UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the period ended June 30, 1998
Transaction 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 (I.R.S. Employer Identification No.)
incorporation or organization)
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 August 3, 1998
Common Stock, par value $2.50 13,881,664
per share
1
USBANCORP, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION:
Consolidated Balance Sheet -
June 30, 1998, December 31, 1997,
and June 30, 1997 3
Consolidated Statement of Income -
Three and Six Months Ended
June 30, 1998, and 1997 4
Consolidated Statement of Changes
in Stockholders' Equity -
Six Months Ended
June 30, 1998, and 1997 6
Consolidated Statement of Cash Flows -
Six Months Ended
June 30, 1998, and 1997 7
Notes to Consolidated Financial
Statements 8
Management's Discussion and Analysis
of Consolidated Financial Condition
and Results of Operations 22
Part II. Other Information 43
2
USBANCORP, INC.
CONSOLIDATED BALANCE SHEET
(In thousands)
June 30 December 31 June 30
1998 1997 1997
(Unaudited) (Unaudited)
ASSETS
Cash and due from banks $ 31,354 $ 38,056 $ 46,320
Interest bearing deposits with banks 241 163 5,378
Investment securities:
Available for sale 577,524 580,115 479,367
Held to maturity (market value
$488,766 on June 30, 1998,
$541,093 on December 31, 1997,
and $571,625 on June 30, 1997) 479,930 532,341 568,174
Assets held in trust for collateralized
mortgage obligation 3,656 4,267 4,765
Loans held for sale 24,798 13,163 14,534
Loans 996,822 981,739 966,282
Less: Unearned income 5,616 5,327 5,205
Allowance for loan losses 11,886 12,113 13,303
Net Loans 979,320 964,299 947,774
Premises and equipment 18,120 17,630 17,780
Accrued income receivable 16,384 17,317 17,648
Mortgage servicing rights 15,093 14,960 14,163
Goodwill and core deposit intangibles 19,869 19,122 20,300
Bank owned life insurance 34,802 33,979 33,189
Other assets 8,233 3,698 6,735
TOTAL ASSETS $ 2,209,324 $ 2,239,110 $ 2,176,127
LIABILITIES
Non-interest bearing deposits $ 157,228 $ 146,685 $ 149,438
Interest bearing deposits 1,021,178 992,842 1,015,692
Total deposits 1,178,406 1,139,527 1,165,130
Federal funds purchased and securities
sold under agreements to repurchase 89,922 92,829 93,156
Other short-term borrowings 88,055 57,892 62,276
Advances from Federal Home Loan Bank 637,418 754,195 663,722
Collateralized mortgage obligation 3,243 3,779 4,208
Guaranteed junior subordinated deferrable
interest debentures 34,500 - -
Long-term debt 6,400 4,361 5,302
Total borrowed funds 859,538 913,056 828,664
Other liabilities 27,306 28,347 26,146
TOTAL LIABILITIES 2,065,250 2,080,930 2,019,940
STOCKHOLDERS' EQUITY See Note #18
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;
24,000,000 shares authorized;
17,338,983 shares issued and 13,853,664
outstanding on June 30, 1998; 17,282,028
shares issued and 14,681,154 outstanding
on December 31, 1997; 17,275,638 shares
issued and 15,035,454 outstanding on June
30, 1997 43,347 14,402 14,396
Treasury stock at cost, 3,485,319 shares on
June 30, 1998, 2,600,874 shares on December
31, 1997, and 2,240,184 shares on June 30,
1997 (53,733) (31,175) (23,491)
Surplus 65,421 93,934 93,894
Retained earnings 86,653 78,866 71,583
Net unrealized holding gains (losses) on
available for sale securities 2,386 2,153 (195)
TOTAL STOCKHOLDERS' EQUITY 144,074 158,180 156,187
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 2,209,324 $ 2,239,110 $ 2,176,127
See accompanying notes to consolidated financial statements.
3
USBANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share data)
Unaudited
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
INTEREST INCOME
Interest and fees on loans and loans
held for sale:
Taxable $ 21,274 $ 20,271 $ 41,932 $ 39,948
Tax exempt 621 619 1,243 1,180
Deposits with banks 63 93 79 121
Federal funds sold and securities
purchased under agreements to resell - 2 - 2
Investment securities:
Available for sale 8,863 7,790 17,796 15,665
Held to maturity 8,233 10,004 17,621 19,204
Assets held in trust for collateralized
mortgage obligation 77 91 152 188
Total Interest Income 39,131 38,870 78,823 76,308
INTEREST EXPENSE
Deposits 10,253 10,785 20,450 21,111
Federal funds purchased and securities
sold under agreements to repurchase 1,279 1,155 2,593 2,481
Other short-term borrowings 1,131 793 2,204 1,762
Advances from Federal Home Loan Bank 9,493 9,136 19,618 17,329
Collateralized mortgage obligation 85 110 177 198
Guaranteed junior subordinated def. int.
debentures 501 - 501 -
Long-term debt 26 22 56 53
Total Interest Expense 22,768 22,001 45,599 42,934
NET INTEREST INCOME 16,363 16,869 33,224 33,374
Provision for loan losses 150 22 300 45
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 16,213 16,847 32,924 33,329
NON-INTEREST INCOME
Trust fees 1,117 999 2,226 1,999
Net realized gains on investment
securities 799 54 1,018 156
Net realized gains on loans held for sale 1,083 313 1,807 588
Wholesale cash processing fees 166 275 352 558
Service charges on deposit accounts 825 821 1,607 1,638
Net mortgage servicing fees 267 579 581 1,151
Bank owned life insurance 403 471 822 855
Other income 1,691 1,288 3,306 2,478
Total Non-Interest Income 6,351 4,800 11,719 9,423
NON-INTEREST EXPENSE
Salaries and employee benefits 7,590 6,962 15,080 13,891
Net occupancy expense 1,124 1,074 2,278 2,201
Equipment expense 1,034 786 1,830 1,658
Professional fees 760 829 1,552 1,593
Supplies, postage, and freight 683 698 1,354 1,350
Miscellaneous taxes and insurance 388 371 744 749
FDIC deposit insurance expense 99 69 137 (18)
Amortization of goodwill and core
deposit intangibles 547 589 1,136 1,178
Other expense 2,482 2,079 4,848 4,061
Total Non-Interest Expense $ 14,707 $ 13,457 $ 28,959 $ 26,663
CONTINUED ON NEXT PAGE
4
CONSOLIDATED STATEMENT OF INCOME
CONTINUED FROM PREVIOUS PAGE
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
INCOME BEFORE INCOME TAXES $ 7,857 $ 8,190 $ 15,684 $ 16,089
Provision for income taxes 2,120 2,350 4,252 4,581
NET INCOME $ 5,737 $ 5,840 $ 11,432 $ 11,508
PER COMMON SHARE DATA:(1)
Basic:
Net income $ 0.41 $ 0.39 $ 0.80 $ 0.75
Average shares outstanding 14,142,453 15,082,329 14,343,861 15,351,186
Diluted:
Net income $ 0.40 $ 0.38 $ 0.78 $ 0.75
Average shares outstanding 14,424,516 15,273,912 14,626,275 15,397,563
Cash Dividends Declared $ 0.14 $ 0.12 $ 0.26 $ 0.22
(1) All per share and share data have been adjusted to
reflect a 3 for 1 stock split effected in the form of a
200% stock dividend that was distributed on July 31, 1998, to
shareholders of record on July 16, 1998.
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, 1996 $ - $ 14,356 $(19,538) $ 93,527 $ 63,358 $ 214 $151,917
Net Income - - - - 11,508 - 11,508
Dividend reinvestment
and stock purchase plan - 40 - 367 - - 407
Net unrealized holding gains
(losses) on investment
securities - - - - - (409) (409)
Treasury stock purchased - - (3,953) - - - (3,953)
Cash dividends paid
($0.22 per share) - - - - (3,283) - (3,283)
Balance June 30, 1997 $ - $ 14,396 $(23,491) $ 93,894 $ 71,583 $ (195) $156,187
Balance December 31, 1997 $ - $ 14,402 $(31,175) $ 93,934 $ 78,866 $ 2,153 $158,180
Net Income - - - - 11,432 - 11,432
Dividend reinvestment
and stock purchase plan - 47 - 385 - - 432
Effect of 3 for 1 stock split
in the form of a 200%
stock dividend - 28,898 - (28,898) - - -
Net unrealized holding gains
(losses) on investment
securities - - - - - 233 233
Treasury stock purchased - - (22,558) - - - (22,558)
Cash dividends paid
($0.26 per share) - - - - (3,645) - (3,645)
Balance June 30, 1998 $ - $ 43,347 $(53,733) $ 65,421 $ 86,653 $ 2,386 $144,074
See accompanying notes to consolidated financial statements.
