FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OFThe 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.
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 of this Form 10-K [x].
AGGREGATE MARKET VALUE OF THE VOTING COMMON STOCK HELD BY NONAFFILIATES OF THE REGISTRANT EQUALS $52,028,606. AS OF FEBRUARY 28, 2002, BASED ON A MARKET PRICE OF $36.50. THE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF FEBRUARY 28, 2002, EQUALS 1,819,167.
Excerpts from the Registrant’s 2001 Annual Report to Shareholders are incorporated herein by reference in response to Part II. The Registrant’s definitive Proxy Statement to be used in connection with the 2002 Annual Meeting of Shareholders is incorporated herein by reference in partial response to Part III.
FIDELITY D & D BANCORP, INC.
PART I
1 BUSINESS
On August 10, 1999, Fidelity D&D Bancorp, Inc (the Company) was incorporated in the Commonwealth of Pennsylvania. Effective June 30, 2000, shareholders of The Fidelity Deposit and Discount Bank (the Bank) exchanged each of their shares of common stock for two shares of the Company’s common stock. The Company is now the holding company for the Bank.
As set forth in the Company’s Registration Statement filed on SEC Form S-4, common stock of the Company that is being held for exchange of common stock of the Bank, may be sold if the exchange does not occur by June 30, 2002. The Company will hold the net proceeds of the sale, together with any unpaid dividends, in a non interest-bearing account. Payment of the proceeds and any unpaid dividends, without interest, will be made upon proper surrender of the Bank’s common stock certificates.
The Company is headquartered at Blakely and Drinker Streets in Dunmore, Pennsylvania 18512. Financial holding company status was elected effective June 27, 2001.
The Bank is a commercial bank chartered by the Commonwealth of Pennsylvania. The Bank’s headquarters are located at Blakely and Drinker Streets in Dunmore, Pennsylvania 18512. The Bank has offered a full range of traditional banking services since it commenced operations in 1903. The Bank has a trust department and also provides alternative financial products. The service area is comprised of the Borough of Dunmore and the surrounding communities in Lackawanna and Luzerne counties.
A complete list of services provided by the Bank is detailed in the section entitled “Products & Services” contained herein.
The Bank is one of two financial institutions headquartered in Dunmore, Pennsylvania. Sources of competition come from:
There are no concentrations of loans that, if lost, would have a materially adverse effect on the business of the Bank. The Bank’s loan portfolio does not have a material concentration within a single industry or group of related industries that are vulnerable to the risk of a near-term severe impact.
On December 31, 2001, the Bank had 172 full-time equivalent employees, including officers and part-time employees.
The Company is subject to the regulations of:
The Bank is subject to the regulations of:
Accounting policies and procedures are designed to comply to accounting principles, generally accepted in the United States of America (GAAP).
Applicable regulations relate to, among other things:
The Bank is examined by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation on an alternate year basis. The last examination was conducted by the Federal Deposit Insurance Corporation at June 30, 2001.
Beside historical information, this Form 10-K contains forward-looking statements. Forward-looking statements are subject to uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. We caution readers not to place undue reliance on these forward-looking statements. The forward-looking statements reflect management’s analysis only as of December 31, 2001. The Company undertakes no obligation to update these forward-looking statements to reflect circumstances that arise after December 31, 2001. Readers should carefully review the risk factors described in other documents the Company files with the Securities and Exchange Commission. Such documents include Quarterly Reports on Form 10-Q.
Forward-looking statements by their nature are subject to assumptions, risks and uncertainties. For a variety of reasons, actual results could differ materially from those contained or implied by the forward-looking statements:
The Company and the Bank are headquartered at the main office on the corner of Blakely and Drinker Streets in Dunmore, Pennsylvania. The main office is a full-service banking center with a walk-up window, drive-in and two twenty-four hour automated teller machines (ATM). Administrative offices, some operational departments and customer service areas are in this building. Trust and personal investment services are available at the main office. There is limited space available for future use. The main office complex is free of any encumbrances.
The Keystone Industrial Park Branch (KIP) in Dunmore, Pennsylvania, is a full-service branch with a drive-in and a twenty-four hour ATM. KIP is free of encumbrances.
One Scranton facility operates from leased space in the Green Ridge Shopping Center. The branch is a full-service branch and has an ATM with twenty-four hour access.
A second Scranton office is in a leased facility located at 139 Wyoming Avenue, Scranton, Pennsylvania. The branch has a walk-up window and provides full service to the downtown Scranton market.
The Financial Center at 338 North Washington Avenue in Scranton, Pennsylvania uses the entire second floor and a portion of the first floor for operations. The remainder of the first floor is a full service branch with a twenty-four hour ATM. A portion of the third floor is currently leased to a non-related entity. Loan operations will occupy the remainder of the third floor in 2002. The Company owns the property free of encumbrance. The Company also owns, free of encumbrance, an adjacent building, which is leased to a non-related entity.
The Abington office is situated on the Morgan Highway in Clarks Summit, Pennsylvania. The building from which the branch operates is leased. The branch provides full-service banking, including a twenty-four hour ATM and drive-in, to our customers located throughout the greater Abington market area.
There is a limited banking facility for employees and patients of the Clarks Summit State Hospital, located within the hospital at Clarks Summit, Pennsylvania. The office is leased under a lease for service provided agreement, from the hospital.
The Bank operates a full-service branch in Bruno’s Supermarket 403 Kennedy Boulevard, Pittston, Pennsylvania. The office contains a twenty-four hour ATM. The space in the supermarket is leased. The office provides service to the Bank’s clientele in Luzerne County, Pennsylvania.
Another full-service branch with a twenty-four hour ATM is located in the Insalaco Shopping Center at 801 Wyoming Avenue, West Pittston, Pennsylvania. The leased facility provides additional service to the Luzerne County market.
A full service office with a twenty-four hour ATM and drive-in operates from leased space at 4010 Birney Avenue, Moosic, Pennsylvania. The branch provides a geographic link between the Lackawanna and Luzerne County offices.
Providing full service to the Bank’s upper valley clientele is the Peckville branch at 1598 Main Street, Peckville, Pennsylvania. The facility is leased and has a twenty-four hour ATM and drive-in.
The Bank expanded its coverage in Luzerne County with the opening of the Kingston office at 247 Wyoming Avenue, Kingston, Pennsylvania. The branch, opened on April 26, 2001, is a full-service office with a drive-in and a twenty-four hour ATM. The Kingston office is leased.
Plans are under way to open another full-service branch in Lackawanna County during 2002. The Eynon branch located on Route 6 business Eynon, Pennsylvania, will be a leased office with a drive-in and a twenty-four hour ATM.
The Bank has contracted space for free standing twenty-four hour ATMs at:
Another free standing twenty-four hour ATM, from which the Bank contracts space, at 1650 W. Main St. Stroudsburg, Pennsylvania, opened during January 2002.
None of the lessors of the properties leased by the Bank are affiliated with the Company or the Bank.
The Company owns two adjacent residential properties in Clarks Green, Pennsylvania. The properties are being rented to parties not affiliated with the Company. Originally it was the intention of the Bank to construct a branch at this location. However, that plan was discontinued with the opening of the Abington office. The sale of both properties is currently being negotiated.
The Bank owns a commercial facility located at 116 - 118 N. Blakely Street Dunmore, Pennsylvania. The facility is currently leased by a non-related entity. The property was acquired for future expansion.
Foreclosed Assets held for sale are:
A sales agreement for the Eynon property was signed in January 2002 with an unrelated party. After the sale, a portion of the property will be leased back to the Bank for the new Eynon branch.
The Bank also holds various vehicles that were either repossessed or were expired leases during 2001.
All foreclosed properties are listed for sale. Repossessed assets are sold at auction. Foreclosed properties and repossessed assets are recorded on the Company’s balance sheet at the lower of cost or fair value. The Bank does not expect to incur any material losses from the sale of these assets.
Expired leases are recorded at their residual value. The Bank carries insurance, which may pay off some or all of a difference between the vehicle’s residual value and the auction sale price. Any deficiency between the residual value and sales price is charged against current earnings. The Bank does not expect to incur any material losses from the sale of these assets.
3 LEGAL PROCEEDINGSIn the Company’s opinion, there are no proceedings pending to which the Company and or Bank is a party or to which its property is subject, which, if decided against the Company, would be of material consequence to the Company’s financial condition. There are no material proceedings pending or contemplated against the Company by government authorities.
4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART II
5 MARKET FOR THE BANK'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Shareholders requesting information about the Company's common stock may contact the Company's Chairman of the Board and President, Michael F. Marranca or the Chief Executive Officer Joseph J. Earyes. Requests may be mailed to:
The common stock of the Company is traded on the over-the-counter bulletin board under the symbol FDBC.
The following table lists the quarterly cash dividends paid and the range of bid and asked prices for the Company’s common stock. Such over-the-counter prices do not include retail mark-ups, markdowns, or commissions. The table also may not represent actual transactions.
2001 2000
Prices Dividends Prices Dividends
High Low Paid High Low Paid
---- --- ---- ---- --- ----
1st Quarter $37.375 $36.00 $.1875 $36.12 $35.12 $.1875
2nd Quarter $37.00 $35.50 $.20 $37.38 $35.25 $.1875
3rd Quarter $37.00 $35.90 $.20 $38.00 $35.75 $.1875
4th Quarter $37.75 $36.40 $.20 $37.75 $37.00 $.1875
The Company expects to continue paying similar dividends in the future. However, future dividends are dependent on earnings, the capital needs of the Company and other factors. Prior to the formation of the Company, the Bank paid dividends on a quarterly basis for over thirty years. Dividends are determined and declared by the Board of Directors. For a further discussion of regulatory capital requirements see Note 15 “Regulatory Matters”, contained within the Notes to Consolidated Financial Statements.
The Company had approximately 1,412 shareholders at February 28, 2002 and approximately 1,412 at December 31, 2001. The number of shareholders is the actual number of individual shareholders of record. Security depositories are considered as individual shareholders for the purpose of determining the approximate number of shareholders.
