SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For Fiscal Period Ended: June 30, 2000
Or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________ to _________
Commission File No: 0-18833
Chester Valley Bancorp Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2598554
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 E. Lancaster Ave., Downingtown PA 19335
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 269-9700
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 Par Value Per Share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [X]
As of September 1, 2000, the aggregate value of the 3,202,820 shares of Common
Stock of the registrant which were issued and outstanding on such date,
excluding 711,233 shares held by all directors and officers of the registrant as
a group, was approximately $ 54.85 million. This figure is based on the closing
sales price of $17.125 per share of the registrant's Common Stock on September
1, 2000.
Number of shares of Common Stock outstanding as of September 1, 2000: 3,914,053
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference:
(1) Portions of the Annual Report to Shareholders for the year ended June 30,
2000, are incorporated into Part II, Items 5 - 8 of this Form 10-K.
(2) Portions of the Definitive Proxy Statement for the 2000 annual meeting of
shareholders are incorporated into Part III, Items 10-13 of this Form
10-K.
INDEX
Page
----
PART I
Item 1. Business........................................................... 1
Item 2. Properties.........................................................45
Item 3. Legal Proceedings..................................................46
Item 4. Submission of Matters to a Vote of Security Holders................46
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters............................................................47
Item 6. Selected Financial Data............................................47
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................47
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.........47
Item 8. Financial Statements and Supplementary Data........................47
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...........................................47
PART III
Item 10. Directors and Executive Officers of the Registrant.................47
Item 11. Executive Compensation.............................................48
Item 12. Security Ownership of Certain Beneficial Owners and Management.....48
Item 13. Certain Relationships and Related Transactions.....................48
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...49
SIGNATURES ..................................................................50
PART I.
ITEM 1. BUSINESS
Forward Looking Statements
In this Form 10-K, the Company has included certain "forward
looking statements" concerning future operations of the Company. It is
management's desire to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This statement is for the
express purpose of availing the Company of the protections of such safe harbor
with respect to all "forward looking statements" contained in this Form 10-K or
incorporated. The Company has used "forward looking statements" to describe
certain of its future plans and strategies including management's expectations
of the Company's future financial results. Management's ability to predict
results or the effect of future plans and strategy is inherently uncertain.
Factors that could affect results include interest rate trends, competition, the
general economic climate in Chester County, the mid-Atlantic region and the
country as a whole, loan delinquency rates, changes in federal and state
regulation, and other uncertainties described in the Company's filings with the
Securities and Exchange Commission, including its Form 10-K for the year ended
June 30, 2000. These factors should be considered in evaluating the "forward
looking statements", and undue reliance should not be placed on such statements.
General
Chester Valley Bancorp Inc. (the "Holding Company") is a unitary
thrift holding company, incorporated in the Commonwealth of Pennsylvania in
August 1989. The business of the Holding Company and its subsidiaries (the
"Company") consists of the operations of First Financial Bank ("First Financial"
or the "Bank"), a Pennsylvania-chartered stock savings and loan association
founded in 1922, and Philadelphia Corporation for Investment Services ("PCIS"),
a full service investment advisory and securities brokerage firm. The Bank
provides a wide range of banking services to individual and corporate customers
through its eight branch banks in Chester County, Pennsylvania. The Bank
provides residential real estate, commercial real estate, commercial and
consumer lending services and funds these activities primarily with retail
deposits and borrowings. PCIS is a registered broker/dealer in all 50 states and
the District of Columbia and it is also registered as an investment advisor with
the Securities and Exchange Commission. PCIS provides many additional services,
including self-directed and managed retirement accounts, safekeeping, daily
sweep money market funds, portfolio and estate valuations, life insurance and
annuities, and margin accounts, to individuals and smaller corporate accounts.
PCIS' offices are located in Wayne and Philadelphia, Pennsylvania.
References to the Company include its wholly owned subsidiaries,
the Bank and PCIS, unless the context of the reference indicates otherwise.
1
Market Area
The Bank's primary market area includes Chester County and
sections of the four contiguous counties (Delaware, Montgomery, Berks, and
Lancaster) in Pennsylvania. Chester County, in which all of the Bank's offices
are located, continues to grow in terms of economic development and population
growth.
Customer deposits with First Financial are insured to the maximum
extent provided by law by the Federal Deposit Insurance Corporation ("FDIC")
through the Savings Associations Insurance Fund ("SAIF"). The Bank is subject to
examination and comprehensive regulation by the FDIC, the Office of Thrift
Supervision ("OTS"), and the Pennsylvania Department of Banking ("Department").
It is a member of the Federal Home Loan Bank ("FHLB") of Pittsburgh ("FHLBP"),
which is one of the 12 regional banks comprising the FHLB System. The Bank is
further subject to regulations of the Board of Governors of the Federal Reserve
System ("Federal Reserve Board") governing reserves required to be maintained
against deposits and certain other matters.
Lending Activities
Loan Portfolio Composition. The Company's net loan portfolio (net
of undisbursed proceeds, deferred fees and allowance for loan losses) totaled
$331.31 million at June 30, 2000, representing approximately 65.3% of the
Company's total assets of $507.15 million at that date.
2
The following table presents information regarding the Company's loan portfolio
by type of loan indicated.
---------------------------------------------------------------------------------
2000 1999
----------------------------------- -------------------------------
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
Real estate loans:
Residential:
Single-family $ 167,451 46.8% $156,514 50.8%
Multi-family -- 0.0% 828 .3%
Commercial 66,221 18.5% 55,197 17.9%
Construction and land acquisition(1) 42,372 11.8% 29,339 9.5%
----------------- ---------------- ---------------- --------------
Total real estate loans 276,044 77.1% 241,878 78.5%
Commercial business loans(2) 19,358 5.4% 14,708 4.8%
Consumer loans(3) 62,433 17.5% 51,416 16.7%
----------------- ---------------- ---------------- --------------
Total loans receivable 357,835 100.0% 308,002 100.0%
================ ==============
Less:
Loans in process (20,908) (11,393)
Allowance for loan losses (3,908) (3,651)
Deferred loan fees (1,713) (1,570)
----------------- ----------------
Net loans receivable 331,306 291,388
Loans held for sale, single-family
residential mortgages -- --
----------------- ----------------
Net loans receivable and loans held
for sale $331,306 $291,388
================= ================
At June 30,
-----------------------------------------------------------------------------------------
1998 1997 1996
------------------------- ---------------------------- -----------------------------
% of % of % of
Total Total Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Real estate loans:
Residential:
Single-family $154,755 53.3% $158,537 58.4% $147,274 62.6%
Multi-family 873 0.3% 893 0.3% 1,256 0.5%
Commercial 41,002 14.1% 33,981 12.5% 22,552 9.6%
Construction and land acquisition(1) 30,646 10.5% 22,907 8.5% 17,028 7.2%
------------ ----------- -------------------------- ------------------ ---------
Total real estate loans 227,276 78.2% 216,318 79.7% 188,110 79.9%
Commercial business loans(2) 11,437 3.9% 7,863 2.9% 5,701 2.4%
Consumer loans(3) 51,829 17.9% 47,343 17.4% 41,486 17.7%
------------ ----------- -------------------------- ------------------ ---------
Total loans receivable 290,542 100.0% 271,524 100.0% 235,297 100.0%
=========== ========= =========
Less:
Loans in process (12,380) (10,092) (7,134)
Allowance for loan losses (3,414) (2,855) (2,667)
Deferred loan fees (1,620) (1,537) (1,533)
------------ ------------------ ------------------
Net loans receivable 273,128 257,040 223,963
Loans held for sale, single-family
residential mortgages 1,101 106 --
-------------
------------------ ------------------
Net loans receivable and loans held
for sale $274,229 $257,146 $ 223,963
============= ================== ==================
- -----------------
(1) Includes construction loans for both residential and commercial real
estate properties.
(2) Consists primarily of secured equipment loans.
(3) Consists primarily of home equity loans and lines of credit, home
improvement, automobile and other personal loans.