6
USBANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Unaudited
Six Months Ended
June 30
1998 1997
OPERATING ACTIVITIES
Net income $ 11,432 $ 11,508
Adjustments to reconcile net income to net cash (used)
provided by operating activities:
Provision for loan losses 300 45
Depreciation and amortization expense 1,247 1,206
Amortization expense of goodwill and core deposit
intangibles 1,136 1,178
Amortization expense of mortgage servicing rights 1,230 831
Net amortization (accretion) of investment securities 410 (56)
Net realized gains on investment securities (1,018) (156)
Net realized gains on loans and loans held for sale (1,807) (588)
Origination of mortgage loans held for sale (205,662) (110,434)
Sales of mortgage loans held for sale 188,480 106,250
Increase (decrease) in accrued income receivable 933 (286)
Increase (decrease) in accrued expense payable (1,145) 1,233
Net cash (used) provided by operating activities (4,464) 10,731
INVESTING ACTIVITIES
Purchases of investment securities and other short-term
investments (283,161) (317,021)
Proceeds from maturities of investment securities and
other short-term investments 133,614 64,536
Proceeds from sales of investment securities and other
short-term investments 205,334 206,739
Long-term loans originated (183,049) (153,563)
Loans held for sale (24,798) (14,534)
Principal collected on long-term loans 198,662 135,537
Loans purchased or participated - (2)
Loans sold or participated - 234
Net decrease in credit card receivable and other short-
term loans 1,218 1,144
Purchases of premises and equipment (1,796) (820)
Sale/retirement of premises and equipment 59 32
Net decrease in assets held in trust for collateralized
mortgage obligation 611 494
Net increase mortgage servicing rights (1,363) (2,500)
Net increase in other assets (5,868) (391)
Net cash provided (used) by investing activities 39,463 (80,115)
FINANCING ACTIVITIES
Proceeds from sales of certificates of deposit 257,101 137,632
Payments for maturing certificates of deposits (238,785) (108,166)
Net increase (decrease) in demand and savings deposits 20,563 (3,074)
Net increase (decrease) in federal funds purchased,
securities sold under agreements to repurchase, and
other short-term borrowings 26,720 (791)
Net principal (repayments) borrowings of advances from
Federal Home Loan Bank (116,777) 58,223
Principal borrowings on long-term debt 3,623 5,068
Repayments of long-term debt (1,584) (3,938)
Common stock cash dividends paid (4,870) (4,067)
Proceeds from sale of guaranteed junior deferrable
interest debentures, net of expenses 33,183 -
Guaranteed junior subordinated deferrable interest
debenture dividends paid (486) -
Proceeds from dividend reinvestment, stock purchase plan,
and stock options exercised 432 407
Purchases of treasury stock (22,558) (3,953)
Net increase (decrease) in other liabilities 1,815 (660)
Net cash (used) provided by financing activities (41,623) 76,681
NET (DECREASE) INCREASE IN CASH EQUIVALENTS (6,624) 7,297
CASH EQUIVALENTS AT JANUARY 1 38,219 44,401
CASH EQUIVALENTS AT JUNE 30 $ 31,595 $ 51,698
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"), USBANCORP Trust Company
("Trust Company"), UBAN Associates, Inc., ("UBAN
Associates") 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 and six month
periods ended June 30, 1998, and 1997, 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 review report
dated July 17, 1998, 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, 1997,
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, 1997.
3. Earnings Per Common Share
During the fourth quarter of 1997, the Company
adopted Statement of Financial Accounting Standards
("SFAS") #128, "Earnings Per Share." Under SFAS #128,
earnings per share are classified as basic earnings per
share and diluted earnings per share. Basic earnings per
share includes only the weighted average common shares
outstanding. Diluted earnings per share includes the
weighted average common shares outstanding and any
dilutive common stock equivalent shares in the
calculation. All prior periods have been restated to
reflect this adoption. Treasury shares are treated as
retired for earnings per share purposes.
8
4. Comprehensive Income
In January 1998, the Company adopted SFAS #130,
"Reporting Comprehensive Income," which established
standards for reporting and displaying comprehensive
income and its components in a financial statement. For
the Company, comprehensive income includes net income and
unrealized holding gains and losses from available for
sale investment securities. The changes of other
comprehensive income are reported as follows (in
millions):
Three Months Ended Six Months Ended
June 30 June 30 June 30 June 30
1998 1997 1998 1997
Net income $5,737 $5,840 $11,432 $11,508
Other comprehensive income, before tax:
Unrealized holding gains(losses) on
investment securities (1,469) 5,751 177 (625)
Less: reclassification adjustment for
gains included in net income (799) (54) (1,018) (156)
Other comprehensive income(loss) before tax (2,268) 5,697 (841) (781)
Income tax expense(credit) related to items
of other comprehensive income (612) 1,634 (228) (222)
Other comprehensive income(loss), net of tax (1,656) 4,063 (613) (559)
Comprehensive income $4,081 $9,903 $10,819 $10,949
5. 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 $3,007,000 in income tax payments in the
first six months of 1998 as compared to $3,886,000 for
the first six months of 1997. Total interest expense
paid amounted to $46,744,000 in 1998's first six months
compared to $41,701,000 in the same 1997 period.
6. Investment Securities
The Company uses 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).
9
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 shareholders' equity on a net of tax basis.
Any security classified as trading assets are reported at
fair value with unrealized aggregate appreciation
(depreciation) included in current income on a net of tax
basis. The Company presently does not engage in trading
activity. Realized gain or loss on securities sold was
computed upon the adjusted cost of the specific
securities sold. The book and market values of
investment securities are summarized as follows (in
thousands):
Investment securities available for sale:
June 30, 1998
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 2,442 $ 9 $ - $ 2,451
U.S. Agency 6,755 109 - 6,864
State and municipal 13,322 241 - 13,563
U.S. Agency mortgage-backed
securities 506,627 3,591 (502) 509,716
Other securities<F1> 44,935 - (5) 44,930
Total $574,081 $ 3,950 $ (507) $577,524
Investment securities held to maturity:
June 30, 1998
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 16,136 $ 21 $ - $ 16,157
U.S. Agency 9,925 73 - 9,998
State and municipal 112,114 2,491 (37) 114,568
U.S. Agency mortgage-backed
securities 337,600 6,500 (383) 343,717
Other securities<F1> 4,155 171 - 4,326
Total $479,930 $ 9,256 $ (420) $488,766
<F1>Other investment securities include corporate notes
and bonds, asset-backed securities, and equity 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 June 30, 1998, 99.0% of the portfolio was rated "AAA"
compared to 98.7% at June 30, 1997. Approximately 0.01%
of the portfolio was rated below "A" or unrated on June
30, 1998.
10
7. Loans Held for Sale
At June 30, 1998, $24,798,000 of newly originated
fixed-rate residential mortgage loans were classified as
"held for sale." It is management's intent to sell these
residential mortgage loans during the next several
months. The residential mortgage loans held for sale are
carried at the lower of aggregate cost or market value.
Net realized and unrealized gains and losses are included
in "Net 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.
8. Loans
The loan portfolio of the Company consists of the
following (in thousands):
June 30 December 31 June 30
1998 1997 1997
Commercial $136,522 $143,113 $151,743
Commercial loans secured
by real estate 322,104 302,620 292,132
Real estate - mortgage 447,521 440,734 425,380
Consumer 90,675 95,272 97,027
Loans 996,822 981,739 966,282
Less: Unearned income 5,616 5,327 5,205
Loans, net of unearned
income $991,206 $976,412 $961,077
Real estate-construction loans were not material at
these presented dates and comprised 2.9% of total loans
net of unearned income at June 30, 1998. The Company has
no credit exposure to foreign countries or highly
leveraged transactions. Additionally, the Company has no
significant industry lending concentrations.
9. 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 criticized and impaired
loans to determine if any specific reserve
allocations are required on an individual loan
basis.
the application of reserve allocations for
commercial and commercial real-estate loans are
calculated by using a three year migration analysis
of net losses incurred within the entire commercial
loan portfolio.
11
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 loans
is based upon review of historical and qualitative
factors, which include but are not limited to,
national and economic trends, delinquencies,
concentrations of credit, and trends in loan volume.
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 and
provides appropriate support for accounting purposes.
When it is determined that the prospects for recovery
of the principal of a loan 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.
12
An analysis of the changes in the allowance for loan
losses follows (in thousands, except ratios):
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
Balance at beginning of period $ 11,880 $ 13,206 $ 12,113 $ 13,329
Charge-offs:
Commercial - 69 128 79
Real estate-mortgage 35 31 127 80
Consumer 264 264 563 505
Total charge-offs 299 364 818 664
Recoveries:
Commercial 27 145 48 198
Real estate-mortgage 57 210 93 232
Consumer 71 84 150 163
Total recoveries 155 439 291 593
Net (recoveries)charge-offs 144 (75) 527 71
Provision for loan losses 150 22 300 45
Balance at end of period $ 11,886 $ 13,303 $ 11,886 $ 13,303
As a percent of average loans
and loans held for sale, net
of unearned income:
Annualized net (recoveries)
charge-offs 0.06% (0.03)% 0.11% 0.02%
Annualized provision for loan
losses 0.06 0.01 0.06 0.01
Allowance as a percent of loans
and loans held for sale, net of
unearned income at period end 1.17 1.36 1.17 1.36
Total classified loans $30,445 $24,590 $30,445 $24,590
Dollar allocation of reserve to
general risk 6,012 6,874 6,012 6,874
Percentage allocation of
reserve to general risk 50.58% 51.67% 50.58% 51.67%
(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 on pages 27 and 37, respectively.)
13
10. Components of Allowance for Loan Losses
The Company uses 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" to account for
impaired loans. 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.
