UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934
For the period ended September 30, 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 October 30, 1998
Common Stock, par value $2.50 13,648,215
per share
1
USBANCORP, INC.
INDEX
PART I. FINANCIAL INFORMATION: Page No.
Consolidated Balance Sheet -
September 30, 1998, December 31, 1997,
and September 30, 1997 3
Consolidated Statement of Income -
Three and Nine Months Ended
September 30, 1998, and 1997 4
Consolidated Statement of Changes
in Stockholders' Equity -
Nine Months Ended
September 30, 1998, and 1997 6
Consolidated Statement of Cash Flows -
Nine Months Ended
September 30, 1998, and 1997 7
Notes to Consolidated Financial
Statements 8
Management's Discussion and Analysis
of Consolidated Financial Condition
and Results of Operations 23
Part II. Other Information 45
2
USBANCORP, INC.
CONSOLIDATED BALANCE SHEET
(In thousands)
September 30 December 31 September 30
1998 1997 1997
(Unaudited) (Unaudited)
ASSETS
Cash and due from banks $ 35,583 $ 38,056 $ 35,169
Interest bearing deposits with banks 854 163 207
Investment securities:
Available for sale 651,785 580,115 526,073
Held to maturity (market value $506,628 on
September 30, 1998, $541,093 on December 31, 1997,
and $559,899 on September 30, 1997) 492,974 532,341 552,440
Assets held in trust for collateralized mortgage
obligation 3,128 4,267 4,545
Loans held for sale 27,675 13,163 9,773
Loans 1,012,473 981,739 972,453
Less: Unearned income 5,209 5,327 5,182
Allowance for loan losses 11,717 12,113 12,930
Net Loans 995,547 964,299 954,341
Premises and equipment 18,021 17,630 17,868
Accrued income receivable 17,216 17,317 17,170
Mortgage servicing rights 15,168 14,960 16,384
Goodwill and core deposit intangibles 19,283 19,122 19,711
Bank owned life insurance 35,213 33,979 33,583
Other assets 8,492 3,698 4,954
TOTAL ASSETS $ 2,320,939 $ 2,239,110 $ 2,192,218
LIABILITIES
Non-interest bearing deposits $ 160,706 $ 146,685 $ 146,553
Interest bearing deposits 1,004,890 992,842 1,006,976
Total deposits 1,165,596 1,139,527 1,153,529
Federal funds purchased and securities sold under
agreements to repurchase 59,196 92,829 99,147
Other short-term borrowings 60,946 57,892 93,926
Advances from Federal Home Loan Bank 817,403 754,195 649,207
Collateralized mortgage obligation 2,766 3,779 4,018
Guaranteed junior subordinated deferrable
interest debentures 34,500 - -
Long-term debt 2,295 4,361 4,829
Total borrowed funds 977,106 913,056 851,127
Other liabilities 31,938 28,347 26,551
TOTAL LIABILITIES 2,174,640 2,080,930 2,031,207
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; 17,348,334 shares issued and 13,661,215
outstanding on September 30, 1998; 17,282,028 shares
issued and 14,681,154 outstanding on December 31,
1997; 17,278,737 shares issued and 14,953,053
outstanding on September 30, 1997 43,371 14,402 14,399
Treasury stock at cost, 3,687,119 shares on September 30,
1998, 2,600,874 shares on December 31, 1997, and
2,325,684 shares on September 30, 1997 (58,543) (31,175) (25,231)
Surplus 65,484 93,934 93,913
Retained earnings 90,043 78,866 75,853
Net unrealized holding gains (losses) on
available for sale securities 5,944 2,153 2,077
TOTAL STOCKHOLDERS' EQUITY 146,299 158,180 161,011
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,320,939 $ 2,239,110 $ 2,192,218
See accompanying notes to consolidated financial statements.
3
USBANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share data)
Unaudited
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
INTEREST INCOME
Interest and fees on loans and
loans held for sale:
Taxable $ 21,354 $ 20,637 $ 63,286 $ 60,585
Tax exempt 625 616 1,868 1,796
Deposits with banks 22 53 101 174
Federal funds sold and securities
purchased under agreements to resell - - - 2
Investment securities:
Available for sale 9,990 8,170 27,786 23,835
Held to maturity 8,193 9,721 25,814 28,925
Assets held in trust for collateralized
mortgage obligation 68 87 220 275
Total Interest Income 40,252 39,284 119,075 115,592
INTEREST EXPENSE
Deposits 10,427 10,963 30,877 32,074
Federal funds purchased and securities
sold under agreements to repurchase 1,564 1,290 4,157 3,771
Other short-term borrowings 1,022 659 3,226 2,421
Advances from Federal Home Loan Bank 10,178 9,345 29,796 26,674
Collateralized mortgage obligation 75 118 252 316
Guaranteed junior subordinated
def. int. debentures 740 - 1,241 -
Long-term debt 47 26 103 79
Total Interest Expense 24,053 22,401 69,652 65,335
NET INTEREST INCOME 16,199 16,883 49,423 50,257
Provision for loan losses 150 23 450 68
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 16,049 16,860 48,973 50,189
NON-INTEREST INCOME
Trust fees 1,104 1,025 3,330 3,024
Net realized gains on
investment securities 737 145 1,755 301
Net realized gains on loans held for sale 887 519 2,694 1,107
Wholesale cash processing fees 178 236 530 794
Service charges on deposit accounts 899 841 2,506 2,479
Net mortgage servicing fees 154 567 735 1,718
Bank owned life insurance 411 393 1,233 1,248
Other income 1,857 1,425 5,163 3,903
Total Non-Interest Income 6,227 5,151 17,946 14,574
NON-INTEREST EXPENSE
Salaries and employee benefits 7,732 7,114 22,812 21,005
Net occupancy expense 1,075 1,111 3,353 3,312
Equipment expense 874 768 2,704 2,426
Professional fees 944 837 2,496 2,430
Supplies, postage, and freight 664 685 2,018 2,035
Miscellaneous taxes and insurance 399 369 1,143 1,118
FDIC deposit insurance expense 68 69 205 51
Amortization of goodwill and
core deposit intangibles 586 589 1,722 1,767
Other expense 2,738 2,082 7,586 6,143
Total Non-Interest Expense $ 15,080 $ 13,624 $ 44,039 $ 40,287
CONTINUED ON NEXT PAGE
4
CONSOLIDATED STATEMENT OF INCOME
CONTINUED FROM PREVIOUS PAGE
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
INCOME BEFORE INCOME TAXES $ 7,196 $ 8,387 $ 22,880 $ 24,476
Provision for income taxes 1,896 2,370 6,148 6,951
NET INCOME $ 5,300 $ 6,017 $ 16,732 $ 17,525
PER COMMON SHARE DATA:<F1>
Basic:
Net income $ 0.39 $ 0.40 $ 1.18 $ 1.16
Average shares outstanding 13,760,019 15,000,666 14,147,108 15,108,780
Diluted:
Net income $ 0.38 $ 0.39 $ 1.16 $ 1.14
Average shares outstanding 14,001,368 15,256,155 14,410,365 15,323,865
