UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the period ended September 30, 1996
Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transaction period from to
Commission File Number 0-11204
USBANCORP, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 25-1424278
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
Main & Franklin Streets, P.O. Box 430, Johnstown, PA 15907-0430
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (814) 533-5300
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
X Yes No
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date.
Class Outstanding at October 31, 1996
Common Stock, par value $2.50 5,148,582
per share
1
USBANCORP, INC.
INDEX
PART I. FINANCIAL INFORMATION: Page No.
Consolidated Balance Sheet -
September 30, 1996, December 31, 1995,
and September 30, 1995 3
Consolidated Statement of Income -
Three Months and Nine Months Ended
September 30, 1996, and 1995 4
Consolidated Statement of Changes
in Stockholders' Equity -
Nine Months Ended
September 30, 1996, and 1995 6
Consolidated Statement of Cash Flows -
Nine Months Ended
September 30, 1996, and 1995 7
Notes to Consolidated Financial
Statements 8
Management's Discussion and Analysis
of Consolidated Financial Condition
and Results of Operations 23
Part II. Other Information 48
2
USBANCORP, INC.
CONSOLIDATED BALANCE SHEET
(In thousands)
September 30 December 31 September 30
1996 1995 1995
(Unaudited) (Unaudited)
ASSETS
Cash and due from banks $ 48,121 $ 45,771 $ 36,575
Interest bearing deposits with
banks 5,304 647 1,513
Federal funds sold and securities
purchased under agreements to
resell - 13,750 -
Investment securities:
Available for sale 494,315 427,112 351,259
Held to maturity (market value
$516,637 on September 30, 1996,
$471,191 on December 31, 1995,
and $523,525 on September 30, 1995) 519,483 463,951 519,411
Assets held in trust for collateralized
mortgage obligation 5,651 7,099 7,430
Loans held for sale 9,490 5,224 2,763
Loans 897,088 832,126 814,526
Less: Unearned income 2,999 2,716 2,676
Allowance for loan losses 13,871 14,914 14,899
Net Loans 880,218 814,496 796,951
Premises and equipment 18,385 18,588 18,992
Accrued income receivable 16,927 16,752 16,218
Mortgage servicing rights 11,708 11,372 11,440
Goodwill and core deposit intangibles 22,068 23,838 25,160
Bank owned life insurance 32,096 30,872 30,469
Other assets 7,077 5,900 13,357
TOTAL ASSETS $ 2,070,843 $ 1,885,372 $ 1,831,538
LIABILITIES
Non-interest bearing deposits $ 147,920 $ 145,379 $ 140,567
Interest bearing deposits 1,004,754 1,032,479 1,050,376
Total deposits 1,152,674 1,177,858 1,190,943
Federal funds purchased and
securities sold under agreements
to repurchase 82,807 63,828 21,761
Other short-term borrowings 139,559 30,528 26,344
Advances from Federal Home Loan Bank 516,011 428,217 412,108
Collateralized mortgage obligation 5,088 6,548 6,891
Long-term debt 4,482 5,061 3,749
Total borrowed funds 747,947 534,182 470,853
Other liabilities 21,182 22,840 26,406
TOTAL LIABILITIES 1,921,803 1,734,880 1,688,202
STOCKHOLDERS' EQUITY
Preferred stock, no par value;
2,000,000 shares authorized;
there were no shares issued and
outstanding for the periods
presented - - -
Common stock, par value $2.50 per share;
12,000,000 shares authorized;
5,740,247 shares issued and 5,147,749
outstanding on September 30, 1996;
5,733,701 shares issued and
5,310,489 outstanding on December 31,
1995; 5,722,669 shares issued and
5,299,457 outstanding on
September 30, 1995 14,351 14,334 14,307
Treasury stock at cost, 592,498 shares
on September 30, 1996, 423,212 shares
on December 31, 1995 and
September 30, 1995 (16,805) (11,007) (11,007)
Surplus 93,481 93,361 93,153
Retained earnings 60,403 50,401 47,720
Net unrealized holding (losses) gains on
available for sale securities (2,390) 3,403 (837)
TOTAL STOCKHOLDERS' EQUITY 149,040 150,492 143,336
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 2,070,843 $ 1,885,372 $ 1,831,538
See accompanying notes to consolidated financial statements.
3
USBANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share data)
Unaudited
Three Months Ended Nine Months Ended
September 30 September 30
1996 1995 1996 1995
INTEREST INCOME
Interest and fees on loans and loans held
for sale:
Taxable $ 18,248 $ 17,412 $ 53,626 $ 51,425
Tax exempt 403 445 1,158 1,694
Deposits with banks 62 51 96 244
Federal funds sold and securities
purchased under agreements to resell - 41 34 139
Investment securities:
Available for sale 8,075 6,256 22,082 16,609
Held to maturity 8,430 8,468 23,980 26,203
Assets held in trust for collateralized
mortgage obligation 112 60 366 407
Total Interest Income 35,330 32,733 101,342 96,721
INTEREST EXPENSE
Deposits 10,472 11,641 31,721 34,210
Federal funds purchased and securities
sold under agreements to repurchase 1,254 685 2,846 4,694
Other short-term borrowings 2,030 57 2,729 1,262
Advances from Federal Home Loan Bank 5,814 6,138 18,419 13,467
Collateralized mortgage obligation 115 189 367 671
Long-term debt 24 55 107 180
Total Interest Expense 19,709 18,765 56,189 54,484
NET INTEREST INCOME 15,621 13,968 45,153 42,237
Provision for loan losses 23 45 68 240
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 15,598 13,923 45,085 41,997
NON-INTEREST INCOME
Trust fees 924 852 2,806 2,546
Net realized gains (losses)
on investment securities 250 (125) 569 599
Net realized gains(losses) on loans and
loans held for sale 320 284 769 (474)
Gain on disposition of business line - - - 905
Wholesale cash processing fees 269 293 808 880
Service charges on deposit accounts 837 736 2,397 2,150
Net mortgage servicing fees 655 617 1,738 1,950
Bank owned life insurance 394 201 1,225 335
Other income 1,273 1,126 3,712 3,119
Total Non-Interest Income 4,922 3,984 14,024 12,010
NON-INTEREST EXPENSE
Salaries and employee benefits 6,485 6,362 18,774 19,000
Net occupancy expense 1,114 1,021 3,368 3,162
Equipment expense 726 801 2,318 2,539
Professional fees 800 564 2,208 1,677
Supplies, postage, and freight 674 661 2,033 1,957
Miscellaneous taxes and insurance 350 355 1,080 1,048
FDIC deposit insurance expense 2,083 113 2,409 1,470
Amortization of goodwill and
core deposit intangibles 589 624 1,770 1,849
Other expense 1,854 2,105 5,406 5,017
Total Non-Interest Expense $ 14,675 $ 12,606 $ 39,366 $ 37,719
CONTINUED ON NEXT PAGE
4
CONSOLIDATED STATEMENT OF INCOME
CONTINUED FROM PREVIOUS PAGE
Three Months Ended Nine Months Ended
September 30 September 30
1996 1995 1996 1995
INCOME BEFORE INCOME TAXES $ 5,845 $ 5,301 $ 19,743 $ 16,288
Provision for income taxes 1,546 1,393 5,219 4,600
NET INCOME $ 4,299 $ 3,908 $ 14,524 $ 11,688
PER COMMON SHARE DATA:
Primary:
Net income $ 0.83 $ 0.72 $ 2.77 $ 2.11
Average shares outstanding 5,203,533 5,447,598 5,252,006 5,529,706
Fully Diluted:
Net income $ 0.82 $ 0.72 $ 2.76 $ 2.11
Average shares outstanding 5,217,025 5,456,042 5,270,000 5,548,170
Cash Dividends Declared $ 0.30 $ 0.27 $ 0.87 $ 0.79
See accompanying notes to consolidated financial statements.
5
USBANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
Unaudited
Net
Unrealized
Holding
Preferred Common Treasury Retained Gains
Stock Stock Stock Surplus Earnings (Losses) Total
Balance December 31, 1994 $ - $ 14,275 $ (3,064) $ 92,923 $ 40,355 $ (7,353) $137,136
Net income - - - - 11,688 - 11,688
Dividend reinvestment
and stock purchase plan - 32 - 230 - - 262
Net unrealized holding
gains (losses) on
investment securities - - - - - 6,516 6,516
Cash dividends declared:
Common stock($0.25
per share on 5,584,722
shares, $0.27 per
share on 5,531,966
shares, and $0.27 per
share on 5,304,457 shares) - - - - (4,323) - (4,323)
Treasury stock, purchase of
295,512 shares at cost - - (7,943) - - - (7,943)
Balance September 30, 1995 $ - $ 14,307 $(11,007) $ 93,153 $ 47,720 $ (837) $143,336
Balance December 31, 1995 $ - $ 14,334 $(11,007) $ 93,361 $ 50,401 $ 3,403 $150,492
Net income - - - - 14,524 - 14,524
Dividend reinvest-
ment and stock
purchase plan - 17 - 120 - - 137
Net unrealized
holding gains
(losses) on
investment
securities - - - - - (5,793) (5,793)
Cash dividends declared:
Common stock
($0.27 per share
on 5,266,539
shares, $0.30 per
share on 5,186,989
shares, and $0.30 per
share on 5,147,403 shares) - - - - (4,522) - (4,522)
Treasury stock, purchase of
169,286 shares at cost - - (5,798) - - - (5,798)
Balance September 30, 1996 $ - $ 14,351 $(16,805) $ 93,481 $ 60,403 $ (2,390) $149,040
See accompanying notes to consolidated financial statements.
6
USBANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Unaudited
Nine Months Ended
September 30
1996 1995
OPERATING ACTIVITIES
Net income $ 14,524 $ 11,688
Adjustments to reconcile net income to net cash
provided by operating activities:
Origination of mortgage loans held for sale (145,095) (95,372)
Sales of mortgage loans held for sale 153,239 93,558
Provision for loan losses 68 240
Depreciation and amortization expense 1,949 1,833
Amortization expense of goodwill and core
deposit intangibles 1,770 1,849
Amortization expense of mortgage servicing rights 944 870
Net amortization (accretion) of investment securities 200 (1,896)
Net realized gains on investment securities (569) (599)
Net realized (gains) losses on loans and loans
held for sale (769) 474
Decrease (increase) in accrued income receivable (175) 676
Increase (decrease) in accrued expense payable (406) 3,852
Net cash provided by operating activities 25,680 17,173
INVESTING ACTIVITIES
Purchases of investment securities and other
short-term investments (500,891) (307,922)
Proceeds from maturities of investment securities and
other short-term investments 123,437 69,733
Proceeds from sales of investment securities and
other short-term investments 246,174 164,099
Long-term loans originated (258,840) (184,934)
Mortgage loans held for sale (9,490) (2,763)
Principal collected on long-term loans 191,285 190,801
Loans purchased or participated (519) (1,752)
Loans sold or participated 663 48,612
Net (increase) decrease in credit card receivable
and other short-term loans (530) 3,836
Purchases of premises and equipment (1,796) (1,860)
Sale/retirement of premises and equipment 49 134
Net decrease in assets held in trust for
collateralized mortgage obligation 1,448 1,674
Net increase of mortgage servicing rights (1,280) (858)
Net decrease (increase) in other assets 722 (32,369)
Net cash used by investing activities (209,568) (53,569)
FINANCING ACTIVITIES
Proceeds from sales of certificates of deposit 200,304 321,146
Payments for maturing certificates of deposits (221,101) (289,610)
Net decrease in demand and savings deposits (4,387) (36,839)
Net increase (decrease) in federal funds purchased,
securities sold under agreements to repurchase,
and other short-term borrowings 126,550 (171,839)
Net principal borrowings of advances
from Federal Home Loan Bank 87,794 212,014
Repayments of long-term debt (579) (2,057)
Common stock cash dividends paid (2,978) (4,294)
Proceeds from dividend reinvestment, stock
purchase plan, and stock options exercised 137 262
Purchases of treasury stock (5,798) (7,943)
Net decrease in other liabilities (2,797) (247)
Net cash provided by financing activities 177,145 20,593
NET DECREASE IN CASH EQUIVALENTS (6,743) (15,803)
CASH EQUIVALENTS AT JANUARY 1 60,168 53,891
CASH EQUIVALENTS AT SEPTEMBER 30 $ 53,425 $ 38,088
See accompanying notes to consolidated financial statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation
The consolidated financial statements include the
accounts of USBANCORP, Inc. (the Company) and its wholly-owned
subsidiaries, United States National Bank in Johnstown (U.S.