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, credit reviews are mandatory for
all commercial and commercial mortgage loans with
balances in excess of $250,000 within an 18 month period.
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.
The Company had loans totalling $1,197,000 and
$1,879,000 being specifically identified as impaired and
a corresponding allocation reserve of $650,000 and
$1,275,000 at June 30, 1998, and June 30, 1997,
respectively. The average outstanding balance for loans
being specifically identified as impaired was $1,170,000
for the first six months of 1998 compared to $2,075,000
for the first six months of 1997. 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 six months
of 1998 or 1997.
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):
14
June 30, 1998 December 31, 1997 June 30, 1997
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 $ 996 13.4% $ 1,020 14.4% $ 1,265 15.6%
Commercial
loans secured
by real estate 2,391 31.7 2,543 30.6 2,523 30.0
Real Estate - mortgage 406 46.5 414 45.9 412 45.0
Consumer 1,431 8.4 1,506 9.1 954 9.4
Allocation to general risk 6,012 - 5,980 - 6,874 -
Allocation for
impaired loans 650 - 650 - 1,275 -
Total $11,886 100.0% $12,113 100.0% $13,303 100.0%
Even though real estate-mortgage loans comprise
approximately 47% of the Company's total loan portfolio,
only $406,000 or 3.4% 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
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 June 30, 1998, 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 #9.)
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
immediately 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.
15
The following table presents information concerning
non-performing assets (in thousands, except percentages):
June December 31 June 30
1998 1997 1997
Non-accrual loans $ 5,212 $6,450 $ 6,036
Loans past due 90
days or more 1,032 1,601 1,515
Other real estate owned 712 807 906
Total non-performing
assets $ 6,956 $8,858 $8,457
Total non-performing
assets as a percent
of loans and loans
held for sale, net
of unearned income,
and other real estate
owned 0 .68% 0.89% 0.87%
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).
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
Interest income due in accordance
with original terms $ 98 $ 91 $ 197 $ 235
Interest income recorded (4) (51) (6) (81)
Net reduction in interest income $ 94 $ 40 $ 191 $ 154
12. 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 Consolidated
Balance Sheet. Unrealized gains or losses on these hedge
transactions are deferred. It is the Company's policy
not to terminate hedge transactions prior to expiration
date.
16
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 is 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 derivative transactions outstanding as of June 30,
1998, are as follows:
Borrowed Funds Hedges
The Company has entered into several interest rate
swaps to hedge short-term borrowings used to leverage the
balance sheet. Specifically, FHLB advances which reprice
between 30 days and one year are being used to fund
fixed-rate agency mortgage-backed securities with
durations ranging from two to three years. Under these
swap agreements, the Company pays a fixed rate of
interest and receives a floating rate which resets
either monthly, quarterly, or annually. The following
table summarizes the interest rate swap transactions
which impacted the Company s first six months of 1998
performance:
Fixed Floating Impact
Notional Start Termination Rate % Rate % Repricing On Interest
Amount Date Date Paid Received Frequency Expense
$40,000,000 3-17-97 3-15-99 6.19 5.66 Monthly $ 99,689
50,000,000 5-08-97 5-10-99 6.20 5.75 Annually 56,930
25,000,000 6-20-97 6-20-99 5.96 5.49 Monthly 58,152
50,000,000 9-25-97 9-25-99 5.80 5.51 Monthly 74,283
The Company believes that its exposure to credit
loss in the event of non-performance by any of the
counterparties (which include Mellon Bank and First
Union) in the interest rate swap agreements 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
total maximum notional amount outstanding of $500 million
for interest rate swaps, and interest rate caps/floors.
The Company had no interest rate caps or floors
outstanding at June 30, 1998, or June 30, 1997.
In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
#133, "Accounting for Derivative Instruments and Hedging
Activities." The Statement establishes accounting and
reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an
asset or liability measured at its fair value. The
Statement requires that changes in the derivative's fair
value be recognized currently in earnings unless specific
hedge accounting criteria are met.
17
Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in
the income statement, and requires that a company must
formally document, designate and assess the effectiveness
of transactions that receive hedge accounting. Statement
#133 is effective for fiscal years beginning after June
15, 1999. Statement #133 cannot be applied
retroactively, but early adoption is permitted.
The Company has not yet quantified the impact of
adopting Statement #133 on our financial statements and
has not determined the timing of, or method of adoption
of Statement #133. However, Statement #133 could
increase volatility in earnings and other comprehensive
income.
13. 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 $14.6 million of goodwill and $5.3 million of
core deposit intangible assets on its balance sheet. The
majority of these intangible assets came from the 1994
Johnstown Savings Bank acquisition.
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. The amortization
expense of these intangible assets reduced the first six
months of 1998 diluted earnings per share by $0.07. 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 1998 $ 1,145
1999 2,250
2000 2,139
2001 2,100
2002 2,100
2003 and after 10,135
A reconciliation of the Company's intangible asset
balances for the first six months of 1998 is as follows
(in thousands):
Total goodwill & core deposit
intangible assets at December 31, 1997 $19,122
Addition due to branch acquisition 1,883
Intangible amortization through June 30, 1998 (1,136)
Balance at June 30, 1998 $19,869
18
14. Federal Home Loan Bank Borrowings
Total FHLB borrowings consist of the following at
June 30, 1998, (in thousands,
except percentages):
Type Maturing Amount Weighted
Average
Rate
Open Repo Plus Overnight $ 49,000 5.91%
Advances and 1998 430,028 5.54
wholesale 1999 151,264 5.77
repurchase 2000 33,750 5.44
agreements 2001 10,126 8.22
2002 8,500 7.06
2003 and after 3,750 6.61
Total Advances and 637,418 5.68
wholesale repurchase
agreements
Total FHLB Borrowings $686,418 5.70%
All of the above borrowings bear a fixed rate of
interest, with the only exceptions being the Open Repo
Plus advances whose rate can change daily. All FHLB
stock along with an interest in unspecified mortgage
loans and mortgage-backed securities, 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.
15. Capital
Quantitative measures established by regulation to
ensure capital adequacy require the Company to maintain
minimum amounts and ratios(set forth in the table below)
of total and Tier 1 capital to risk-weighted assets, and
of Tier 1 capital to average assets. Management believes
that as of June 30, 1998, the Company meets all capital
adequacy requirements to which it is subject.
As of June 30, 1998, and 1997, as well as, December
31, 1997, the Federal Reserve categorized the Company as
"Well Capitalized" under the regulatory framework for
prompt corrective action. To be categorized as well
capitalized, the Company must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. There are no conditions or
events since notification that management believes have
changed the Company's classification category.
19
To Be Well
Capitalized Under
For Capital Prompt Corrective
As of June 30, 1998 Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(In thousands, except ratios)
Total Capital (to Risk
Weighted Assets)
Consolidated $ 166,471 15.60% $ 85,373 8.00% $ 106,716 10.00%
U.S. Bank 90,988 15.75 46,185 8.00 57,731 10.00
Three Rivers Bank 71,931 14.77 38,964 8.00 48,705 10.00
Tier 1 Capital (to Risk
Weighted Assets)
Consolidated 154,585 14.49 42,686 4.00 64,030 6.00
U.S. Bank 85,204 14.76 23,092 4.00 34,638 6.00
Three Rivers Bank 65,843 13.52 19,482 4.00 29,223 6.00
Tier 1 Capital (to Average
Assets)
Consolidated 154,585 7.03 87,990 4.00 109,987 5.00
U.S. Bank 85,204 6.93 49,183 4.00 61,479 5.00
Three Rivers Bank 65,843 6.85 38,439 4.00 48,049 5.00
16. Guaranteed Junior Subordinated Deferrable Interest Debentures
On April 28, 1998, the Company announced that it
completed a $34.5 million public offering of 8.45% Trust
Preferred Securities, which represent undivided
beneficial interests in the assets of a recently formed
Delaware business trust, USBANCORP Capital Trust I. The
Trust Preferred Securities will mature on June 30, 2028,
and are callable at par at the option of the Company
after June 30, 2003.
Proceeds of the issue were invested by USBANCORP
Capital Trust I in Junior Subordinated Debentures issued
by USBANCORP, Inc. The Trust Preferred Securities are
fully and unconditionally guaranteed by USBANCORP, Inc.
Net proceeds from the $34.5 million offering were used
for general corporate purposes, including the repayment
of debt, the repurchase of USBANCORP common stock, and
investments in and advances to the Company's
subsidiaries. The Trust Preferred Securities are listed
on Nasdaq under the symbol "UBANP."
17. Branch Acquisition
On June 8, 1998, Three Rivers Bank and National City
Bank of Pennsylvania ("National City") consummated a
Purchase and Assumption Agreement (the "Branch
Agreement"), pursuant to which Three Rivers Bank
purchased certain assets and assumed certain liabilities
of two National City offices located in Allegheny County.
Pursuant to the Branch Agreement, and subject to certain
conditions set forth therein, Three Rivers Bank:
(i)assumed certain deposit liabilities totalling
approximately $27 million; (ii)purchased all the real
estate and furniture and fixtures of these two branch
locations; (iii)purchased the safe deposit box business
conducted at the branches; (iv)assumed contracts that
relate to the operation of the branches; and (v)purchased
the vault cash. In consideration for the assumption of
the deposit liabilities, Three Rivers Bank paid National
City a deposit premium of 7.0% or approximately $1.9
million.