3
Contractual Maturities. The following table sets forth the contractual
principal repayments of the total loan portfolio, including loans in process, of
the Company as of June 30, 2000, by categories of loans. All loans are included
in the period in which they mature. Loans held for sale are not included.
Principal Repayments
Contractually Due in Year(s) Ended June 30,
-------------------------------------------------------------------------
(In Thousands)
Total
Outstanding
at 2006
June 30, 2002-and
2000 2001 2005 Thereafter
-------------- ---------- --------- -----------------
Real estate loans:
Residential $167,451 $ 25,057 $ 32,459 $109,935
Commercial 66,221 2,486 53,909 9,826
Construction and land acquisition 42,372 16,249 12,911 13,212
Commercial business loans 19,358 12,154 5,538 1,666
Consumer loans 62,433 6,680 17,391 38,362
-------------------------------------------------------------------------
Total loans $357,835 $ 62,626 $122,208 $173,001
=========================================================================
The following table sets forth, as of June 30, 2000, the dollar amount of all
loans contractually due after June 30, 2001, which have fixed interest rates and
floating or adjustable rates.
Contractual Obligations
Due After June 30, 2001
--------------------------------
Floating/
Fixed Adjustable
Rates Rates
------------- ----------------
(In Thousands)
Real estate loans:
Residential $ 95,456 $ 46,938
Commercial 9,922 53,813
Construction and land acquisition 3,023 23,100
Commercial business loans 6,960 244
Consumer loans 55,634 119
------------- ----------------
Total loans $ 170,995 $ 124,214
============= ================
4
Contractual principal repayments of loans do not necessarily
reflect the actual term of the Company's loan portfolio. The average life of
mortgage loans is substantially less than their contractual terms because of
loan prepayments and because of enforcement of due-on-sale clauses, which give
the Company the right to declare a loan immediately due and payable in the
event, among other things, that the borrower sells the real property subject to
the mortgage and the loan is not repaid. The average life of mortgage loans
tends to increase, however, when current mortgage loan rates substantially
exceed rates on existing mortgage loans and, conversely, decrease when rates on
existing mortgage loans substantially exceed current mortgage loan rates.
Origination, Purchase and Sale of Loans. As a
Pennsylvania-chartered savings institution, First Financial has general
authority pursuant to the Savings Association Code of 1967, as amended ("State
Code"), to originate and purchase loans secured by real estate located
throughout the United States. Due to the Company's strong community orientation,
substantially all of the Company's total mortgage loan portfolio is secured by
real estate located in its primary market area.
Residential and commercial real estate loans are originated
directly by the Bank through salaried loan officers. In addition, from time to
time the Bank utilizes third-party originators who use the same credit
guidelines and standards as the Bank to originate residential loans. Residential
and commercial real estate loan originations are normally attributable to
referrals from real estate brokers and builders and other financial
institutions, mortgage brokers, depositors and walk-in customers. Consumer loan
originations are primarily attributable to existing customers and referrals, as
well as third party automobile loans originated through dealers.
The Bank periodically identifies certain loans as held for sale
at the time of origination. These loans consist primarily of fixed-rate,
single-family residential mortgage loans which meet the underwriting
characteristics of certain government-sponsored enterprises (conforming loans).
The majority of conforming loans sold to date have consisted of sales to Freddie
Mac ("FHLMC") of fixed-rate mortgage loans in furtherance of the Company's goal
of better matching the maturities and interest-rate sensitivity of its assets
and liabilities. In selling conforming loans, the Bank has retained the
servicing thereon in order to increase its non-interest income. At June 30,
2000, the Bank serviced $23.67 million of mortgage loans for others. Sales of
loans produce future servicing income and provide funds for additional lending
and other purposes. The Bank is a qualified servicer for FHLMC, Fannie Mae
("FNMA"), and Ginnie Mae ("GNMA").
5
The following table shows total loans and loans held for sale
originated, purchased, sold and repaid during the periods indicated.
Year Ended June 30,
-------------------------------------------------------------
2000 1999 1998
---------------- ---------------- ----------------
(In Thousands)
Total loans receivable and loans held for sale at
beginning of period $ 308,002 $291,643 $271,630
Real estate loan originations:
Residential (1)
Commercial 26,926 31,705 39,329
Construction and land acquisition (2) 10,002 18,914 9,398
24,374 21,852 21,057
---------------- -------------- -------------
Total real estate
loan originations 61,302 72,471 69,784
Consumer loans (3) 33,748 24,540 24,771
Commercial business loans 22,551 17,312 11,896
---------------- -------------- -------------
Total loan
originations 117,601 114,323 106,451
---------------- -------------- -------------
Principal loan repayments 67,594 96,487 77,481
Sales of loans 174 1,477 8,957
---------------- -------------- -------------
Total principal
repayments
and sales 67,768 97,964 86,438
---------------- -------------- -------------
Net increase in
loans and loans
held for sale 49,833 16,359 20,013
---------------- --------------
-------------
Total loans receivable and loans
held for sale at end of period $ 357,835 $308,002 $291,643
================ ============== =============
- ---------------
(1) Includes both single-family and multi-family residential loans.
(2) Includes construction loans for both residential and commercial real
estate properties.
(3) Includes home equity loans and lines of credit, home equity improvement,
automobile and other personal loans.
Loans on Existing Single-Family Residential Properties. The Bank
currently offers adjustable-rate mortgages ("ARMs") which have up to 30-year
terms and interest rates which adjust either annually or every three years, or
which are fixed initially for the first three years, five years, seven years, or
ten years, and adjust annually thereafter, based upon changes in an index based
on the weekly average yield on United States Treasury securities adjusted to a
constant maturity of one year or three years, respectively, as made available by
the Federal Reserve Board plus a margin. The amount of any increase or decrease
in the interest rate for ARMs is limited to 1% or 2% per year and 6% over the
life of the loan. Substantially all of the ARMs originated by the Bank cannot be
converted to fixed-rate loans. The interest rates of ARMs may not adjust
6
as rapidly as changes in the Company's cost of funds. In order to minimize risk,
ARM borrowers are qualified at the rate which would be in effect after the first
interest rate adjustment, if that rate is higher than the initial rate. The
Bank's ARMs require that any payment adjustment resulting from a change in the
interest rate of the ARM be sufficient to result in full amortization of the
loan by the end of the loan term and, thus, do not permit any of the increased
payment to be added to the principal amount of the loan, or so-called negative
amortization. Due to the declining interest rate environment and leveling of the
yield curve, the Bank experienced significant refinancings of its ARM portfolio
into its fixed rate mortgage products in 1999 and to a lesser degree in 2000.
Fixed-rate residential mortgage loans currently originated generally
have 30-year terms, although some have 15-year terms with commensurately lower
interest rates. The Bank also offers a bi-weekly mortgage which is a fixed-rate
loan with bi-weekly payments. Based on current interest rates, it is repaid in
approximately 22 years. Substantially all of the Bank's long-term, fixed-rate
residential mortgage loans and ARMs include "due on sale" clauses which the loan
balance becomes due upon the sale of the property.
The Bank also makes second mortgage loans and home equity loans. See
"Lending Activities - Consumer Loans."
Loans on Existing Commercial and Multi-Family Properties. During the
past several years, the Bank has originated permanent loans secured by
multi-family and income-producing properties such as condominiums, apartment
buildings, office buildings and, to a lesser extent, hotels and small shopping
centers. The Bank intends to increase its emphasis on the origination of
commercial real estate loans and, accordingly, intends to increase its
commercial lending staff. The Bank's Commercial Loan Department currently
consists of seven loan officers, all but one of whom joined the Bank's staff
with substantial prior commercial lending experience. The origination of
multi-family residential and commercial real estate loans has resulted in the
shortening of the average maturity and an increase in the interest rate
sensitivity of the Bank's loan portfolio as well as to generate increased fee
income. All of the Bank's multi-family residential and commercial real estate
loan portfolio is secured by properties located in the Company's primary market
area. As of June 30, 2000, commercial and multi-family real estate loans,
excluding construction loans for such properties, amounted to $66.22 million, or
18.5% of the total loan portfolio.