The Company has established a Dividend Reinvestment Plan for its shareholders. The Plan is designed to make the Company’s stock more available to our shareholders and to raise additional capital for future needs.
Assets, Deposits and Capital 2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Total assets $569,029,838 $491,077,054 $446,569,505 $348,069,896 $289,758,826
Total investment securities 153,973,988 119,756,391 109,262,221 78,607,860 72,712,902
Net loans 353,976,324 333,600,975 296,193,518 235,430,079 194,516,933
Loans available-for-sale 16,150,020 9,953,958 4,895,124 8,527,076 7,885,791
Total deposits 407,778,728 339,310,328 294,366,985 239,734,390 217,771,895
Total shareholders' equity 40,172,230 37,215,063 31,841,549 33,745,541 28,183,276
Operating Results
Total interest income $ 36,379,689 $ 35,085,780 $ 28,541,051 $ 23,443,709 $ 21,018,230
Total interest expense (20,853,631) (21,468,230) (15,375,799) (12,308,632) (10,639,884)
------------- ------------- ------------- ------------- -------------
Net interest income 15,526,058 13,617,550 13,165,252 11,135,077 10,378,346
Provision for loan losses (2,474,637) (1,158,260) (530,000) (646,000) (622,800)
------------- ------------- ------------- ------------- -------------
Net interest income after provision for
loan losses 13,051,421 12,459,290 12,635,252 10,489,077 9,755,546
Other income 3,701,578 3,005,218 2,227,787 1,902,734 1,303,470
Other expense (11,998,997) (11,699,489) (10,170,458) (7,609,162) (6,583,334)
------------- ------------- ------------- ------------- -------------
Income before provision for income taxes 4,754,002 3,765,019 4,692,581 4,782,649 4,475,682
Provision for income taxes (905,866) (558,391) (894,888) (1,246,760) (1,185,008)
------------- ------------- ------------- ------------- -------------
Net Income $3,848,136 $3,182,628 $3,797,693 $3,535,889 $3,290,674
============= ============= ============= ============= =============
Effective tax rate 19.05% 15.47% 19.07% 26.07% 26.48%
============= ============= ============= ============= =============
Net income per share * $ 2.12 $ 1.76 $ 2.12 $ 2.08 $ 1.98
============= ============= ============= ============= =============
Net income per share (diluted)* $ 2.12 $ 1.76 $ 2.12 $ 2.08 $ 1.98
============= ============= ============= ============= =============
Dividends declared $1,426,097 $1,366,075 $1,344,141 $ 1,200,409 $ 1,062,530
Dividends per share * $ 0.79 $ 0.76 $ 0.75 $ 0.70 $ 0.64
Weighted average number of shares
outstanding * 1,811,391 1,803,674 1,792,232 1,697,108 1,665,988
Actual shares outstanding at year end 1,819,168 1,806,274 900,392 893,647 837,260
Dividend payout ratio 37.06% 42.92% 35.39% 33.95% 32.29%
Return on average assets 0.72% 0.67% 0.94% 1.13% 1.20%
Return on average equity 9.64% 9.54% 11.42% 11.78% 12.43%
Equity to assets 7.06% 7.58% 7.13% 9.70% 9.73%
Equity to deposits 9.85% 10.97% 10.82% 14.08% 12.94%
*Based on weighted average shares and adjusted for the stock exchange in 2000.
Amounts reported for the years 1997 through 2000 have been restated as disclosed in Note 2 of the Notes to Consolidated Financial Statements contained herein.
The information required by Item 7a is set forth at Item 7 “Liquidity Management and Interest Rate Sensitivity” contained within Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and incorporated herein by reference.
The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate and reasonable. The Company’s methodology for determining the allowance for loan losses is described in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination. Further, a task force of the American Institute of Certified Public Accountants is working on detailed implementation guidance for calculating the allowance for loan losses. Implementation of that detailed implementation guidance, which may be issued in 2002, could result in an adjustment to the allowance.
Another material estimate is the calculation of fair values of the Company’s investment securities. The Company receives estimated fair values of investment securities from an independent valuation service through a broker. In developing these fair values, the valuation service uses estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of investment securities tend to vary among valuation services. Accordingly, when selling investment securities, management typically obtains price quotes from more than one source. As described in Notes 1 and 3 of the consolidated financial statements, the large majority of the Company’s investment securities are classified as available-for-sale. Accordingly, these securities are carried at fair value on the consolidated balance sheet, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income (included in shareholders’ equity).
The fair value of residential mortgage loans classified as available-for-sale is obtained from the Federal National Mortgage Association (Fannie Mae). The fair value of SBA loans classified as available-for-sale is obtained from an outside pricing source. The market to which the Bank sells mortgage and other loans is restricted and price quotes from other sources are not typically obtained. Further discussion on the accounting treatment of available-for-sale loans is in the section entitled “Loans available-for-sale”, contained within Management’s Discussion and Analysis.
All significant accounting policies are contained in Note 1 “Nature of Operations and Summary of Significant Accounting Policies”, contained within the Notes to Consolidated Financial Statements, and incorporated herein by reference.
The following discussion and analysis presents the significant changes in the results of operations and financial condition of the Company and its wholly-owned subsidiary, the Bank. This discussion should be read in conjunction with the consolidated financial statements and notes included in this report.
A comparison of balance sheet accounts and percentage to total assets at December 31, 2001, 2000 and 1999:
(Thousands of Dollars)
2001 2000 1999
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Assets
Cash and due from banks $19,845 3.49% $5,503 1.12% $6,416 1.44%
Interest-bearing deposits with
Depository institutions 5,800 1.02 3,277 0.67 11,542 2.58
Investment securities 153,974 27.06 119,756 24.39 109,262 24.47
Net loans 353,976 62.21 333,601 67.93 296,194 66.32
Loans Available-for-sale 16,150 2.84 9,954 2.03 4,895 1.10
Accrued interest receivable 3,268 0.57 3,546 0.72 2,971 0.67
Bank premises and equipment 11,514 2.02 11,391 2.32 9,506 2.13
Foreclosed assets held for sale 688 0.12 353 0.07 413 0.09
Other assets 3,815 0.67 3,696 0.75 5,370 1.20
--------- ------- -------- ------- -------- -------
Total assets $ 569,030 100.00% $491,077 100.00% $446,569 100.00%
========= ======= ======== ======= ======== =======
Liabilities
Deposits, noninterest-bearing $53,302 9.37% $ 47,185 9.61% $ 37,241 8.34%
Certificates of deposit of $100,000
or more 132,680 23.32 94,718 19.29 66,643 14.92
Other interest-bearing deposits 221,797 38.98 197,407 40.20 190,483 42.65
Short-term borrowings 54,481 9.57 48,025 9.78 60,249 13.49
Other borrowed funds 63,000 11.07 63,000 12.82 57,305 12.83
Accrued interest payable and other
Liabilities 3,598 0.63 3,527 0.72 2,807 0.64
--------- ------- -------- ------- -------- -------
Total liabilities 528,858 92.94 453,862 92.42 414,728 92.87
Shareholders' equity 40,172 7.06 37,215 7.58 31,841 7.13
--------- ------- -------- ------- -------- -------
Total liabilities and shareholders'
Equity $ 569,030 100.00% $491,077 100.00% $446,569 100.00%
========= ======= ======== ======= ======== =======
The year 2001Due to the economic volatility experienced throughout 2001, many investors moved funds from mutual funds into insured financial institutions. The Bank experienced growth in most deposit segments in reaction to market conditions. A $18,209,000 increase in internet-generated deposits in 2001, clearly reflects this trend.
Internet-generated deposits of $26,449,000 comprise 6.49% of total deposits at December 31, 2001, whereas they were only 2.43% of total deposits at December 31, 2000. Approximately $8,500,000 of these deposits were certificates of deposit (CDs) with terms exceeding twelve months. During the fourth quarter of 2001, the Bank lowered the rates on internet-generated CDs and as a planned result the growth in internet-generated deposits stopped.
With the flatness in the national economy predicted for 2002, the Bank anticipates that it will retain internet-generated deposit accounts for the near future.
Among the reasons cited by depositors as to why they selected the Bank are:
Personal demand deposit accounts (DDAs) increased $3,051,000 or 15.82% from $19,283,000 at December 31, 2000, to $22,334,000 at December 31, 2001. Part of the growth is attributed to recent branch expansion. For example, the new Kingston office had $273,000 in personal DDAs at December 31, 2001. Personal DDAs at the Peckville office, which opened in February 2000, increased $217,000 during 2001.
Commercial DDAs and Public Fund DDAs grew $4,302,000 or 19.40% from $22,180,000 at December 31, 2000, to $26,482,000 at December 31, 2001. Increased commercial lending relationships contributed to the growth in commercial deposits, as also did the successful marketing of commercial deposit products. Commercial products include:
Official Bank checks issued and outstanding decreased $1,237,000 from $5,723,000 at December 31, 2000, to $4,486,000 at December 31, 2001.
As a net result of these changes, total noninterest-bearing deposits grew $6,116,000 or 12.96% from $47,186,000 at December 31, 2000, to $53,302,000 at December 31, 2001. The increase in noninterest-bearing deposits represents 9.06% of the growth in total deposits during 2001.
Interest-bearing deposits increased $62,352,000 or 21.34% from $292,125,000 at December 31, 2000, to $354,477,000 at December 31, 2001.
Savings and club accounts collectively increased $2,029,000 in 2001.
Due to the drop in deposit rates throughout 2001, NOW accounts and money market deposits declined $2,191,000 and $7,980,000, respectively. A portion of this decrease was transferred into CDs, as depositors favored a guaranteed rate over liquidity.
CDs rose $70,494,000 or 34.20%. Personal CDs grew $32,601,000 or 21.35%. Nonpersonal CDs grew $19,739,000 or 40.76%. Public fund CDs increased $18,154,000 or 73.32% over year-end 2000.