Bank), Three Rivers Bank and Trust Company (Three Rivers
Bank), Community Bancorp, Inc. (Community), USBANCORP Trust
Company (Trust Company), and United Bancorp Life Insurance
Company (United Life). In addition, the Parent Company is an
administrative group that provides support in such areas as
audit, finance, investments, loan review, general services,
loan policy, and marketing. Intercompany accounts and
transactions have been eliminated in preparing the
consolidated financial statements.
2. Basis of Preparation
The unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting
principles for interim financial information. In the opinion
of management, all adjustments that are of a normal recurring
nature and are considered necessary for a fair presentation
have been included. They are not, however, necessarily
indicative of the results of consolidated operations for a
full year.
With respect to the unaudited consolidated financial
information of the Company for the three month and nine month
periods ended September 30, 1996, and 1995, Arthur Andersen
LLP, independent public accountants, conducted reviews (based
upon procedures established by the American Institute of
Certified Public Accountants) and not audits, as set forth in
their separate report dated October 18, 1996, appearing
herein. This report does not express an opinion on the
interim unaudited consolidated financial information. Arthur
Andersen LLP has not carried out any significant or additional
audit tests beyond those which would have been necessary if
its report had not been included. The December 31, 1995,
numbers are derived from audited financial statements.
For further information, refer to the consolidated
financial statements and accompanying notes included in the
Company's "Annual Report and Form 10-K" for the year ended
December 31, 1995.
3. Earnings Per Common Share
The Company uses the treasury stock method to calculate
common stock equivalent shares outstanding for purposes of
determining both primary and fully diluted earnings per share.
Treasury shares are treated as retired for earnings per share
purposes.
8
4. Consolidated Statement of Cash Flows
On a consolidated basis, cash equivalents include cash
and due from banks, interest bearing deposits with banks, and
federal funds sold and securities purchased under agreements
to resell. For the Parent Company, cash equivalents also
include short-term investments. The Company made $3,789,000
in income tax payments in the first nine months of 1996 as
compared to $2,071,000 for the first nine months of 1995.
Total interest expense paid amounted to $56,595,000 in 1996's
first nine months compared to $49,592,000 in the same 1995
period.
5. Investment Securities
Effective January 1, 1994, the Company adopted Statement
of Financial Accounting Standards (SFAS) 115, "Accounting for
Certain Investments in Debt and Equity Securities," which
specifies a methodology for the classification of securities
as either held to maturity, available for sale, or as trading
assets. Securities are classified at the time of purchase as
investment securities held to maturity if it is management's
intent and the Company has the ability to hold the securities
until maturity. These held to maturity securities are carried
on the Company's books at cost, adjusted for amortization of
premium and accretion of discount which is computed using the
level yield method which approximates the effective interest
method. Alternatively, securities are classified as available
for sale if it is management's intent at the time of purchase
to hold the securities for an indefinite period of time and/or
to use the securities as part of the Company's asset/liability
management strategy. Securities classified as available for
sale include securities which may be sold to effectively
manage interest rate risk exposure, prepayment risk, and other
factors (such as liquidity requirements). These available for
sale securities are reported at fair value with unrealized
aggregate appreciation/(depreciation) excluded from income and
credited/(charged) to a separate component of shareholder's
equity on a net of tax basis. The Company presently does not
engage in trading activity. The book and market values of
investment securities are summarized as follows (in
thousands):
Investment securities available for sale:
September 30, 1996
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 13,928 $ 165 $ (35) $ 14,058
U.S. Agency 9,225 8 (48) 9,185
State and municipal 21,636 451 - 22,087
U.S. Agency mortgage-backed
securities 417,913 1,422 (5,243) 414,092
Other securities<F1> 34,893 - - 34,893
Total $497,595 $ 2,046 $ (5,326) $494,315
<F1>Other investment securities include corporate notes and
bonds, asset-backed securities, and equity securities.
9
Investment securities held to maturity:
September 30, 1996
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 6,175 $ - $ (32) $ 6,143
U.S. Agency 27,461 17 (282) 27,196
State and municipal 106,950 1,088 (633) 107,405
U.S. Agency mortgage-backed
securities 375,725 1,447 (4,489) 372,683
Other securities<F1> 3,172 46 (8) 3,210
Total $519,483 $ 2,598 $ (5,444) $516,637
Investment securities available for sale:
December 31, 1995
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 22,431 $ 421 $ (14) $ 22,838
U.S. Agency 12,408 7 (27) 12,388
State and municipal 58,698 1,269 (89) 59,878
U.S. Agency mortgage-backed
securities 296,669 4,784 (311) 301,142
Other securities<F1> 30,869 1 (4) 30,866
Total $421,075 $ 6,482 $ (445) $427,112
Investment securities held to maturity:
December 31, 1995
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 796 $ 11 $ - $ 807
U.S. Agency 31,512 511 (9) 32,014
State and municipal 97,900 1,973 (140) 99,733
U.S. Agency mortgage-backed
securities 330,312 5,777 (957) 335,132
Other securities<F1> 3,431 75 (1) 3,505
Total $463,951 $ 8,347 $ (1,107) $471,191
<F1>Other investment securities include corporate notes and
bonds, asset-backed securities, and equity securities.
10
Investment securities available for sale:
September 30, 1995
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 22,423 $ 320 $ (65) $ 22,678
U.S. Agency 12,815 - (175) 12,640
State and municipal 280 3 (2) 281
U.S. Agency mortgage-backed
securities 286,428 2,602 (912) 288,118
Other securities<F1> 27,557 2 (17) 27,542
Total $349,503 $ 2,927 $ (1,171) $351,259
Investment securities held to maturity:
September 30, 1995
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 797 $ 7 $ - $ 804
U.S. Agency 35,976 25 (166) 35,835
State and municipal 139,918 2,020 (662) 141,276
U.S. Agency mortgage-backed
securities 339,310 3,804 (951) 342,163
Other securities<F1> 3,410 39 (2) 3,447
Total $519,411 $ 5,895 $ (1,781) $523,525
<F1>Other investment securities include corporate notes and
bonds, asset-backed securities, and equity securities.
All purchased investment securities are recorded on
settlement date which is not materially different from the
trade date. Realized gains and losses are calculated by the
specific identification method and are included in "Net
realized gain or loss on investment securities."
Maintaining investment quality is a primary objective of
the Company's investment policy which, subject to certain
limited exceptions, prohibits the purchase of any investment
security below a Moody's Investor's Service or Standard &
Poor's rating of "A." At September 30, 1996, 98.8% of the
portfolio was rated "AAA" and 98.9% "AA" or higher as compared
to 97.2% and 97.6%, respectively, at September 30, 1995.
Approximately 1.0% of the portfolio was rated below "A" or
unrated on September 30, 1996.
The Company may sell covered call options on securities
held in the available for sale investment portfolio. At the
time a call is written, the Company records a liability equal
to the premium fee received. The call liability is marked to
market monthly and the offset is made to earnings. During the
first nine months of 1996, contracts covering securities
totalling $18 million closed generating $28,000 of income.
The Company limits total covered call options outstanding at
any time to $25 million of available for sale securities.
There were no open written call options at September 30, 1996.
11
6. Loans Held for Sale
At September 30, 1996, $9,490,000 of fixed-rate
residential mortgage loans originated during 1996 were
classified as "held for sale." It is management's intent to
sell these residential mortgage loans during the next several
months. Servicing rights are generally retained on sold
loans. This strategy is executed in an effort to help
neutralize long-term interest rate risk. The residential
mortgage loans held for sale are carried at the lower of
aggregate amortized cost or market value. Net realized and
unrealized gains and losses are calculated by the specific
identification method and are included in "Net realized gains
(losses) on loans held for sale"; unrealized net valuation
adjustments (if any) are recorded in the same line item on the
Consolidated Statement of Income.
7. Loans
The loan portfolio of the Company consists of the
following (in thousands):
September December September
30, 31, 30,
1996 1995 1995
Commercial $140,128 $103,546 $101,887
Commercial loans secured
by real estate 228,296 179,793 175,126
Real estate - mortgage 415,197 414,967 399,928
Consumer 113,467 133,820 137,585
Loans 897,088 832,126 814,526
Less: Unearned income 2,999 2,716 2,676
Loans, net of unearned
income $894,089 $829,410 $811,850
Real estate-construction loans were not material at
these presented dates and comprised 2.2% of total loans net of
unearned income at September 30, 1996. The Company has no
credit exposure to foreign countries or highly leveraged
transactions. Additionally, the Company has no significant
industry lending concentrations.
8. Allowance for Loan Losses and Charge-Off Procedures
As a financial institution which assumes lending and
credit risks as a principal element of its business, the
Company anticipates that credit losses will be experienced in
the normal course of business. Accordingly, the Company
consistently applies a comprehensive methodology and
procedural discipline which is updated on a quarterly basis at
the subsidiary bank level to determine both the adequacy of
the allowance for loan losses and the necessary provision for
loan losses to be charged against earnings. This methodology
includes:
a detailed review of all classified assets to determine
if any specific reserve allocations (which includes
impaired loans) are required on an individual loan basis.
12
the application of reserve allocations to all criticized
and classified assets based upon allocation
percentages which were calculated by using a five
year historical average for actual losses
incurred on loans with an olem (other loans
especially mentioned), substandard, or doubtful
rating.
the application of reserve allocations to installment and
mortgage loans which are based upon historical charge-off
experience for those loan types. The residential mortgage
loan allocation is based upon the Company's five year
historical average of actual loan charge-offs experienced
in that category. The same methodology is used to
determine the allocation for consumer loans except the
allocation is based upon an average of the most recent
actual three year historical charge-off experience for
consumer loans.
the application of reserve allocations to all performing
loans based upon a five year historical average for
actual losses incurred from all loan review
categories.
the maintenance of a general unallocated reserve of at
least 20% of the systematically determined minimum
amount from the items listed above in order to
provide conservative positioning in the event of
any unforeseen deterioration in the economy. This
20% policy requirement was mandated by the Board
of Directors after the Company experienced
significant credit quality problems in the period
from 1985 to 1989. It must be emphasized that the
Board views this policy as establishing a minimum
requirement only and the requirement of a general
unallocated reserve of at least 20% of the
determined need is prudent recognition of the
fact that reserve estimates, by definition, lack
precision.
After completion of this process, a formal meeting of the
Loan Loss Reserve Committee is held to evaluate the adequacy
of the reserve and establish the provision level for the next
quarter. The Company believes that the procedural discipline,
systematic methodology, and comprehensive documentation of
this quarterly process is in full compliance with all
regulatory requirements.
When it is determined that the prospects for recovery of
the principal of a loan(including impaired loans) have
significantly diminished, the loan is immediately charged
against the allowance account; subsequent recoveries, if any,
are credited to the allowance account. In addition,
non-accrual and large delinquent loans are reviewed monthly to
determine potential losses. Consumer loans are considered
losses when they are 90 days past due, except loans that are
insured for credit loss.
