition for deposits has historically come from commercial banks, other
savings and loan associations, savings banks and credit unions conducting
business in its primary market area. The Bank also encounters competition for
deposits from money market and other mutual funds, as well as corporate and
government securities and insurance companies. The principal methods used by the
Bank to attract deposit accounts include offering a variety of services and
interest rates and providing convenient office locations and expanded banking
hours. The Bank's competition for real estate and other loans comes principally
from other savings institutions, credit unions, commercial banks, mortgage
banking companies, insurance companies, and other institutional lenders. First
Financial competes for loans through interest rates, loan maturities, loan fees
and the quality of service extended to borrowers and real estate brokers.
Employees
The Company had 142 full-time employees and 30 part-time employees as
of June 30, 1999. None of these employees are represented by a collective
bargaining agent and the Company believes that it enjoys good relations with its
personnel.
34
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of the Company and the Bank as in effect as of
the date of this Annual Report on Form 10-K. The description of these laws and
regulations, as well as descriptions of laws and regulations contained elsewhere
herein, does not purport to be complete and is qualified in its entirety by
reference to applicable laws and regulations.
In recent periods there have been various legislative proposals in the
U.S. Congress to eliminate the thrift charter and the OTS. Although the Company
currently is unable to predict whether the existence of the thrift charter and
the OTS may be the subject of future legislation and, if so, what the final
contents of such legislation will be and their effects, if any, on the Company
and the Bank, such legislation could result in, among other things, the Company
becoming subject to the same regulatory capital requirements, activities
limitations and other requirements which are applicable to bank holding
companies under the Bank Holding Company Act of 1956 ("BHCA"). Unlike savings
and loan holding companies, bank holding companies are subject to regulatory
capital requirements, which generally are comparable to the regulatory capital
requirements which are applicable to the Bank, and unlike unitary savings and
loan holding companies such as the Company, which generally are not subject to
activities limitations, bank holding companies generally are prohibited from
engaging in activities or acquiring or controlling, directly or indirectly, the
voting securities or assets of any company engaged in any activity other than
banking, managing or controlling banks and bank subsidiaries or other activities
that the Federal Reserve Board has determined, by regulation or otherwise, to be
so closely related to banking or managing or controlling banks as to be a proper
incident thereto.
Regulation of the Company
Federal Regulation-General. The Company is a registered savings and
loan holding company within the meaning of the Home Owners' Loan Act. As such,
the Company is subject to OTS regulations, examinations, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.
Federal Activities Restrictions. There are generally no restrictions on
the activities of a savings and loan holding company which holds only one
subsidiary savings association. However, if the Director of the OTS determines
that there is reasonable cause to believe that the continuation by a savings and
loan holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and
35
loan holding companies, if the savings association subsidiary of such a holding
company fails to meet the Qualified Thrift Lender ("QTL") test, then such
unitary holding company shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings association re-qualifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company. See "-Regulation of the Bank - Qualified Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings associations) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings associat