20
18. Other Events
The Company announced at its regularly scheduled
board meeting on Friday, May 22, 1998, the Board of
Directors declared a 3 for 1 stock split effected in the
form of a 200% stock dividend. The distribution was paid
July 31, 1998, to shareholders of record on July 16,
1998. All per share and share data in the Company's Form
10-Q have been adjusted to reflect the stock split.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
("M.D.& A.")
.....PERFORMANCE OVERVIEW.....The Company's net income
for the second quarter of 1998 totaled $5,737,000 or
$0.40 per share on a diluted basis. When compared to the
$5,840,000 or $0.38 per diluted share reported for the
second quarter of 1997, the 1998 results reflect a 5.3%
increase in diluted earnings per share and a 1.8%
decrease in net income. Note that all share and per
share data has been adjusted to reflect a 3 for 1 stock
split effected in the form of a 200% stock dividend which
was distributed on July 31, 1998, to shareholders of
record on July 16, 1998. The Company's return on equity
averaged 15.32% for the second quarter of 1998 which was
comparable with the 15.36% return on equity reported in
the second quarter of 1997. The Company s return on
assets dropped by five basis points to 1.04% in the
second quarter of 1998.
USBANCORP completed several important strategic
initiatives in the second quarter of 1998 which will
favorably impact return on equity performance. The
successful execution of a $34.5 million retail offering
of trust preferred securities provided the Company with
the necessary capital to continue to execute an active
treasury stock repurchase program and complete the
acquisition of two National City Branch Offices in
Allegheny County with $27 million in deposits. As a
result of these effective capital management strategies
and increased non-interest revenue in 1998, USBANCORP
demonstrated earnings per share growth despite
compression in the Company s net interest margin caused
by the flat treasury yield curve. Specifically, total
non-interest income increased by $1.6 million or 32.3%
while net interest income declined by $506,000 or 3.0%
from the prior year second quarter. This net $1.0
million increase in total revenue was offset by higher
non-interest expense and an increase in the provision for
loan losses. Total non-interest expense was $1.2 million
or 9.3% higher in the second quarter of 1998 while the
provision for loan losses increased by $128,000. The
Company's earnings per share, however, were enhanced by
the repurchase of its common stock because there were
849,000 fewer average diluted shares outstanding in the
second quarter of 1998. The following table summarizes
some of the Company's key performance indicators (in
thousands, except per share and ratios):
Appearing on this page was a graphic presentation of diluted earnings
per share for the past seven quarters. The data points presented
were: $0.40, $0.38, $0.40, $0.39, $0.38, $0.37, and $0.35 respectively.
22
Three Months Ended Three Months Ended
June 30, 1998 June 30, 1997
Net income $ 5,737 $ 5,840
Diluted earnings per share 0.40 0.38
Return on average equity 15.32% 15.36%
Return on average assets 1.04 1.09
Average diluted common
shares outstanding 14,425 15,274
.....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 second quarter of 1998 to the second quarter of
1997 (in thousands, except percentages):
Three Months Ended
June 30
1998 1997 $ Change % Change
Interest income $ 39,131 $ 38,870 261 0.7
Interest expense 22,768 22,001 767 3.5
Net interest income 16,363 16,869 (506) (3.0)
Tax-equivalent adjustment 704 756 (52) (6.9)
Net tax-equivalent
interest income $ 17,067 $ 17,625 (558) (3.2)
Net interest margin 3.25% 3.46% (0.21)% N/M
N/M - Not meaningful.
USBANCORP's net interest income on a tax-equivalent
basis decreased by $558,000 or 3.2% due to the negative
impact of a 21 basis point decline in the net interest
margin to 3.25%. The drop in the net interest margin
reflects an 18 basis point decline in the earning asset
yield due primarily to accelerated mortgage prepayments
in both the securities and loan portfolios resulting from
the flat treasury yield curve and the reinvestment of
these cash flows in lower yielding assets. The cost of
funds increased by three basis points due in part to the
interest cost associated with the $34.5 million of
guaranteed junior subordinated deferrable interest
debentures issued on April 30, 1998.
23
This margin compression offset the benefits resulting from growth in
the earning asset base. Total average earning assets
were $60 million higher in the second quarter of 1998 due
primarily to a $50 million or 5.2% increase in total
loans. The overall growth in the earning asset base was
one strategy used by the Company to leverage its capital.
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% and
net income variability to plus or minus 15% over a twelve
month period. (See further discussion under Interest
Rate Sensitivity).
...COMPONENT CHANGES IN NET INTEREST INCOME...Regarding
the separate components of net interest income, the
Company's total interest income for the second quarter of
1998 increased by $261,000 or 0.7% when compared to the
same 1997 period. This increase was due primarily to a
$60 million or 2.9% increase in total average earning
assets which caused interest income to rise by $1.1
million. This positive factor was partially offset by an
18 basis point drop in the earning asset yield to 7.64%
which caused a $877,000 reduction in interest income.
Within the earning asset base, the yield on total
investment securities decreased by 36 basis points to
6.64% while the yield on the total loan portfolio
declined by three basis points to 8.66%. Accelerated
prepayments of mortgage related assets were the primary
factor causing the compression in the earning asset
yield. These heightened prepayments reflect increased
customer refinancing activity due to drops in
intermediate- and long-term interest rates on the
treasury yield curve. Note that the decline in the loan
portfolio yield was not as significant as the drop in the
investment securities portfolio yield due partially to
the collection of prepayment penalties on certain
commercial mortgage loan pay-offs.
The Company's total interest expense for the second
quarter of 1998 increased by $767,000 or 3.5% when
compared to the same 1997 quarter. This higher interest
expense was due primarily to a $50 million increase in
average interest bearing liabilities that caused interest
expense to rise by $610,000. The growth in interest
bearing liabilities included the issuance of $34.5
million of guaranteed junior subordinated deferrable
interest debentures which impacted average balances for
the second quarter of 1998 by $23 million. The remainder
of the interest bearing liability increase occurred in
short-term borrowings and FHLB advances which were used
to fund the previously mentioned earning asset growth.
For the second quarter of 1998, the Company's total level
of short-term borrowed funds and FHLB advances averaged
$842 million or 37.9% of total assets compared to an
average of $805 million or 37.4% of total assets for the
second quarter of 1997. These borrowed funds had an
average cost of 5.66% in the second quarter of 1998 which
was 159 basis points greater than the average cost of
deposits which amounted to 4.07%. This greater
dependence on borrowings to fund the earning asset base,
along with the interest costs associated with the
guaranteed junior subordinated deferrable interest
debentures, were the factors responsible for the three
basis point increase in the total cost of interest
bearing liabilities to 4.84% in the second quarter of
1998. This increase in the total cost of funds occurred
despite an 18 basis point drop in the cost of deposits to
4.07%.
24
It is recognized that interest rate risk does exist
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 $165 million of off-balance sheet
hedging transactions which help fix the variable funding
costs associated with the use of short-term borrowings to
fund earning assets. (See further discussion under Note
#12.) The Company also has asset liability policy
parameters which limit the maximum amount of borrowings
to 40% of total assets. With accelerated prepayments
expected to continue in 1998, the Company expects to
channel cash flow from the investment securities
portfolio into the loan portfolio. If new loan
opportunities do not occur or if the incremental spread
on new investment security purchases is not at least 100
basis points greater than the short-term borrowed funds
costs, then the Company will de-lever the balance sheet
by paying-off borrowings.
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.
25
Three Months Ended June 30 (In thousands, except percentages)
1998 1997
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 $ 1,010,058 $ 22,099 8.66% $ 960,245 $ 21,097 8.69%
Deposits with banks 7,029 63 3.57 7,646 93 4.83
Federal funds sold
and securities
purchased under
agreement to resell - - - 106 2 5.39
Investment securities:
Available for sale 566,046 9,054 6.40 472,233 8,086 6.85
Held to maturity 493,807 8,542 6.92 576,035 10,257 7.12
Total investment
securities 1,059,853 17,596 6.64 1,048,268 18,343 7.00
Assets held in trust for
collateralized
mortgage obligation 3,849 77 8.01 4,942 91 7.38
Total interest earning
assets/interest income 2,080,789 39,835 7.64 2,021,207 39,626 7.82
Non-interest earning assets:
Cash and due from banks 34,406 32,499
Premises and equipment 17,880 17,894
Other assets 98,438 95,000
Allowance for loan losses (11,904) (13,267)
TOTAL ASSETS $2,219,609 $2,153,333
CONTINUED ON NEXT PAGE
26
THREE MONTHS ENDED JUNE 30
CONTINUED FROM PREVIOUS PAGE
1998 1997
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest bearing liabilities:
Interest bearing deposits:
Interest bearing demand $ 90,690 $ 224 0.99% $ 91,335 $ 226 0.99%
Savings 173,305 640 1.48 189,524 799 1.69
Money markets 166,309 1,555 3.75 150,520 1,390 3.70
Other time 580,049 7,834 5.42 586,144 8,370 5.73
Total interest bearing
deposits 1,010,353 10,253 4.07 1,017,523 10,785 4.25
Short term borrowings:
Federal funds purchased,
securities sold under
agreements to repurchase
and other short-term
borrowings 184,787 2,410 5.16 152,421 1,948 5.10
Advances from Federal
Home Loan Bank 656,852 9,493 5.80 652,328 9,136 5.62
Collateralized mortgage
obligation 3,416 85 10.02 4,359 110 10.10
Guaranteed junior subordinated
deferrable interest
debentures 23,383 501 8.58 - - -
Long-term debt 3,697 26 2.82 5,484 22 1.64
Total interest bearing
liabilities/interest expense 1,882,488 22,768 4.84 1,832,115 22,001 4.81
Non-interest bearing liabilities:
Demand deposits 159,561 141,481
Other liabilities 27,382 27,238
Stockholders' equity 150,178 152,499
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $2,219,609 $2,153,333
Interest rate spread 2.79 3.01
Net interest income/
net interest margin 17,067 3.25% 17,625 3.46%
Tax-equivalent adjustment (704) (756)
Net Interest Income $16,363 $16,869
....PROVISION FOR LOAN LOSSES.....The Company's provision
for loan losses for the second quarter of 1998 totaled
$150,000 or 0.06% of average total loans which
represented a $128,000 increase from the provision level
experienced in the 1997 second quarter. The Company s
net charge-offs amounted to $144,000 or 0.06% of average
loans in the second quarter of 1998 compared to net
recoveries of $75,000 or 0.03% of average loans in the
1997 second quarter. The higher provision in 1998 was
due to the increased net-charge offs and continued growth
of commercial and commercial real-estate loans. 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.