Cash Dividends Declared $ 0.14 $ 0.12 $ 0.40 $ 0.33
<F1> 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 - - - - 17,525 - 17,525
Dividend reinvestment
and stock purchase plan - 43 - 386 - - 429
Net unrealized holding
gains (losses) on
investment securities - - - - - 1,863 1,863
Treasury stock purchased - - (5,693) - - - (5,693)
Cash dividends paid
($0.33 per share) - - - - (5,030) - (5,030)
Balance September 30, 1997 $ - $ 14,399 $(25,231) $ 93,913 $ 75,853 $ 2,077 $ 161,011
Balance December 31, 1997 $ - $ 14,402 $(31,175) $ 93,934 $ 78,866 $ 2,153 $ 158,180
Net Income - - - - 16,732 - 16,732
Dividend reinvestment
and stock purchase plan - 71 - 448 - - 519
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 - - - - - 3,791 3,791
Treasury stock purchased - - (27,368) - - - (27,368)
Cash dividends paid
($0.40 per share) - - - - (5,555) - (5,555)
Balance September 30, 1998 $ - $ 43,371 $(58,543) $ 65,484 $ 90,043 $ 5,944 $ 146,299
See accompanying notes to consolidated financial statements.
6
USBANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Unaudited
Nine Months Ended
September 30
1998 1997
OPERATING ACTIVITIES
Net income $ 16,732 $ 17,525
Adjustments to reconcile net income
to net cash provided (used) by
operating activities:
Provision for loan losses 450 68
Depreciation and amortization expense 1,871 1,800
Amortization expense of goodwill and
core deposit intangibles 1,722 1,767
Amortization expense of mortgage
servicing rights 1,950 1,261
Net amortization (accretion) of
investment securities 553 (5)
Net realized gains on investment securities (1,755) (301)
Net realized gains on loans and
loans held for sale (2,694) (1,107)
Origination of mortgage loans held for sale (305,206) (190,206)
Sales of mortgage loans held for sale 297,895 182,184
Increase in accrued income receivable 101 192
Increase (decrease) in accrued expense payable 492 (7)
Net cash provided by operating activities 12,111 13,171
INVESTING ACTIVITIES
Purchases of investment securities and
other short-term investments (532,482) (418,445)
Proceeds from maturities of investment
securities and other short-term investments 185,937 95,595
Proceeds from sales of investment securities
and other short-term investments 321,095 249,723
Long-term loans originated (272,589) (214,256)
Loans held for sale (27,675) (9,773)
Principal collected on long-term loans 261,566 193,651
Loans purchased or participated - (2)
Loans sold or participated 44 234
Net decrease in credit card receivable
and other short-term loans 2,449 1,490
Purchases of premises and equipment (2,329) (1,531)
Sale/retirement of premises and equipment 67 61
Net decrease in assets held in trust for
collateralized mortgage obligation 1,139 714
Net increase mortgage servicing rights (2,158) (5,151)
Net increase in other assets (8,453) (229)
Net cash used by investing activities (73,389) (107,919)
FINANCING ACTIVITIES
Proceeds from sales of certificates of deposit 375,822 209,325
Payments for maturing certificates of deposits (364,526) (182,571)
Net increase (decrease) in demand and
savings deposits 14,773 (11,963)
Net (decrease) increase in federal funds
purchased, securities sold under
agreements to repurchase, and other
short-term borrowings (31,592) 36,660
Net principal borrowings of advances from
Federal Home Loan Bank 63,208 43,708
Principal borrowings on long-term debt 11,123 5,068
Repayments of long-term debt (13,189) (4,411)
Common stock cash dividends paid (4,870) (7,572)
Proceeds from sale of guaranteed
junior deferrable interest debentures,
net of expenses 33,183 -
Guaranteed junior subordinated deferrable
interest debenture dividends paid (1,215) -
Proceeds from dividend reinvestment,
stock purchase plan, and stock options
exercised 519 429
Purchases of treasury stock (27,368) (5,693)
Net increase in other liabilities 3,628 2,743
Net cash provided by financing activities 59,496 85,723
NET DECREASE IN CASH EQUIVALENTS (1,782) (9,025)
CASH EQUIVALENTS AT JANUARY 1 38,219 44,401
CASH EQUIVALENTS AT SEPTEMBER 30 $ 36,437 $ 35,376
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, U.S. Bank
("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 nine month periods ended September 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 October 16, 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 in other comprehensive income are reported as follows (in
thousands):
Three Months Ended Nine Months Ended
September 30 September 30 September 30 September 30
1998 1997 1998 1997
Net income $ 5,300 $ 6,017 $ 16,732 $ 17,525
Other comprehensive income, before tax:
Unrealized holding gains(losses) on
investment securities 5,474 3,497 5,651 2,872
Less: reclassification adjustment for
gains included in net income (737) (145) (1,755) (301)
Other comprehensive income(loss)
before tax 4,737 3,352 3,896 2,571
Income tax expense(credit) related to
items of other comprehensive income 1,248 947 1,047 730
Other comprehensive income(loss),
net of tax 3,489 2,405 2,849 1,841
Comprehensive income $ 8,789 $ 8,422 $ 19,581 $ 19,366
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
$4,930,000 in income tax payments in the first nine months of 1998 as
compared to $5,887,000 for the first nine months of 1997. Total interest
expense paid amounted to $69,160,000 in 1998's first nine months compared
to $65,342,000 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:
September 30, 1998
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 442 $ 19 $ - $ 461
U.S. Agency 41,765 576 - 42,341
State and municipal 13,074 250 - 13,324
U.S. Agency
mortgage-backed
securities 540,913 8,110 (69) 548,954
Other securities<F1> 46,690 15 - 46,705
Total $ 642,884 $ 8,970 $ (69) $ 651,785
Investment securities held to maturity:
September 30, 1998
Gross Gross
Book Unrealized Unrealized Market
Value Gains Losses Value
U.S. Treasury $ 16,126 $ 114 $ - $ 16,240
U.S. Agency 23,927 483 - 24,410
State and municipal 123,041 3,141 (43) 126,139
U.S. Agency
mortgage-backed
securities 325,664 9,888 (57) 335,495
Other securities<F1> 4,216 128 - 4,344
Total $ 492,974 $ 13,754 $ (100) $506,628
<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 September 30, 1998, 98.6% of the portfolio was rated
"AAA" compared to 98.7% at September 30, 1997.