13
An analysis of the changes in the allowance for loan
losses follows (in thousands, except ratios):
Three Months Ended Nine Months Ended
September 30 September 30
1996 1995 1996 1995
Balance at beginning of period $13,988 $14,886 $14,914 $15,590
Reduction due to disposition of
business line - - - (342)
Charge-offs:
Commercial 13 57 1,016 562
Real estate-mortgage 55 1 84 86
Consumer 210 175 535 463
Total charge-offs 278 233 1,635 1,111
Recoveries:
Commercial 65 54 247 150
Real estate-mortgage - 16 33 27
Consumer 73 131 244 345
Total recoveries 138 201 524 522
Net charge-offs 140 32 1,111 589
Provision for loan losses 23 45 68 240
Balance at end of period $13,871 $14,899 $13,871 $14,899
As a percent of average loans
and average loans held for
sale, net of unearned income:
Annualized net charge-offs 0.06% 0.02% 0.18% 0.10%
Annualized provision for
loan losses 0.01 0.02 0.01 0.04
Allowance as a percent of loans
and loans held for sale,
net of unearned income at
period end 1.54 1.83 1.54 1.83
Allowance as a multiple of net
annualized charge-offs, at
period end 24.90x 117.36x 9.35x 18.92x
Total classified loans $25,519 $28,471 $25,519 $28,471
Dollar allocation of reserve
to general risk 5,564 7,327 5,564 7,327
Percentage allocation of
reserve to general risk 40.11% 49.18% 40.11% 49.18%
(For additional information, refer to the "Provision for Loan
Losses" and "Loan Quality" sections in the Management's Discussion
and Analysis of Consolidated Financial Condition and Results of
Operations beginning on pages 29 and 40, respectively.)
9. Components of Allowance for Loan Losses
Effective January 1, 1995, the Company adopted SFAS 114,
"Accounting by Creditors for Impairment of a Loan" which was
subsequently amended by SFAS 118, "Accounting by Creditors for
Impairment of a Loan-Income Recognition and Disclosures." SFAS
114 addresses the treatment and disclosure of certain loans
where it is
probable that the creditor will be unable to collect all
amounts due according to the contractual terms of the loan
agreement. This standard defines the term "impaired loan" and
indicates the method used to measure the impairment. The
measurement of impairment may be based upon: 1) the present
value of expected future cash flows discounted at the loan's
effective interest rate; 2) the observable market price of the
impaired loan; or 3) the fair value of the collateral of a
collateral dependent loan. Additionally, SFAS 118
requires the disclosure of how the creditor recognizes
interest income related to these impaired loans.
14
The Company's policy is to individually review, as
circumstances warrant, each of its commercial and commercial
mortgage loans to determine if a loan is impaired. At a
minimum, annual credit reviews are mandatory for all
commercial and commercial mortgage loans with balances in
excess of $300,000. The Company has also identified two pools
of small dollar value homogeneous loans which are evaluated
collectively for impairment. These separate pools are for
residential mortgage loans and consumer loans. Individual
loans within these pools are reviewed and removed from the
pool if factors such as significant delinquency in payments of
90 days or more, bankruptcy, or other negative economic
concerns indicate impairment.
At September 30, 1996, the Company had $2,107,000 in
loans being specifically identified as impaired and a
corresponding allocation of $937,000 was made to the
allowance. The average outstanding balance for loans being
specifically identified as impaired was $2,486,000 for the
first nine months of 1996. All of the impaired loans are
collateral dependent, therefore the fair value of the
collateral of the impaired loans is evaluated in measuring the
impairment. There was no interest income recognized on
impaired loans during the first nine months of 1996 as the
Company generally applies any collected cash interest payments
on impaired loans directly to principal.
The following table sets forth the allocation of the
allowance for loan losses among various categories. This
allocation is determined by using the consistent quarterly
procedural discipline which was discussed above. This
allocation, however, is not necessarily indicative of the
specific amount or specific loan category in which future
losses may ultimately occur (in thousands, except
percentages):
September 30, 1996 December 31, 1995 September 30, 1995
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category Category Category
Amount to Loans Amount to Loans Amount to Loans
Commercial $ 1,902 15.5% $ 2,127 12.3% $ 2,732 12.5%
Commercial
loans secured
by real
estate 3,914 25.3 3,286 21.5 3,277 21.4
Real estate -
mortgage 570 47.0 345 50.2 325 49.3
Consumer 984 12.2 600 16.0 903 16.8
Allocation to
general risk 5,564 - 7,471 - 7,327 -
Allocation for
impaired
loans 937 - 1,085 - 335 -
Total $13,871 100.0% $14,914 100.0% $14,899 100.0%
15
Even though real estate-mortgage loans comprise
approximately 47% of the Company's total loan portfolio, only
$570,000 or 4.1% of the total allowance for loan losses is
allocated against this loan category. The real estate-
mortgage loan allocation is based upon the Company's five year
historical average of actual loan charge-offs experienced in
that category. The same methodology is used to determine the
allocation for consumer loans except the allocation is based
upon an average of the most recent actual three year
historical charge-off experience for consumer loans. The
disproportionately higher allocations for commercial loans and
commercial loans secured by real estate reflect the increased
credit risk associated with this type of lending and the
Company's historical loss experienced in these categories.
At September 30, 1996, management of the Company
believes the allowance for loan losses was adequate to cover
potential yet undetermined losses within the Company's loan
portfolio. The Company's management is unable to determine in
what loan category future charge-offs and recoveries may
occur. (For a complete discussion concerning the operations
of the "Allowance for Loan Losses" refer to Note 8.)
10. Purchased and Originated Mortgage Servicing Rights
During the second quarter of 1995, the Company adopted
SFAS 122, "Accounting for Mortgage Servicing Rights," an
amendment of SFAS 65, "Accounting for Certain Mortgage Banking
Activities." In accordance with this new standard, the Company
recognizes as separate assets the rights to service mortgage
loans for others whether the servicing rights are acquired
through purchases or loan originations. The fair value of
capitalized mortgage servicing rights is based upon the
present value of estimated expected future cash flows. Based
upon current fair values, capitalized mortgage servicing
rights are periodically assessed for impairment, which is
recognized in the income statement during the period in which
impairment occurs by establishing a corresponding valuation
allowance. For purposes of performing its impairment
evaluation, the Company stratifies its portfolio of
capitalized mortgage servicing rights on the basis of certain
risk characteristics, including loan type and note rate.
Under SFAS 65, the cost of originated mortgage servicing
rights was not recognized as an asset and was charged to
earnings when the related loan was sold. The net effect of
SFAS 122 was the capitalization of costs of originating
mortgage servicing rights of $249,000 and $258,000 in the
first nine months of 1996 and 1995, respectively.
16
11. Non-performing Assets
Non-performing assets are comprised of (i) loans which
are on a non-accrual basis, (ii) loans which are contractually
past due 90 days or more as to interest or principal payments
some of which are insured for credit loss, and (iii) other
real estate owned (real estate acquired through foreclosure
and in-substance foreclosures). All loans, except for loans
that are insured for credit loss, are placed on non-accrual
status upon becoming 90 days past due in either principal or
interest. In addition, if circumstances warrant, the accrual
of interest may be discontinued prior to 90 days. In all
cases, payments received on non-accrual loans are credited to
principal until full recovery of principal has been
recognized; it is only after full recovery of principal that
any additional payments received are recognized as interest
income. The only exception to this policy is for residential
mortgage loans wherein interest income is recognized on a cash
basis as payments are received.
The following table presents information concerning non-
performing assets (in thousands, except percentages):
September 30 December 31 September 30
1996 1995 1995
Non-accrual loans $5,635 $7,517 $5,405
Loans past due 90
days or more 1,709 995 894
Other real estate owned 151 914 883
Total non-performing
assets $7,495 $9,426 $7,182
Total non-performing
assets as a percent
of loans and loans
held for sale, net
of unearned income,
and other real estate
owned 0.83% 1.13% 0.88%
The Company is unaware of any additional loans which are
required to either be charged-off or added to the non-
performing asset totals disclosed above. Other real estate
owned is recorded at the lower of 1) fair value minus
estimated costs to sell or 2) carrying cost.
The following table sets forth, for the periods
indicated, (i) the gross interest income that would have been
recorded if non-accrual loans had been current in accordance
with their original terms and had been outstanding throughout
the period or since origination if held for part of the
period, (ii) the amount of interest income actually recorded
on such loans, and (iii) the net reduction in interest income
attributable to such loans (in thousands). There was no
interest income recognized on impaired loans during the first
nine months of 1996 or 1995.
17
Three Months Ended Nine Months Ended
September 30 September 30
1996 1995 1996 1995
Interest income due in accordance
with original terms $ 101 $ 152 $ 423 $ 439
Interest income recorded (6) (471) (12) (532)
Net reduction in interest
income $ 95 $ (319) $ 411 $ (93)
12. Incentive Stock Option Plan
Under the Company's Incentive Stock Option Plan (the
Plan) options can be granted (the Grant Date) to employees
with executive, managerial, technical, or professional
responsibility as selected by a committee of the board of
directors. The Plan was amended on April 25, 1995, to
authorize the grant of options covering up to 285,000 shares
of common stock. The option price at which a stock option may
be exercised shall be a price as determined by the board
committee but shall not be less than 100% of the fair market
value per share of common stock on the Grant Date. The
maximum term of any option granted under the Plan cannot
exceed 10 years. The following stock options were granted:
Shares Shares Option
Under Available Price
Option For Option Per Share
Balance at December 31, 1994 75,867 38,500
Increased authorized
options - 157,000
Options granted 56,800 (56,800) $21.44-30.63
Options exercised (23,846) - 17.25-25.00
Options forfeited (3,000) 3,000 21.44-23.88
Balance at December 31, 1995 105,821 141,700 $17.25-30.63
Options granted 78,000 (78,000) $ 32.56
Options exercised (6,546) - 17.25-28.86
Balance at September 30, 1996 177,275 63,700 $17.25-32.56
On or after the first anniversary of the Grant Date, one-third
of such options may be exercised. On or after the second
anniversary of the Grant Date, two-thirds of such options may
be exercised minus the aggregate number of such options
previously exercised. On or after the third anniversary of
the Grant Date, the remainder of the options may be exercised.
18
13. Off-Balance Sheet Hedge Instruments
Policies
The Company uses various interest rate contracts, such as
interest rate swaps, caps and floors, to help manage interest
rate and market valuation risk exposure, which is incurred in
normal recurrent banking activities. These interest rate
contracts function as hedges against specific assets or
liabilities on the Company's Consolidated Balance Sheet.
Gains or losses on these hedge transactions are deferred and
recognized as adjustments to interest income or interest
expense of the underlying assets or liabilities over the hedge
period.
For interest rate swaps, the interest differential to be
paid or received is accrued by the Company and recognized as
an adjustment to interest income or interest expense of the
underlying assets or liabilities being hedged. Since only
interest payments are exchanged, the cash requirement and
exposure to credit risk are significantly less than the
notional amount.
Any premium or transaction fee incurred to purchase
interest rate caps or floors are deferred and amortized to
interest income or interest expense over the term of the
contract. Unamortized premiums related to the purchase of
caps and floors are included in other assets on the
Consolidated Balance Sheet. A summary of the off-balance
sheet hedge transactions outstanding as of September 30, 1996,
are as follows:
Borrowed Funds Hedges
On March 16, 1995, the Company entered into an interest
rate swap agreement with a notional amount of $60 million and
a termination date of March 16, 1997. Under the terms of the
swap agreement, the Company pays a two year fixed interest
rate of 6.93% and receives 90 day Libor which resets
quarterly. The counter-party in this unsecured transaction is
PNC Bank.
This swap agreement was executed to hedge short-term
borrowings which were incurred to fund investment securities
as part of the increased leveraging of the balance sheet.
Specifically, FHLB term advances which reprice quarterly are
being used to fund fixed-rate agency mortgage-backed
securities with durations ranging from two to three years.