27
At June 30, 1998, 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 $6.0 million at June 30,
1998, or 51% of the allowance for loan losses.
.....NON-INTEREST INCOME.....Non-interest income for the
second quarter of 1998 totaled $6.4 million which
represented a $1.6 million or 32.3% increase when
compared to the same 1997 quarter. This increase was
primarily due to the following items:
a $118,000 or 11.8% increase in trust fees to $1.1
million in the second quarter of 1998. This trust
fee growth reflects increased assets under
management due to the profitable expansion of the
Trust Company's business.
a $770,000 increase in gains realized on loans held
for sale due to heightened residential mortgage
refinancing and origination activity at the
Company's mortgage banking subsidiary. Total
mortgage loans closed amounted to $96 million in the
second quarter of 1998 compared to $62 million in
the same 1997 period. The Company also generated
$398,000 in gains on the sale of servicing rights
which is reflected in the above gain figure. It is
the Company s ongoing strategy to sell newly
originated 30 year fixed-rate residential mortgage
loans excluding those loans retained for CRA
purposes.
a $745,000 increase in gains realized on investment
security sales as the Company modestly delevered the
investment portfolio by selling mortgage backed
securities which were experiencing rapid
prepayments. Given the expected continuation of a
relatively "flat" treasury yield curve in the second
half of 1998, the Company will continue to
reposition the investment securities portfolio by
selling rapidly prepaying mortgage backed securities
and extending the portfolio duration by investing a
portion of the sale proceeds in longer maturity
securities.
a $403,000 or 31.3% increase in other income due in
part to additional income resulting from ATM
surcharging, other mortgage banking processing fees,
credit card charges, and revenue generated from
annuity and mutual fund sales in the Company s
financial service subsidiaries.
Appearing on this page is a graphic presentation of total
non-interest income for the past seven quarters. The data
points were: $6,351, $5,368, $5,629, $5,151, $4,800, $4,623
and $4,665 (in thousands) respectively.
28
a $312,000 or 53.9% decrease in net mortgage
servicing fee income due to greater amortization
expense on mortgage servicing rights as a result of
faster mortgage prepayment speeds in 1998. Given
the flatness of the treasury yield curve and
heightened mortgage refinancing activity, the
Company expects this trend of increased amortization
expense to continue and possibly accelerate further
throughout the remainder of 1998.
.....NON-INTEREST EXPENSE.....Non-interest expense for
the second quarter of 1998 totaled $14.7 million which
represented a $1.3 million or 9.3% increase when compared
to the same 1997 quarter. This increase was primarily
due to the following items:
a $628,000 or 9.0% increase in salaries and
employee benefits due to merit pay increases, higher
commission expense, higher profit sharing expense,
and increased medical insurance premiums.
a $248,000 or 31.6% increase in equipment expense
due to technology related expenses such as the
system costs associated with optical disk imaging of
customer statements.
a $403,000 increase in other expense due to
increased advertising expense, higher outside
processing fees, heightened foreclosure losses, and
costs associated with Year 2000 compliance.
.....YEAR 2000.....The Year 2000("Y2K") issue is the
result of computer programs having been written using two
digits, rather than four, to define the applicable year.
Any of the Company's computer systems that have date-
sensitive software or date-sensitive hardware may
potentially recognize a date using "00" as the Year 1900
rather than the Year 2000. This could result in system
failure or miscalculations causing disruptions of
operations, including, among other things, a temporary
inability to process transactions, send statements or
engage in similar normal business activities.
As previously disclosed in the Company's "1997
Annual Report and Form 10K", USBANCORP has been actively
working on the Year 2000 computer problem and has made
significant progress in ensuring that both its
information technology and non-information technology
systems and applications will be Y2K compliant. To date,
the Company has completed the inventory, assessment and
strategy phases of its Year 2000 program. During these
phases, the Company identified hardware and software that
required modification, developed implementation plans,
prioritized tasks and established implementation
timelines. The Company is targeting to have the majority
of testing completed and, if necessary, any mission
critical systems repaired by year-end 1998. The status of
mission critical applications as certified by vendor is as
follows:
Compliant 60%
Working on attaining compliance 37%
System will be replaced 3%
29
The Y2K process has also required that the Company
work with vendors, third-party service providers, and
customers. The Company continues to communicate with all
its vendors and large commercial customers to determine
the extent to which the Company is vulnerable to these
parties failure to remediate their own Year 2000 issue.
For significant mission critical vendors, the Company
will validate that they are Year 2000 compliant by
December 31, 1998, or make plans to switch to a new
vendor or system that is compliant. The Company is also
developing contingency plans that will help limit the
impact that may result from the failure of a mission
critical system or vendor to become Y2K compliant. The
Y2K status of all vendors, suppliers, utilities and
municipalities is currently as follows:
Compliant 14%
Working on Attaining Compliance 40%
No response 46%
The Company recognizes the serious risks it faces
regarding credit customers not properly remediating their
automated systems to conform with Year 2000 related
problems. The failure of a loan customer to prepare
adequately to conform with Year 2000 could have an
adverse effect on such customer's operations and
profitability, in turn limiting their ability to repay
loans in accordance with scheduled terms. The Company
expects to have substantially completed a detailed
analysis of its major loan customers compliance with Year
2000 by September 30, 1998, and based upon available
information and known events will consider the impact on
its loan loss reserve for potential or actual customer
non-compliance as appropriate.
The Company is using both internal and external
resources to complete its comprehensive Y2K compliance
program. The Company currently estimates that the total
cost to achieve Y2K compliance will approximate $1.7
million. Approximately 66% of this total cost represents
incremental expenses to the Company while approximately
34% represents the internal cost of redeploying existing
information technology resources to the Y2K issue. To
date, the Company has expensed $300,000 or 18% of its
total estimated cost to achieve Year 2000 compliance.
The Company does not believe that these expenditures have
yet had, nor will have, a material impact on the results
of operation, liquidity, or capital resources.
.....INCOME TAX EXPENSE.....The Company's provision for
income taxes for the second quarter of 1998 was $2.1
million reflecting an effective tax rate of 27.0%. The
Company's 1997 second quarter income tax provision was
$2.4 million or an effective tax rate of 28.7%. The
lower income tax expense and effective tax rate in 1998
was due primarily to a reduced level of pre-tax income
combined with a relatively consistent level of tax-free
asset holdings between periods. The tax-free asset
holdings consist primarily of municipal investment
securities, bank owned life insurance, and commercial
loan tax anticipation notes. Net deferred income taxes
of $4.8 million have been provided as of June 30, 1998,
on the differences between taxable income for financial
and tax reporting purposes.
30
SIX MONTHS ENDED JUNE 30, 1998 VS. SIX MONTHS ENDED JUNE 30, 1997
.....PERFORMANCE OVERVIEW.....The Company's net income
for the first six months of 1998 totaled $11,432,000 or
$0.78 per share on a diluted basis. The Company's net
income for first half of 1997 totaled $11,508,000 or
$0.75 per share on a diluted basis. The 1998 results
reflect a $0.03 or a 4.0% improvement in diluted earnings
per share and a $76,000 or 0.7% decrease in net income
when compared to the same six month period in 1997. The
Company's return on equity averaged 14.94% for the first
six months of 1998 which was comparable with the 15.14%
return on equity reported in the first half of 1997. The
Company s return on assets dropped by six basis points to
1.03% for the first six months of 1998.