Approximately 0.01% of the portfolio was rated below "A"
or unrated on September 30, 1998.
10
7. Loans Held for Sale
At September 30, 1998, $27,675,000 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):
September 30 December 31 September 30
1998 1997 1997
Commercial $ 149,962 $ 143,113 $ 150,050
Commercial loans secured
by real estate 332,458 302,620 284,242
Real estate - mortgage 441,834 440,734 441,846
Consumer 88,219 95,272 96,315
Loans 1,012,473 981,739 972,453
Less: Unearned income 5,209 5,327 5,182
Loans, net of unearned
income $ 1,007,264 $ 976,412 $ 967,271
Real estate-construction loans were not material at
these presented dates and comprised 3.9% of total loans
net of unearned income at September 30, 1998. The
Company has no direct foreign exposure and does not
invest in or lend to hedge funds. 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 in
order to provide conservative positioning in the
event of any unforeseen deterioration in the
regional economy and to provide protection against
potential credit risks resulting from external
factors such as the projected continued growth of
the loan portfolio and Year 2000. It must be
emphasized that a general unallocated reserve 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 Nine Months Ended
September 30 September 30
1998 1997 1998 1997
Balance at beginning of period $ 11,886 $ 13,303 $ 12,113 $ 13,329
Charge-offs:
Commercial 36 244 164 323
Real estate-mortgage 145 15 272 95
Consumer 267 389 830 894
Total charge-offs 448 648 1,266 1,312
Recoveries:
Commercial 27 170 75 368
Real estate-mortgage 32 5 125 237
Consumer 70 77 220 240
Total recoveries 129 252 420 845
Net charge-offs 319 396 846 467
Provision for loan losses 150 23 450 68
Balance at end of period $ 11,717 $ 12,930 $ 11,717 $ 12,930
As a percent of average loans
and loans held for sale, net
of unearned income:
Annualized net charge-offs 0.12% 0.16% 0.11% 0.06%
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 1.13 1.32 1.13 1.32
Total classified loans $ 28,089 $ 23,489 $ 28,089 $ 23,489
Dollar allocation of reserve to
general risk 5,410 6,570 5,410 6,570
Percentage allocation of
reserve to general risk 46.17% 50.81% 46.17% 50.81%
(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 28
and 39, 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 $1,977,000 and
$1,698,000 being specifically identified as impaired and
a corresponding allocation reserve of $955,000 and
$1,066,000 at September 30, 1998, and September 30, 1997,
respectively. The average outstanding balance for loans
being specifically identified as impaired was $1,439,000
for the first nine months of 1998 compared to $1,949,000
for the first nine 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 nine 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
September 30, 1998 December 31, 1997 September 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 $ 1,004 14.5% $ 1,020 14.4% $ 830 15.4%
Commercial
loans secured
by real estate 2,142 32.1 2,543 30.6 2,756 29.1
Real Estate -
mortgage 777 45.4 414 45.9 449 46.2
Consumer 1,429 8.0 1,506 9.1 1,259 9.3
Allocation to
general risk 5,410 - 5,980 - 6,570 -
Allocation for
impaired loans 955 - 650 - 1,066 -
Total $11,717 100.0% $12,113 100.0% $12,930 100.0%
Even though real estate-mortgage loans comprise
approximately 45% of the Company's total loan portfolio,
only $777,000 or 6.6% 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 September 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):
September 30 December 31 September 30
1998 1997 1997
Non-accrual loans $ 5,196 $ 6,450 $ 6,368
Loans past due 90
days or more 905 1,601 1,419
Other real estate owned 1,217 807 1,084
Total non-performing
assets $ 7,318 $ 8,858 $ 8,871
Total non-performing
assets as a percent
of loans and loans
held for sale, net
of unearned income,
and other real estate
owned 0 .71% 0.89% 0.91%
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 fair value minus
estimated costs to sell, or 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 Nine Months Ended
September 30 September 30
1998 1997 1998 1997
Interest income due in accordance
with original terms $ 99 $ 116 $ 296 $ 351
Interest income recorded (10) (14) (16) (95)
Net reduction in interest income $ 89 $ 102 $ 280 $ 256
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 to
typically not 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 September
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 nine 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 $ 152,617
50,000,000 5-08-97 5-10-99 6.20 5.64 Annually 209,375
25,000,000 6-20-97 6-20-99 5.96 5.51 Monthly 84,680
50,000,000 9-25-97 9-25-99 5.80 5.52 Monthly 106,992
$165,000,000 $ 553,664
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 September 30, 1998, or September 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 $14.2 million of goodwill and $5.1 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 nine
months of 1998 diluted earnings per share by $0.11. 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 $ 586
1999 2,250
2000 2,139
2001 2,100
2002 2,100
2003 and after 10,108
A reconciliation of the Company's intangible asset
balances for the first nine 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 September 30, 1998 (1,722)
Balance at September 30, 1998 $19,283
18
14. Federal Home Loan Bank Borrowings
Total FHLB borrowings consist of the following at
September 30, 1998, (in thousands,
except percentages):
Type Maturing Amount Weighted
Average
Rate
Open Repo Plus Overnight $ 27,000 5.91%
Advances and 1998 285,018 5.65
wholesale 1999 1,259 6.09
repurchase 2000 173,750 4.94
agreements 2001 10,126 8.22
2002 258,500 5.72
2003 and after 88,750 5.30
Total Advances and 817,403 5.52
wholesale repurchase agreements
Total FHLB Borrowings $844,403 5.53%
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 September 30, 1998, the Company meets all
capital adequacy requirements to which it is subject.