This hedge transaction increased interest expense by $558,000
for the first nine months of 1996 and by $227,000 for the
first nine months of 1995.
On September 29, 1995, the Company entered into an
interest rate swap agreement with a notional amount of $25
million and a termination date of September 29, 1997. Under
the terms of the swap agreement, the Company pays a two year
fixed interest rate of 6.05% and receives 90 day Libor which
resets quarterly. The counterparty in this unsecured
transaction is Mellon Bank.
19
This swap agreement was executed to hedge short-term
borrowings used to leverage the balance sheet. Specifically,
FHLB advances which reprice every 30 to 90 days are being used
to fund fixed-rate agency mortgage-backed securities with a
two year duration. This hedge transaction increased interest
expense by $92,000 for the first nine months of 1996.
CMO Liability Hedge
During the first quarter of 1994, the Company entered
into an interest rate swap agreement with a termination date
of February 11, 1997. Under the terms of the swap agreement,
the Company will receive a fixed interest rate of 5% and pay
a floating interest rate defined as the 90 day Libor which
resets quarterly. The counter-party in this unsecured
transaction is PNC Bank.
This swap agreement was initiated to hedge interest rate
risk in a declining, stable, or modestly rising rate
environment. Specifically, this transaction hedges the CMO
liability on the Company's Consolidated Balance Sheet by
effectively converting the fixed percentage cost to a variable
rate cost. This hedge also offsets market valuation risk
since any change in the market value of the swap agreement
correlates in the opposite direction with a change in the
market value of the CMO liability. Overall, this swap
agreement increased interest expense by $44,000 in the first
nine months of 1996 and $85,000 for the same 1995 period.
The Company believes that its exposure to credit loss in
the event of non-performance by any of the counter-parties is
remote.
The Company monitors and controls all off-balance sheet
derivative products with a comprehensive Board of Director
approved hedging policy. This policy permits a maximum
notional amount outstanding of $250 million for interest rate
swaps, and a maximum notional amount outstanding of $250
million for interest rate caps/floors. The Company had no
interest rate caps or floors outstanding at September 30,
1996.
14. Goodwill and Core Deposit Intangible Assets
USBANCORP's balance sheet shows both tangible assets
(such as loans, buildings, and investments) and intangible
assets (such as goodwill). The Company now carries $17.3
million of goodwill and $4.8 million of core deposit
intangible assets on its balance sheet. The majority of these
intangible assets came from the 1994 JSB acquisition ($25.9
million) and the 1993 Integra Branches acquisition ($1.2
million).
20
The Company is amortizing core deposit intangibles over
periods ranging from five to ten years while goodwill is being
amortized over a 15 year life. The straight line method of
amortization is being used for both of these categories of
intangibles. It is important to note that this intangible
amortization expense is not a future cash outflow. The
following table reflects the future amortization expense of
the intangible assets (in thousands):
Remaining 1996 $ 590
1997 2,356
1998 2,170
1999 2,014
2000 1,904
2001 and after 13,034
A reconciliation of the Company's intangible asset
balances for the first nine months of 1996 is as follows (in
thousands):
Total goodwill & core deposit
intangible assets at 12/31/95 $23,838
Intangible amortization expense
through 9/30/96 (1,770)
Total goodwill & core deposit
intangible assets at 9/30/96 $22,068
Goodwill and other intangible assets are reviewed for
possible impairment at a minimum annually, or more frequently,
if events or changed circumstances may affect the underlying
basis of the asset. The Company uses an estimate of the
subsidiary banks undiscounted future earnings over the
remaining life of the goodwill and other intangibles in
measuring whether these assets are recoverable.
21
15. Federal Home Loan Bank Borrowings
Total FHLB borrowings consist of the following at September
30, 1996, (in thousands, except percentages):
Type Maturing Amount Weighted
Average
Rate
Flexline Overnight $114,650 5.90%
Advances and 1996 309,000 5.55
wholesale 1997 2,750 5.61
repurchase 1998 176,886 5.11
agreements 1999 1,250 6.09
2000 3,750 6.15
2001 and
after 22,376 7.51
Total advances and 516,012 5.44
wholesale repurchase
agreements
Total FHLB Borrowings $630,662 5.52%
All of the above borrowings bear a fixed rate of
interest, with the only exceptions being the Flexline whose
rate can change daily. All FHLB stock and an interest in
unspecified mortgage loans, with an aggregate statutory value
equal to the amount of the advances, have been pledged as
collateral with the Federal Home Loan Bank of Pittsburgh to
support these borrowings. During the first quarter of 1996
and as reflected in the above table, the Company extended $150
million of FHLB borrowings from a 30 day maturity to a two
year term at a fixed cost of approximately 5.00%.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ("M.D.& A.")
THIRD QUARTER September 30, 1996 vs. THIRD QUARTER September
30, 1995
.....PERFORMANCE OVERVIEW.....The Company's net income for the
third quarter of 1996 totalled $4,299,000 or $0.82 per share
on a fully diluted basis. The Company's net income for the
third quarter of 1995 totalled $3,908,000 or $0.72 per share
on a fully diluted basis. The 1996 results reflect a $391,000
or 10.0% earnings increase and a $0.10 or 13.9% improvement in
fully diluted earnings per share when compared to the 1995
third quarter results. This earnings improvement occurred
despite the recognition of a special assessment to
recapitalize the Savings Association Insurance Fund(SAIF) in
the third quarter of 1996. This special assessment amounted
to $1,368,000 on an after-tax basis and reduced third quarter
1996 fully diluted earnings per share by $0.26. For the third
quarter of 1996, the Company's return on average equity
increased by 85 basis points to 11.53%.
Revenue growth generated from the core banking business
more than offset higher non-interest expense causing the
overall improvement in the Company's financial performance.
Specifically, net interest income increased by $1.7 million or
11.8% while total non-interest income grew by $938,000 or
23.5%. Total non-interest expense increased by $2.1 million
or 16.4% due primarily to the SAIF charge which amounted to
$1.9 million on a pre-tax basis. Excluding the SAIF charge,
total non-interest expense increased by only $144,000 or 1.1%
from the third quarter 1995 level. The Company's earnings per
share were also enhanced by the repurchase of its common
stock. There were 239,000 fewer average fully diluted shares
outstanding in the third quarter of 1996 than in the same 1995
period.
Appearing on this page was a graph reflecting the fully diluted
earnings per share for the past five quarters. The data points
were $0.82, $1.01, $0.93, $0.77 and $0.72.
23
The following table summarizes some of the Company's key
performance indicators (in thousands, except per share and
ratios):
Three Months Ended Three Months Ended
September 30, 1996 September 30, 1995
Net income $ 4,299 $ 3,908
Fully diluted earnings
per share 0.82 0.72
Return on average assets 0.86% 0.85%
Return on average equity 11.53 10.68
Average fully diluted common
shares outstanding 5,217 5,456
.....NET INTEREST INCOME AND MARGIN.....The Company's net
interest income represents the amount by which interest income
on earning assets exceeds interest paid on interest bearing
liabilities. Net interest income is a primary source of the
Company's earnings; it is affected by interest rate
fluctuations as well as changes in the amount and mix of
earning assets and interest bearing liabilities. It is the
Company's philosophy to strive to optimize net interest margin
performance in varying interest rate environments.
The following table compares the Company's net interest
income performance for the third quarter of 1996 to the third
quarter of 1995 (in thousands, except percentages):
Three Months Ended
September 30
1996 1995 Change % Change
Interest income $ 35,330 $ 32,733 $ 2,597 7.9
Interest expense 19,709 18,765 944 5.0
Net interest income 15,621 13,968 1,653 11.8
Tax-equivalent
adjustment 730 672 58 8.6
Net tax-equivalent
interest income $ 16,351 $ 14,640 $ 1,711 11.7
Net interest margin 3.51% 3.44% 0.07% <F1>
<F1>Not meaningful.
24
USBANCORP's net interest income on a tax-equivalent basis
increased by $1.7 million or 11.7% due to growth in earning
assets and improved net interest margin performance. The
third quarter 1996 net interest margin of 3.51% was seven
basis points better than the prior year third quarter net
interest margin of 3.44% and reflects the benefits of reduced
funding costs and a fifth consecutive quarter of loan growth.
The total cost of funds decreased by 22 basis points as
deposit and borrowing costs dropped by 25 and 60 basis points,
respectively. Growth in higher yielding loans helped limit
the decline in the earning asset yield to 11 basis points
despite the lower interest rate environment which was
experienced in the third quarter of 1996. Total loans
outstanding averaged $858 million or 73.8% of total deposits
in the third quarter of 1996 compared to an average of $799
million or 66.5% of total deposits in the third quarter of
1995. This growth in loans combined with greater balance
sheet leveraging through the investment securities portfolio
to cause total average earning assets to be $164 million
higher in the third quarter of 1996.
.....BALANCE SHEET LEVERAGING.....The Company's ongoing
strategy to use borrowed funds to purchase earning assets in
order to leverage the balance sheet and equity contributes to
increased net interest income but a lower net interest margin
percentage. The source for the borrowed funds is
predominately the Federal Home Loan Bank (FHLB) as each of the
Company's subsidiary banks are members of the FHLB. Examples
of FHLB borrowings used by the Company include 30 and 90 day
wholesale reverse repurchase agreements, overnight
borrowings, one year term funds tied to 90 day Libor, and term
advances. These funds are used primarily to purchase
available for sale and held to maturity mortgage backed
investment securities with durations ranging from one to three
years. For the third quarter of 1996, the Company's total
level of short-term borrowed funds and FHLB advances averaged
$649 million or 32.6% of total assets compared to an average
of $448 million or 24.4% of total assets for the third quarter
of 1995. These borrowed funds had an average cost of 5.56% in
the third quarter of 1996 which was 147 basis points greater
than the average cost of deposits which amounted to 4.09%.
When compared to the Company's third quarter 1996 earning
asset yield, the net interest spread earned on assets funded
with deposits amounted to 3.62% compared to a net interest
spread of 2.15% on assets funded with short-term borrowings
and FHLB advances. This third quarter 1996 net interest
spread of 2.15% on assets funded with borrowed money compared
favorably to a net interest spread of 1.72% earned on
leveraged assets in the prior year third quarter.
The maximum amount of leveraging the Company can perform
is controlled by internal policy requirements to maintain a
minimum asset leverage ratio of no less than 6.0% (see further
discussion under Capital Resources) and to limit net interest
income variability to plus or minus 7.5% (see further discussion under
Interest Rate Sensitivity). The Company continuously
evaluates the approximate $10 million of cash flow received
monthly from the investment portfolio and makes one of the
following three decisions which can impact the leveraged
position of the balance sheet:
1) The Company can use the money to fund any loan demand
that cannot be funded with existing cash flow from the loan
portfolio or deposits.
25
2) The Company can use the money to fund new investment
security purchases provided that the incremental spread over
the current short-term borrowing cost is not less than 100
basis points.
3) The Company can use the money to paydown short-term
borrowings if the incremental spread that can be earned on new
investment purchases is not deemed sufficient.
It is recognized that interest rate risk does exist,
particularly in a rising interest rate environment, from this
use of borrowed funds to leverage the balance sheet. To
neutralize a portion of this risk, the Company has executed a
total of $85 million of off-balance sheet hedging transactions
which help fix the variable funding costs associated with the
leveraging of the balance sheet. (See further discussion
under Note 13.) Additionally, during the first quarter of 1996
the Company took advantage of the flatness of the Treasury
yield curve to further reduce the interest rate risk
associated with the balance sheet leveraging. Specifically,
$150 million of non-hedged borrowings with the FHLB were
extended from a 30 day maturity to a two year term at a fixed
cost of approximately 5.0%. This liability extension strategy
helped reduce both short-term interest rate risk and the cost
of borrowings.