The growth in diluted earnings per share resulted
from a combination of increased non-interest income and
a reduced number of shares outstanding due to the success
of the Company s ongoing treasury stock repurchase
program. Specifically, non-interest income increased by
$2.3 million or 24.4% while the number of diluted shares
outstanding decreased by 772,000 or 5.0% in the first six
months of 1998. These positive factors offset the
negative impact on earnings of higher non-interest
expense, an increased loan loss provision, and a reduced
amount of net interest income resulting from compression
in the net interest margin. The following table
summarizes some of the Company's key performance
indicators (in thousands, except per share and ratios):
Six Months Ended Six Months Ended
June 30, 1998 June 30, 1997
Net income $11,432 $11,508
Diluted earnings per share 0.78 0.75
Return on average equity 14.94% 15.14%
Return on average assets 1.03 1.09
Average diluted common
shares outstanding 14,626 15,398
.....NET INTEREST INCOME AND MARGIN.....The following
table compares the Company's net interest income
performance for the first six months of 1998 to the first
six months of 1997 (in thousands, except percentages):
Six Months Ended
June 30
1998 1997 $ Change % Change
Interest income $ 78,823 $ 76,308 2,515 3.3
Interest expense 45,599 42,934 2,665 6.2
Net interest income 33,224 33,374 (150) (0.4)
Tax-equivalent adjustment 1,424 1,504 (80) (5.3)
Net tax-equivalent
interest income $ 34,648 $ 34,878 (230) (0.7)
Net interest margin 3.27% 3.47% (0.20)% N/M
N/M - Not meaningful.
31
USBANCORP's net interest income on a tax-equivalent
basis decreased by $230,000 or 0.7% due to the negative
impact of a 20 basis point decline in the net interest
margin to 3.27%. The drop in the net interest margin
reflects a 16 basis point decline in the earning asset
yield due primarily to accelerated mortgage prepayments
in both the securities and loan portfolios and the
reinvestment of these cash flows into lower yielding
assets. The cost of funds increased by five basis points
as growth in the earning asset base was funded primarily
with borrowings from the Federal Home Loan Bank. This
margin compression offset the benefits resulting from a
higher level of earning assets. Total average earning
assets were $106 million higher in the first half of 1998
as total loans grew by $53 million or 5.6% while
investment securities increased by $55 million or 5.3%.
...COMPONENT CHANGES IN NET INTEREST INCOME...Regarding
the separate components of net interest income, the
Company's total interest income for the first six months
of 1998 increased by $2.5 million or 3.3% when compared
to the same 1997 period. This increase was due primarily
to a $106 million or 5.3% increase in total average
earning assets which caused interest income to rise by
$4.1 million. This positive factor was partially offset
by a 16 basis point drop in the earning asset yield to
7.65% which caused a $1.7 million reduction in interest
income. Within the earning asset base, the yield on total
investment securities decreased by 26 basis points to
6.71% while the yield on the total loan portfolio
declined by five basis points to 8.64%. Accelerated
prepayments of mortgage related assets and the
reinvestment of this cash into lower yielding assets was
the primary factor causing the reduced earning asset
yield.
Continued improvement in the loan-to-deposit ratio
contributed to the earning asset growth. The Company s
loan-to-deposit ratio averaged 86.2% for the first six
months of 1998 compared to an average of 82.4% for the
same period in 1997. This loan growth resulted from the
Company s ability to take market share from its
competitors through strategies which emphasize convenient
customer service and hard work. Other factors
contributing to the loan growth were a stable economic
environment and the formation of two loan production
offices in the higher growth markets of Westmoreland and
Centre Counties.
The Company's total interest expense for the first
half of 1998 increased by $2.7 million or 6.2% when
compared to the same 1997 period. This higher interest
expense was due primarily to a $92 million increase in
average interest bearing liabilities which caused
interest expense to rise by $2.2 million. This growth in
interest bearing liabilities occurred predominantly in
short-term and FHLB borrowings which were used to fund
the previously mentioned earning asset growth. For the
first six months of 1998, the Company's total level of
short-term borrowed funds and FHLB advances averaged $871
million or 39.0% of total assets compared to an average
of $784 million or 36.9% of total assets for the first
six months of 1997. These borrowed funds had an average
cost of 5.61% in the first half of 1998 which was 152
basis points greater than the average cost of deposits.
This greater dependence on borrowings to fund the earning
asset base was a key factor responsible for the five
basis point increase in the total cost of interest
bearing liabilities from 4.79% in the first half of 1997
to 4.84% in the first half of 1998. This increase in the
total cost of funds occurred despite a 12 basis point
drop in the cost of interest bearing deposits to 4.09%.
32
The table that follows provides an analysis of net
interest income on a tax-equivalent basis for the six
month periods ended June 30, 1998 and June 30, 1997. For
a detailed discussion of the components and assumptions
included in the table, see the paragraph before the
quarterly tables on page 25.
Six Months Ended June 30 (In thousands, except percentages)
1998 1997
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 $ 1,002,476 $ 43,585 8.64% $ 949,029 $ 41,531 8.69%
Deposits with banks 4,586 79 3.43 5,448 121 4.42
Federal funds sold
and securities
purchased under
agreement to resell - - - 72 2 5.25
Investment securities:
Available for sale 580,234 18,763 6.47 456,741 16,045 7.03
Held to maturity 506,322 17,668 6.98 574,859 19,925 6.93
Total investment
securities 1,086,556 36,431 6.71 1,031,600 35,970 6.97
Assets held in trust for
collateralized
mortgage obligation 4,004 152 7.64 5,062 188 7.50
Total interest earning
assets/interest income 2,097,622 80,247 7.65 1,991,211 77,812 7.81
Non-interest earning assets:
Cash and due from banks 33,241 33,129
Premises and equipment 17,839 17,990
Other assets 98,758 97,144
Allowance for loan losses (11,985) (13,289)
TOTAL ASSETS $2,235,475 $2,126,185
CONTINUED ON NEXT PAGE
33
SIX MONTHS ENDED JUNE 30
CONTINUED FROM PREVIOUS PAGE
1998 1997
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest bearing liabilities:
Interest bearing deposits:
Interest bearing demand $ 90,256 $ 444 0.98% $ 90,561 $ 446 0.99%
Savings 173,855 1,294 1.48 191,264 1,603 1.69
Money markets 164,374 3,082 3.74 151,702 2,757 3.66
Other time 579,353 15,630 5.45 577,957 16,305 5.69
Total interest bearing
deposits 1,007,838 20,450 4.09 1,011,484 21,111 4.21
Short term borrowings:
Federal funds purchased,
securities sold under
agreements to repurchase
and other short-term
borrowings 183,803 4,797 5.21 162,700 4,243 5.26
Advances from Federal
Home Loan Bank 687,103 19,618 5.69 621,538 17,329 5.62
Collateralized mortgage
obligation 3,551 177 10.08 4,479 198 8.91
Guaranteed junior subordinated
deferrable interest
debentures 11,692 501 8.58 - - -
Long-term debt 3,908 56 2.86 5,377 53 1.98
Total interest bearing
liabilities/interest expense 1,897,895 45,599 4.84 1,805,578 42,934 4.79
Non-interest bearing liabilities:
Demand deposits 155,616 140,054
Other liabilities 27,661 27,265
Stockholders' equity 154,303 153,288
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $2,235,475 $2,126,185
Interest rate spread 2.81 3.02
Net interest income/
net interest margin 34,648 3.27% 34,878 3.47%
Tax-equivalent adjustment (1,424) (1,504)
Net Interest Income $33,224 $33,374
....PROVISION FOR LOAN LOSSES.....The Company's provision
for loan losses for the first six months of 1998 totaled
$300,000 or 0.06% of average total loans which
represented a $255,000 increase from the provision level
experienced in the first six months of 1997. The
Company s net charge-offs amounted to $527,000 or 0.11%
of average loans in first half of 1998 compared to net
charge-offs of $71,000 or 0.02% of average loans in the
first half of 1997. The higher provision in 1998 was due
to the increased net-charge offs and continued growth of
commercial and commercial real-estate loans. At June 30,
1998, the balance in the allowance for loan losses
totaled $11.9 million or 171% of total non-performing
assets.
34
.....NON-INTEREST INCOME.....Non-interest income for the
first six months of 1998 totaled $11.7 million which
represented a $2.3 million or 24.4% increase when
compared to the same period in 1997. This increase was
primarily due to the following items:
a $227,000 or 11.4% increase in trust fees to $2.2
million in the first half of 1998. This trust fee
growth reflects increased assets under management
due to the profitable expansion of the Trust
Company's business.
a $1.2 million increase in gains realized on loans
held for sale due to heightened residential mortgage
refinancing and origination activity at the
Company's mortgage banking subsidiary. Total
mortgage loans closed amounted to $208 million in
the first half of 1998 compared to $110 million in
the same 1997 period. The Company also generated
$480,000 in gains on the sale of servicing rights
which is reflected in the above gain figure.
an $862,000 increase in gains realized on investment
security sales as the Company has executed asset
liability strategies to reposition the portfolio by
selling mortgage backed securities which were
experiencing rapid prepayments.
a $828,000 or 33.4% increase in other income due in
part to additional income resulting from ATM
surcharging, other mortgage banking processing fees,
credit card charges, and revenue generated from
annuity and mutual fund sales in the Company s
financial service subsidiaries.
a $570,000 or 49.5% decrease in net mortgage
servicing fee income due to greater amortization
expense on mortgage servicing rights as a result of
faster mortgage prepayment speeds in 1998. Given
the flatness of the treasury yield curve and
heightened mortgage refinancing activity, the
Company expects this trend of increased amortization
expense to continue and possibly accelerate further
throughout the remainder of 1998.