As of September 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 September 30, 1998 Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk (In thousands, except ratios)
Weighted Assets)
Consolidated $ 165,664 14.92% $ 88,830 8.00% $ 111,038 10.00%
U.S. Bank 91,529 15.38 47,621 8.00 59,526 10.00
Three Rivers Bank 73,000 14.25 40,976 8.00 51,220 10.00
Tier 1 Capital (to Risk
Weighted Assets)
Consolidated 153,947 13.86 44,415 4.00 66,623 6.00
U.S. Bank 85,894 14.43 23,811 4.00 35,716 6.00
Three Rivers Bank 66,918 13.06 20,488 4.00 30,732 6.00
Tier 1 Capital (to Average
Assets)
Consolidated 153,947 6.79 90,717 4.00 113,397 5.00
U.S. Bank 85,894 6.81 50,448 4.00 63,060 5.00
Three Rivers Bank 66,918 6.68 40,059 4.00 50,074 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 September 30,
2028, and are callable at par at the option of the
Company after September 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 Acquisitions
National City Branches:
On January 30, 1998, Three Rivers Bank and National
City Bank of Pennsylvania ("National City") entered into
a Purchase and Assumption Agreement (the "Branch
Agreement"), pursuant to which Three Rivers Bank agreed
to purchase certain assets and assume 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;
20
(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.
In addition, Three Rivers Bank purchased cash reserve
loans at par value. The transaction closed on June 5,
1998.
First Western Branches:
On October 14, 1998, the Company and First Western
Bancorp, Inc. ("First Western") announced that their
banking subsidiaries have reached a definitive agreement
for the Company to purchase three branch offices in
western Pennsylvania from First Western. Additionally,
as part of the transaction, First Western will acquire
one branch from the Company. The Company's U.S. Bank
subsidiary will acquire the Ebensburg and Barnesboro
offices of First Western which are located in Cambria
County. The Company's Three Rivers Bank subsidiary will
acquire the Kiski Valley office of First Western located
in Westmoreland County in exchange for the Three Rivers
Bank's Moon Township office located in Allegheny County.
Overall on a net basis, the Company will acquire
approximately $92 million in deposits, $11 million in
consumer loans and the related fixed assets, leases, safe
deposit box business and other agreements at the branch
offices. The cash purchase, subject to regulatory
approval, is expected to be completed in the first
quarter of 1999. The Company will pay a core deposit
premium of approximately 10% for the acquired deposits
and purchase the consumer loans and fixed assets at book
value. The Company expects these branch acquisitions to
be accretive to earnings in 1999.
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.
The Company announced that the Pennsylvania
Department of Banking has approved the change of charter
for its subsidiary, United States National Bank in
Johnstown, to a State Charter. United States National
Bank in Johnstown will now be called U.S. Bank.
Additionally the change in charter will allow for
supervision by one regulatory agency throughout the
Company.
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 third quarter of 1998 totaled $5.3 million or
$0.38 per share on a diluted basis. When compared to the
$6.0 million or $0.39 per diluted share reported for the
third quarter of 1997, the 1998 results reflect a 2.6%
decrease in diluted earnings per share and a 11.9%
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 14.55% for the third quarter of 1998 which was
down slightly from the 15.07% return on equity reported
in the third quarter of 1997. The Company s return on
assets dropped by 18 basis points to 0.92% in the third
quarter of 1998.
Compression in the Company s net interest margin and
a higher level of non-interest expense offset the benefit
of an increased amount of non-interest income to cause
the drop in earnings in the third quarter of 1998.
Specifically, total non-interest income increased by $1.1
million or 20.9% while net interest income declined by
$684,000 or 4.1% from the prior year third quarter. This
net $392,000 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
$1.5 million or 10.7% higher in the third quarter of 1998
while the provision for loan losses increased by
$127,000. The Company's earnings per share, however,
were enhanced by the repurchase of its common stock
because there were 1.3 million fewer average diluted
shares outstanding in the third quarter of 1998. The
following table summarizes some of the Company's key
performance indicators (in thousands, except per share
and ratios):
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
Net income $ 5,300 $ 6,017
Diluted earnings per share 0.38 0.39
Return on average equity 14.55% 15.07%
Return on average assets 0.92 1.10
Average diluted common
shares outstanding 14,001 15,256
.....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.
22
The following table
compares the Company's net interest income performance
for the third quarter of 1998 to the third quarter of
1997 (in thousands, except percentages):
Three Months Ended
September 30
1998 1997 $ Change % Change
Interest income $ 40,252 $ 39,284 968 2.5
Interest expense 24,053 22,401 1,652 7.4
Net interest income 16,199 16,883 (684) (4.1)
Tax-equivalent adjustment 711 721 (10) (1.4)
Net tax-equivalent
interest income $ 16,910 $ 17,604 (694) (3.9)
Net interest margin 3.15% 3.46% (0.31)BP N/M
N/M - Not meaningful.
BP - Basis point
USBANCORP's net interest income on a tax-equivalent
basis decreased by $694,000 or 3.9% due to the negative
impact of a 31 basis point decline in the net interest
margin to 3.15%. The drop in the net interest margin
reflects a 24 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 four 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, and an increased use
of borrowings to fund earning asset growth. This margin
compression offset the benefits resulting from growth in
the earning asset base.
Total average earning assets were $115 million higher
in the third quarter of 1998 due primarily to a $44
million or 4.5% increase in total loans and a $72 million
or 6.9% increase in investment securities. The Company
has been able to demonstrate solid loan growth in
commercial loans and direct consumer and home equity
loans in 1998. The higher level of investment securities
resulted from more aggressive buying of securities in the
third quarter of 1998 due to expected declines in
interest rates in future months. 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 third quarter of
1998 increased by $968,000 or 2.5% when compared to the
same 1997 period.
23
This increase was due primarily to a
$115 million or 5.6% increase in total average earning
assets which caused interest income to rise by $2.2
million. This positive factor was partially offset by a
24 basis point drop in the earning asset yield to 7.59%
which caused a $1.4 million reduction in interest income.
Within the earning asset base, the yield on total
investment securities decreased by 35 basis points to
6.66% while the yield on the total loan portfolio
declined by nine basis points to 8.58%. 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 and a favorable shift
in the loan portfolio mix away from lower yielding
indirect auto loans.