.....COMPONENT CHANGES IN NET INTEREST INCOME.....Regarding
the separate components of net interest income, the Company's
total tax-equivalent interest income for the third quarter of
1996 increased by $2.7 million or 7.9% when compared to the
1995 third quarter. This increase was due to a $164 million
or 9.7% increase in total average earning assets because the
earning asset yield decreased between quarters. The increase
in average earning assets reflects $59 million of growth in
total loans and $110 million of growth in investment
securities. Within the earning asset base, the yield on total
investment securities declined by three basis points to 6.88%
while the yield on the total loan portfolio dropped by 31
basis points to 8.61%. The more significant drop in the loan
portfolio yield was due in part to fewer interest recoveries
on non-accrual loans in the 1996 quarter. In the prior year
third quarter, the Company collected an unusually large
$437,000 of interest recoveries on non-accrual loans which
increased the loan portfolio yield by 20 basis points. Both
the loan portfolio and investment portfolio yields were
negatively impacted by the lower interest rate environment as
the prime rate and fed funds rate were approximately 50 basis
points lower in the third quarter of 1996 as compared to the
third quarter of 1995.
26
The Company's total interest expense for the third
quarter of 1996 increased by $944,000 or 5.0% when compared to
the same 1995 quarter. This higher interest expense was due
entirely to an increased volume of interest bearing
liabilities which more than offset the benefits of a reduced
cost of funds. Specifically, total interest bearing
liabilities were $155 million higher on average in the third
quarter of 1996 which caused interest expense to increase by
$1.8 million. Within the liability mix, total borrowed funds
increased by $200 million in order to fund greater balance
sheet leverage and replace a $45 million outflow in interest
bearing deposits. Interest expense savings resulting from
reductions in the rates paid for both deposits and borrowed
funds partially offset the additional interest expense caused
by the increased size of the balance sheet. As previously
mentioned, the Company's cost of deposits decreased by 25
basis points to 4.09% and the cost of all borrowed funds
dropped by 60 basis points to 5.56%. The combination of all
these price and liability composition movements caused
USBANCORP's average cost of interest bearing liabilities to
decrease by 22 basis points from 4.88% during the third
quarter of 1995 to 4.66% during the third quarter of 1996.
The table that follows provides an analysis of net
interest income on a tax-equivalent basis setting forth (i)
average assets, liabilities, and stockholders' equity, (ii)
interest income earned on interest earning assets and interest
expense paid on interest bearing liabilities, (iii) average
yields earned on interest earning assets and average rates
paid on interest bearing liabilities, (iv) USBANCORP's
interest rate spread (the difference between the average yield
earned on interest earning assets and the average rate paid on
interest bearing liabilities), and (v) USBANCORP's net
interest margin (net interest income as a percentage of
average total interest earning assets). For purposes of this
table, loan balances include non-accrual loans and interest
income on loans includes loan fees or amortization of such
fees which have been deferred, as well as, interest recorded
on non-accrual loans as cash is received. Additionally, a tax
rate of approximately 34% is used to compute tax equivalent
yields.
27
Three Months Ended September 30 (In thousands, except
percentages)
1996 1995
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest earning assets:
Loans and loans held
for sale, net of
unearned income $ 858,047 $ 18,796 8.61% $ 798,923 $ 18,002 8.92%
Deposits with banks 4,650 62 5.18 4,753 51 4.21
Federal funds sold
and securities
purchased under
agreement to resell - - - 2,949 41 5.41
Investment securities:
Available for sale 483,479 8,075 6.68 355,474 6,256 7.04
Held to maturity 509,541 9,015 7.08 527,744 8,995 6.82
Total investment
securities 993,020 17,090 6.88 883,218 15,251 6.91
Assets held in trust for
collateralized
mortgage obligation 5,977 112 7.48 8,001 60 2.98
Total interest earning
assets/interest income 1,861,694 $ 36,060 7.71% 1,697,844 $ 33,405 7.82%
Non-interest earning assets:
Cash and due from banks 34,706 35,318
Premises and equipment 18,273 19,038
Other assets 92,949 95,826
Allowance for loan
losses (13,964) (14,951)
TOTAL ASSETS $1,993,658 $1,833,075
CONTINUED ON NEXT PAGE
28
THREE MONTHS ENDED September 30
CONTINUED FROM PREVIOUS PAGE
1996 1995
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest bearing
liabilities:
Interest bearing
deposits:
Interest bearing
demand $ 80,948 $ 200 0.98% $ 86,346 $ 308 1.42%
Savings 207,638 876 1.68 227,467 1,030 1.80
Other time 731,088 9,396 5.11 751,176 10,303 5.44
Total interest bearing
deposits 1,019,674 10,472 4.09 1,064,989 11,641 4.34
Short-term borrowings:
Federal funds
purchased, secur-
ities sold under
agreements to
repurchase and other
short-term
borrowings 247,582 3,284 5.23 67,578 742 4.33
Advances from Federal
Home Loan Bank 401,674 5,814 5.76 380,088 6,138 6.41
Collateralized mortgage
obligation 5,409 115 8.47 7,243 189 10.35
Long-term debt 4,608 24 2.12 3,950 55 5.52
Total interest bearing
liabilities/interest
expense 1,678,947 19,709 4.66 1,523,848 18,765 4.88
Non-interest bearing
liabilities:
Demand deposits 143,596 137,237
Other liabilities 22,810 26,818
Stockholders' equity 148,305 145,172
TOTAL LIABILITIES AND
STOCKHOLDERS'
EQUITY $1,993,658 $1,833,075
Interest rate spread 3.05 2.94
Net interest income/
net interest margin 16,351 3.51% 14,640 3.44%
Tax-equivalent adjustment (730) (672)
Net Interest Income $15,621 $13,968
29
....PROVISION FOR LOAN LOSSES.....The Company's provision for
loan losses for the third quarter of 1996 totalled $23,000 or
0.01% of average total loans. This represented a reduction of
$22,000 from the third quarter 1995 provision of $45,000 or
0.02% of average total loans. The continued adequacy of the
allowance for loan losses at each of the Company's banking
subsidiaries supported the reduction in the provision level.
The Company applies a consistent methodology and procedural
discipline to evaluate the adequacy of the allowance for loan
losses at each subsidiary bank on a quarterly basis. At
September 30, 1996, the allowance for loan losses at each of
the Company's banking subsidiaries was in compliance with the
Company's policy of maintaining a general unallocated reserve
of at least 20% of the systematically determined minimum
reserve need. In total, the Company's general unallocated
reserve was $5.6 million at September 30, 1996, or 40.1% of
the allowance for loan losses. Additionally, the reduction in
the provision level was also supported by a favorable downward
trend in substandard and doubtful classified asset categories
experienced during 1995 and the first nine months of 1996.
Total classified loans dropped by $3.0 million or 10.4% from
$28.5 million at September 30, 1995, to $25.5 million at
September 30, 1996.
.....NON-INTEREST INCOME.....Non-interest income for the third
quarter of 1996 totalled $4.9 million which represented a
$938,000 or 23.5% increase when compared to the same 1995
period. This increase was primarily due to a combination of
the following items:
a $72,000 or 8.5% increase in trust fees to $924,000 in
the third quarter of 1996. This trust fee growth is
prompted by increased assets under management due to the
profitable expansion of the Trust Company's business
throughout western Pennsylvania including the Greater
Pittsburgh marketplace. For the first nine months of
1996, the Trust Company's business development efforts
have generated new trust assets amounting to $62 million
which will generate annual fees approximating $272,000.
a $250,000 gain realized on the sale of investment
securities available for sale in the third quarter of
1996 compared to a $125,000 loss realized on investment
security sales in the third quarter of 1995(a net
favorable shift of $375,000). The 1996 third quarter gain
resulted from the sale of $80 million of mortgage-backed
securities and $28 million of tax-exempt securities.
These sales were executed to (1) provide liquidity to
fund anticipated loan growth and (2) improve future
portfolio earnings.
a $101,000 or 13.7% increase in deposit service charges
to $837,000. This increase resulted primarily from fewer
waivers of overdraft charges due to enhanced monitoring
techniques and pricing increases on several demand
deposit account related services.
a $193,000 net increase in the cash surrender value of a
$32.1 million Bank Owned Life Insurance Policy as the
total balance of this asset was outstanding for the
entire third quarter of 1996 compared to only part of the
third quarter in 1995.
a $147,000 increase in other income due in part to
additional income resulting from ATM transaction charges,
other mortgage banking processing fees, credit card
charges, and premium income commissions from insurance
sales.
30
.....NON-INTEREST EXPENSE.....Non-interest expense for the
third quarter of 1996 totalled $14.7 million which represented
a $2.1 million or 16.4% increase when compared to the same
1995 period. This increase was primarily due to the following
items:
a $2.0 million increase in FDIC deposit insurance expense
as the Company accrued a special assessment to
recapitalize the SAIF in the third quarter of 1996. This
Congressionally mandated special assessment amounted to
$1.9 million on a pre-tax basis as a result of a charge
of 65.7 cents per $100 of SAIF insured deposits held as
of March 31, 1995. Beginning January 1, 1997, the annual
rate the Company pays on SAIF deposits will drop from 23
cents to 6.44 cents per $100 of deposits while the rate
on Bank Insurance Fund(BIF) deposits will increase from
zero cents to 1.29 cents per $100 of deposits.
Approximately $890 million or 77% of the Company's
deposits are covered by the BIF while the remaining $263
million or 23% are part of the SAIF. The Company
currently estimates that 1997 pre-tax income will be
favorably impacted by approximately $300,000 as a result
of these deposit premium changes.
a $123,000 increase in salaries and employee benefits due
to higher bonus and pension costs in the third quarter of
1996.
a $236,000 increase in professional fees due to higher
legal and other professional fees in the third quarter of
1996.
a $251,000 decrease in other expense due to lower
advertising expense, other real estate owned expense,
bank correspondent charges, and educational training
expenses.
.....INCOME TAX EXPENSE.....The Company's provision for income
taxes for the third quarter of 1996 was $1.5 million
reflecting an effective tax rate of 26.5%. The Company's 1995
third quarter income tax provision was $1.4 million or an
effective tax rate of 26.3%. The Company's uses tax-free
asset holdings such as municipal investment securities and
bank owned life insurance to manage its effective tax rate.
Net deferred income taxes of $674,000 have been provided as of
September 30, 1996, on the differences between taxable income
for financial and tax reporting purposes.
31
NINE MONTHS ENDED September 30, 1996 vs. NINE MONTHS ENDED
September 30, 1995
.....PERFORMANCE OVERVIEW.....The Company's net income for the
first nine months of 1996 totalled $14,524,000 or $2.76 per
share on a fully diluted basis. The Company's net income for
the first nine months of 1995 totalled $11,688,000 or $2.11
per share on a fully diluted basis. The 1996 results reflect
a $2,836,000 or 24.3% earnings increase and a $0.65 or 30.8%
improvement in fully diluted earnings per share when compared
to the 1995 first nine months results. For year-to-date 1996,
the Company's return on average equity increased by 203 basis
points to 13.02% while the return on average assets increased
by 15 basis points to 1.01%.
The Company's improved financial performance reflects
continued success in executing tactical strategies contained
in the Company's 1996 budget plan. This improved financial
performance is evidenced by increased levels of both net
interest income and non-interest income, and a reduced loan
loss provision. The growth in revenue more than offset higher
non-interest expense due primarily to the previously discussed
SAIF charge. The Company's earnings per share were also
enhanced by the repurchase of its common stock. There were
278,000 fewer average fully diluted shares outstanding in the
first nine months of 1996 than in the same 1995 period. The
following table summarizes some of the Company's key
performance indicators (in thousands, except per share and
ratios):
Nine Months Ended Nine Months Ended
September 30, 1996 September 30, 1995
Net income $14,524 $11,688
Fully diluted earnings
per share 2.76 2.11
Return on average assets 1.01% 0.86%
Return on average equity 13.02 10.99
Average fully diluted common
shares outstanding 5,270 5,548
Presented on this page was a graph of return on equity for the past
five quarters. The data points were 11.53%, 14.40%, 13.14%, 11.15%,
and 10.68%.