A substantial majority of commercial real estate loans have interest
rates which adjust annually after an initial three- or five-year term by a
margin over the corresponding United States Treasury yield for securities with
the same term. These loans typically have amortization periods of up to 20
years, but occasionally provide that the loans can be called by the Bank prior
to the end of the amortization period, generally at three, five, seven or ten
years after origination.
7
Commercial and multi-family residential real estate lending entails
significant additional risks as compared with single-family residential property
lending. Commercial and multi-family residential real estate loans typically
involve large loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans is typically dependent on the successful
operation of the business or real estate project. The success of such projects
is sensitive to changes in supply and demand conditions in the market for
commercial and multi-family residential real estate as well as economic
conditions generally.
The Bank seeks to ensure that the property securing these loans will
generate sufficient cash flow to adequately cover operating expenses and debt
service payments. To this end, permanent commercial and multi-family residential
real estate loans generally are made with a loan-to-value ratio of 75% or less.
In underwriting commercial and multi-family residential real estate loans,
consideration is given to the property's operating history, future operating
projections, current and projected occupancy, position in the local and regional
market, location and physical condition. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower. The Bank
usually obtains full or partial loan guarantees from the principal(s) involved.
Construction Loans. The Bank also offers both fixed-rate and
adjustable-rate residential and commercial construction loans. Residential
construction loans are offered to individuals building their primary or
secondary residence as well as to selected local developers to construct up to
four-family dwellings. Advances are made on a percentage of completion basis,
usually consisting of six draws. Residential construction loans convert to
permanent loans at the end of 12 months or upon completion of construction,
whichever occurs first. At June 30, 2000, $31.41 million or 8.8% of the
Company's total loan portfolio consisted of construction loans including loans
in process. Loans in process related to such loans totaled $16.86 million at
June 30, 2000.
The Bank has been active in construction lending for many years and
intends to continue its involvement in such lending in the future. Construction
lending is generally considered to involve a higher degree of risk of loss than
long-term financing on improved, occupied real estate. Risk of loss on
construction loans is dependent largely upon the accuracy of the initial
appraisal of the property's projected value at completion of construction as
well as the estimated cost, including interest, of construction. During the
construction phase, a number of factors could result in delays and cost
overruns. If either estimate proves to be inaccurate and the borrower is unable
to provide additional funds, the lender may be required to advance funds beyond
the amount originally committed to permit completion of the project and/or be
confronted at the maturity of the construction loan with a project whose value
is insufficient to assure full repayment.
8
Land Acquisition and Development Loans. The Bank also offers land
acquisition and development loans. These types of loans are generally provided
only to local developers with strong financial positions and with whom the Bank
is familiar. These loans typically have terms of one to three years and carry a
floating interest rate normally indexed to the Wall Street Journal Prime. The
Bank will lend up to 75% of the appraised value of the project. At June 30,
2000, $10.96 million, or 3.1% of the Company's total loan portfolio consisted of
land acquisition and development loans, including loans in process. Loans in
process on such loans totaled $4.05 million at June 30, 2000. Like construction
lending, these loans generally are considered to involve a higher degree of risk
of loss than long-term financing on approved occupied real estate. The Bank is
actively pursuing developers who can both demonstrate the ability to meet cash
flow projections in order to repay loans through a very strong financial
position and have a reputation for successfully completing such projects in
similar situations with the Bank.
Consumer Loans. The Bank offers a wide variety of consumer loans,
including home equity loans, home improvement loans, equity lines of credit,
secured and unsecured personal loans and automobile loans. The Bank has
aggressively marketed consumer loans in order to provide a wider range of
financial services to its customers and because of the shorter terms and
normally higher interest rates on such loans. As of June 30, 2000, consumer
loans amounted to $62.43 million or 17.5% of the total loan portfolio.
The Bank's home equity lines of credit currently provide for terms of
up to 10 years. The interest rate on the "Prime Line" adjusts monthly to the
Wall Street Journal Prime Rate. The regular equity line of credit adjusts
monthly at 1.50% above the Wall Street Journal Prime Rate. The limit of such
loan is the borrower's equity in his residence, subject to certain income
qualifications. The Bank also makes fixed-rate, fixed-term home equity loans on
which it takes a first- or second-mortgage lien on the borrower's property.
These loans have terms of up to 15 years. The balance of the fixed-rate
mortgages on the properties cannot exceed in the aggregate 80% of the appraised
value of the properties. Home equity lines of credit and fixed-rate home equity
loans amounted to $5.50 million and $48.88 million, respectively, as of June 30,
2000. The Bank also originates fixed-rate bridge loans with loan-to-value ratios
of no greater than 80% of the value of the secured real estate and at a maximum
term of twelve months. At June 30, 2000, there was no balance for these loans.
At June 30, 2000, the balance was $494,000 for fixed-rate loans secured
by certificates of deposit or marketable securities. Unsecured personal loans
amounted to $465,000 at June 30, 2000 and consisted of fixed-rate loans with
maximum loan balances of $5,000 and terms no greater than 48 months. The Bank
also originates fixed-rate loans on new and used automobiles. The terms of such
loans do not exceed 60 months on new cars and 48 months on used cars. Automobile
loans amounted to $6.24 million at June 30, 2000. The Bank's current line of
credit provides for unsecured loans of up to $1,000 for terms of up to 36 months
with an interest rate set at 6.0% over the Wall Street Journal Prime Rate
adjusted monthly. Such loans have a floor of 10.0% and a ceiling of 18.0% and
totaled $264,000 at June 30, 2000. In addition, the Bank originates Visa and
MasterCard credit card loans with up to $5,000 lines of credit and at an
interest rate set at 6.0% over the Prime Rate. At June 30, 2000, the Company had
$408,000 in credit card loans outstanding.
9
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss, divorce, illness and personal bankruptcy. In
most cases, any repossessed collateral for a defaulted consumer loan will not
provide an adequate source of repayment of the outstanding loan balance because
of improper repair and maintenance of the underlying security. The Bank believes
that the generally higher yields earned on consumer loans compensate for the
increased credit risk associated with such loans and that consumer loans are
important to its efforts to increase the interest rate sensitivity and shorten
the average maturity of its loan portfolio.
Commercial Business Loans. The Bank makes commercial business loans
directly to businesses located in its market area. The Bank targets small and
medium sized businesses with the majority of the loans being originated in
amounts of less than $750,000. Applications for commercial business loans are
obtained primarily from existing customers, branch referrals and direct inquiry.
As of June 30, 2000, commercial business loans totaled $19.36 million or 5.4% of
the total loan portfolio.
Commercial business loans originated by the Bank generally have terms
of five years or less and fixed interest rates or adjustable interest rates tied
to the Wall Street Journal Prime plus a margin. Such loans are generally secured
by real estate, receivables, equipment, or inventory and are generally backed by
the personal guarantees of the principals of the borrower. Commercial business
loans generally have shorter terms to maturity and provide higher yields than
residential mortgage loans. Although commercial business loans generally are
considered to involve greater credit risk than certain other types of loans,
management intends to continue to offer commercial business loans to small and
medium sized businesses in an effort to better serve our community's needs,
obtain core non-interest bearing deposits, and increase the Company's interest
rate spread.
Regulatory Requirements and Underwriting Policies. Under the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") and
pursuant to the parity provisions of the State Code, the aggregate loans that
the Company may make to any borrower and its affiliates is limited to 15% of
unimpaired capital for unsecured loans and 25% of capital for loans secured by
readily marketable collateral. At June 30, 2000, pursuant to such provisions,
the Bank was permitted to extend credit to any one borrower totaling $5.41
million. Special rules applicable to savings associations' provide authority to
develop domestic residential housing units up to the lesser of 30% of the
savings association's unimpaired capital and unimpaired surplus or $30.0
million, if: (a) the purchase price of a single-family unit does not exceed
$500,000; (b) the savings association is in compliance with the fully phased-in
capital standards; (c) the OTS director, by order, authorizes the higher limit;
(d) the loans made to all borrowers in the aggregate do not exceed 150% of the
savings association's unimpaired capital and unimpaired surplus; and (e) all
loans comply with applicable loan-to-value requirements. At June 30, 2000, the
Bank's largest loan or group of loans to one borrower, including related
entities, aggregated $5.26 million, and is in conformity with the current loans
to one borrower regulations described above.