The maturity distribution of CDs $100,000 or more at December 31, 2001 is as follows:
3 Months 3 - 6 6 - 12 Over
or less Months Months 12 months Total
------- ------ ------ --------- -----
$34,870,205 $10,697,915 $26,123,776 $60,988,099 $132,679,995
The over 12 months maturity distribution of CDs $100,000 or more increased $16,591,000 over 2000. This category represents 14.96% of total deposits at December 31, 2001 as compared to 13.08% in 2000. The increase provides the Bank with a stable source of funds for future requirements.
Total public fund deposits of $54,510,000 represent 13.37% of total deposits at December 31, 2001. Public funds at December 31, 2001 increased 17.59% over 2000. CDs comprise $44,855,000 of public fund deposits.
Bank policy states that public fund deposits with original maturities of one year or less cannot exceed 25% of total assets. At December 31, 2001 that ratio was 3.35%. Many of the public entities have had deposit relations with the Bank for a number of years. Other relations developed through branch expansion. While there may be a higher degree of risk
in retaining these deposits due to funding and earnings requirements of these depositors, the Bank is confident that it can maintain and increase this important source of funds.
At the end of 2001, total deposits had grown $68,469,000 or 20.18% from $339,310,000 at December 31, 2000, to $407,779,000 at December 31, 2001.
Short-term borrowings:With the increase in deposits and repurchase agreements (Repos), the Bank paid off short-term borrowings at the Federal Home Loan Bank of Pittsburgh (FHLB) which were $10,950,000 at December 31, 2000.
Repos are included with short-term borrowings on the balance sheet (see Note 8 “Short-term Borrowings”, contained within the Notes to Consolidated Financial Statements). Repos increased $18,271,000 or 50.77% from $35,987,000 at December 31, 2000 to $54,258,000 at December 31, 2001. Sweep accounts comprise approximately 74% of Repos. A sweep account transfers excess noninterest-bearing DDA funds into an interest-bearing Repo on a daily basis.
Long-term debt:Long-term debt consists of borrowings from the FHLB. The weighted average rate on funds borrowed at December 31, 2001, was 5.59%. The weighted-average rate is 166 basis points below the tax-equivalent yield of 7.25% on average earning assets for the year ending December 31, 2001. Rates on the advances are adjustable quarterly, should market rates increase. However, year-end rates on similar FHLB advances are 298 basis points below the rates being paid by the Bank. It is unlikely that FHLB borrowing rates will increase above the rates currently being quoted by the FHLB during 2002. Should this occur, the Bank has the option, at that time, to repay or renegotiate the advances.
At December 31, 2001, the Bank had the ability to borrow an additional $48,000,000 at the FHLB. The FHLB has short, medium and long-term funding products available to the Bank. Most lines of credit extended to banks by other lenders are short-term.
Balance Sheet, Assets:Total assets of the Company increased $77,953,000 or 15.87% during 2001. The increase is the result of growth primarily in deposits and Repos, as previously discussed, and the retention of profits.
Cash and due from banks:During the final week of December 2001, the Bank began to process its cash letter through the Federal Reserve Bank, Philadelphia, Pa., (Fed). Cash letters consists of cashed or deposited checks that are not drawn on the Bank and need to be sent for collection. The Fed was selected based on lower processing costs and improved availability of funds collection. It is estimated that the savings will approximate $30,000 annually.
While the transition was in process, correspondent bank balances ran higher than normal. This was done to insure that all processing reports were thoroughly understood in order to avoid potential overdrafts. The Bank anticipates that correspondent balances will return to historic levels during 2002.
Investments:Total investments had an increase during 2001 of $34,218,000, net of the change in the market value of available-for-sale investments. However, the amount of net change doesn’t truly reflect the activity during 2001, which was caused by market volatility.
With the fall in market rates, United States Government Agency bonds of $89,295,000 and municipal securities of $3,820,000 were called during 2001. United States Government Agency bonds of $4,000,000, classified as held-to-maturity, were included in the total amount called. There were no losses incurred on any called bond.
FHLB stock of $1,793,000, net of purchases, was redeemed by the FHLB during 2001. The FHLB requires participants to purchase stock to support borrowings. The FHLB determines the amount of stock required and at times may redeem stock.
Payments on mortgaged-backed securities increased from $1,207,000 during 2000, to $2,820,000 during 2001, as a result of the decline in market rates. Included in the total were payments of $1,234,000 on held-to-maturity bonds.
In 2001, the Bank sold United States Government Agency bonds and municipal investments from the available-for-sale category, having a net book value of $12,000,000 and $2,004,000, respectively, at the time of sale. Included in that amount were securities of $7,000,000 that the Bank had for less than one year, the shortest time period being five months. The remainder had been in the investment portfolio of the Bank between one and ten years. The investments were sold to protect the Bank from call provisions, which all the investments had, and for liquidity purposes.
There were no sales of investments categorized as held-to–maturity in 2001 and there were no trading securities during 2001.
United States Government Agency bonds totaling $137,904,000, mortgage-backed securities of $7,107,000 and preferred term securities of $1,000,000 were purchased in 2001. After careful consideration of the characteristics of the individual securities and their potential reaction to market changes, $18,994,000 United States Government Agency bonds were classified as held-to-maturity. The remaining securities were classified as available-for-sale.
Of the total amount purchased, United States Government Agency bonds with a par amount totaling $33,000,000 had maturities under five years. While the rates on these bonds were less than those with longer maturities, the purchases were made taking potential future market rate changes into consideration. Should rates increase, the proceeds of these bonds at maturity could be reinvested at higher rates quicker than bonds with longer maturities.
Preferred term securities are pooled borrowings by financial institutions located within the United States. The deposits of the institutions are insured by the Federal Deposit Insurance Corporation. The institutions must have a five-year satisfactory operating history and tier 1 capital greater than ten percent. The securities offer a slight diversity in the investment portfolio, approximately 200 basis points above Federal Funds, floating interest rate and five-year call protection.
Classifying bonds as held-to-maturity protects the balance sheet from downward market trends that available-for-sale securities are exposed to. The decision to classify securities as available-for-sale gives the Bank greater flexibility in the management of the investment portfolio and overall liquidity management.
The Bank actively monitors depreciation in the bond portfolio. When an individual bond, classified as available-for-sale, starts to depreciate, the Bank will determine if it is advisable to sell the security and reinvest the proceeds at a higher yield. Such considerations are based on current market conditions and liquidity needs. Even though bonds in the Bank’s portfolio may depreciate in market value, the principal and interest of the United States Government Agency bonds, mortgage-backed securities and municipal investments is guaranteed by the issuer.
Investments constituted 27.06% of total assets at December 31, 2001. Held-to-maturity securities were $21,640,000. The remaining $132,334,000 of the portfolio was classified as available-for-sale.
A comparison of investments at year-end for the three previous periods is as follows:
2001 2000 1999
---- ---- ----
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
U.S. Government Agencies $118,229,745 76.78% $ 81,513,237 68.07% $ 73,348,911 67.13%
Mortgage Backed Securities 19,349,772 12.57 15,033,019 12.55 7,686,688 7.04
State & Municipal Subdivisions 11,609,765 7.54 17,530,127 14.64 22,556,775 20.64
Preferred Term Securities 1,000,000 0.65 0 0.00 0 0.00
Common Stock 3,784,706 2.46 5,680,007 4.74 5,669,847 5.19
- ---------------------------------------------------------------------------------------------------------------------------
Total $ 153,973,988 100.00% $119,756,390 100.00% $109,262,221 100.00%
===========================================================================================================================
The distribution of debt securities by stated maturity date at December 31, 2001 is as follows:
1 Year 1 Through 5 Through More than
or less 5 years 10 years 10 years Total
------- ------- -------- -------- -----
U.S. Government Agencies $ 0 $ 32,512,284 $ 40,076,787 $ 45,640,674 $118,229,745
Mortgage Backed Securities 4,711 5,704 1,641,630 17,697,727 19,349,772
State & Municipal Subdivisions 200,653 985,853 6,235,904 4,187,355 11,609,765
Preferred Term Securities 0 0 0 1,000,000 1,000,000
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities $ 205,364 $ 33,503,841 $ 47,954,321 $ 68,525,756 $150,189,282
===========================================================================================================================
Debt securities are net of unrealized loss on available-for-sale securities. Net unrealized loss on available-for-sale debt securities at December 31, 2001, was $1,912,190. Debt securities do not include common stock, having a market value of $3,784,706 at December 31, 2001.
The tax equivalent yield on debt securities by stated maturity date at December 31, 2001, is as follows:
1 Year 1 Through 5 Through More than
or less 5 years 10 years 10 years Total
------- ------- -------- -------- -----
U.S. Government Agencies 0.000% 4.502% 5.779% 6.621% 5.751%
Mortgaged Backed Securities 7.863 7.000 5.377 6.284 6.207
State & Municipal Subdivisions 6.882 7.298 7.246 7.114 7.196
Preferred Term Securities 0.000 0.000 0.000 3.625 3.625
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities 6.390% 4.580% 5.960% 6.520% 5.910%
===========================================================================================================================
Loans:Gross loans increased $20,276,000 or 5.99% from $338,699,000 at December 31, 2000, to $358,975,000 at December 31, 2001. Gross loans represent 63.09% of total assets at December 31, 2001.
Loan growth was modest relative to previous years. Growth in the portfolio was slowed by the economic downturn both nationally and locally. As lending rates fell, prepayments on existing loans increased. Loans refinanced at lower rates increased the Bank’s exposure to interest-rate risk from potential market upturns. Many new and refinanced loans were classified as available-for-sale, with the intention of immediate sale. As detailed in the “Consolidated Statement of Cash Flows” contained herein, proceeds from the sale of loans in 2001 increased by $15,119,000 over 2000.