The Company's total interest expense for the third
quarter of 1998 increased by $1.7 million or 7.4% when
compared to the same 1997 quarter. This higher interest
expense was due primarily to a $118 million increase in
average interest bearing liabilities that caused interest
expense to rise by $1.4 million. The growth in interest
bearing liabilities included the issuance of $34.5
million of 8.45% guaranteed junior subordinated
deferrable interest debentures which increased interest
expense by $740,000 in the third quarter of 1998. 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 third quarter of 1998, the Company's
total level of short-term borrowed funds and FHLB
advances averaged $889 million or 38.9% of total assets
compared to an average of $810 million or 37.4% of total
assets for the third quarter of 1997. These borrowed
funds had an average cost of 5.68% in the third quarter
of 1998 which was 162 basis points greater than the
average cost of deposits which amounted to 4.06%. 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 four
basis point increase in the total cost of interest
bearing liabilities to 4.88% in the third quarter of
1998. This increase in the total cost of funds occurred
despite a 22 basis point drop in the cost of interest
bearing deposits to 4.06%.
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 future months, the Company will
try to channel cash flow from the investment securities
portfolio into the loan portfolio.
24
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 September 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 $1,016,548 $ 22,179 8.58% $ 972,332 $ 21,454 8.67%
Deposits with banks 2,856 22 3.03 3,496 53 5.92
Federal funds sold
and securities
purchased under
agreement to resell - - - - - -
Investment securities:
Available for sale 631,619 10,180 6.45 486,916 8,411 6.91
Held to maturity 490,586 8,514 6.94 563,117 10,000 7.10
Total investment
securities 1,122,205 18,694 6.66 1,050,033 18,411 7.01
Assets held in trust for
collateralized
mortgage obligation 3,475 68 7.84 4,689 87 7.35
Total interest earning
assets/interest income 2,145,084 40,963 7.59 2,030,550 40,005 7.83
Non-interest earning assets:
Cash and due from banks 36,064 32,639
Premises and equipment 18,116 17,987
Other assets 100,218 97,814
Allowance for loan
losses (11,898) (12,998)
TOTAL ASSETS $2,287,584 $2,165,992
CONTINUED ON NEXT PAGE
26
THREE MONTHS ENDED September 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 $ 89,774 $ 224 0.99% $ 90,921 $ 226 0.99%
Savings 172,594 671 1.54 184,631 791 1.70
Money markets 171,993 1,566 3.61 153,868 1,449 3.74
Other time 585,710 7,966 5.40 587,650 8,497 5.74
Total interest bearing
deposits 1,020,071 10,427 4.06 1,017,070 10,963 4.28
Short term borrowings:
Federal funds purchased,
securities sold under
agreements to repurchase
and other short-term
borrowings 188,632 2,586 5.36 152,790 1,949 5.00
Advances from Federal
Home Loan Bank 700,224 10,178 5.77 657,045 9,345 5.64
Collateralized mortgage
obligation 3,079 75 9.66 4,143 118 11.29
Guaranteed junior subordinated
deferrable interest
debentures 34,500 740 8.58 - - -
Long-term debt 7,456 47 2.50 5,000 26 2.06
Total interest bearing
liabilities/interest expense 1,953,962 24,053 4.88 1,836,048 22,401 4.84
Non-interest bearing liabilities:
Demand deposits 163,321 145,949
Other liabilities 25,788 25,542
Stockholders' equity 144,513 158,453
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $2,287,584 $2,165,992
Interest rate spread 2.71 3.00
Net interest income/
net interest margin 16,910 3.15% 17,604 3.46%
Tax-equivalent adjustment (711) (721)
Net Interest Income $16,199 $16,883
....PROVISION FOR LOAN LOSSES.....The Company's provision
for loan losses for the third quarter of 1998 totaled
$150,000 or 0.06% of average total loans which
represented a $127,000 increase from the provision level
experienced in the 1997 third quarter. The Company s net
charge-offs amounted to $319,000 or 0.12% of average
loans in the third quarter of 1998 compared to $396,000
or 0.16% of average loans in the 1997 third quarter. The
higher provision in 1998 was due to continued growth of
commercial and commercial real-estate loans and a higher
level of net-charge offs on a year-to-date basis. The
Company applies a consistent methodology and procedural
discipline to evaluate the adequacy of the allowance for
loan losses at each subsidiary bank on a quarterly basis.
At September 30, 1998, the balance in the allowance for
loan losses totalled $11.7 million or 160% of non-
performing assets and 1.13% of total loans outstanding.
27
.....NON-INTEREST INCOME.....Non-interest income for the
third quarter of 1998 totaled $6.2 million which
represented a $1.1 million or 20.9% increase when
compared to the same 1997 quarter. This increase was
primarily due to the following items:
a $79,000 or 7.7% increase in trust fees to $1.1
million in the third quarter of 1998. This trust fee
growth reflects increased assets under management
due to the profitable expansion of the Trust
Company's business.
a $368,000 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 $100 million in
the third quarter of 1998 compared to $80 million in
the same 1997 period. The Company also generated
$201,000 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 $592,000 increase in gains realized on investment
security sales as the Company has focused on selling
mortgage backed securities which were experiencing
rapid prepayments. These security sales are part of
an asset liability management strategy to extend the
duration of the portfolio while maintaining yield.
a $432,000 or 30.3% increase in other income due in
part to additional income resulting from ATM
surcharging, other mortgage banking processing fees,
credit card merchant income, and revenue generated
from annuity and mutual fund sales in the Company s
financial service subsidiaries.
a $413,000 or 72.8% 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 lower interest rate environment and heightened
mortgage refinancing activity, the Company expects
this trend of increasing amortization expense on the
servicing rights to continue in the fourth quarter.
.....NON-INTEREST EXPENSE.....Non-interest expense for
the third quarter of 1998 totaled $15.1 million which
represented a $1.5 million or 10.7% increase when
compared to the same 1997 quarter. This increase was
primarily due to the following items:
a $618,000 or 8.7% increase in salaries and
employee benefits due in part to $175,000 of
severance costs resulting from a realignment of the
Company s retail banking division which caused a
reduction of 12 full-time equivalent employees. On
an ongoing basis, this realignment to a customer
driven sales and service focus will save the Company
in excess of $300,000. The remainder of the
increase in salaries and employee benefits resulted
from merit pay increases, higher commission expense,
and increased medical insurance premiums.