10
The Bank is currently permitted to lend up to 100% of the appraised
value of the real property securing a loan; however, if the amount of a
residential loan originated or refinanced exceeds 90% of the appraised value,
the Bank is required by federal regulations, the State Code and Department
regulations to obtain private mortgage insurance on the portion of the principal
amount of the loan that exceeds 80% of the appraised value of the security
property. Pursuant to underwriting guidelines adopted by the Board of Directors,
private mortgage insurance must be obtained on all residential loans whose
loan-to-value ratios exceed 80%. The Bank will generally lend up to 97% of the
appraised value of one-to four-family owner-occupied residential dwellings when
the required private mortgage insurance is obtained. The Bank generally
originates loans of up to 75% of the appraised value of the properties securing
its commercial real estate and commercial business loans and 75% of the
appraised value upon completion or sale price, whichever is lower, for
construction loans. With respect to construction loans for owner-occupied
properties made in connection with the providing of the permanent financing, the
Bank will lend up to 90% of the appraised value when the required private
mortgage insurance is obtained.
In the loan approval process, the Bank assesses both the borrower's
ability to repay the loan and the adequacy of the proposed security. In
connection therewith, the Bank obtains an appraisal of the security property and
information concerning the income, financial condition, employment and credit
history of the applicant. Loans must be approved at various management levels,
including the Board of Directors, depending on the amount of the loan.
Residential mortgage loans, commercial business and commercial real estate
loans, and any other loans in excess of $1.00 million require approval by the
Board of Directors. In addition, any loan in excess of $500,000 which exhibits
certain characteristics concerning the borrower or the project requires approval
by the Board of Directors.
For mortgage loans the Bank requires title insurance insuring the
priority of its lien, as well as fire and extended coverage casualty insurance,
in order to protect the properties securing its real estate loans. Borrowers
must also obtain flood insurance policies where the property is in a flood plain
as designated by the Federal Emergency Management Agency. Borrowers may be
required to advance funds on a monthly basis together with each payment of
principal and interest to a mortgage loan account from which the Company makes
disbursements for items such as real estate taxes, hazard insurance premiums and
private mortgage insurance premiums as they fall due.
Loan Fee and Servicing Income. In addition to interest earned on loans,
the Bank receives income through servicing of loans and fees in connection with
loan originations, loan modifications, late payments, prepayments, repayments
and changes of property ownership and for miscellaneous services related to its
loans. Income from these activities varies from period to period with the volume
and type of loans made.
Loan origination fees and certain related direct loan origination costs
are offset and the resulting net amount is deferred and amortized over the life
of the related loans as an adjustment to the yield of such related loans.
However, in the event the related loan is sold, any deferred loan fees or costs
remaining with respect to such loan should be taken into income.
11
The Bank currently charges loan origination fees which are
calculated as a percentage of the amount of the loan. The fees received in
connection with the origination of commercial real estate loans have generally
amounted to two points (one point being equivalent to 1% of the principal amount
of the loan). In addition, the Bank typically receives fees from two to three
points in connection with the origination of new, conventional, one-to
four-family mortgages and 3.5 points in connection with the origination of
construction loans.
At June 30, 2000, the Bank was servicing $23.67 million of loans
for others, substantially all of which were whole loans sold by the Bank to the
FHLMC. The Bank receives a servicing fee of approximately 1/4 or 3/8 of 1% on
such loans.
Non-Performing Loans and Real Estate Owned ("REO"). When a
borrower fails to make a required loan payment, the Bank attempts to cause the
default to be cured by contacting the borrower. In general, contacts are made
after a payment is more than 15 days past due, at which time a late charge is
assessed. Defaults are cured promptly in most cases. If the delinquency on a
mortgage loan exceeds 90 days and is not cured through the Bank's normal
collection procedures, or an acceptable arrangement is not worked out with the
borrower, the Company will institute measures to remedy the default, including
commencing a foreclosure action or, in special circumstances, accepting from the
mortgagor a voluntary deed of the secured property in lieu of foreclosure. The
remedies available to the Bank in the event of a default or delinquency with
respect to certain residential mortgage loans, and the procedures by which such
remedies may be exercised, are subject to Pennsylvania law and regulations.
Under Pennsylvania law, a lender is prohibited from accelerating the maturity of
a residential mortgage loan, commencing any legal action (including foreclosure
proceedings) to collect on such loan, or taking possession of any loan
collateral until the lender has first provided the delinquent borrower with at
least 30 days prior written notice specifying the nature of the delinquency and
the borrower's right to correct such delinquency. In addition, the lender's
ability to exercise any remedies it may have with respect to loans for one- or
two-family principal residences located in Pennsylvania is further restricted
(including the lender's right to foreclose on such property) until the lender
has provided the delinquent borrower with written notice detailing the
borrower's rights to seek consumer credit counseling and state financial
assistance and until the borrower has exhausted or failed to pursue such rights.
These provisions of Pennsylvania law may delay for several months the Bank's
ability to foreclose upon residential loans secured by real estate located in
the Commonwealth of Pennsylvania. In addition, the uniform FNMA/FHLMC lending
documents used by the Bank, as well as most other residential lenders in
Pennsylvania, requires notice and a right to cure similar to that provided under
Pennsylvania law.
12
Non-accrual loans are loans on which the accrual of interest ceases
when the collection of principal or interest payments is determined to be
doubtful by management. It is the policy of the Company to discontinue the
accrual of interest when principal or interest payments are delinquent 90 days
or more (unless the loan principal and interest are determined by management to
be fully secured and in the process of collection), or earlier, if the financial
condition of the borrower raises significant concern with regard to the ability
of the borrower to service the debt in accordance with the current loan term.
Interest income is not accrued until the financial condition and payment record
of the borrower once again demonstrate the ability to service the debt. When a
loan is placed on non-accrual status, previously accrued but unpaid interest is
deducted from interest income. Non-real estate consumer loans more than 120 days
delinquent are required to be written off in accordance with federal
regulations.
If foreclosure is effected, the property is sold at a public auction in
which the Company may participate as a bidder. If the Company is the successful
bidder, the acquired real estate property is then included in the Company's
"real estate owned" account until it is sold. When property is acquired, it is
recorded at the lower of carrying value or fair value less disposal cost at the
date of acquisition and any write-down resulting therefrom is charged to the
allowance for loan losses. Interest accrual ceases on the date of acquisition
and all costs incurred in maintaining the property from that date forward are
expensed. Costs incurred for the improvement or development of such property are
capitalized to the extent they do not exceed the property's fair value. No loss
reserves are maintained on REO and future write-downs for cost beyond the fair
value are expensed. The Company is permitted under Department and OTS
regulations to finance sales of REO by "loans to facilitate," which may involve
more favorable interest rates and terms than generally would be granted under
the Bank's underwriting guidelines. However, at June 30, 2000, the Company did
not have any loans to facilitate.
For purposes of applying the measurement criteria for impaired loans,
the Company excludes large groups of smaller-balance homogeneous loans,
primarily consisting of residential real estate loans and consumer loans as well
as commercial loans with balances of less than $100,000. For applicable loans,
the Company evaluates the need for impairment recognition when a loan becomes
non-accrual or earlier if, based on management's assessment of the relevant
facts and circumstances, it is probable that the Company will be unable to
collect all proceeds due according to the contractual terms of the loan
agreement. At June 30, 2000, the Company did not have any impaired loans. The
Company's policy for the recognition of interest income on impaired loans is the
same as for non-accrual loans discussed above. Impaired loans are charged off
when the Company determines that foreclosure is probable and the fair value of
the collateral is less than the recorded investment of the impaired loan.
13
The following table sets forth information regarding non-accrual loans
and REO held by the Company at the dates indicated. The Company did not have any
(i) loans which are 90 days or more delinquent but on which interest is being
accrued or (ii) loans which were classified as restructured troubled debt at any
of the dates presented.