Non-interest income as a percentage of total revenue
increased from 21.3% in the first six months of 1997 to
25.3% in the first six months of 1998.
.....NON-INTEREST EXPENSE.....Non-interest expense for
the first six months of 1998 totaled $29.0 million which
represented a $2.3 million or 8.6% increase when compared
to the same 1997 period. This increase was primarily due
to the following items:
a $1.2 million or 8.6% increase in salaries and
employee benefits due to merit pay increases, higher
commission and incentive payments, increased profit
sharing expense, and increased medical insurance
premiums.
a $155,000 increase in FDIC deposit insurance
expense due primarily to the non-recurrence of a
$105,000 refund received in 1997.
35
a $787,000 increase in other expense due to higher
employee training costs, advertising expense,
outside processing fees, foreclosure losses, and
costs associated with Year 2000 compliance.
.....INCOME TAX EXPENSE.....The Company's provision for
income taxes for the first six months of 1998 was $4.3
million reflecting an effective tax rate of 27.1%. The
Company's comparable period 1997 income tax provision was
$4.6 million or an effective tax rate of 28.5%. The lower
income tax expense and effective tax rate in 1998 was due
primarily to a reduced level of pre-tax income combined
with a relatively consistent level of tax-free income.
.....NET OVERHEAD BURDEN.....The Company's efficiency
ratio (non-interest expense divided by total revenue)
increased to 62.5% in the first six months of 1998
compared to 60.2% for the first six months of 1997.
Factors contributing to the higher efficiency ratio in
1998 include the compression experienced in the net
interest margin and the costs associated with several
strategic initiatives which began in 1997 and are
designed to diversify the Company s revenue stream in
future years. These new strategic initiatives include
the opening of financial services subsidiaries which sell
annuities, mutual funds, and insurance, the establishment
of the first full service mobile bank branch in Western
Pennsylvania, and the opening of two loan production
offices. Additionally, the repurchase of the Company s
stock has a favorable impact on return on equity but a
negative impact on the efficiency ratio due to the
interest cost associated with borrowings which provide
funds to repurchase the stock(i.e. the interest on the
guaranteed junior subordinated deferrable interest
debentures). Employee productivity ratios were
relatively constant as net income per employee averaged
approximately $15,000 for both the first half of 1997 and
1998. Total assets per employee improved 5.2% from $2.8
million for the first six months of 1997 to $2.9 million
for the first six months of 1998.
.....BALANCE SHEET.....The Company's total consolidated
assets were $2.209 billion at June 30, 1998, compared
with $2.239 billion at December 31, 1997, which
represents a decrease of $30 million or 1.3% due to some
modest deleveraging of the balance sheet. During the
first six months of 1998, total loans and loans held for
sale increased by approximately $27 million or 2.7% due
to growth in commercial mortgage loans as a result of the
successful execution of strategies to increase both
middle market and small business lending. Heightened
refinancing activity and a successful direct consumer
loan promotion also contributed to growth in residential
mortgage and home equity loans. Consumer loans continued
to decline due to net run-off experienced in the indirect
auto loan portfolio as the Company has exited this low
margin line of business. Total investment securities
decreased by $55 million as the Company has used cash
flow from mortgage-backed securities prepayments and
sales to pay down borrowings given the current flatness
of the treasury yield curve.
36
Total deposits increased by $39 million or 3.4%
since December 31, 1997, due largely to the acquisition
of $27 million of deposits with the purchase of two
National City branch offices in Allegheny County. These
acquired deposits were used to paydown borrowings. The
issuance of guaranteed junior subordinated deferrable
interest debentures provided the Company with $34.5
million of funds which were used to repurchase treasury
stock and paydown borrowings. Overall, the Company's
total short- term and FHLB borrowings decreased by $90
million since December 31, 1997.
.....LOAN QUALITY.....The following table sets forth
information concerning USBANCORP's loan delinquency and
other non-performing assets (in thousands, except
percentages):
June 30 December 31 June 30
1998 1997 1997
Total loan delinquency (past due
30 to 89 days) $ 9,769 $19,890 $11,588
Total non-accrual loans 5,212 6,450 6,036
Total non-performing assets<F1> 6,956 8,858 8,457
Loan delinquency, as a percentage
of total loans and loans held
for sale, net of unearned income 0.96% 2.01% 1.19%
Non-accrual loans, as a percentage
of total loans and loans held
for sale, net of unearned income 0.51 0.65 0.62
Non-performing assets, as a
percentage of total loans and
loans held for sale, net of
unearned income, and other
real estate owned 0.68 0.89 0.87
<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.
Between December 31, 1997, and June 30, 1998, each
of the key asset quality indicators demonstrated
improvement. Total loan delinquency declined by $10.1
million causing the delinquency ratio to drop to less
than 1.0%. Total non-performing assets decreased by $1.9
million since year-end 1997 causing the non-performing
assets to total loans ratio to drop to 0.68%. The
overall improvement in asset quality resulted from
enhanced collection efforts on residential mortgage loans
and continued low levels of non-performing commercial
loans.
37
.....ALLOWANCE FOR LOAN LOSSES.....The following table
sets forth the allowance for loan losses and certain
ratios for the periods ended (in thousands, except
percentages):
June 30 December 31 June 30
1998 1997 1997
Allowance for loan losses $ 11,886 $ 12,113 $ 13,303
Amount in the allowance
for loan losses
allocated to "general risk" 6,012 5,980 6,874
Allowance for loan losses as
a percentage of each of
the following:
total loans and loans
held for sale,
net of unearned income 1.17% 1.22% 1.36%
total delinquent loans
(past due 30 to 89 days) 121.67 60.90 114.80
total non-accrual loans 228.05 187.80 220.39
total non-performing assets 170.87 136.75 157.30
Since December 31, 1997, the balance in the
allowance for loan losses has declined by $227,000 to
$11.9 million due to net charge-offs exceeding the loan
loss provision. The Company's allowance for loan losses
at June 30, 1998, was 171% of non-performing assets and
228% of non-accrual loans. Both of these coverage ratios
improved since year-end 1997 due to the Company's lower
level of non-performing assets. It is important to note
that approximately $3.9 million or 57% of the Company s
non-performing assets are residential mortgages which
exhibit a historically low level of net charge-off.
.....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, net 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, net income and
capital levels over specific future time periods. The
simulation modeling forecasts earnings under a variety of
scenarios that incorporate changes in the absolute level
of interest rates, the shape of the yield curve,
prepayments and changes in the volumes and rates of
various loan and deposit categories. The simulation
modeling also incorporates all off balance sheet hedging
activity as well as assumptions about reinvestment and
the repricing characteristics of certain assets and
liabilities without stated contractual maturities;
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. For static GAP analysis, USBANCORP typically
defines interest rate sensitive assets and liabilities as
those that reprice within six months or one year; and
3)duration and market value sensitivity measures are also
utilized when they can provide added value to the overall
interest rate risk management process. The overall
interest rate risk position and strategies are reviewed
by senior management and Company's Board of Directors on
an ongoing basis.
38
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. The Company's asset
liability management policy seeks to limit net interest
income variability over the first twelve months of the
forecast period to plus or minus 7.5% and net income
variability to plus or minus 15.0% based upon varied
economic rate forecasts which include interest rate
movements of up to 200 basis points and alterations of
the shape of the yield curve. Additionally, the Company
recently began using market value sensitivity measures to
further evaluate the balance sheet exposure to changes in
interest rates. Market value of portfolio equity
sensitivity analysis captures the dynamic aspects of
long-term interest rate risk across all time periods by
incorporating the net present value of expected cash
flows from the Company s assets and liabilities. No
formal ALCO policy parameters have yet been established
for changes in the variability of market value of
portfolio equity.
The following table presents an analysis of the
sensitivity inherent in the Company s net interest
income, net income and market value of portfolio equity.
The interest rate scenarios in the table compare the
Company s base forecast or most likely rate scenario at
June 30, 1998, to scenarios which reflect ramped
increases and decreases in interest rates of 200 basis
points along with performance in a stagnant rate scenario
with interest rates held flat at the June 30, 1998,
levels. The Company s most likely rate scenario is based
upon published economic consensus estimates. Each rate
scenario contains unique prepayment and repricing
assumptions which are applied to the Company s expected
balance sheet composition which was developed under the
most likely interest rate scenario.
Variability of Change In
Interest Rate Net Interest Variability of Market Value of
Scenario Income Net Income Portfolio Equity
Base 0% 0% 0%
Flat (0.35) (0.70) (1.51)
200bp increase (5.01) (10.52) (19.74)
200bp decrease 3.07 1.19 13.67
As indicated in the table, the maximum negative
variability of USBANCORP's net interest income and net
income over the next twelve month period was (5.0%) and
(10.5%) respectively, under an upward rate shock forecast
reflecting a 200 basis point increase in interest rates.
The noted variability under this forecast was within the
Company s ALCO policy limits. The variability of market
value of portfolio equity was (19.7%) under this interest
rate scenario. The off-balance sheet borrowed funds
hedges(see footnote #12) also helped reduce the
variability of forecasted net interest income, net
income, and market value of portfolio equity in a rising
interest rate environment.