32
.....NET INTEREST INCOME AND MARGIN.....The following table
compares the Company's net interest income and margin
performance for the first nine months of 1996 to the first
nine months of 1995 (in thousands, except percentages):
Nine Months Ended
September 30
1996 1995 Change % Change
Interest income $101,342 $ 96,721 $ 4,621 4.8
Interest expense 56,189 54,484 1,705 3.1
Net interest income 45,153 42,237 2,916 6.9
Tax-equivalent
adjustment 2,259 2,067 192 9.3
Net tax-equivalent
interest income $ 47,412 $ 44,304 $ 3,108 7.0
Net interest margin 3.52% 3.48% 0.04% <F1>
<F1>Not meaningful.
USBANCORP's net interest income on a tax-equivalent basis
increased by $3.1 million or 7.0%. This increased net
interest income was due to a higher volume of earning assets
and a four basis point improvement in the net interest margin
percentage to 3.52%. For the first nine months of 1996, total
average earning assets were $98 million higher than the
comparable 1995 period due to greater leveraging of the
balance sheet(see previous discussion under Balance Sheet
Leveraging). The modest improvement in the net interest
margin percentage reflects the cost of funds decreasing to a
greater extent than the earning asset yield.
.....COMPONENT CHANGES IN NET INTEREST INCOME.....Regarding
the separate components of net interest income, the Company's
total tax-equivalent interest income for the first nine months
of 1996 increased by $4.8 million or 4.9% when compared to the
same 1995 period. This increase was due entirely to a $98
million or 5.8% increase in total average earning assets which
caused interest income to rise by $5.7 million. This net
increase in average earning assets reflects $88 million of
growth in investment securities and a $19 million increase in
total loans. The additional interest income generated from
higher earning asset volumes was partially offset by an
unfavorable rate variance as the Company's total earning asset
yield decreased by eight basis points to 7.71%. Within the
earning asset base, the yield on total investment securities
declined by 15 basis points to 6.83% due primarily to the
lower interest rate environment experienced in the first nine
months of 1996. Both the prime rate and fed funds rate were
approximately 60 basis points lower in the first nine months
of 1996 as compared to the first nine months of 1995.
33
Despite the lower interest rate environment, the yield on
the total loan portfolio decreased by only four basis points
to 8.63%. A mix shift in the loan portfolio towards higher
yielding commercial product is favorably impacting the total
loan portfolio yield. Total commercial and commercial
mortgage loans comprised 40.8% of total loans at September
30, 1996, compared to 33.8% at December 31, 1995. Residential
mortgage loans comprised 47.0% of total loans at September 30,
1996, compared to 50.2% at December 31, 1995. The higher
commercial loan totals resulted from increased production from
both small business (loans less than $250,000) and middle
market lending. This improved new loan production was due
primarily to more effective sales efforts which have included
an intensive customer calling program and canvassing of small
commercial businesses. This enhanced commercial loan
production also attests to the modest economic growth of the
Western Pennsylvania market. The reduced dependence on
residential mortgage loans as an earning asset reflects the
Company's ongoing strategy to sell newly originated 30 year
fixed-rate mortgage product.
The Company's total interest expense for the first nine
months of 1996 increased by $1.7 million or 3.1% when compared
to the same 1995 period. This higher interest expense was
caused by a $103 million increase in average interest bearing
liabilities which caused interest expense to rise by $3.6
million. Within the liability mix, total borrowed funds
increased by $144 million in order to fund greater balance
sheet leverage and replace a $41 million outflow in interest
bearing deposits. Lower rates paid for both deposits and FHLB
borrowings caused a favorable rate variance which partially
offset the increased interest expense resulting from the
higher level of interest bearing liabilities. The cost of
deposits decreased by 15 basis points to 4.11% as the Company
was able to reprice all major deposit categories downward
during the first nine months of 1996. Due to the lower
interest rate environment and the favorable extension of $150
million of non-hedged FHLB borrowings at a fixed rate of 5.0%,
the Company's cost of borrowed funds averaged 5.64% for the
first nine months of 1996 or 59 basis points lower than the
6.23% average for the first nine months of 1995. The
combination of all these price and liability composition
movements caused USBANCORP's average cost of interest bearing
liabilities to decrease by 18 basis points from 4.83% during
the first nine months of 1995 to 4.65% during the first nine
months of 1996.
The table that follows provides an analysis of net
interest income on a tax-equivalent basis setting forth (i)
average assets, liabilities, and stockholders' equity, (ii)
interest income earned on interest earning assets and interest
expense paid on interest bearing liabilities, (iii) average
yields earned on interest earning assets and average rates
paid on interest bearing liabilities, (iv) USBANCORP's
interest rate spread (the difference between the average yield
earned on interest earning assets and the average rate paid on
interest bearing liabilities), and (v) USBANCORP's net
interest margin (net interest income as a percentage of
average total interest earning assets). For purposes of this
table, loan balances include non-accrual loans and interest
income on loans includes loan fees or amortization of such
fees which have been deferred, as well as, interest recorded
on non-accrual loans as cash is received. Additionally, a tax
rate of approximately 34% is used to compute tax-equivalent
yields.
34
Nine Months Ended September 30 (In thousands, except percentages)
1996 1995
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest earning assets:
Loans and loans held
for sale, net of
unearned income $ 841,961 $ 55,171 8.63% $ 823,300 $ 53,669 8.67%
Deposits with banks 2,670 96 4.72 6,847 244 4.83
Federal funds sold
and securities
purchased under
agreement to resell 834 34 5.38 3,024 139 6.03
Investment securities:
Available for sale 444,908 22,082 6.62 307,111 16,609 7.21
Held to maturity 490,334 25,852 7.03 540,124 27,720 6.84
Total investment
securities 935,242 47,934 6.83 847,235 44,329 6.98
Assets held in trust for
collateralized
mortgage obligation 6,475 366 7.55 8,419 407 6.46
Total interest earning
assets/interest income 1,787,182 $103,601 7.71% 1,688,825 $ 98,788 7.79%
Non-interest earning assets:
Cash and due from banks 35,154 36,644
Premises and equipment 18,315 19,097
Other assets 96,658 80,230
Allowance for loan
losses (14,510) (15,226)
TOTAL ASSETS $1,922,799 $1,809,570
CONTINUED ON NEXT PAGE
35
NINE MONTHS ENDED September 30
CONTINUED FROM PREVIOUS PAGE
1996 1995
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest bearing
liabilities:
Interest bearing
deposits:
Interest bearing
demand $ 82,073 $ 613 1.00% $ 94,458 $ 1,019 1.44%
Savings 212,664 2,683 1.69 233,133 3,307 1.89
Other time 735,183 28,425 5.16 743,197 29,884 5.36
Total interest bearing
deposits 1,029,920 31,721 4.11 1,070,788 34,210 4.26
Short-term borrowings:
Federal funds
purchased, secur-
ities sold under
agreements to
repurchase and other
short-term
borrowings 144,160 5,575 5.18 146,859 5,956 5.48
Advances from Federal
Home Loan Bank 425,516 18,419 5.80 277,056 13,467 6.50
Collateralized mortgage
obligation 5,911 367 8.30 7,595 671 11.81
Long-term debt 4,727 107 2.38 4,744 180 5.07
Total interest bearing
liabilities/interest
expense 1,610,234 56,189 4.65 1,507,042 54,484 4.83
Non-interest bearing
liabilities:
Demand deposits 139,739 135,252
Other liabilities 23,767 25,053
Stockholders' equity 149,059 142,223
TOTAL LIABILITIES AND
STOCKHOLDERS'
EQUITY $1,922,799 $1,809,570
Interest rate spread 3.06 2.96
Net interest income/
net interest margin 47,412 3.52% 44,304 3.48%
Tax-equivalent adjustment (2,259) (2,067)
Net Interest Income $45,153 $42,237
....PROVISION FOR LOAN LOSSES.....The Company's provision for
loan losses for the first nine months of 1996 totalled $68,000
or 0.01% of average total loans compared to a provision of
$240,000 or 0.04% of average total loans for the same 1995
period. The reduced provision in 1996 reflects the continued
adequacy of the allowance for loan losses at each of the
Company's banking subsidiaries and a declining trend in
classified assets. At September 30, 1996, the balance in the
allowance for loan losses totalled $13.9 million or 185.1% of
total non-performing assets.
36
.....NON-INTEREST INCOME.....Non-interest income for the first
nine months of 1996 totalled $14.0 million which represented
a $2.0 million or 16.8% increase when compared to the same
1995 period. This increase was primarily due to the following
items:
a $260,000 or 10.2% increase in trust fees to $2.8
million in the first nine months of 1996. This trust fee
growth reflects increased assets under management as a
result of successful business development efforts in the
Company's Southwestern Pennsylvania marketplace.
a $769,000 gain realized on the sale of loans held for
sale in the first nine months of 1996 compared to a
$474,000 loss realized on this same type of activity in
the first nine months of 1995 (a net favorable shift of
$1.2 million). The 1996 gain resulted from normal sales
activity at the Company's mortgage banking subsidiary.
The 1995 loss resulted from the first quarter sale of $34
million of fixed-rate residential mortgage loans with a
weighted average coupon of 7.79% and a weighted average
maturity of 168 months. This sale was executed to
diversify the Company's balance sheet mix and reduce its
overall level of fixed-rate residential mortgage loans
resulting from the Johnstown Savings Bank acquisition.
The majority of the proceeds from the sale were
reinvested in adjustable-rate agency securities to
increase the repricing sensitivity of the Company's
earning assets.
a $212,000 or 10.9% decrease in net mortgage servicing
fee income to $1.7 million. This amount resulted from
$2.7 million of mortgage servicing fees net of $944,000
of amortization expense of the cost of purchased and
originated mortgage servicing rights. The decline in
earnings between years was due in part to increased
amortization expense on the mortgage servicing rights as
a result of faster mortgage prepayment speeds in 1996.
a $905,000 gain was realized on the disposition of
Frontier Finance Company, a subsidiary of Community
Savings Bank, in the first quarter of 1995. This
business line was sold because it did not fit into the
Company's future strategic plans and was not meeting
internal return on equity performance requirements.
There were no business line dispositions in the first
nine months of 1996.
a $890,000 increase in the net cash surrender value of a
$32.1 million Bank Owned Life Insurance Policy as the
total balance of this asset was outstanding for the
entire nine months of 1996 compared to only a portion of
the period in 1995.
a $593,000 increase in other income due in part to
additional income resulting from ATM transaction charges,
other mortgage banking processing fees, credit card
charges, letters of credit fees, and check supply sales.
37
.....NON-INTEREST EXPENSE.....Non-interest expense for the
first nine months of 1996 totalled $39.4 million which
represented a $1.6 million or 4.4% increase when compared to
the same 1995 period. This increase was primarily due to the
following items:
a $226,000 decrease in salaries and employee benefits due
to eight fewer FTE, reduced profit sharing expense, and
lower group insurance medical premiums as a result of a
switch to a managed care program.
a $531,000 increase in professional fees due to higher
legal and other professional fees in the first nine
months of 1996.
a $939,000 increase in FDIC deposit insurance expense due
to the previously discussed special assessment to
recapitalize the SAIF.
a $389,000 increase in other expense due to higher
advertising expense, other real estate owned expense,
telephone expense, and outside processing fees.