Year Ended June 30,
----------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------- ------------- ------------- ---------- ----------
(Dollars In Thousands)
Non-accrual loans:
Residential real estate loans $ 735 $ 568 $ 771 $ 417 $ 1,166
Commercial real estate loans -- -- -- -- --
Construction and land loans -- -- 55 -- 737
Commercial business loans -- 258 -- -- 18
Consumer loans 207 107 420 331 297
-------------- ------------- ------------ ---------- -----------
Total non-accrual loans $ 942 $ 933 $ 1,246 $ 748 $ 2,218
============== ============= ============ ========== ===========
Total non-accrual loans
to total assets .19% .21% .33% .23% .81%
Total REO -- -- -- -- $121
Total non-accrual loans and
REO to total assets .19% .21% .33% .23% .85%
At June 30, 2000 non-accrual real estate loans included nine
residential mortgage loans aggregating $735,000, all secured by single-family
residential properties.
The total amount of non-performing loans was $942,000, $933,000 and
$1.25 million at June 30, 2000, 1999 and 1998, respectively. If these
non-performing loans had been current in accordance with their original terms
and had been outstanding throughout the period, the gross amount of interest
income for fiscal 2000, 1999, and 1998 that would have been recorded for these
loans was $82,000, $75,200, and $111,800. Interest income on these
non-performing loans included in income for fiscal 2000, 1999, and 1998,
amounted to $24,000, $26,100, and $57,560, respectively.
Allowances for Losses on Loans and Classified Assets. The allowance for
loan losses is maintained at a level that management considers adequate to
provide for losses based upon an evaluation of known and inherent risks in the
loan portfolio. Management's evaluation is based upon, among other things,
delinquency trends, the volume of non-performing loans, prior loss experience of
the portfolio, current economic conditions and other relevant factors. Although
management believes it has used the best information available to it in making
such determinations, and that the present allowance for loan losses is adequate,
future adjustments to the allowance may be necessary, and net income may be
adversely affected if circumstances differ substantially from
14
the assumptions used in determining the level of the allowance. Management may
in the future further increase the level of its allowance for loan losses as a
percentage of total loans and non-performing loans in the event the level of
multi-family residential and commercial real estate loans (which generally are
considered to have a greater risk of loss than single-family residential
mortgage loans) as a percentage of its total loan portfolio continues to
increase. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for losses on
loans. Such agencies may require the Company to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination. The allowance is increased by the provision for loan
losses which is charged to operations. Loan losses, other than those incurred on
loans held for sale, are charged directly against the allowance and recoveries
on previously charged-off loans are generally added to the allowance. At June
30, 2000, the Bank's allowance for loan losses was $3.91 million or 1.18% of
total net loans receivable and 414.9% of total non-performing loans compared to
$3.65 million or 1.24% of net loans and 391.3% of total non-performing loans at
June 30, 1999.
The following table summarizes activity in the Company's allowance for
loan losses during the periods indicated.
As of June 30,
-------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------- --------------- ---------------- -------------- --------------
(Dollars in Thousands)
Allowance at beginning of period $ 3,651 $ 3,414 $ 2,855 $ 2,667 $ 2,449
Loans charged off against the allowance:
Residential real estate (8) (58) (12) (117) (101)
Construction and land -- -- (177) --
Commercial business (131) -- -- (1) (2)
Consumer (32) (119) (69) (82) (43)
------- ------- ------- ------- -------
Total charge-offs (171) (177) (81) (377) (146)
Recoveries:
Residential real estate -- -- 21 37 --
Construction and land -- -- -- 4 16
Commercial business 2 -- -- -- --
Consumer 6 24 13 1 8
------- ------- ------- ------- -------
Total recoveries 8 24 34 42 24
Net charge-offs (163) (153) (47) (335) (122)
Provision for loan losses
Charged to operating expenses 420 390 606 523 340
------- ------- ------- ------- -------
Allowance at year end $ 3,908 $ 3,651 $ 3,414 $ 2,855 $ 2,667
======= ======= ======= ======= =======
Ratio of net charge-offs to
average loans outstanding 0.05% 0.05% 0.02% 0.13% 0.05%
======= ======= ======= ======= =======
Ratio of allowance to period-end
net loans 1.18% 1.24% 1.23% 1.10% 1.18%
======= ======= ======= ======= =======
15
The following table presents information regarding the Company's total
allowance for losses on loans as well as the allocation of such amounts to the
various categories of the loan portfolio. (Dollars in Thousands)
At June 30,
-----------------------------------------------------------------------------------------------
2000 1999 1998 1997
--------------------- ------------------- -------------------- --------------------
% of % of % of % of
Loans Loans Loans Loans
to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ -----
Residential real estate loans $ 700 46.8% $ 638 51.1% $ 789 53.6% $ 778 58.7%
Commercial real estate loans 1,553 18.5% 1,415 17.9% 1,050 14.1% 871 12.5%
Construction and land loans 241 11.8% 194 9.5% 201 10.5% 139 8.5%
Commercial business loans 632 5.4% 726 4.8% 357 3.9% 278 2.9%
Consumer loans 782 17.5% 678 16.7% 1,017 17.9% 789 17.4%
------- ----- ------- ----- ------- ----- ------- -----
Total allowance for loan losses $ 3,908 100.0% $ 3,651 100.0% $ 3,414 100.0% $ 2,855 100.0%
======= ===== ======= ===== ======= ===== ======= =====
Total allowance for loan losses
to total non-performing loans 414.9% 391.3% 274.0% 381.7%
===== ===== ===== =====
Total non-performing loans $ 942 $ 933 $ 1,246 $ 748
====== ====== ======= ======
At June 30,
-------------------
1996
-------------------
% of
Loans
to Total
Amount Loans
------ -----
Residential real estate loans $ 898 63.1%
Commercial real estate loans 585 9.6%
Construction and land loans 280 7.2%
Commercial business loans 207 2.4%
Consumer loans 697 17.7%
-------- ----------
Total allowance for loan losses $ 2,667 100.0%
======== =========
Total allowance for loan losses
to total non-performing loans 120.2%
========
Total non-performing loans $ 2,218
========
16
The Company monitors the quality of its assets on a regular
basis. Under regulations of the OTS, all of the Company's assets are subject to
being classified under a classification system that has three categories: (i)
substandard, (ii) doubtful and (iii) loss. An asset may fall within more than
one category and a portion of the asset may remain unclassified. The Company is
required to review the classification of its assets on a regular basis. In
addition, in connection with the examinations of First Financial by the OTS, the
FDIC, and the Department, the examiners have the authority to identify problem
assets and, if appropriate, classify them and/or require adjustments to the
carrying value of such assets.
Assets classified substandard are considered inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. Assets so classified must have a well-defined
weakness or weaknesses. They are characterized by the distinct possibility that
the insured institution will sustain some loss if the deficiencies are not
corrected.
Assets classified doubtful are considered to have all the
weaknesses inherent in those classified substandard with the added
characteristic that the weaknesses make collection or liquidation in full, on
the basis of currently existing facts, conditions, and values, highly
questionable and improbable.
Assets classified loss are considered uncollectable and of such
little value that their continuance as assets without establishment of a
specific reserve is not warranted. This classification does not mean that an
asset has absolutely no recovery or salvage value, but rather, that it is not
practical or desirable to defer writing off a basically worthless asset even
though partial recovery may be affected in the future.
At June 30, 2000 and 1999, the Company's classified assets, which
consisted of assets classified as substandard or doubtful, totaled $1.59 million
and $1.24 million, respectively. The Company did not have any REO at June 30,
2000 and 1999. Included in the assets classified substandard at June 30, 2000
and 1999, were all loans 90 days past due and loans which are less than 90 days
delinquent but inadequately protected by the current paying capacity of the
borrower or of the collateral pledged, and have a well-defined weakness that may
jeopardize the liquidation of the debt. The majority of loans which are
classified but otherwise performing are residential mortgage loans.
The loans designated as special mention by the Company amounted
to $102,300 and $0 at June 30, 2000 and 1999, respectively. The Company also
includes in the special mention category an investment with a balance of $4.37
million to an extended term healthcare provider which was performing but had
characteristics which warranted management to classify it special mention.