39
.....LIQUIDITY.....Liquidity can be analyzed by utilizing
the Consolidated Statement of Cash Flows. Cash
equivalents decreased by $6.6 million from December 31,
1997, to June 30, 1998, due primarily to $41.6 million of
net cash used by financing activities and $4.5 million of
net cash used by operating activities. This more than
offset $39.5 million of net cash provided by investing
activities. Within investing activities, the cash
proceeds from investment security maturities and sales
exceeded purchases of investment securities by $55.8
million. Cash advanced for new loan fundings totaled
$208 million and was approximately $9 million greater
than the cash received from loan principal payments and
sales. Within financing activities, cash generated from
the sale of new certificates of deposit exceeded cash
payments for maturing certificates of deposit by $18
million. An increase in demand and savings deposits
provided $21 million of cash and includes the acquired
National City branch deposits. Net proceeds from the
issuance of guaranteed junior subordinated deferrable
interest debentures provided the Company with $33 million
of cash. The net paydown of advances from the Federal
Home Loan Bank used $117 million of cash.
.....CAPITAL RESOURCES.....As presented in Note #15, each
of the Company s regulatory capital ratios increased
between December 31, 1997, and June 30, 1998, due to the
issuance of the $34.5 million of guaranteed junior
subordinated deferrable interest debentures which qualify
as Tier 1 capital. Specifically, the Tier 1 capital and
asset leverage ratio increased from 12.96% and 6.25% at
December 31, 1997, to 14.49% and 7.03% at June 30, 1998.
The Company targets an operating level of 6.50% for the
asset leverage ratio because management and the Board of
Directors believes that this level provides an optimal
balance between regulatory capital requirements and
shareholder value needs. Strategies that the Company
uses to manage its capital include common dividend
payments, treasury stock repurchases, and earning asset
growth. Through the remainder of 1998, the Company
expects to leverage its capital more through treasury
stock repurchases and common dividend payments as the
expectations for a relatively flat treasury yield curve
will limit opportunities for additional earning asset
growth.
The Company has used funds provided from the
issuance of the guaranteed junior subordinated deferrable
interest debentures to repurchase 884,000 shares or $22.6
million of its common stock during the first six months
of 1998. Through June 30, 1998, the Company has
repurchased a total of 3.8 million shares of its common
stock at a total cost of $53.7 million or $13.97 per
share. The Company plans to continue its treasury stock
repurchase program which currently permits a maximum
total repurchase authorization of $70 million. During
the second quarter of 1998, the Board of Directors
eliminated the previous maximum price per share threshold
at which the stock could be repurchased of 250% of book
value.
The Company exceeds all regulatory capital ratios
for each of the periods presented. Furthermore, each of
the Company's subsidiary banks is 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.
40
The Company's declared Common Stock cash dividend
per share was $0.26 for the first six months of 1998
which was an 18.2% increase over the $0.22 per share
dividend for the same 1997 interim period. The Company s
Board of Directors believes that a competitive common
dividend is a key component of total shareholder return
particularly for retail shareholders.
.....FORWARD LOOKING STATEMENT.....This report contains
various forward-looking statements and includes
assumptions concerning the Company's operations, future
results, and prospects. These forward-looking statements
are based upon current expectations and are subject to
risk and uncertainties. In connection with the "safe
harbor" provisions of the Private Securities Litigation
Reform Act of 1995, the Company provides the following
cautionary statement identifying important factors which
could cause the actual results or events to differ
materially from those set forth in or implied by the
forward-looking statements and related assumptions.
Such factors include the following: (i) the effect
of changing regional and national economic conditions;
(ii) significant changes in interest rates and prepayment
speeds; (iii) credit risks of commercial, real estate,
consumer, and other lending activities; (iv) changes in
federal and state banking regulations; (v) the presence
in the Company's market area of competitors with greater
financial resources than the Company and; (vi) other
external developments which could materially impact the
Company's operational and financial performance.
41
SERVICE AREA MAP
Presented on this page was a service area map depicting the six
county area serviced by the Company.
42
Part II Other Information
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of
USBANCORP, Inc. was held on April 28, 1998.
The results of the items submitted for a
vote are as follows:
A. The following four Directors, whose term will
expire in 2001, were elected:
Number of Votes % of total
Cast for Class I outstanding
Director shares voted
Michael F. Butler 3,746,473 77.93%
James C. Dewar 3,734,065 77.67%
Terry K. Dunkle 3,744,574 77.89%
Jack Sevy 3,740,524 77.81%
B. The proposal to increase the number of shares of
common stock of USBANCORP, Inc. available for
issuance under the USBANCORP, Inc. 1991 Stock
Option Plan from 285,000 shares to 485,000 shares.
For 3,544,301
Against 315,552
Abstain 64,888
Broker non-votes 16,278
C. The consideration of an amendment of USBANCORP's
articles of incorporation to increase the number
of shares of USBANCORP, Inc. common stock to
24,000,000 shares, par value $2.50.
For 3,513,525
Against 347,812
Abstain 63,403
Broker non-votes 16,278
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Articles of Incorporation, as
amended (Incorporated by
reference to Exhibit III to
Registration Statement No. 2-
79639 on Form S-14, Exhibits 4.2
and 4.3 to Registration
Statement No. 33-685 on Form S-
2, Exhibit 4.1 to Registration
Statement No. 33-56604 on Form
S-3, Exhibit 3.1 to the
Registrant's Annual Report on
Form 10-K for the year ended
December 31, 1994, and Exhibit
3.1 to the Registrant's Form 10-
Q for quarter ended June 30, 1998).
43
3.2 Bylaws, as amended and restated
(Incorporated by reference to
Exhibit 3.2 to the Registrant's
Annual Report on Form 10-K for
the year ended December 31,
1994).
15.1 Letter re: unaudited interim
financial information
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
USBANCORP, Inc. announced that its Board of
Directors has declared a 3 for 1 stock split
in the form of a 200% stock dividend on May
27, 1998.
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: August 13, 1998
/s/Terry K. Dunkle
Terry K. Dunkle
Chairman, President and
Chief Executive Officer
Date: August 13, 1998
/s/Jeffrey A. Stopko
Jeffrey A. Stopko
Senior Vice President and
Chief Financial Officer
44
STATEMENT OF MANAGEMENT RESPONSIBILITY
July 17, 1998
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/Jeffrey A. Stopko
Terry K. Dunkle Jeffrey A. Stopko
Chairman, President & Senior Vice President &
Chief Executive Officer Chief Financial Officer
45
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 June 30, 1998
and 1997, and the related consolidated statements of
income for the three-month and six-month periods
then ended and the related consolidated statements
of changes in stockholders equity and cash flows
for the six-month periods then ended. These
financial statements are the responsibility of the
Company's management.
We conducted our review 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 review, 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, 1997, and, in our report dated January
23, 1998, except for the matter discussed in
Note 23, as to which the date is January 30, 1998,
we expressed an unqualified opinion on that
statement. In our opinion, the information set
forth in the accompanying consolidated balance sheet
as of December 31, 1997, 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,
July 17, 1998
46
July 17, 1998
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 June 30, 1998, which
includes our report dated July 17, 1998, 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
47
Exhibit 3.1
ARTICLES OF AMENDMENT - DOMESTIC BUSINESS
CORPORATION
DSCB:15-1915
In compliance with the requirements of 15
Pa.C.S. 1915 (relating to articles of amendment),
the undersigned business corporation, desiring to
amend its Articles, hereby states that:
1. The name of the corporation is: USBANCORP, Inc.
2. The address of this corporation's current
registered office in this Commonwealth or name
of its commercial registered office provider
and county of venue is:
MAIN AND FRANKLIN STREETS, JOHNSTOWN, PA 15901
COUNTY: CAMBRIA
3. The corporation is incorporated under the
provisions of the Pennsylvania Business
Corporation Law of 1933.
4. The original date of its incorporation is: May 3, 1982
5. (Check, and if appropriate complete, one of the
following):
X The amendment shall be effective upon the
filing of these Articles of Amendment
in the Department of State.
The amendment shall be effective on:
6. (Check one of the following):
X The amendment was adopted by the
shareholders pursuant to 15 Pa.C.S. 1914(a) and (b).
X The amendment was adopted by the board of
directors pursuant to 15 Pa.C.S. 1914 (c).
7. The Amendment adopted by the corporation, set
forth in full, is as follows:
THE FIRST PARAGRAPH OF ARTICLE FIFTH OF THE
ARTICLES OF INCORPORATION, AS AMENDED, BE
FURTHER AMENDED TO READ IN ITS ENTIRETY AS
FOLLOWS:
THE AGGREGATE NUMBER OF SHARES WHICH
USBANCORP SHALL HAVE THE AUTHORITY TO
ISSUE IS 2,000,000 SHARES OF PREFERRED
STOCK, WITHOUT PAR VALUE, AND 24,000,000
SHARES OF COMMON STOCK WITH THE PAR VALUE
OF $2.50.
8. (Check if the amendment restates the Articles):
The restated Articles of Incorporation
supersede the original Articles and all
amendments thereto.
IN TESTIMONY WHEREOF, the undersigned corporation
has caused these Articles of Amendment to be signed
by a duly authorized officer thereof this 12th day
of May, 1998.
USBANCORP, Inc.
By: \s\Terry K. Dunkle
Terry K. Dunkle, President
48