.....INCOME TAX EXPENSE.....The Company's provision for income
taxes for the first nine months of 1996 was $5.2 million
reflecting an effective tax rate of 26.4%. The Company's
income tax provision for the first nine months of 1995 was
$4.6 million or an effective tax rate of 28.2%. The lower
effective tax rate in 1996 was caused by increased total tax-
free asset holdings which were $24 million higher on average
in the first nine months of 1996 as compared to the first nine
months of 1995.
.....NET OVERHEAD BURDEN.....The Company's efficiency
ratio(non-interest expense divided by total revenue, which
consists of tax-equivalent net interest income and non-
interest income) showed significant improvement as it declined
from 67.0% for the first nine months of 1995 to 64.1% for the
first nine months of 1996. Excluding the $1.9 million SAIF
special assessment, the Company's efficiency ratio for the
first nine months of 1996 averaged 60.9%. The increased
revenue generated in 1996 is a key factor responsible for the
improved efficiency ratio. The Company is well positioned to
achieve its goal of reducing this ratio to below 60% by mid-
1997. Employee productivity ratios also continued to
demonstrate improvement as total assets per employee averaged
$2.6 million for the first nine months of 1996 a 7.4% increase
over the $2.4 million average for the same period in 1995.
38
.....BALANCE SHEET.....The Company's total consolidated assets
were $2.071 billion at September 30, 1996, compared with
$1.885 billion at December 31, 1995, which represents an
increase of $186 million or 9.9% due to increased leveraging
of the balance sheet. During the first nine months of 1996,
total loans and loans held for sale increased by approximately
$69 million or 8.3% due to the previously mentioned growth in
commercial and commercial mortgage loans. Consumer loans
continued to decline due to net run-off experienced in the
indirect auto loan portfolio. This indirect auto loan run-off
has overshadowed improved direct consumer loan production from
the Company's branch offices which for the first nine months
of 1996 was $14 million or 59% greater than the comparable
1995 period. Investment securities increased by $122.7
million due to purchases of mortgage-backed and municipal
securities. A significant portion of the securities portfolio
growth occurred during the third quarter of 1996 as the
Company took advantage of a temporary 30-50 basis point
steepening of the treasury yield curve to purchase higher
yielding securities.
Total deposits declined by $25.2 million or 2.1% since
December 31, 1995. The majority of this run-off occurred in
certificate of deposits as the Company experienced more
aggressive competitor deposit pricing during the third
quarter. The Company's total borrowed funds position
increased by $213.8 million as these borrowings were used to
fund the increased investment security purchases noted above.
Overall, the Company's asset leverage ratio was 6.31% at
September 30, 1996. The Company expects to use cash flow from
the investment securities portfolio to de-lever the balance
sheet by approximately $50 million during the fourth quarter
of 1996 in order to bring the asset leverage ratio up to the
targeted operating level of 6.50%.
.....MARKET AREA ECONOMY.....The rate of economic growth in
the third quarter slowed from previous quarters as expected by
the Federal Reserve. The Labor Department reported employment
costs rose 0.6% in the third quarter, compared to the 0.8%
increase in the second quarter of 1996. This was the smallest
gain since the 0.6% increase in the third quarter of 1995.
Evidence of economic weakness and low inflation are factors
which could persuade the Federal Reserve to hold off raising
interest rates in the near future.
In the Johnstown region, seasonal reductions caused the
Cambria-Somerset unemployment rate to rise 0.1% in September
to 6.9%, the first increase in 1996. The Johnstown region has
experienced modest declines in deposit volumes during much of
1996, while the Pittsburgh region's deposits have decreased
slightly from July. Lending pipelines have improved and
activity continues to be generally strong in both markets as
evidenced by the increased new loan fundings in 1996.
In the Johnstown marketplace, a 47-unit, three story
Motel 6 is planned for the Napoleon Place area. The budget
motel will face the clock tower at Napoleon Place, a 3.4 acre
tract in the city's Kernville neighborhood.
In the Pittsburgh marketplace, Lazarus officials unveiled
a design for a $78 million, 251,000 square foot department
store, which will be located at Fifth Avenue and Wood Street
in Pittsburgh's downtown area. In addition, a joint venture
to develop the Leetsdale Intermodal Distribution site will
cost $5 million and could create as many as 200 new jobs from
the handling of cargoes rarely seen on local rivers, such as
food and paper.
39
.....LOAN QUALITY.....USBANCORP's written lending policies
require underwriting, credit analysis, and loan documentation
standards be met prior to funding any loan. After the loan
has been approved and funded, continued periodic credit review
is required. Credit reviews are mandatory for all commercial
loans and for all commercial mortgages in excess of $250,000
within an 18 month period. In addition, due to the secured
nature of residential mortgages and the smaller balances of
individual installment loans, sampling techniques are used on
a continuing basis for credit reviews in these loan areas.
The following table sets forth information concerning
USBANCORP's loan delinquency and other non-performing assets
(in thousands, except percentages):
September 30 December 31 September 30
1996 1995 1995
Total loan delinquency (past due
30 to 89 days) $14,608 $14,324 $14,287
Total non-accrual loans 5,635 7,517 5,405
Total non-performing assets<F1> 7,495 9,426 7,182
Loan delinquency, as a percentage
of total loans and loans held
for sale, net of unearned income 1.62% 1.72% 1.75%
Non-accrual loans, as a percentage
of total loans and loans held
for sale, net of unearned
income 0.62 0.90 0.66
Non-performing assets, as a
percentage of total loans and
loans held for sale, net of
unearned income, and other
real estate owned 0.83 1.13 0.88
<F1>Non-performing assets are comprised of (i) loans that
are on a non-accrual basis, (ii) loans that are contractually
past due 90 days or more as to interest and principal
payments some of which are insured for credit loss,
and (iii) other real estate owned. All loans, except for
loans that are insured for credit loss, are placed on non-
accrual status upon becoming 90 days past due in
either principal or interest.
Total loan delinquency amounted to $14.6 million or
1.62% of total loans outstanding at September 30, 1996 which
was slightly improved from the 1.72% delinquency rate at
December 31, 1995. Non-performing assets also demonstrated
a favorable decline since year-end due primarily to enhanced
collection efforts on residential mortgage loans and the
success of the Company's ongoing commercial loan workout
programs.
40
.....ALLOWANCE FOR LOAN LOSSES.....The following table sets
forth changes in the allowance for loan losses and certain
ratios for the periods ended (in thousands, except
percentages):
September 30 December 31 September 30
1996 1995 1995
Allowance for loan losses $ 13,871 $ 14,914 $ 14,899
Amount in the allowance
for loan losses
allocated to "general risk" 5,564 7,471 7,327
Allowance for loan losses as
a percentage of each of
the following:
total loans and loans
held for sale,
net of unearned income 1.54% 1.79% 1.83%
total delinquent loans
(past due 30 to 89 days) 94.95 104.12 104.28
total non-accrual loans 246.16 198.40 275.65
total non-performing assets 185.07 158.22 207.45
Since December 31, 1995, the balance in the allowance
for loan losses has declined by $1,043,000 to $13.9 million
due to net charge-offs exceeding the loan loss provision. Net
charge-offs for the first nine months of 1996 amounted to
$1,111,000 or 0.18% of total average loans compared to net
charge-offs of $589,000 or 0.10% of total average loans for
the same 1995 period. The higher 1996 net charge-offs reflect
the second quarter charge-off of one $756,000 commercial
loan(for which a full loan loss reserve allocation had been
previously established in 1995). The Company's allowance for
loan losses as a percentage of non-performing assets increased
to 185.1% at September 30, 1996, compared to 158.2% at
December 31, 1995. This coverage ratio improved since year-
end 1995 due to the Company's reduced level of non-performing
assets.
.....INTEREST RATE SENSITIVITY.....Asset/liability management
involves managing the risks associated with changing interest
rates and the resulting impact on the Company's net interest
income and capital. The management and measurement of
interest rate risk at USBANCORP is performed by using the
following tools: 1) simulation modeling which analyzes the
impact of interest rate changes on net interest income and
capital levels over specific future time periods by projecting
the yield performance of assets and liabilities in numerous
varied interest rate environments; and 2)static "GAP" analysis
which analyzes the extent to which interest rate sensitive
assets and interest rate sensitive liabilities are matched at
specific points in time.
41
For static GAP analysis, USBANCORP typically defines
interest rate sensitive assets and liabilities as those that
reprice within six months or one year. Maintaining an
appropriate match is one method of avoiding wide fluctuations
in net interest margin during periods of changing interest
rates. The difference between rate sensitive assets and rate
sensitive liabilities is known as the "interest sensitivity
GAP." A positive GAP occurs when rate sensitive assets exceed
rate sensitive liabilities repricing in the same time period
and a negative GAP occurs when rate sensitive liabilities
exceed rate sensitive assets repricing in the same time
period. A GAP ratio (rate sensitive assets divided by rate
sensitive liabilities) of one indicates a statistically
perfect match. A GAP ratio of less than one suggests that a
financial institution may be better positioned to take
advantage of declining interest rates rather than increasing
interest rates, and a GAP ratio of more than one suggests the
converse.
The following table presents a summary of the Company's
static GAP positions (in thousands, except for the GAP
ratios):
September 30 December 31 September 30
1996 1995 1995
Six month cumulative GAP
RSA................ $ 643,036 $ 589,200 $ 473,810
RSL................ (891,937) (845,020) (783,187)
Off-balance sheet
hedges.......... 25,000 75,000 75,000
GAP................ $(223,901) $(180,820) $(234,377)
GAP ratio.......... 0.74X 0.77X 0.67X
GAP as a % of total
assets.......... (10.81)% (9.59)% (12.80)%
GAP as a % of total
capital......... (150.23) (120.15) (163.52)
One year cumulative GAP
RSA................ $ 868,548 $ 787,615 $ 718,221
RSL................ (1,018,097) (986,669) (937,557)
Off-balance sheet
hedges........ - 75,000 75,000
GAP................ $(149,549) $(124,054) $(144,336)
GAP ratio.......... 0.85X 0.86X 0.83X
GAP as a % of total
assets.......... (7.22)% (6.58)% (7.88)%
GAP as a % of total
capital......... (100.34) (82.43) (100.70)
When September 30, 1996, is compared to December 31,
1995, both the Company's six month and one year cumulative GAP
ratios became more negative due to increased leveraging of the
balance sheet. As separately disclosed in the above table,
the hedge transactions (described in detail in Note 13)
reduced the negativity of the six month GAP by $25 million and
had no impact on the one year GAP because the scheduled
maturity of all off-balance sheet hedges is now under one
year.
A portion of the Company's funding base is low cost core
deposit accounts which do not have a specific maturity date.
The accounts which comprise these low cost core deposits
include passbook savings accounts, money market accounts, NOW
accounts, daily interest savings accounts, purpose clubs, etc.
At September 30, 1996, the balance in these accounts totalled
$443 million or 21.4% of total assets. Within the above
static GAP table, approximately $148 million or 33.5% of the
total low cost core deposits are assumed to be rate sensitive
liabilities which reprice in one year or less; this assumption
is based upon historical experience in varying interest rate
environments and is consistently used for all GAP ratios
presented. The Company recognizes that the pricing of these
accounts is somewhat inelastic when compared to normal rate
movements and generally assumes that up to a 250 basis point
increase in rates will not necessitate a change in the cost of
these accounts.
42
There are some inherent limitations in using static GAP
analysis to measure and manage interest rate risk. For
instance, certain assets and liabilities may have similar
maturities or periods to repricing but the magnitude or degree
of the repricing may vary significantly with changes in market
interest rates. As a result of these GAP limitations,
management places primary emphasis on simulation modeling to
manage and measure interest rate risk. At September 30, 1996,
these varied economic interest rate simulations indicated that
the maximum negative variability of USBANCORP's net interest
income over the next twelve month period was -3.7% under an
upward rate shock forecast reflecting a 200 basis point
increase in interest rates. Capital impairment under this
simulation was estimated to be less than 1.0% and net income
was reduced by approximately 7.4%. The off-balance sheet
borrowed funds hedge transactions also helped reduce the
variability of forecasted net interest income in a rising
interest rate environment. The Company's asset liability
management policy seeks to limit net interest income
variability to plus or minus 7.5% based upon varied economic rate forecasts
which include interest rate movements of up to 200 basis
points.