Although special mention assets are not considered or classified as substandard,
doubtful or loss, they do have a potential weakness which may, if not corrected,
result in increased risk of loss at some future date.
17
Securities Activities
Historically, interest and dividends on securities have provided the
Company with a significant source of revenue. At June 30, 2000, the Company's
securities portfolio and interest-bearing deposits aggregated $153.29 million or
30.2% of its total assets. First Financial's securities and interest-bearing
deposits are used to meet certain federal liquidity ratios. The liquidity ratios
are met in part by investing in securities that qualify as liquid assets under
OTS regulations. (See "Regulation - Regulation of the Bank - Liquidity
Requirements"). Such securities include obligations issued or fully guaranteed
by the United States Government, certain federal agency obligations, certain
time deposits and negotiable certificates of deposit issued by commercial banks
and other specified investments, including commercial paper and other
securities. Investment decisions are made by members of senior management within
guidelines approved by the Company's Board of Directors.
The Company divides its securities portfolio into three segments: (a)
held to maturity; (b) available for sale; and (c) trading. Securities in the
held to maturity category are accounted for at amortized cost. Trading
securities are accounted for at quoted market prices with changes in market
values being recorded as gain or loss in the income statement. All other
securities are included in the available for sale category and are accounted for
at fair value with unrealized gains or losses, net of taxes, being reflected as
adjustments to equity. At June 30, 2000, the Company had a net unrealized loss
on securities available for sale, net of taxes, of $3.26 million.
18
The following table sets forth the Company's securities portfolio and
interest-earning deposits at carrying value at the dates indicated.
At June 30,
-------------------------------------------------------------------------
2000 1999 1998
---------------------- ------------------ --------------------
(In Thousands)
Interest-bearing deposits $ 8,164 $ 13,409 $ 11,861
Trading account securities 12,838 9,221 20,352
Investment securities held to maturity:
U.S. Government and agency obligations 25,110 -- 4,500
Municipal notes and bonds (1) 8,332 3,229 7,394
Mortgage-backed securities 640 791 1,123
Other 5,739 3,781 2,583
---------------------- ------------------ --------------------
Total investment securities held to
maturity 39,821 7,801 15,600
---------------------- ------------------ --------------------
Investment securities available for sale:
U.S. Government and agency obligations 26,639 47,242 12,296
Municipal notes and bonds (1) 34,160 27,378 15,173
Mortgage-backed securities 13,804 15,817 9,431
Equity securities 858 1,336 1,096
Debt securities 14,798 15,430 307
Other 2,209 2,397 --
---------------------- ------------------ --------------------
Total investment securities available for
sale 92,468 109,600 38,303
---------------------- ------------------ --------------------
Total securities and interest-bearing
deposits $ 153,291 $ 140,031 $ 86,116
====================== ================== ====================
(1) The income from municipal notes and bonds are generally non-taxable for
federal and state purposes.
The contractual maturity or repricing characteristics of the Company's
investment portfolio is considerably more interest rate sensitive than that of
its loan portfolio. Consequently, the investment portfolio provides a
significant source of liquidity and protection against interest rate risk. The
weighted average term to maturity or repricing of the Company's investment
securities held to maturity was 4.8 years at June 30, 2000 and 3.1 years at June
30, 1999.
19
The amortized cost and estimated fair value of investment securities at June 30,
2000, by contractual maturity, are shown below.
Estimated Weighted
Amortized Fair Average
Cost Value Yield
---------------- --------------- ---------------
(Dollars in Thousands)
Held to Maturity
Due in one year or less $ 210 $ 209 4.97%
Due after one year through five years 17,216 17,008 6.37%
Due after five years through ten years 9,130 8,696 6.96%
Due after ten years 7,526 7,367 6.87%
No stated maturity 5,739 5,740 0.00%
---------------- --------------- ---------------
Total held to maturity $ 39,821 $ 39,020 5.65%
================ =============== ===============
Available for Sale
Due in one year or less $ -- $ -- 0.00%
Due after one year through five years 23,058 22,567 6.09%
Due after five years through ten years 14,964 14,341 6.08%
Due after ten years 58,294 54,703 6.75%
No stated maturity 1,453 857 0.00%
--------------- -------------- --------------
Total available for sale $ 97,769 $ 92,468 6.42%
================ =============== ===============
The weighted average yield, based on amortized cost, is presented on a
taxable equivalent basis.
As of June 30, 2000, investments in the debt and/or equity securities
of any one issuer (excluding U.S. Government and federal agencies) did not
exceed 10% of the Company's stockholders' equity.
Sources of Funds
General. Deposits obtained through branch offices have traditionally
been the principal source of the Company's funds for use in lending and for
other general business purposes. The Company also derives funds from
amortization and prepayments of outstanding loans and sales of loans. From time
to time, the Company also may borrow funds from the FHLBP and other sources.
Borrowings may be used on a short-term basis to compensate for seasonal or other
reductions in deposits or other inflows at less than projected levels, as well
as on a longer term basis to support expanded lending and investment activities.
Deposits. The Company obtains deposits primarily from residents of
Chester County, and to a lesser extent Berks, Delaware, Lancaster and Montgomery
Counties, Pennsylvania. Currently, the principal methods used by First Financial
to attract deposit accounts include the offering of services and accounts,
competitive interest rates, and convenient office locations and service hours.
Other than during times of inverse or flat yield curves the Bank has adopted a
pricing program for its certificate accounts which provides for higher rates of
interest on its longer term certificates in order to encourage depositors to
20
invest in certificates with longer maturities, thus reducing the interest rate
sensitivity of the Company's deposit portfolio. First Financial also offers a
tiered money market account that pays higher interest on higher balances so as
to maintain a relatively stable core of deposits even when its certificate
accounts mature.
Market conditions have caused First Financial to rely primarily on
short-term certificate accounts and other deposit alternatives that are more
responsive to market interest rates than passbook accounts and regulated
fixed-rate, fixed-term certificates that were historically the Company's primary
sources of deposits. First Financial's current deposit products include
non-interest-bearing accounts, passbook/statement savings accounts, NOW checking
accounts, money market deposit accounts, certificates of deposit ranging in
terms from 30 days to five years and certificates of deposit in denominations of
$100,000 or more ("jumbo certificates"). Included among these deposit products
are individual retirement account certificates ("IRA certificates") and Keogh
accounts.
The following table shows the balances of the Company's deposits as of
the dates indicated:
At June 30,
-----------------------------------------------------------------------------
2000 1999 1998
------------------------ ------------------------ ----------------------
(Dollars in Thousands)
% of % of % of
Amount Deposits Amount Deposits Amount Deposits
------ -------- ------ -------- ------ --------
Non-interest-bearing accounts $ 38,192 10.1% $ 33,007 9.2% $ 32,361 10.9%
NOW checking accounts 38,652 10.2% 36,012 10.0% 31,770 10.6%
Savings accounts 26,636 7.0% 29,033 8.1% 27,164 9.1%
Money market accounts 41,690 11.0% 47,464 13.2% 35,610 11.9%
Certificates of deposit less than
$100,000 126,910 33.6% 137,559 38.2% 133,801 44.9%
Certificates of deposit with
$100,000 minimum balance 106,398 28.1% 76,439 21.3% 37,485 12.6%
------------ ---------- ---------- ------------ ---------- ---------
Total deposits $ 378,478 100.0% $ 359,514 100.0% $ 298,191 100.0%
============ ========== ========== ============ ========== =========
21
The following table shows the weighted average interest rate of the Company's
deposits by type of account at June 30, 2000:
Weighted
Amount Avg. Rate
------------- ----------
(In Thousands)
Non-interest-bearing accounts $ 38,192 --%
NOW checking accounts 38,652 1.57%
Savings accounts 26,636 1.71%
Money market accounts 41,690 4.00%
Certificates of deposit less than
$100,000 126,910 5.60%
Certificates of deposit with
$100,000 minimum balance 106,398 5.72%
--------- -------
Total deposits $378,478 4.21%
========== =======
The following table sets forth the net deposit flows of the Company for the
periods indicated:
Year Ended June 30,
--------------------------------------
2000 1999 1998
---------- ----------- ----------
(In Thousands)
Increase before interest credited $ 5,089 $ 50,465 $ 27,568
Interest credited 13,875 10,857 9,873
---------- ----------- ----------
Net deposit increase $ 18,964 $ 61,322 $ 37,441
========== =========== ==========
The following table shows the balances of certificates of deposit with balances
of $100,000 or greater which mature during the periods indicated and the balance
at June 30, 2000.