28
a $106,000 or 13.8% increase in equipment expense
due to technology related expenses such as the
system costs associated with optical disk imaging of
customer statements.
a $656,000 increase in other expense due in part to
the establishment of a $266,000 impairment reserve
on the mortgage servicing portfolio. This reserve
was needed on certain tranches of mortgage servicing
rights whose market value had fallen below cost due
to reductions in long-term interest rates over the
past quarter. It is likely that the Company will
have to establish additional impairment reserves in
the fourth quarter of 1998 given expected
continuation of a low interest rate environment.
Other factors contributing to the higher level of
expense included increased advertising expense,
outside processing fees, 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 the first quarter 1999. The Company
has reviewed the building and office equipment for
embedded micro chip problems. The required components to
correct the problems discovered have been ordered for
delivery by year end 1998 and will be tested when
installed. The status of mission critical applications
as certified by vendors is as follows:
Compliant 85%
Working on attaining compliance 12%
System will be replaced 3%
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.
29
The Company's
business resumption plan is also being expanded to
address the potential problems of Y2K such as the loss of
power, telecommunications, or the failure of a mission
critical vendor. The Y2K status of all vendors,
suppliers, utilities and municipalities is currently as
follows:
Compliant 25%
Working on Attaining Compliance 29%
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. During the
third quarter, the Company completed a detailed analysis
of its major loan customers' compliance with Year 2000.
The focus of the analysis was on commercial credit
exposures with balances in excess of $250,000 and
included discussions between loan officers, customers,
and information system representatives in select cases.
As a result of this analysis, the Company currently
believes that the unallocated portion of the loan loss
reserve is adequate to cover the potential customer
credit risk with Year 2000.
The Company has also begun to address the potential
liquidity risks associated with Year 2000. The Company
has reviewed its top 100 deposit customers by branch and
offered educational sessions to help them better
understand the Y2K problem. Additionally, the Company
has developed a contingency funding plan which provides
for the use of brokered deposits and more aggressive
wholesale borrowings should the Company experience an
outflow of deposits. From an asset liability management
standpoint, the Company has begun to emphasize deposit
products which encourage extension of shorter term
maturities into products maturing after the century date
change to further limit liquidity risk.
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 $1.4
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 $418,000 or 30% 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 third quarter of 1998 was $1.9
million reflecting an effective tax rate of 26.3%. The
Company's 1997 third quarter income tax provision was
$2.4 million or an effective tax rate of 28.3%. 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.
30
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 $7.4 million have been provided as of September 30,
1998, on the differences between taxable income for
financial and tax reporting purposes.
NINE MONTHS ENDED September 30, 1998 VS. NINE MONTHS
ENDED September 30, 1997
.....PERFORMANCE OVERVIEW.....The Company's net income
for the first nine months of 1998 totaled $16.7 million
or $1.16 per share on a diluted basis. The Company's net
income for the first nine months of 1997 totaled $17.5
million or $1.14 per share on a diluted basis. The 1998
results reflect a $0.02 or 1.8% improvement in diluted
earnings per share and a $793,000 or 4.5% decrease in net
income when compared to the same nine month period in
1997. The Company's return on equity averaged 14.81% for
the first nine months of 1998 which was down slightly
from the 15.12% return on equity reported in the first
nine months of 1997.
USBANCORP completed several important strategic
initiatives in the first nine months of 1998 which will
favorably impact future 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 modest earnings per share growth despite
compression in the Company s net interest margin caused
by the flat treasury yield curve. Specifically, non-
interest income increased by $3.4 million or 23.1% while
the number of diluted shares outstanding decreased by
914,000 or 6.0% in the first nine months of 1998 due to
the success of the Company s ongoing treasury stock
repurchase program. 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):
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
Net income $16,732 $17,525
Diluted earnings per share 1.16 1.14
Return on average equity 14.81% 15.12%
Return on average assets 0.99 1.10
Average diluted common
shares outstanding 14,410 15,324
.....NET INTEREST INCOME AND MARGIN.....The following
table compares the Company's net interest income
performance for the first nine months of 1998 to the
first nine months of 1997 (in thousands, except
percentages):
31
Nine Months Ended
September 30
1998 1997 $ Change % Change
Interest income $ 119,075 $ 115,592 3,483 3.0
Interest expense 69,652 65,335 4,317 6.6
Net interest income 49,423 50,257 (834) (1.7)
Tax-equivalent
adjustment 2,135 2,225 (90) (4.0)
Net tax-equivalent
interest income $ 51,558 $ 52,482 (924) (1.8)
Net interest margin 3.23% 3.47% (0.24)BP N/M
N/M - Not meaningful.
BP - Basis point
USBANCORP's net interest income on a tax-equivalent
basis decreased by $924,000 or 1.8% due to the negative
impact of a 24 basis point decline in the net interest
margin to 3.23%. The drop in the net interest margin
reflects a 19 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 four basis points
as growth in the earning asset base was funded primarily
with borrowings from the Federal Home Loan Bank. The
interest cost associated with the $34.5 million of
guaranteed junior subordinated deferrable interest
debentures also contributed to the higher cost of funds.
This margin compression offset the benefits resulting
from a higher level of earning assets. Total average
earning assets were $109 million higher in the first nine
months of 1998 as total loans grew by $50 million or 5.3%
while investment securities increased by $61 million or
5.8%.
...COMPONENT CHANGES IN NET INTEREST INCOME...Regarding
the separate components of net interest income, the
Company's total interest income for the first nine months
of 1998 increased by $3.5 million or 3.0% when compared
to the same 1997 period. This increase was due primarily
to a $109 million or 5.4% increase in total average
earning assets which caused interest income to rise by
$6.2 million. This positive factor was partially offset
by a 19 basis point drop in the earning asset yield to
7.63% which caused a $2.7 million reduction in interest
income. Within the earning asset base, the yield on total
investment securities decreased by 30 basis points to
6.69% while the yield on the total loan portfolio
declined by five basis points to 8.63%. 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 86.6% for the first nine
months of 1998 compared to an average of 83.4% 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.