For a further discussion on these issues, see the MD&A sections entitled, “Loans available-for-sale” and “Liquidity Management and Interest Rate Sensitivity”. Additional discussion is in Note 1 “Nature of Operations and Summary of Significant Accounting Policies – Loans Held for Sale”, contained within the Notes to Consolidated Financial Statements, and incorporated herein by reference.
Increases in the amount of non-performing loans and net charge-offs also reflect the economic downturn. For a further discussion of delinquencies and net charge-offs, see the MD&A section entitled “Provision for Loan Losses”. Further discussion is in Note 1 “Nature of Operations and Summary of Significant Accounting Policies – Allowance for Loan Losses” and Note 5 “Loans and Leases” contained within the Notes to Consolidated Financial Statements, and incorporated herein by reference.
As a commitment to the market area, the Bank continues to seek quality loans, both commercial and consumer. However, the results of 2001 caused the Bank to review lending policies and collection efforts. Additional personnel, including a new experienced chief credit officer, were hired late in 2001, to address these concerns.
It is anticipated that the volume of prepayments and refinance requests will decrease, as rates become less volatile. Furthermore, new loans will be structured to better withstand market fluctuations and improved collection efforts should curtail serious delinquencies.
In the final analysis, the commitment of the Bank to our local communities remains strong and the Bank is sufficiently capitalized and structured to deal with these challenges.
Commercial loans at December 31, 2001 represent 49.88% of total gross loans, as compared to 43.29% at December 31, 2000. Commercial loans increased $32,433,000 or 22.12% from $146,611,000 at December 31, 2000, to $179,044,000 at December 31, 2001. The Bank increased the portfolio to improve profitability and to better service our community.
The Bank continues to originate loans using the Small Business Administration (SBA) guaranteed loan program. In return for the Bank funding a loan, which met the criteria of the program, the SBA guarantees a material portion of the principal balance to the Bank, should the borrower default.
Tax-free industrial development loans made to or backed by local municipalities increased 18.03% to $12,112,000 at December 31, 2001.
The Bank participates in the Pennsylvania Capital Access Program (PENNCAP). PENNCAP is a small business lending program whereby the State allocates a reserve fund to be used in the event the Bank were to experience a loss on a loan registered in the program. At December 31, 2001, $5,048,000 commercial loans were registered in this program. Loans registered in the PENNCAP program at December 31, 2001 increased 8.47% over the previous year-end.
The Bank continues to serve the local market with real estate loans. Real estate and construction loan totals of $102,187,000 were 28.47% of gross loans at December 31, 2001. Outstanding balances of real estate loans declined $10,727,000 since December 31, 2000.
In addition to prepayments, residential mortgages of $19,382,000, classified as available-for-sale, were sold on the secondary market. Servicing rights on sold loans were retained by the Bank. Servicing rights are retained so the borrower can still deal directly with the Bank. The loans were sold to provide the Bank with liquidity necessary to meet loan demand and to mitigate potential interest-rate risk from potential market rate increases. At December 31, 2001, the outstanding balance of sold residential mortgage loans in which the Bank retained servicing rights was $53,000,000.
Included with real estate loans are home equity lines of credit. The outstanding balance on the credit lines increased $642,000 or 12.14% from $5,289,000 at December 31, 2000 to $5,931,000 at December 31, 2001.
Consumer loans and direct-financing leases decreased $1,430,000 or 1.81% from $79,174,000 at December 31, 2000, to $77,744,000 at December 31, 2001. A combination of prepayments and the decision not to aggressively seek new leases
brought about this decline. Consumer loans also include credit card advances, which increased $215,000 or 7.29% to $3,162,000 at December 31, 2001.
In addition to direct issuance of credit cards, the Bank issues cards under an Affinity Credit Card program. Affinity Cards are initially offered to cardholders at below market rates for a predetermined time. After the time expires, the cards are repriced at rates usually slightly below market rates. A percent of the interest charged is donated to a named entity. Participating with the Bank in the program are:
At December 31, 2001, the outstanding balance on Affinity Cards was $1,211,000, or 38.30% of the outstanding credit card portfolio. The Bank is pursuing new program participants for 2002.
A comparison of loans by amount at year-end for the five previous periods is as follows (all loans are domestic):
2001 2000 1999 1998 1997
----- ----- ---- ---- ----
Real estate $ 96,740,226 $109,942,570 $111,242,490 $99,955,640 $87,931,770
Consumer 67,782,196 66,441,389 64,998,362 47,549,512 38,673,662
Commercial 179,043,816 146,610,685 113,061,093 85,425,708 67,201,013
Direct financing leases 9,961,967 12,733,075 5,710,579 2,248,990 1,536,074
Real estate construction 5,446,870 2,971,504 5,335,753 3,810,975 2,568,997
- ---------------------------------------------------------------------------------------------------------------------
Gross loans 358,975,075 338,699,223 300,348,277 238,990,825 197,911,516
Less:
Unearned discount 1,256,818 1,833,968 982,384 553,033 585,517
Allowance for loan losses 3,741,933 3,264,280 3,172,375 3,007,713 2,809,066
- ---------------------------------------------------------------------------------------------------------------------
Net Loans $353,976,324 $333,600,975 $296,193,518 $235,430,079 $194,516,933
=====================================================================================================================
Loans available-for-sale $16,150,020 $9,953,958 $4,895,124 $8,527,076 $7,885,791
=====================================================================================================================
A comparison of gross loans by percent at year-end for the five previous periods is as follows:
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Real estate 26.95% 32.46% 37.04% 41.82% 44.43%
Consumer 18.88 19.62 21.64 19.90 19.54
Commercial 49.88 43.29 37.64 35.74 33.96
Direct financing leases 2.77 3.76 1.90 0.94 0.78
Real estate construction 1.52 0.87 1.78 1.60 1.29
- ---------------------------------------------------------------------------------------------------------------------
Gross loans 100.00% 100.00% 100.00% 100.00% 100.00%
=====================================================================================================================
There are no concentrations of loans to a number of borrowers engaged in similar activities exceeding 10% of total loans, that are not otherwise disclosed as a category in tables above.
The following table sets forth the maturity distribution of the loan portfolio at December 31, 2001. Excluded from the table are non-construction real estate loans, consumer loans and direct financing leases (amounts in thousands):
1 year 1 - 5 More than
or less years 5 years Total
------- ----- ------- -----
Commercial loans $51,482 $49,655 $77,907 $179,044
Real estate construction 5,447 5,447
- ---------------------------------------------------------------------------------------------
Total $56,929 $49,655 $77,907 $184,491
=============================================================================================
The following table sets forth the sensitivity changes in interest rates for commercial and real estate construction loans at December 31, 2001 (amounts in thousands):
1 - 5 More than
years 5 years Total
----- ------- -----
Fixed interest rate $17,657 $21,814 $39,471
Variable interest rate 31,998 56,093 88,091
- ---------------------------------------------------------------------------------
Total $49,655 $77,907 $127,562
=================================================================================
Loans available-for sale:Loans are classified as available-for-sale at origination. Should market rates increase, fixed rate loans and loans not immediately repricable would no longer produce yields consistent with the current market. To protect the Bank from interest-rate risk, loans meeting these conditions may be classified as saleable. Certain consideration is also given to current liquidity needs.
Fees or costs associated with loan originations are capitalized and charged or credited to loan income over the term of the loan. The measures apply to both available-for-sale and held-to- maturity loans.
Saleable loans are carried on the balance sheet at the lower of cost or fair value. If the fair value falls below cost, the difference is charged to current earnings. Appreciation in the portfolio is credited to current earnings, only to the extent of previous write-downs below cost.
Due to the falling rate environment experienced in 2001, the Bank increased loans available-for-sale by $6,196,000 or 62.25% to $16,150,000 at December 31, 2001 due to concern of potential interest-rate risk.
Bank premises and equipment, net:Additions to premises and equipment were $1,224,000 before depreciation of $1,101,000 in 2001. Improvements to and equipping the new Kingston branch accounted for $718,000 of the increase. The remainder was used for system improvements and the expansion of the ATM network.
Foreclosed assets held for sale:The $335,000 increase was primarily due to repossessed vehicles and from vehicles returned at the expiration of direct financing lease agreements.
Personal DDAs increased $2,141,000 or 12.49% from $17,158,000 at December 31, 1999, to $19,299,000 at December 31, 2000. During 2000, the Bank accepted personal deposits of $13,000 from internet-generated accounts.
Commercial DDAs and Public Fund DDAs grew $3,812,000 or 20.75% from $18,368,000 at December 31, 1999, to $22,180,000 at December 31, 2000. Commercial deposits grew as a result of increased commercial lending relationships and the successful marketing of Bank products designed for the commercial segment.
Official Bank checks issued and outstanding increased $3,991,000 from $1,716,000 at December 31, 1999, to $5,707,000 at December 31, 2000.
As a net result of these changes noninterest-bearing deposits grew $9,944,000 or 26.70% from $37,242,000 at December 31, 1999, to $47,186,000 at December 31, 2000. The increase in non interest-bearing deposits represents 22.13% of the growth in total deposits during 2000.
Interest-bearing deposits increased $34,999,000 or 13.61% from $257,126,000 at December 31, 1999, to $292,125,000 at December 31, 2000.
NOW accounts increased $7,434,000 or 24.16% during 2000. The growth was based on the tiered Super NOW account that has a monthly interest rate based on a discount of the most current auction of the 13-week United State Treasury bill. During 1999, NOW accounts increased $16,014,000. During 2000, the Bank accepted deposits of $37,000 from internet-generated accounts.
Money market deposit accounts and savings accounts declined $10,004,000 or 17.69%. During 1999, these deposits grew $7,388,000. The decrease, during 2000, in money market and savings deposits was caused in part by the transfer of funds into the higher rate NOW accounts and certificates of deposit (CDs).
CDs rose $37,540,000 or 22.27%. Personal CDs grew $13,090,000 or 9.38%. Non-personal CDs grew $16,642,000 or 138.17%. Public fund CDs increased $7,808,000 or 46.06% over year-end 1999. During 2000 the Bank accepted brokered deposits of $9,851,000 for liquidity purposes. The Bank also accepted $8,190,000 in new CDs from the internet.