Balances at June 30, 2000 Maturing
=======================================================
(In Thousands)
At Within Three Six to After
June 30, Three to Six Twelve Twelve
2000 Months Months Months Months
---------- ------------ -------- ---------- ---------
Certificates of deposit with $100,000
minimum balance $ 106,398 $ 19,138 $5,677 $ 19,357 $ 62,226
========== ============ ======== ========== =========
22
The following table presents the average balance by type of deposit and the
average rate paid by type of deposit for the periods indicated.
Year Ended June 30,
---------------------------------------------------------------------------------------------
2000 1999 1998
--------------------------- -------------------------- -----------------------------
(Dollars in Thousands)
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
------- ---- ------- ---- ------- ----
NOW checking accounts $ 37,667 1.57% $ 33,278 1.48% $ 29,328 1.81%
Savings accounts 27,017 1.74% 31,392 1.81% 25,991 2.67%
Money market accounts 43,178 3.99% 43,147 3.65% 29,847 3.57%
Certificates of deposit
less than $100,000 130,335 5.35% 149,713 5.55% 126,286 5.90%
Certificates of deposit with 5.17%
$100,000 minimum balance 75,845 5.23% 52,917 35,725 4.94%
The greater variety of deposit accounts offered by First Financial has
increased its ability to retain deposits and has allowed it to be more
competitive in obtaining new funds, although the threat of disintermediation
(the flow of funds away from savings institutions into direct investment
vehicles such as government and corporate securities) still exists. However,
these types of accounts have been and continue to be more costly than
traditional accounts during periods of high interest rates. In addition, First
Financial has become much more susceptible to short-term fluctuations in deposit
flows, as customers have become more rate conscious and willing to move funds
into higher-yielding accounts. Thus, both the ability of First Financial to
attract and maintain deposits as well as its cost of funds have been, and will
continue to be, affected significantly by economic market conditions.
In an effort to attract increasing amounts of non-interest-bearing
deposits, First Financial offers a basic checking account which features no-fee
checking with a minimum balance of $50.
First Financial also offers a business checking account which grants
credits against service charges based on the average daily balance. It is
management's belief that such accounts represent an excellent source of deposits
that are not affected by interest rates.
First Financial attempts to control the flow of deposits by pricing its
accounts to remain generally competitive with other financial institutions in
its primary market area, but does not necessarily seek to match the highest
rates paid by competing institutions.
First Financial's deposits are obtained primarily from persons who are
residents of Pennsylvania. First Financial does not advertise for deposits
outside of Pennsylvania or accept brokered deposits, and management believes
that at June 30, 2000 an insignificant amount of First Financial's deposits were
held by non-residents of Pennsylvania.
23
Borrowings. First Financial may obtain advances from the FHLBP upon the
security of the common stock it owns in that bank and certain of its residential
mortgage loans, provided certain standards related to credit worthiness have
been met. See "Regulation - Regulation of the Bank - Federal Home Loan Bank
System." Such advances are made pursuant to several different credit programs,
each of which has its own interest rate and range of maturities. FHLBP advances
are generally available to meet seasonal and other withdrawals of deposit
accounts and to expand lending and investment activities, as well as to aid the
efforts of members to establish better asset and liability management through
the extension of maturities of liabilities. At June 30, 2000, the Company had
$86.78 million in FHLBP advances outstanding. In addition to its ability to
obtain advances from the FHLBP under several different credit programs, the
Company has established a line of credit with the FHLBP, in an amount not to
exceed 10% of the Company's maximum borrowing capacity, which credit line is
$15.45 million, and is subject to certain conditions, including the holding of a
predetermined amount of FHLBP stock as collateral. At June 30, 2000, there was
no balance outstanding on the line of credit.
The following table presents certain information regarding short-term
borrowings (borrowings with a maturity of one year or less) for the periods
indicated:
Year Ended June 30,
-------------------------------------------------------
2000 1999 1998
--------------- -------------- ------------
(Dollars in Thousands)
Short-term borrowings:
Balance outstanding at end
of period $ 46,948 $16,731 $17,601
Weighted average interest rate
at end of period 6.61% 5.43% 5.28%
Average balance outstanding $ 55,753 $18,596 $16,417
Maximum amount outstanding
at any month-end during
the period $79,059 $35,320 $25,323
Weighted average interest rate
during the period 5.96% 5.51% 5.58%
Yields Earned and Rates Paid
The largest components of the Company's total income and total expense
are interest income and interest expense. As a result, the Company's earnings
are dependent primarily upon net interest income, which is determined by the
Company's net interest rate spread (i.e., the difference between the yields
earned on interest-earning assets and the rates paid on interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities.
24
Interest Income and Interest Spread Analysis
The following table sets forth, for the periods indicated,
information regarding (i) the total dollar amount of interest income of the
Company from interest-earning assets and the resultant average yields; (ii) the
total dollar amount of interest expense on interest-bearing liabilities and the
resultant average cost; (iii) net interest income; (iv) interest rate spread;
and (v) net interest-earning assets and their net yield. Average balances are
determined on a monthly basis which is representative of operations.
-----------------------------------------------------------------------------------
2000 1999
--------------------------------------- ---------------------------------------
(Dollars in Thousands)
Average Yield/ Average Yield/
Balance(1) Interest(2) Rate(2) Balance(1) Interest(2) Rate(2)
----------- ----------- ------- ---------- ----------- -------
Assets:
Loans and loans held for sale $313,378 $24,689 7.88% $280,544 $22,875 8.15%
Securities and
other investments 145,687 10,298 7.07% 113,110 7,137 6.31%
----------- ------------ ----------- ------------
Total interest-
earning assets 459,065 34,987 7.62% 393,654 30,012 7.62%
------------ ----------- ------------
-
----------- -----------
Total assets $ 482,342 $411,746
=========== ===========
Liabilities and Stockholders' Equity:
Deposits and repurchase agreements $315,962 $13,700 4.34% $287,627 12,711 4.42%
FHLB advances and
other borrowings 90,184 5,275 5.85% 53,595 2,971 5.54%
----------- ------------ ----------- ------------
Total interest-
bearing liabilities $406,146 $18,975 4.67% 341,222 $15,682 4.60%
Non-interest-bearing liabilities 42,033 36,962
Stockholders' equity 34,163 33,562
----------- -----------
Total liabilities and stockholders' equity $482,342 $411,746
=========== ===========
Net interest income/interest rate spread $16,012 2.95% $14,330 3.03%
============ ============
=========== =========
Net interest-earning assets/net yield on
interest-earning assets $52,919 3.49% $52,432 3.64%
=========== =========== =========== =========
Ratio of average interest-earning assets to
interest-bearing liabilities 113% 115%
======= =======
Year Ended June 30,
----------------------------------------------------------
1998
----------------------------------------------------------
Average Yield/
Balance(1) Interest(2) Rate(2)
---------- ----------- -------
Assets:
Loans and loans held for sale $264,106 $22,298 8.44%
Securities and
other investments 60,777 3,906 6.43%
------------ -----------------
Total interest-
earning assets 324,883 26,204 8.07%
-----
Non-interest earning assets 15,141
------------
Total assets $340,024
============
Liabilities and Stockholders' Equity:
Deposits and repurchase agreements $247,903 $11,476 4.63%
FHLB advances and
other borrowings 31,813 1,933 6.08%
------------ -----------------
Total interest-
bearing liabilities 279,716 $13,409 4.79%
Non-interest-bearing liabilities 30,167
Stockholders' equity 30,141
------------
Total liabilities and stockholders' equity $340,024
============
Net interest income/interest rate spread $12,795 3.28%
================= =============
Net interest-earning assets/net yield on
interest-earning assets $45,167 3.94%
============ =============
Ratio of average interest-earning assets to
interest-bearing liabilities 116%
=============
(1) Non-accruing loans are included in the average balance.