Within the investment portfolio at September 30, 1996,
48.8% of the portfolio is currently classified as available
for sale and 51.2% as held to maturity. The available for
sale classification provides management with greater
flexibility to manage the securities portfolio to better
achieve overall balance sheet rate sensitivity goals and
provide liquidity if needed. Furthermore, it is the Company's
intent to continue to diversify its loan portfolio to increase
liquidity and rate sensitivity and to better manage
USBANCORP's long-term interest rate risk by continuing to sell
newly originated 30 year fixed-rate mortgage loans. The
Company will usually retain servicing rights at its mortgage
banking subsidiary and recognize fee income over the remaining
lives of the loans sold at an average rate of approximately 30
basis points on the loan balances outstanding.
.....LIQUIDITY.....Financial institutions must maintain
liquidity to meet day-to-day requirements of depositor and
borrower customers, take advantage of market opportunities,
and provide a cushion against unforeseen needs. Liquidity
needs can be met by either reducing assets or increasing
liabilities. Sources of asset liquidity are provided by
short-term investment securities, time deposits with banks,
federal funds sold, banker's acceptances, and commercial
paper. These assets totalled $171 million at September 30,
1996, $169 million at December 31, 1995, and $187 at September
30, 1995. Maturing and repaying loans as well as the monthly
cash flow associated with certain mortgage-backed securities
are other significant sources of asset liquidity.
43
Liability liquidity can be met by attracting deposits
with competitive rates, using repurchase agreements, buying
federal funds, or utilizing the facilities of the Federal
Reserve or the Federal Home Loan Bank systems. USBANCORP's
subsidiaries utilize a variety of these methods of liability
liquidity. At September 30, 1996, USBANCORP's subsidiaries
had approximately $55.0 million of unused lines of credit
available under informal arrangements with correspondent banks
compared to $168.4 million at September 30, 1995. These lines
of credit enable USBANCORP's subsidiaries to purchase funds
for short-term needs at current market rates. Additionally,
each of the Company's subsidiary banks are members of the
Federal Home Loan Bank which provides the opportunity to
obtain intermediate- to longer-term advances up to
approximately 80% of their investment in assets secured by
one-to-four family residential real estate. This would
suggest a current total available Federal Home Loan Bank
borrowing capacity of approximately $127.3 million.
Furthermore, USBANCORP had available at September 30, 1996,
$9.0 million of a total $14.5 million unsecured line of
credit.
Liquidity can be further analyzed by utilizing the
Consolidated Statement of Cash Flows. Cash equivalents
decreased by $6.7 million from December 31, 1995, to September
30, 1996, due primarily to $209.6 million of net cash used by
investing activities. This more than offset $25.7 million of
net cash provided by operating activities and $177.1 million
of net cash provided by financing activities. Within
investing activities, purchases of investment securities
exceeded the cash proceeds from investment security maturities
and sales by approximately $131.3 million. Cash advanced for
new loan fundings totalled $258.8 million and was
approximately $67.6 million greater than the cash received
from loan principal payments. Within financing activities,
cash payments for maturing certificates of deposit exceeded
cash generated from the sale of new certificates of deposit by
$20.8 million. Net principal borrowings of advances from
Federal Home Loan Bank and long-term debt provided $87.2
million of cash.
44
.....CAPITAL RESOURCES.....The following table highlights the
Company's compliance with the required regulatory capital
ratios for each of the periods presented (in thousands, except
ratios):
September 30, 1996 December 31, 1995 September 30, 1995
Amount Ratio Amount Ratio Amount Ratio
RISK-ADJUSTED
CAPITAL RATIOS
Tier 1 capital $ 129,362 13.27% $ 123,251 13.63% $ 119,013 13.22%
Tier 1 capital minimum
requirements 38,987 4.00 36,162 4.00 36,014 4.00
Excess $ 90,375 9.27% $ 87,089 9.63% $ 82,999 9.22%
Total capital $ 141,546 14.52% $ 134,552 14.88% $ 130,267 14.47%
Total capital minimum
requirements 77,975 8.00 72,325 8.00 72,027 8.00
Excess $ 63,571 6.52% $ 62,227 6.88% $ 58,240 6.47%
Total risk-
adjusted
assets $ 974,687 $ 904,062 $ 900,339
ASSET LEVERAGE
RATIO
Tier 1 capital $ 129,362 6.31% $ 123,251 6.63% $ 119,013 6.59%
Tier 1 capital
minimum
requirements 102,558 5.00 92,907 5.00 90,361 5.00
Excess $ 26,804 1.31% $ 30,344 1.63% $ 28,652 1.59%
Total adjusted
assets $2,051,165 $1,858,131 $1,807,215
Between December 31, 1995, and September 30, 1996, each
of the Company's regulatory capital ratios decreased due to
greater leveraging of the balance sheet through the investment
securities portfolio and loan portfolio in the third quarter.
As a result of this increased size of the balance sheet, the
asset leverage ratio dropped to 6.31% which is slightly below
the Company's targeted operating level of 6.50%. Management
believes that a 6.50% asset leverage ratio provides an optimal
balance between regulatory capital requirements and
shareholder value needs. The Company expects to use cash flow
from the investment securities portfolio to delever the
balance sheet by approximately $50 million during the fourth
quarter of 1996 in order to bring the asset leverage ratio
back up to the 6.50% operating level.
The Company used funds provided by a $12 million
unsecured line of credit to repurchase 169,000 shares or $5.8
million of its common stock during the first nine months of
1996. The rate on this unsecured line of credit floats at 50
basis points under the prime rate. Through September 30,
1996, the Company has repurchased a total of 592,000 shares of
its common stock at a total cost of $16.8 million or $28.36
per share. The Company plans to continue its treasury stock
repurchase program which currently permits a maximum total
repurchase authorization of $30 million. The maximum price
per share at which the Company can repurchase stock is 150% of
book value. At September 30, 1996, the book value of the
Company's common stock was $28.95 per share.
45
The Company exceeds all regulatory capital ratios for
each of the periods presented. Furthermore, each of the
Company's subsidiary banks are considered "well capitalized"
under all applicable FDIC regulations. It is the Company's
ongoing intent to continue to prudently leverage the capital
base in an effort to increase return on equity performance
while maintaining necessary capital requirements. It is,
however, the Company's intent to maintain the FDIC "well
capitalized" classification for each of its subsidiaries to
ensure the lowest deposit insurance premium and to maintain an
asset leverage ratio of no less than 6.0%.
The Company's declared Common Stock cash dividend per
share was $0.87 for the first nine months of 1996 which was a
10.1% increase over the $0.79 per share dividend for the same
1995 interim period. The dividend yield on the Company's
common stock now approximates 3.1% compared to an average
common dividend yield for Pennsylvania bank holding companies
of approximately 2.9%. The Company remains committed to a
progressive total shareholder return which includes
maintaining the common dividend at a higher level than peer.
The graph on this page presents the common shares outstanding for
the past five quarters. The data points in thousands are 5,148,
5,187, 5,267, 5,308, and 5,299.
46
Presented on this page was a service area map reflecting the six counties
serviced by the Company. The counties served include Allegheny, Cambria,
Clearfield, Somerset, Washington, and Westmoreland.
47
Part II Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit
15.1 Letter re: unaudited interim financial
information
(b) Reports on Form 8-K: There were no reports
filed on Form 8-K during the first nine months
of 1996.
Pursuant to the requirements of the Securities Exchange
Act of 1934, the registrant duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
USBANCORP, Inc.
Registrant
Date: November 13, 1996 \s\Terry K. Dunkle
Terry K. Dunkle
Chairman, President and
Chief Executive Officer
Date: November 13, 1996 \s\Orlando B. Hanselman
Orlando B. Hanselman
Executive Vice President &
Chief Financial Officer
48
STATEMENT OF MANAGEMENT RESPONSIBILITY
October 18, 1996
To the Stockholders and
Board of Directors of
USBANCORP, Inc.
Management of USBANCORP, Inc. and its subsidiaries
have prepared the consolidated financial statements
and other information in the Form 10-Q in accordance
with generally accepted accounting principles and are
responsible for its accuracy.
In meeting its responsibilities, management relies on
internal accounting and related control systems, which
include selection and training of qualified personnel,
establishment and communication of accounting and
administrative policies and procedures, appropriate
segregation of responsibilities, and programs of
internal audit. These systems are designed to provide
reasonable assurance that financial records are
reliable for preparing financial statements and
maintaining accountability for assets, and that assets
are safeguarded against unauthorized use or
disposition. Such assurance cannot be absolute
because of inherent limitations in any internal
control system.
Management also recognizes its responsibility to
foster a climate in which Company affairs are
conducted with the highest ethical standards. The
Company's Code of Conduct, furnished to each employee
and director, addresses the importance of open
internal communications, potential conflicts of
interest, compliance with applicable laws, including
those related to financial disclosure, the
confidentiality of propriety information, and other
items. There is an ongoing program to assess
compliance with these policies.
The Audit Committee of the Company's Board of
Directors consists solely of outside directors. The
Audit Committee meets periodically with management and
the independent accountants to discuss audit,
financial reporting, and related matters. Arthur
Andersen LLP and the Company's internal auditors have
direct access to the Audit Committee.
\s\Terry K. Dunkle \s\Orlando B. Hanselman
Terry K. Dunkle Orlando B. Hanselman
Chairman, President & Executive Vice President &
Chief Executive Officer Chief Financial Officer
49
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of
USBANCORP, Inc.:
We have reviewed the accompanying consolidated balance
sheets of USBANCORP, Inc. (a Pennsylvania corporation)
and Subsidiaries as of September 30, 1996 and 1995,
and the related consolidated statements of income for
the three- and nine-month periods ended September 30,
1996 and 1995, and the consolidated statements of
changes in stockholders equity and cash flows for the
nine-month periods ended September 30, 1996 and 1995.
These financial statements are the responsibility of
the Company's management.
We conducted our reviews in accordance with standards
established by the American Institute of Certified
Public Accountants. A review of interim financial
information consists principally of applying
analytical procedures to financial data and making
inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope
than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material
modifications that should be made to the financial
statements referred to above for them to be in
conformity with generally accepted accounting
principles.
We have previously audited, in accordance with
generally accepted auditing standards, the
consolidated balance sheet of USBANCORP, Inc. as of
December 31, 1995, and, in our report dated January
25, 1996, we expressed an unqualified opinion on that
statement. In our opinion, the information set forth
in the consolidated balance sheet as of December 31,
1995, is fairly stated, in all material respects, in
relation to the balance sheet from which it has been
derived.
\s\ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Pittsburgh, Pennsylvania,
October 18, 1996
50
July 19, 1996
To the Stockholders and Board of Directors of
USBANCORP, INC.:
We are aware that USBANCORP, Inc. has incorporated by
reference in its Registration Statements on Form S-3
(Registration No. 33-56604); Form S-8 (Registration
No. 33-53935); Form S-8 (Registration No. 33-55845);
Form S-8 (Registration No. 33-55207); and Form S-8
(Registration No. 33-55211) its Form 10-Q for the
quarter ended September 30, 1996, which includes our
report dated October 18, 1996, covering the unaudited
interim financial statement information contained
therein. Pursuant to Regulation C of the Securities
Act of 1933 (the Act), that report is not considered a
part of the registration statements prepared or
certified by our firm or a report prepared or
certified by our firm within the meaning of Sections 7
and 11 of the Act.
Very truly yours,
\s\ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
51