At the end of 2000, total deposits had grown $44,943,000 or 15.27% from $294,367,000 at December 31, 1999, to $339,310,000 at December 31, 2000.
The success at gathering new deposits by branch expansion is evidenced by the deposit totals at the locations opened during the last twenty-four months. Total deposits at the three branches opened during 1999 increased $13,489,000 during 2000. The Peckville office, in eleven months, had deposit totals of $9,410,000 at December 31, 2000. Those branches contributed 50.97% of the total growth in deposits during 2000.
Short-term Borrowings:Having successfully passed the advent of “Year 2000", the Bank reduced short-term borrowings at the Federal Home Loan Bank (FHLB) by $19,650,000, from $30,600,000 at December 31, 1999, to $10,950,000 at December 31, 2000. Repurchase Agreements (Repos) are included with short-term borrowings, on the balance sheet. Repos increased
$7,500,000 or 26.33% from $28,487,000 at December 31, 1999, to $35,987,000 at December 31, 2000. Sweep accounts comprise approximately 70% of Repos.
Long-term debt:The Bank repaid maturing long-term debt of $1,305,000 at the FHLB in 2000. As interest rates increased during 2000, the Bank restructured $41,000,000 variable rate long-term debt at the FHLB. The purpose of the restructure was to minimize the increase in interest expense. Another $7,000,000 was borrowed in long-term funds from the FHLB to fund loan demand and for other liquidity needs. The weighted-average rate on funds borrowed at December 31, 2000 was 5.59%. The weighted-average rate is 236 basis points below the tax equivalent yield of 7.95% on average earning assets for the month ending December 31, 2000.
Balance sheet Assets:Total assets of the Company increased $44,508,000 or 9.97% during 2000. The increase is the result of growth in the liability section, as previously discussed and the retention of profits.
Cash and Due from Banks:At December 31, 1999, total cash and due from banks was $17,957,000. This amount was established to provide additional liquidity in the event of any Year 2000 problems. Of that amount $11,542,000 was in an interest-bearing account at the Federal Home Loan Bank. Having successfully passed year-end 1999, the Bank reduced the level of additional cash and cash equivalents by $9,178,000 at December 31, 2000, to more historic levels. The funds were used to paydown short-term borrowings.
Investments:Total investments had an increase during 2000 of $10,494,000, net of the change in the market value of available-for-sale investments.
United States Government Agency bonds totaling $4,000,000 par value, having a weighted average rate of 8.01%, and Pennsylvania municipal bonds with a par value of $1,860,00 and a weighted average tax-equivalent rate of 8.02%, were purchased in 2000. The investments were classified as available-for-sale.
The Bank sold certain qualifying residential mortgage loans totaling $8,329,000 to FNMA and immediately repurchased the assets as investments (mortgage backed securities). The purpose of this strategy was threefold:
Since it was determined that the securities would not be sold in the future, the Bank classified them as held-to–maturity. This classification protects the balance sheet from downward market trends that available-for-sale securities are exposed to.
Municipal securities and other investments of $1,898,000 were purchased in 2000. Those assets were categorized as available-for-sale. One municipal security of $150,000 was called in 2000.
In 2000, the Bank sold municipal investments from the available-for-sale category having a net book value of $7,466,000 at the time of sale. Included in that amount were securities of $1,412,000 that the Bank had for less than one year, the shortest time period being six months. The remainder had been assets of the Bank between two and nine years. The investments were sold to protect the Bank from call provisions, which all the investments had, and for liquidity purposes.
There were no sales of investments categorized as held-to-maturity during 2000 and there are no trading securities in 2000.
Investments constituted 24.39% of total assets at December 31, 2000. Held-to maturity securities were $7,879,000. The remaining $111,877,000 of the portfolio was classified as available-for-sale. The decision to classify securities as available-for-sale gives the Bank greater flexibility in the management of the investment portfolio.
The tax equivalent yield on debt securities by stated maturity date at December 31, 2000, is as follows (yields are based on amortized cost):
1 year 1 through 5 through More than
or less 5 years 10 years 10 years Total
------- ------- -------- -------- -----
U.S. Government Agencies 0.000% 6.005% 6.574% 6.946% 6.809%
Mortgage Backed Securities 0.000 7.567 6.448 6.534 6.531
State & Municipal Subdivisions 7.120 7.289 7.297 7.297 7.293
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities 7.120% 6.592% 6.714% 6.914% 6.847%
===========================================================================================================================
Loans:
Gross loans increased $38,351,000 or 12.77% from $300,348,000 in 1999, to $338,699,000 in 2000. Gross loans represent 68.97% of total assets at December 31, 2000.
Commercial loans at December 31, 2000 represent 43.29% of total gross loans, as compared to 37.64% at December 31, 1999. Commercial loans increased $33,550,000 or 29.67% from $113,061,000 at December 31, 1999, to $146,611,000 at December 31, 2000. The Bank increased the portfolio to improve profitability and to better service our community.
At December 31, 2000, the outstanding balance of SBA loans was $4,904,000, a 12.26% increase over 1999.
Tax-free industrial development loans made to or backed by local municipalities increased 41.72% to $10,262,000 at December 31, 2000.
Throughout the year, the Bank has worked closely with Northeast Pennsylvania Economic Development Council, City of Scranton Office of Economic Community Development and the Pennsylvania Economic Development Finance.
Real estate and construction loans of $112,914,000 were 33.34% of gross loans at December 31, 2000. While the outstanding balance of real estate loans at December 31, 2000 were $3,664,000 less than the balances at December 31, 1999, several factors must be considered. As detailed in the discussion of investments, fixed rate residential mortgages of
$8,329,000 were securitized through FNMA and reclassified as investments. In addition, residential mortgages of $8,383,000 were sold on the secondary market, with the Bank retaining the servicing rights. The loans were sold to provide the Bank with liquidity necessary to meet loan demand.
Included with real estate loans are home equity lines of credit. The outstanding balance on the credit lines increased $829,000 or 18.59% from $4,460,000 at December 31, 1999, to $5,289,000 at December 31, 2000.
Consumer loans increased $1,443,027 or 2.22% from $64,998,000 at December 31, 1999, to $66,441,000 at December 31, 2000. The largest portion of consumer loans are simple interest loans secured by vehicles. At December 31, 2000 auto loans were $28,045,000.
During 2000, the Bank sold $7,000,000 loans secured by vehicles that had been initiated by car dealers. The Bank reviewed the loans in an attempt to retain the borrowers who had other relationships with the Bank. The loans were sold without recourse and servicing rights. The loans were sold to provide liquidity.
Credit card outstanding balances increased $1,450,000 or 96.82% from $1,497,00 at December 31, 1999, to $2,947,000 at December 31, 2000.
In 2000, the Bank started an Affinity Credit Card program. At December 31, 2000, the outstanding balance on Affinity Cards was $1,264,000.
Direct financing leases increased $7,022,000 or 122.97% from $5,711,000 at December 31, 1999, to $12,733,000 at December 31, 2000. The growth primarily resulted from increased demand from auto dealers for consumer auto leases.
There are no concentrations of loans to a number of borrowers engaged in similar activities exceeding 10% of total loans that are not otherwise disclosed as a category in tables above.
The Bank sold residential real estate mortgage loans in 2000. At December 31, 2000, the outstanding balance of sold residential mortgage loans in which the Bank retained servicing rights was $42,631,000.
The following table sets forth the maturity distribution of the loan portfolio at December 31, 2000. Excluded from the table are real estate loans, consumer loans and direct financing leases (amounts in thousands):
1 year 1 - 5 More than
or less years 5 years Total
------- ----- ------- -----
Commercial loans $45,214 $40,539 $60,858 $146,611
Real estate construction 2,972 2,972
- ---------------------------------------------------------------------------------------------
Total $48,186 $40,539 $60,858 $149,583
=============================================================================================
The following table sets forth the sensitivity changes in interest rates for commercial and real estate construction loans at December 31, 2000, (amounts in thousands):
1 - 5 More than
Years 5 years Total
----- ------- -----
Fixed interest rate $25,768 $20,775 $46,543
Variable interest rate 14,771 40,083 54,854
- ---------------------------------------------------------------------------------
Total $40,539 $60,858 $101,397
=================================================================================
Fixed asset additions were $2,930,000 in 2000.
Main Office and KIP renovations were $1,393,000 and $393,000 respectively. The renovations were made to modernize and improve both facilities. Another $55,000 was capitalized for system upgrades and furniture at the newly remodeled KIP branch.
The Bank acquired a commercial property in Dunmore, Pennsylvania for future expansion. The acquisition cost was $128,000.
Leasehold improvements of $198,000 and furniture and fixture additions of $120,000 were needed to open the new Peckville branch.
Additions to furniture and fixtures for system hardware and software requirements were $363,000 during 2000.
Other Assets:Due to the market appreciation of available-for-sale investments, the deferred tax asset of $2,408,000 at December 31, 1999, was reduced $1,725,000 to $683,000 at December 31, 2000.
Mortgage servicing rights increased $129,000 from $123,000 at December 31, 1999 to $252,000 at December 31, 2000, due to the mortgages sold during 2000.
Capital ResourcesThe Bank’s major source of capital has been from the retention of earnings, as reflected below:
Net Dividends Earnings
Income Declared Retained
------ -------- --------
2001 $3,848,136 $1,426,097 $2,422,039
2000 3,182,628 1,366,075 1,816,553
1999 3,797,693 1,344,141 2,453,552
1998 3,535,889 1,200,409 2,335,480
1997 3,290,674 1,062,530 2,228,144
Capital was further increased in 2001, through the Dividend Reinvestment Plan (DRIP). Shareholders reinvested $420,000 in dividends to purchase additional shares of stock.