32
The Company's total interest expense for the first
nine months of 1998 increased by $4.3 million or 6.6%
when compared to the same 1997 period. This higher
interest expense was due primarily to a $101 million
increase in average interest bearing liabilities which
caused interest expense to rise by $3.7 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. The growth in interest bearing liabilities also
included the issuance of $34.5 million of 8.45%
guaranteed junior subordinated deferrable interest
debentures which increased interest expense by $1.2
million. For the first nine months of 1998, the
Company's total level of short-term borrowed funds and
FHLB advances averaged $877 million or 38.9% of total
assets compared to an average of $793 million or 37.1% of
total assets for the first nine months of 1997. These
borrowed funds had an average cost of 5.67% in the first
nine months of 1998 which was 159 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 four basis point
increase in the total cost of interest bearing
liabilities from 4.81% in the first nine months of 1997
to 4.85% in the first nine months of 1998. This increase
in the total cost of funds occurred despite a 15 basis
point drop in the cost of interest bearing deposits to
4.08%.
The table that follows provides an analysis of net
interest income on a tax-equivalent basis for the nine
month periods ended September 30, 1998, and September 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.
33
Nine Months Ended September 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 $1,007,166 $ 65,764 8.63% $ 956,796 $ 62,985 8.68%
Deposits with banks 4,009 101 3.33 4,797 174 4.80
Federal funds sold
and securities
purchased under
agreement to resell - - - 48 2 5.22
Investment securities:
Available for sale 597,363 28,943 6.46 466,799 23,904 6.83
Held to maturity 501,077 26,182 6.97 570,946 30,477 7.12
Total investment
securities 1,098,440 55,125 6.69 1,037,745 54,381 6.99
Assets held in trust for
collateralized
mortgage obligation 3,828 220 7.69 4,938 275 7.45
Total interest earning
assets/interest income 2,113,443 121,210 7.63 2,004,324 117,817 7.82
Non-interest earning assets:
Cash and due from banks 34,182 32,965
Premises and equipment 17,931 17,989
Other assets 99,245 97,368
Allowance for loan
losses (11,956) (13,192)
TOTAL ASSETS $2,252,845 $2,139,454
CONTINUED ON NEXT PAGE
34
NINE MONTHS ENDED September 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 $ 90,094 $ 669 0.99% $ 90,681 $ 673 0.99%
Savings 173,434 1,965 1.51 189,053 2,394 1.69
Money markets 166,914 4,648 3.72 152,424 4,206 3.69
Other time 581,473 23,595 5.43 581,188 24,801 5.71
Total interest bearing
deposits 1,011,915 30,877 4.08 1,013,346 32,074 4.23
Short term borrowings:
Federal funds purchased,
securities sold under
agreements to repurchase
and other short-term
borrowings 185,414 7,383 5.32 159,398 6,192 5.19
Advances from Federal
Home Loan Bank 691,476 29,796 5.76 633,373 26,674 5.63
Collateralized mortgage
obligation 3,394 252 9.95 4,367 316 9.66
Guaranteed junior subordinated
deferrable interest
debentures 19,294 1,241 8.58 - - -
Long-term debt 5,091 103 2.70 5,251 79 2.00
Total interest bearing
liabilities/interest expense 1,916,584 69,652 4.85 1,815,735 65,335 4.81
Non-interest bearing liabilities:
Demand deposits 158,185 142,019
Other liabilities 27,036 26,690
Stockholders' equity 151,040 155,010
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $2,252,845 $2,139,454
Interest rate spread 2.78 3.01
Net interest income/
net interest margin 51,558 3.23% 52,482 3.47%
Tax-equivalent adjustment (2,135) (2,225)
Net Interest Income $49,423 $50,257
....PROVISION FOR LOAN LOSSES.....The Company's provision
for loan losses for the first nine months of 1998 totaled
$450,000 or 0.06% of average total loans which
represented a $382,000 increase from the provision level
experienced in the first nine months of 1997. The
Company s net charge-offs amounted to $846,000 or 0.11%
of average loans in first nine months of 1998 compared to
net charge-offs of $467,000 or 0.06% of average loans in
the first nine months 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 September 30, 1998, the balance in the
allowance for loan losses totaled $11.7 million or 160%
of total non-performing assets.
35
.....NON-INTEREST INCOME.....Non-interest income for the
first nine months of 1998 totaled $17.9 million which
represented a $3.4 million or 23.1% increase when
compared to the same period in 1997. This increase was
primarily due to the following items:
a $306,000 or 10.1% increase in trust fees to $3.3
million in the first nine months of 1998. This trust
fee growth reflects increased assets under
management due to the profitable expansion of the
Trust Company's business.
a $1.6 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 $305 million in
the first nine months of 1998 compared to $190
million in the same 1997 period. The Company also
generated $681,000 in gains on the sale of servicing
rights which is reflected in the above gain figure.
a $1.5 million 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 $1.3 million or 32.3% 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.
a $983,000 or 57.2% 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. The
Company expects this trend of increasing
amortization expense on the servicing rights to
continue in the fourth quarter.
Non-interest income as a percentage of total revenue
increased from 21.7% in the first nine months of 1997 to
25.8% in the first nine months of 1998. This
diversification of the revenue stream will continue to be
a key strategic focal point for the Company in the
future.
.....NON-INTEREST EXPENSE.....Non-interest expense for
the first nine months of 1998 totaled $44.0 million which
represented a $3.8 million or 9.3% increase when compared
to the same 1997 period. This increase was primarily due
to the following items:
a $1.8 million or 8.6% increase in salaries and
employee benefits due to merit pay increases, higher
commission and incentive payments, severance costs,
increased profit sharing expense, and increased
medical insurance premiums.
a $278,000 or 11.5% increase in equipment expense
due to technology related expenses such as the
system costs associated with optical disk imaging of
customer statements.
36
a $1.4 million increase in other expense due to the
establishment of a $266,000 impairment reserve on
mortgage servicing rights, higher advertising
expense, increased outside processing fees,
heightened foreclosure losses, and costs associated
with Year 2000 compliance.
.....INCOME TAX EXPENSE.....The Company's provision for
income taxes for the first nine months of 1998 was $6.1
million reflecting an effective tax rate of 26.9%. The
Company's comparable period 1997 income tax provision was
$7.0 million or an effective tax rate of 28.4%. 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 63.4% in the first nine months of 1998
compared to 60.1% for the first nine 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). Total assets per employee improved 5.6%
from $2.8 million for the first nine months of 1997 to
$2.9 million for the first nine months of 1998.