The reinvestment in 2001 was greater than 2000 but more in line with 1999. During 2000, the Bank’s DRIP ended when it merged with the Company. The Company had to receive regulatory approval for its own DRIP and during the process two dividend payments were disbursed. After the approval was granted, shareholders had to apply to become part of the Company’s DRIP.
Capital was affected by changes in market rates, which caused a $63,000 improvement, net of deferred taxes, in the fair value of investments classified as available-for-sale. At December 31, 2000, the Bank reported a net unrealized loss on AFS securities of $1,325,000. At December 31, 2001, the loss was reduced to $1,262,000.
Fluctuations in the capital markets cause frequent changes in the fair value of available-for-sale securities. A future decline in value should not indicate a material weakness in the capital position of the Company. The Company monitors market conditions closely and is prepared to take remedial action when appropriate.
Capital is evaluated in relation to total assets and the risk associated with those assets. With greater capital resources, a bank is more likely to be able to meet its cash obligations and absorb unforeseen losses. Federal regulatory definitions of capital adequacy take the form of minimum ratios. The Bank exceeds all minimum regulatory capital requirements (see Note 15 “Regulatory Matters”, contained within the Notes to Consolidated Financial Statements, and incorporated herein by reference).
A yearly comparison of growth trends is as follows (Increase/(Decrease)):
Earning Short-term Other
Assets % Assets % Deposits % Borrowings % Borrowings %
------ - ------ - -------- - ---------- - ---------- -
2001 $77,952,784 16% $60,585,502 13% $68,468,400 20% $ 6,456,267 13% $ 0 0%
2000 44,507,549 10 44,562,595 10 44,943,343 15 (12,224,325) (20) 5,695,000 10
1999 98,499,609 29 88,171,199 26 54,632,595 23 30,843,747 105 15,053,000 36
1998 58,311,070 20 54,885,888 19 21,962,495 10 304,848 1 30,000,000 245
1997 21,100,757 8 21,363,323 8 5,940,340 3 9,510,675 49 2,252,000 22
Earning assets do not include loans placed on non-accrual.
Liquidity Management and Interest Rate Sensitivity:Liquidity for a bank is primarily the ability to meet working capital requirements and to fund customers’ needs for borrowings and withdrawals. The Bank further desires to have funds available at certain times to take advantage of appropriate investment opportunities. Other considerations include capital expansion, dividend payments and unforeseen events. Sources of liquidity are:
Normally, long-term borrowed funds and stock issuance are used for long-term asset acquisitions or capital considerations and not for short-term liquidity needs.
Management monitors asset and liability maturities to match anticipated cash flow requirements. These cash flow requirements are reviewed with the use of internally generated reports. The Bank has instituted certain procedures and policy guidelines to manage interest-rate risk. These guidelines enable management to react to interest rate changes and potential shifts in the volumes of assets and liabilities. One objective is to insulate the net interest margin from
significant fluctuations. Included in these guidelines are tolerance levels that specify the percentage of asset paydowns and maturities to potential liability maturities and runoff.
The intent of the Bank is to maintain a cumulative gap (rate sensitive assets to rate sensitive liabilities) ratio, over a one year time horizon, between 0.75 and 1.25. At December 31, 2001, the ratio was 0.96. That ratio was arrived at by scheduling investments by call date and liabilities by expected maturity or repricing dates.
Under current market conditions, it was felt that certain securities in the investment portfolio, which had the potential to be called prior to stated maturity, were more likely than not to be called. Even though it is believed that market rates will not significantly change during 2002, many of the investments have rates above the current market and this makes it more likely such securities will be called by the issuers sometime before their scheduled maturity dates.
Loans were scheduled by cash flow projections to the date of maturity or the date of next rate change. Loans available-for-sale were scheduled by stated maturity dates.
Over the years, the Bank has sold fixed-rate mortgage loans to the secondary market. The decision to pursue this course of action was based upon two parameters:
The following chart depicts the contractual maturity and repricing characteristics of interest-earning assets. When evaluating interest-rate risk, the data is refined to include optionality. Such analysis takes into account call features, cash flows, prepayment assumptions and other factors, which may affect the rate sensitivity of the assets (amounts in thousands of dollars):
90 days 91 through 1 to 5 5 or more
or less 365 days years years Total
- ----------------------------------------------------------------------------------------------------------------------
Loans:
Fixed rate............................. $ 4,147 $ 9,916 $ 54,181 $153,012 $ 221,256
Adjustable rate........................ 100,637 24,155 23,263 900 148,955
Debt Securities:
Fixed rate............................. 82,383 30,802 29,858 5,048 148,091
Adjustable rate........................ 2,036 62 - - 2,098
Interest-bearing deposits................ 5,800 - - - 5,800
- ----------------------------------------------------------------------------------------------------------------------
Total.................. $195,003 $ 64,935 $107,302 $158,960 $ 526,200
======================================================================================================================
Nonaccrual loans of $4,914,000 and investments in common stock of $3,785,000 at December 31, 2001 are not included in the maturity distribution table. Loans include those designated as available-for-sale.
Earning assets are based on book value. Book value is net of unrealized losses in the available-for-sale investment portfolio. The total of net unrealized losses in the portfolio before federal taxes is $1,912,000. The net loss reflects the December 31, 2001 market value of the available-for sale investment portfolio. If held until maturity, the Bank would receive full face value.
Scheduling investments by call dates and using amortized cost instead of market values on available-for-sale investments would make the presentation more asset-sensitive in the earlier gap periods.
Investments with call provisions are likely to be called in a downward rate environment. Fixed rate investments of $111,900,000, subject to call during 2002, have maturity dates exceeding one year. Of that amount, $37,000,000 have rates of 6.50% or more which would greatly increase the potential for these bonds to be called, based on year-end rates.
Loans due to mature in one year or less do not include principal reductions on fixed rate loans and leases that historically prepay in a downward rate environment.
The following chart depicts the contractual maturity and repricing characteristics of liabilities with either a defined maturity or repricing schedule. Non-maturity deposits are based on an aging schedule. In evaluating interest-rate risk, data may be refined depending on the anticipated direction of interest rates, expected shifts in volume and other factors which may affect the specific liability’s rate sensitivity.
90 days 91 through 1 to 5 or more
or less 365 days 5 years years Total
------- -------- -------- -------- ---------
Deposits, noninterest- bearing $ 2,068 $ 6,498 $ 25,042 $ 19,694 $ 53,302
Certificates of deposit over $100,000 34,870 36,822 60,883 105 132,680
Other interest-bearing deposits 14,830 59,145 111,411 36,411 221,797
Securities sold under repurchase agreement 52,987 1,265 6 - 54,258
Demand notes, U.S. Treasury 223 - - - 223
Long-term debt 53,000 10,000 - - 63,000
- --------------------------------------------------------------------------------------------------------
Total $157,978 $113,730 $197,342 $ 56,210 $ 525,260
========================================================================================================
Liabilities not having stated maturity dates have been scheduled based upon an aging of the liabilities. The time frames relied upon suggest that the liabilities will have the potential to possibly reprice to current market rates or be withdrawn within the stated period.
For example, at December 31, 2001, the one-year cumulative gap shows that $8,566,000 noninterest-bearing deposits will payout over the next twelve months. In reality, non interest-bearing deposits grew $6,210,000 during 2001. Historical data suggests that the Bank will not experience appreciable repricing or runoff of these non interest-bearing accounts over the course of the next twelve months.
At December 31, 2001, the Bank had the following additional sources of funds, which totaled $76,967,000, available to meet liquidity requirements:
Because more investments were pledged for public funds and Repos than was necessary at December 31, 2001, the available amount at the Fed could be increased approximately $6,576,000.
Management continually monitors the gaps between assets and liabilities and makes adjustments as market rates change. Presently Management believes that there is adequate liquidity to meet normal requirements.
Interest rate risk management:Interest-rate risk management is an integral part of the Asset/ Liability management process. The management of and authority to assume interest-rate risk is the responsibility of the Company’s Asset/Liability Committee (ALCO). ALCO is
comprised of senior management and the Board of Directors. ALCO meets quarterly to monitor the ratio of interest sensitive assets to interest sensitive liabilities. The process to review interest rate risk is a regular part of the management of the Company. Consistent policies to measure and report interest-rate risk are in effect. In addition, policies are reviewed annually by the committee. The annual review establishes acceptable limits on the impact to earnings from shifts in interest rates. These limits may be altered during the year, if so warranted.
Interest-rate risk is defined as the degree to which interest rate movements may affect net interest income, net income and the balance sheet. Fluctuations in rates can affect both interest income and interest expense through the balance of repricing assets and source funds. In addition, changes in interest rates may affect the volume of various assets and liabilities.
If more assets reprice than liabilities within a given time horizon, the balance sheet is positively gapped. This position suggests that the net interest margin and net income would be positively impacted should interest rates rise. Conversely, the net interest margin would be adversely affected should rates fall.
If the balance sheet has more liabilities repricing than assets within a given time horizon, the balance sheet is liability sensitive and negatively gapped. In a declining rate environment, this suggests that net interest income has the potential to improve but with rising rates, net interest income has the potential to decrease.
The Bank uses a simulation model, which attempts to measure the impact changes in rates and/or volumes may have on net interest income, net income and capital adequacy. The model measures the impact of changing interest rates for several scenarios. The following table illustrates the theoretical impact of interest rate changes. The rate movements shown below represent parallel shifts in the yield curve, occurring immediately and lasting for the twelve-month projection.
The analysis assumes that December 31, 2001 levels of assets and liabilities will grow by approximately nine percent over the next twelve months. In the normal course of events, balance sheet growth during a given twelve-month period is anticipated. Growth will affect both revenues and expense. Generally, a higher rate of growth will produce higher levels of net revenues. On a year to year basis, the average rate of the Bank’s growth over the past five years has been slightly above twenty percent. The Bank considers growth of nine percent to be a conservative estimate of how much the Bank will grow in size by the end of 2002. The relative mix of assets and liabilities should remain constant in 2002.