.....BALANCE SHEET.....The Company's total consolidated
assets were $2.321 billion at September 30, 1998,
compared with $2.239 billion at December 31, 1997, which
represents an increase of $82 million or 3.7% due to some
additional leveraging of the balance sheet. During the
first nine months of 1998, total loans and loans held for
sale increased by approximately $45 million or 4.6% due
to growth in commercial and 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 profit line of business. Total
investment securities increased by $32 million as the
Company more aggressively purchased securities in the
third quarter of 1998 due to expected declines in
interest rates in future months and projections for
continued strong cashflow from mortgage backed securities
into 1999.
Total deposits increased by $26 million or 2.3%
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.
37
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 at the Parent Company. The
remainder of the asset growth was funded by a $33 million
increase in total short-term and FHLB borrowings. The
repurchase of treasury stock was the major factor causing
the net $12 million decline in total equity 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):
September 30 December 31 September 30
1998 1997 1997
Total loan delinquency (past due
30 to 89 days) $12,858 $19,890 $15,227
Total non-accrual loans 5,196 6,450 6,368
Total non-performing assets<F1> 7,318 8,858 8,871
Loan delinquency, as a percentage
of total loans and loans held
for sale, net of unearned income 1.24% 2.01% 1.56%
Non-accrual loans, as a percentage
of total loans and loans held
for sale, net of unearned
income 0.50 0.65 0.65
Non-performing assets, as a
percentage of total loans and
loans held for sale, net of
unearned income, and other
real estate owned 0.71 0.89 0.91
<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 September 30, 1998, each of the
key asset quality indicators demonstrated improvement. Total loan
delinquency declined by $7.0 million causing the delinquency ratio
to drop to 1.24%. Total non-performing assets decreased by $1.5
million since year-end 1997 causing the non-performing assets to
total loans ratio to drop to 0.71%. The overall improvement in
asset quality resulted from enhanced collection efforts on
residential mortgage loans and continued low levels of non-
performing commercial loans.
.....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):
38
September 30 December 31 September 30
1998 1997 1997
Allowance for loan losses $ 11,717 $ 12,113 $ 12,930
Amount in the allowance
for loan losses
allocated to "general risk" 5,410 5,980 6,570
Allowance for loan losses as
a percentage of each of
the following:
total loans and loans
held for sale,
net of unearned income 1.13% 1.22% 1.32%
total delinquent loans
(past due 30 to 89 days) 91.13 60.90 84.91
total non-accrual loans 225.50 187.80 203.05
total non-performing assets 160.11 136.75 145.76
Since December 31, 1997, the balance in the
allowance for loan losses has declined by $396,000 to
$11.7 million due to net charge-offs exceeding the loan
loss provision. The Company's allowance for loan losses
at September 30, 1998, was 160% of non-performing assets
and 226% 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 $3.5 million or 48% of the
Company s non-performing assets are residential mortgages
which exhibit a historically low level of net charge-off.
The decline in the portion of the allowance for loan
losses allocated to general risk was due primarily to
increased specific allocations for impaired loans.
.....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)
market value of portfolio equity sensitivity analysis.
The overall interest rate risk position and strategies
are reviewed by senior management and Company's Board of
Directors on an ongoing basis.
39
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
September 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 September 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 (0.66) (1.42) (1.79)
200bp increase (4.32) (8.51) (14.28)
200bp decrease 0.44 (7.18) 20.80
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 (4.3%) and
(8.5%) 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 (14.3%) under this interest
rate scenario. The off-balance sheet borrowed funds
hedges (see Note #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.
40
.....LIQUIDITY.....Liquidity can be analyzed by utilizing
the Consolidated Statement of Cash Flows. Cash
equivalents decreased by $1.8 million from December 31,
1997, to September 30, 1998, due primarily to $73.4
million of net cash used by investing activities. This
more than offset $12.1 million of net cash provided by
operating activities and $59.5 million of net cash
provided by financing activities. Within investing
activities, cash purchases of investment securities
exceeded proceeds from investment security maturities and
sales by $25.5 million. Cash advanced for new loan
fundings totaled $273 million and was approximately $11
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 $11 million. An
increase in demand and savings deposits provided $15
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.
Increased borrowings from the Federal Home Loan Bank also
provided the Company with $63 million of cash.
.....CAPITAL RESOURCES.....As presented in Note #15, each
of the Company s regulatory capital ratios increased
between December 31, 1997, and September 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 13.86% and 6.79% at September 30,
1998. The Company targets an operating range of 6.0% to
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. The Company expects that the asset
leverage ratio will decline to approximately 6.25% in the
first quarter of 1999 when the acquisition of the First
Western Branches is completed.
The Company has used funds provided from the
issuance of the guaranteed junior subordinated deferrable
interest debentures to repurchase 1.1 million shares or
$27.4 million of its common stock during the first nine
months of 1998. Through September 30, 1998, the Company
has repurchased a total of 3.7 million shares of its
common stock at a total cost of $58.5 million or $15.88
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.
41
The Company's declared Common Stock cash dividend
per share was $0.40 for the first nine months of 1998
which was an 21.2% increase over the $0.33 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; (vi) the ability of
third party vendors upon whom the Company relies, loan
customers and businesses and governmental units generally
to achieve Y2K compliance on a timely basis and; (vii)
other external developments which could materially impact
the Company's operational and financial performance.
42
SERVICE AREA MAP
Presented on this page was a service area map reflecting the
six counties serviced by the Company.
43
Part II Other Information
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).
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: There were no reports
filed on Form 8-K for the quarter ending
September 30, 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: November 13, 1998 /s/Terry K. Dunkle
Terry K. Dunkle
Chairman, President and
Chief Executive Officer
Date: November 13, 1998 /s/Jeffrey A. Stopko
Jeffrey A. Stopko
Senior Vice President and
Chief Financial Officer
44
STATEMENT OF MANAGEMENT RESPONSIBILITY
October 16, 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 September 30, 1998 and 1997, and the
related consolidated statements of income for the three-
month and nine-month periods then ended and the related
consolidated statements of changes in stockholders equity
and cash flows for the nine-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,
October 16, 1998
46
October 16, 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 September 30,
1998, which includes our report dated October 16, 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