The interest rate movements are immediate and the revenue impacts are estimated for the subsequent twelve-month period.
The table below shows the increase or (decrease) from 2001 reported figures that would occur under the interest rate changes over a twelve-month period beginning January 1, 2002:
Basis Point Change, change in thousands +400 bps +200 bps +100 bps 12/31/01 -100 bps -200 bps -400 bps
- ---------------------------------------- ----------- ----------- ----------- --------------- ----------- ----------- -----------
Net Interest Income $16,147 $16,768 $17,079 $15,526 $17,234 $16,458 $14,439
Net Income $4,040 $4,579 $4,695 $3,848 $4,848 $4,156 $2,771
Present Value of Equity $54,634 $47,805 $44,189 $40,172 $35,753 $30,531 $21,291
======================================== =========== =========== =========== =============== =========== =========== ===========
Proforma +400 bps +200 bps +100 bps 12/31/01 -100 bps -200 bps -400 bps
- ---------------------------------------- ----------- ----------- ----------- --------------- ----------- ----------- -----------
Earnings Per Share $2.23 $2.50 $2.61 $2.12 $2.67 $2.29 $1.53
======================================== =========== =========== =========== =============== =========== =========== ===========
At January 1, 2002, if there was an immediate 200 basis point increase in all market interest rates, net interest income is projected to increase by $1,242,000 over the next twelve months, a 8.00% increase from 2001‘s net interest income. The present value of Bank capital is projected to increase 19.00% to $47,805,000.
If there were an immediate 200 basis point decrease in rates, net interest income is projected to increase $932,000 or 6.00% over twelve months. The present value of the Bank’s capital is projected to decrease 24.00% to $30,531,000.
The reason for earnings improvement under both 200 basis point scenarios is twofold. Historically, when rates increase, the Bank immediately raises borrowing rates and seeks opportunities in the bond market to improve net interest income. Rates on interest-bearing liabilities may be gradually increased, depending on funding requirements. Conversely, when rates decline the Bank is more likely to decrease liability rates before it decreases rates on new loans.
Secondly, the weighted average rate on term deposits and Repos of $190,739,000, maturing within twelve months, was 4.08% at December 31, 2001. The Bank’s offering rate for CDs at December 31, 2001 was 2.25%. If rates went up 200 basis points CDs would be costing approximately the same as at year-end and rates on interest-bearing assets would have increased.
Therefore, under either 200 basis point scenario the Bank is able to improve net interest income.
The same does not hold true should rates drop 400 basis points. At December 31, 2001, non-term interest-bearing deposits of $76,981,000 were at rates of 1.67% or less. It would not be possible to reduce those deposit rates a full 400 basis points at this point in the economic cycle.
The interest rate changes described above are extreme. However, the market events of 2001 proved that rates can move dramatically over the course of twelve months. While the decrease in national prime occurred not immediately but with eleven reductions, prime was reduced 475 basis points.
The projections require a variety of assumptions, including but not limited to prepayment speeds on assets, and, as such, the results should be viewed as approximations. It should be noted that, while the reader is cautioned that these are approximations of possible but not certain events, the December 31, 2000 projection for 2001 net interest income in a 400 basis point declining rate environment was within 96% of actual results.
Should changing interest rates have a negative effect on the financial position of the Bank, prompt corrective measures would be undertaken to minimize any adverse impact.
The percent change in the present value of equity in either an upward or downward 200 basis point shift is within the Bank’s tolerance level of 25%.
The severity of the decrease in the present value of equity in a 400 basis point rate decrease relates to the inability to reduce all interest-bearing liabilities the full 400 basis points. The market value of assets would theoretically increase since rates on assets would either be at or above the current market. With the inability to effectively reduce rates on all interest-bearing liabilities, the liabilities would be above market rates and overvalued. The overvaluation of the liabilities would be deducted from equity to bring that combined section into balance with assets.
Although interest rates have the potential to change appreciably over the course of a year, it is unlikely that some of the more extreme rate changes depicted in the table above will occur, given current market conditions.
2001 2000 1999
---- ---- ----
Net income $3,848,136 $3,182,628 $3,797,693
Earnings per share $2.12 $1.76 $2.12
Increase/(decrease) per share 20.45% (16.98)% 1.92%
Per share data has been adjusted for the stock exchange in 2000.
Net Interest Income:The Federal Reserve Bank lowered the discount rate eleven times in 2001. The discount rate is the rate at which the Federal Reserve Bank lends overnight funds to banks. In response to these actions, national prime dropped 475 basis points from 9.50% to 4.75%.
There is a 234 basis point differential between the weighted average of national prime in 2001 and 2000. The weighted average of national prime in 2001 and 2000 was 6.90% and 9.24%, respectively. This difference reflects on the yield on earning assets and the cost of funds when comparing both years.
The actions of the Federal Reserve Bank caused decreases in the rates charged on loans that were subject to repricing and on the rates offered on new loans in 2001. Approximately 23% of the entire loan portfolio was subject to immediate repricing at December 31, 2001. Rates charged on new loans paralleled the reductions in prime. Sales of older loans contributed to the decline in the overall yield on loans.
Market reaction to the drop in prime significantly increased the amount of bonds called during 2001. To properly collateralize public fund deposits and Repos, the Bank had to replace the called bonds with bonds producing a lower yield.
Excess funds from asset turnover and the increase of liabilities were sold daily. The rates on these “Fed funds sold” were at historic lows.
Due to the combination of these factors, the tax equivalent yield on earning assets decreased 58 basis points.
Interest expense was also effected by the decline in national prime. In addition to the drop in rates paid on deposits and Repos, the Bank used the increase in funds to payoff $10,950,000 in short-term borrowings at the FHLB, further reducing interest expense. There were rate promotions at the new Kingston branch to develop deposit growth. This had minimal effect on the overall reduction of interest expense.
The effect of market changes caused a 72 basis point decrease in the cost of funds.
With the 14 basis point increase in the tax-equivalent net interest spread and volume increases in loans and investments, net interest income rose $1,909,000 or 14.02% during 2001.
During 2000, the Federal Reserve Bank raised the discount rate three times. These actions caused national prime to increase from 8.50% to 9.50%. The weighted average rate of national prime rose 124 basis points.
The actions of the Federal Reserve Bank caused increases in the rates charged on loans that were subject to repricing and on the rates offered on new loans in 2000. Approximately 18% of the entire loan portfolio was subject to immediate repricing at December 31, 2000.
To remain competitive, the rates charged on new residential mortgages and consumer loans did not rise directly with the increases in prime. New products, such as the Affinity Card, were offered at discounts from established Bank products.
With the increase in national prime, it became difficult to sell from the inventory of fixed rate residential loans at a break even level. The sale of loans provides a source of funds that can then be loaned at a higher yield in a rising rate market.
In the preceding year, the Bank realized a significant increase in short-term public fund deposits and Repos. To properly secure these deposits, the Bank purchased callable fixed rate bonds. When rates increased, the bonds were not called, as the issuers took advantage of the lower cost of borrowings.
Due to the combination of these factors, the Bank was only able to recognize a 35 basis point improvement in the tax equivalent yield on earning assets.
In order to provide the liquidity to meet loan demand and thereby improve the yield on earning assets, the Bank began to raise the interest rates paid on deposits and Repos. Interest expense was also effected by a rise in the rates charged on borrowed funds. In addition, the cost of funds was increased by deposit promotions, including the Super NOW and internet-generated deposit accounts and the acceptance of brokered funds.
The effect of these increases caused an 80 basis point increase in the cost of funds.
Despite a 45 basis point reduction in tax-equivalent net interest spread, net interest income rose $452,000 or 3.44% during 2000. This was primarily accomplished through volume increases in loans and investments.
A comparison of average earnings assets and the net tax equivalent yields for 2001, 2000 and 1999, in thousands, is as follows:
2001 2000 1999
--------------------------------------------------------------------------------------------
Average Revenue Yield Average Revenue Yield Average Revenue Yield
Earning assets: Balance (Expense) (Cost) Balance (Expense) (Cost) Balance (Expense) (Cost)
--------------------------------------------------------------------------------------------
Interest-bearing deposits $12,716 $181 1.42% $6,833 $45 0.66% $6,629 $89 1.34%
-------- -------- -------- -------- -------- -------- -------- -------- --------
Investments:
US Treasuries 0 0 0.00 0 0 0.00 2,985 205 6.87
US Government Agencies 85,365 5,535 6.48 81,741 5,545 6.78 63,863 4,257 6.67
Mortgage-backed securities 16,971 1,070 6.30 13,180 876 6.65 6,946 444 6.39
State & Municipal 15,144 1,017 6.72 21,320 1,520 7.12 23,698 1,649 6.96
Other 4,311 272 6.31 5,555 383 6.90 3,390 219 6.46
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total Investments 121,791 7,894 6.48 121,796 8,324 6.51 100,882 6,774 6.71
-------- -------- -------- -------- -------- -------- -------- -------- --------
Loans:
Commercial 169,621 13,748 8.11 138,420 12,473 9.01 110,446 9,004 8.15
Consumer 62,180 5,436 8.74 60,728 5,272 8.68 47,588 3,996 8.40
Real estate 110,854 8,207 7.40 118,375 8,720 7.37 118,637 8,826 7.44
Direct financing leases 10,026 724 7.22 8,775 764 8.71 3,101 296 9.55
Credit cards 2,959 283 9.56 2,054 202 9.83 1,230 147 11.95
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total loans 355,640 28,398 7.99 328,352 27,431 8.35 281,002 22,269 7.92
-------- -------- -------- -------- -------- -------- -------- -------- --------
Federal funds sold 20,501 544 2.65 0 0 0 2,682 128 4.77
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total earning assets $510,648 $37,017 7.25% $456,981 $35,800 7.83% $391,195 $29,260 7.48%
=========================================================================================================================
Interest-bearing liabilities
Deposits:
Savings $31,523 ($448) 1.42% $32,881 ($631) 1.92% $35,548 ($723) 2.03%
NOW 35,513 (747) 2.10 38,125 (1,840) 4.83 17,838 (333) 1.87
MMDA 11,538 (324) 2.81 13,655 (533) 3.90 14,569 (500) 3.43
CDs < $100,000 130,494 (7,133) 5.47 109,665 (6,291) 5.74 107,531 (5,685) 5.29
CDs > $100,000 123,928 (6,871) 5.54 91,055 (5,783) 6.35 66,095 (3,584) 5.42
Clubs 1,287 (33) 2.56 1,216 (32) 2.61 1,176 (33) 2.81
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total Deposits 334,283 (15,556) 4.65 286,597 (15,110) 5.27 242,757 (10,858) 4.47
-------- -------- -------- -------- -------- -------- -------- -------- --------
Repurchase agreements 40,970 (1,510) 3.69 34,149 (1,917) 5.61 31,639 (1,519) 4.80
Borrowed funds 66,674 (3,788) 5.68 74,070 (4,441) 6.00 56,943 (2,999) 5.27
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities $441,927 ($20,854) 4.72% $394,816 ($21,468) 5.44% $331,339 ($15,376) 4.64%
-------- -------- -------- -------- -------- -------- -------- -------- --------
Net interest income $16,163 $14,332 $13,884
======== ======== ========
Net interest spread 2.53% 2.39% 2.84%
Net interest margin 3.17% 3.14% 3.55%
Total average assets $533,007 $472,838 $403,953
======== ======== ========
Average noninterest-bearing
deposits $46,921 $41,813 $36,129
======== ======== ========
Interest income was adjusted to a tax-equivalent basis to recognize the income from tax-exempt assets as if the interest was taxable. This treatment allows a uniform comparison to be made between yields on assets. The calculations were computed on a fully tax-equivalent basis using the corporate federal tax rate of 34%.
Nonaccrual loans and any related interest recorded have been included in computing the average rate earned on the loan portfolio. Installment loans and direct financing leases are presented net of unearned interest. All deposits are in domestic bank offices. The average balances are based on amortized cost and do not reflect unrealized gains or losses.
Net yield on earning assets represents the difference between interest revenue and (expense) divided by total average earning assets.
The following table reflects the change in net interest income attributable to fluctuations in volume and rate:
Years ended December 31,
( in thousands )
2001 Compared to 2000 2000 Compared to 1999
Increase (Decrease) due to Increase (Decrease) due to
-------------------------- --------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
Interest income:
Loans and leases:
Mortgage $ (553) $ 39 $ (514) $ (20) $ (86) $ (106)
Commercial 2,462 (1,304) 1,158 2,498 986 3,484
Consumer 303 (83) 220 1,709 77 1,786
Total loans and leases 2,212 (1,348) 864 4,187 977 5,164
Investment securities, interest-bearing
deposits and federal funds sold 886 (456) 430 1,294 86 1,380
Total interest income $ 3,098 $(1,804) $ 1,294 $ 5,481 $ 1,063 $6,544
Interest expense:
Deposits:
Certificates of deposit greater
than $100,000 $ 1,821 $ (726) $ 1,095 $ 1,585 $ 615 $2,200
Other 1,069 (1,717) (648) 1,191 860 2,051
Total deposits 2,890 (2,443) 447 2,776 1,475 4,251
Other interest-bearing liabilities (169) (893) (1,062) 1,169 672 1,841
Total interest expense $ 2,721 $(3,336) $ (615) $ 3,945 $ 2,147 $6,092
Net interest income $ 377 $(1,532) $ 1,909 $ 1,536 $(1,084) $452
The portion of the total difference attributable to both volume and rate changes during the periods has been allocated to the volume and rate components based upon the absolute dollar amount of the change in each component prior to the allocation. Tax- exempt income was not converted to a tax-equivalent basis on the rate volume analysis.
Provision for Loan Losses:The provision is an expense charged against earnings for actual or potential losses from uncollectible loans and leases. Through the provision, the allowance for loan loss is funded. Loans determined to be uncollectible are charged-off against the allowance.
The Bank has established an Asset Quality Committee which meets monthly to review known and potential problem loans and leases. The committee is comprised of senior management, credit administration and collection personnel. The committee reports quarterly to the Credit Administration Committee of the Board of Directors.
Management continuously reviews the risks inherent in the loan and lease portfolios. Specific factors used to evaluate the adequacy of the loan loss provision during this formal process include:
The Bank does not have significant concentrations of loans in specific industries or outside the Northeastern Pennsylvania geographic area. For the period ended December 31, 2001, there were no adjustments made to the historical loan loss experience for the factors specified above. There are no individual significant nonperforming loans.
The following table sets forth loans and lease financing charge-offs and recoveries, through the allowance for loan loss by category for the past five years:
(in thousands)
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Balance at beginning of period $3,264 $3,172 $3,008 $2,809 $2,590
--------- --------- --------- --------- ---------
Charge-offs:
Commercial and all other 1,003 602 139 193 286
Real estate 119 75 146 43
Consumer 909 456 196 258 183
Lease financing 180 18 - 86 15
--------- --------- --------- --------- ---------
Total 2,211 1,151 481 580 484
--------- --------- --------- --------- ---------
Recoveries:
Commercial and all other 86 14 46 56 47
Real estate 3 17 6 36 5
Consumer 108 53 63 39 28
Lease financing 17 1 - 2 -
--------- --------- --------- --------- ---------
Total 214 85 115 133 80
--------- --------- --------- --------- ---------
Net charge-offs 1,997 1,066 366 447 404
--------- --------- --------- --------- ---------
Additions charged to operations 2,475 1,158 530 646 623
--------- --------- --------- --------- ---------
Balance at end of period $3,742 $3,264 $3,172 $3,008 $2,809
========= ========= ========= ========= =========
Net charge-offs to average loans outstanding 0.56% 0.33% 0.13% 0.20% 0.23%
Allowance for loan loss to net charge-offs 187.38% 306.19% 866.67% 672.93% 695.30%
Allowance for loan loss to net loans 1.01% 0.95% 1.05% 1.23% 1.39%
Loans 30 - 89 days past due and accruing $7,156 $11,049 $4,914 $2,829 $3,521
Loans 90 days or more past due and accruing $5,398 $1,493 $2,917 $2,689 $2,189
Allowance for loan loss to loans 90 days or
more past due and accruing 69.32% 218.69% 108.74% 111.86% 128.32%
Nonaccruing loans $4,914 $2,287 $1,210 $1,364 $1,076
Allowance for loan loss to nonaccruing loans 76.15% 142.75% 262.15% 220.49% 261.09%
Allowance for loan loss to non-performing loans 36.29% 86.37% 76.86% 74.21% 86.03%
Average net loans $352,230 $325,163 $277,809 $218,170 $178,363
As evidenced in the table above, there has been no significant difference between the additions charged to operations and actual net charge-off results over the last five years.
The allowance for loan losses can generally absorb losses throughout the loan and lease portfolios. However, in some instances an allocation is made for specific loans or groups of loans.
As detailed in the table above, the allowance for loan loss expressed as a percent of net charge-offs has been declining for the past two years due to the increase in the amount of loans being charged off.
The slowing economy has impacted the loan portfolio the past two years. That trend is reflected in the increase in charged-off loans, especially commercial and consumer. The increase in the number of delinquencies necessitated the hiring of additional collection personnel.
Allocation of the allowance among major categories of loans for the past five years is summarized below. This table should not be interpreted as an indication that charge-offs in future periods will occur in these amounts or proportions, or that the allocation indicates future charge-off trends.
2001 2000 1999 1998 1997
----- ----- ---- ---- ----
Category
Real Estate $ 269,490 $ 117,534 $1,165,295 $1,066,687 $ 877,939
Consumer 959,408 736,613 692,878 507,946 399,063
Commercial 2,197,365 2,270,663 1,196,789 914,305 678,407
Direct financing leases 136,091 131,150 62,989 25,397 19,953
Real estate 0 0 31,494 25,397 19,953
construction
Unallocated 179,579 8,320 22,930 467,981 813,751
- ---------------------------------------------------------------------------------------------------------------------------
Total $3,741,933 $3,264,280 $3,172,375 $3,007,713 $2,809,066
===========================================================================================================================
Consumer loans include credit cards.
The December 31, 2000 allocation for commercial loans was $2,271,000 compared to actual 2001 net charge-offs of $917,000. The positive variance was the result of collection efforts in 2001. The 2001 commercial loan allocation is based upon delinquency levels at year-end.
The December 31, 2000 allocation for all other categories of loans and leases was adequate compared to the actual net charge-offs in 2001.
Over the last five years, management has analyzed and relied on similar factors in determining the amount of loan loss provision relative to the adequacy of the allowance for loan loss. The methodology used by the bank to analyze the adequacy of the allowance for loan losses is as follows (loans and leases are collectively referred to as loans):
Allocation of the allowance for loan losses for different categories of loans is based on the methodology used by the Bank, as explained above. The changes in the allocations from year to years is based upon year end reviews of the loan and lease portfolios.
The following table sets forth non-performing assets for the past five years (in thousands):
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Net loans $370,126 $343,555 $301,089 $243,957 $202,403
Restructured loans $0 $0 $0 $0 $0
Loans past due 90 days or more and accruing 5,398 1,493 2,917 2,689 2,189
Nonaccrual loans 4,914 2,287 1,210 1,364 1,076
- ----------------------------------------------------------------------------------------------------------------------
Non-performing loans 10,312 3,780 4,127 4,053 3,265
Foreclosed real estate 465 353 413 201 276
Repossessed assets 158 0 0 0 0
- ----------------------------------------------------------------------------------------------------------------------
Total non-performing assets $10,935 $4,133 $4,540 $4,254 $3,541
======================================================================================================================
Nonaccrual loans to net loans 1.33% 0.67% 0.40% 0.56% 0.53%
Non-performing assets to net loans, foreclosed real estate
and repossessed assets