(2) The indicated interest and annual yield and rate are presented on a
taxable equivalent basis using the Federal marginal income tax rate of 34%
adjusted for the 20% interest expense disallowance (27.2%) for 2000, 1999,
and 1998.
25
Rate/Volume Analysis
The following table presents certain information regarding
changes in interest income and interest expense of the Company for the periods
indicated. Interest income and the annual rate are calculated on a taxable
equivalent basis using the Federal marginal income tax rate of 34% adjusted for
the 20% interest expense disallowance (27.2%). For each category of
interest-earning assets and interest-bearing liabilities, information is
provided with respect to changes attributable to (1) changes in volume (change
in volume multiplied by old rate), (2) changes in rate (change in rate
multiplied by old volume) and (3) changes in rate/volume (change in rate
multiplied by change in volume). The changes in rate/volume (3) is allocated to
the change in volume variance and the change in the rate variance on a pro rated
basis for fiscal 2000.
2000 Compared to 1999 1999 Compared to 1998
Increase (Decrease) Due to Increase (Decrease) Due to
----------------------------------------- ---------------------------------------------
Volume Rate Total Volume Rate Total
------------ ----------- -------------- ------------ ------------ ------------
(In Thousands)
Interest income on interest-
earning assets:
Loans and loans
held for sale $2,594 $(780) $1,814 $1,359 $(782) $ 577
Securities and
other investments 2,230 931 3,161 3,305 (74) 3,231
------ ----- ------ ------ ----- ------
Total interest income 4,824 151 4,975 4,664 (856) 3,808
------ ----- ------ ------ ----- ------
Interest expense on interest-
bearing liabilities:
Deposits and repurchase
agreements 1,225 (236) 989 1,775 (540) 1,235
FHLB advances and other
borrowings 2,129 175 2,304 1,223 (185) 1,038
------ ----- ------ ------ ----- ------
Total interest expense 3,354 (61) 3,293 2,998 (725) 2,273
------ ----- ------ ------ ----- ------
Net change in net interest
Income $1,470 $ 212 $1,682 $1,666 ($131) $1,535
====== ===== ====== ====== ===== ======
26
Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. The Company's market risk arises primarily from the interest rate
risk inherent in its lending and deposit taking activities. To that end,
management actively monitors and manages its interest rate risk exposure.
The Company's profitability is affected by fluctuations in interest
rates. A sudden and substantial change in interest rates may adversely impact
the Company's earnings to the extent that the yields on interest-sensitive
assets and interest-sensitive liabilities do not change at the same speed, to
the same extent, or on the same basis. The Company monitors the impact of
changes in interest rates between assets and liabilities as discussed in the
Company's Interest Rate Sensitivity Analysis under the Asset/Liability
Management caption in the Company's Annual Report to Shareholders for Fiscal
2000 (see Exhibit 13 hereto). Although interest rate sensitivity gap analysis is
a useful measurement tool and contributes towards effective asset liability
management, it is difficult to predict the effect of changing interest rates
based solely on that measure. An alternative methodology is to estimate the
impact on net interest income and on net portfolio value of an immediate change
in interest rates in 100 basis point increments. Net portfolio value ("NPV") is
defined as the net present value of assets, liabilities, and off-balance sheet
contracts. The chart below is the estimated effect of immediate changes in
interest rates at the specified levels at June 30, 2000 and 1999, calculated in
compliance with Thrift Bulletin No. 13A:
Year Ended June 30, 2000
-------------------------------------------------------------------------------------------------------------------
Change in Interest Estimated Net Market Value
Rates in Basis Points of Portfolio Equity NPV as % of PV of Average Assets
--------------------- ------------------- --------------------------------
(Rate Shock) Amount $ Change % Change NPV Ratio Change
------------ ------ -------- -------- --------- ------
(Dollars in Thousands)
300 $ 11,239 $ (27,997) -71% 2.42% (535)
200 20,147 (19,089) -49% 4.22% (355)
100 30,107 (9,658) -25% 6.02% (175)
Static 39,236 -- -- 7.77% --
(100) 48,425 9,189 23% 9.34% 157
(200) 56,015 16,779 43% 10.55% 278
(300) 69,669 30,433 78% 12.67% 490
Year Ended June 30, 1999
-------------------------------------------------------------------------------------------------------------------
Change in Interest Estimated Net Market Value
Rates in Basis Points of Portfolio Equity NPV as % of PV of Average Assets
--------------------- ------------------- --------------------------------
(Rate Shock) Amount $ Change % Change NPV Ratio Change
------------ ------ -------- -------- --------- ------
(Dollars in Thousands)
300 $ 11,975 $ (27,443) -70% 2.86% (580)
200 20,823 (18,595) -47% 4.83% (382)
100 29,578 (9,331) -24% 6.80% (186)
Static 39,418 -- -- 8.66% --
(100) 48,191 8,773 22% 10.31% 166
(200) 56,700 17,282 44% 11.83% 318
(300) 66,518 27,100 69% 13.51% 485
27
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV require the making of
certain assumptions which may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. In this regard,
the NPV table presented above assumes that the composition of the Company's
interest sensitive assets and liabilities existing at the beginning of a period
remains constant over the period being measured and also assumes that a
particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the NPV table provides an indication of the
Company's interest rate risk exposure at a particular point in time, such
measurements are not intended to and do not provide a precise forecast of the
effect of changes in market interest rates on the Company's net interest income
and will differ from actual results.
The Company's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset/liability
structure to obtain the maximum yield/cost spread on that structure. The Company
relies primarily on its asset/liability structure to control interest rate risk.
The Company continually evaluates interest rate risk management
opportunities, including the use of derivative financial instruments. Management
believes that hedging instruments currently available are not cost-effective
and, therefore, has focused its efforts on increasing the Company's yield/cost
spread through wholesale and retail opportunities.
Ratios
The following table shows certain income and financial condition ratios
for the periods indicated. All averages are based on month-end balances.
Year Ended June 30,
---------- ------------ ------------
2000 1999 1998
---------- ------------ ------------
Return on average assets
(income divided by average
total assets) 0.94% 1.02% 1.07%
Return on average equity
(income divided by average equity) 13.34% 12.55% 12.03%
Equity-to-assets ratio
(average equity divided by
average assets) 7.08% 8.15% 8.86%
Dividend pay-out ratio 30.35% 27.39% 33.90%
28
Subsidiaries of First Financial
At June 30, 2000, the Bank was permitted by regulations to invest up to
2% of assets in the capital stock of, and secured and unsecured loans to,
subsidiary corporations or service corporations and under certain circumstances
may make conforming loans to service corporations in greater amounts. As a
Pennsylvania-chartered savings institution, the Bank may diversify into any
business activity approved in advance by the Department. In addition, First
Financial could invest up to 30% of its assets in finance subsidiaries. Such
subsidiaries must be limited purpose subsidiaries whose sole purpose is to issue
debt or equity securities that the parent association is authorized to issue
directly and to remit the proceeds of such issuance to the parent association.
The Bank operates (as a wholly owned subsidiary) D & S Service
Corporation ("D & S Service"), which has participated in the development for
sale of residential properties, in particular condominium conversions and also
the development of commercial properties in order for the Bank to expand its
facilities to accommodate its growth. All of such projects have either been
located in or within close proximity to the Bank's primary market area. D & S
Service operates two wholly owned subsidiaries: Wildman Projects and D & F
Projects, Inc.
At June 30, 2000, the Bank was authorized to have a maximum investment
of $10.08 million in its one first-tier wholly-owned subsidiary, D & S Service.
As of such date, the Bank had invested $1.01 million in this subsidiary.
Acquisition
On May 29, 1998, the Company acquired PCIS, a full service investment
advisory and securities brokerage firm. The transaction was accounted for as a
pooling of interests and the shareholders of PCIS received 23.4239 shares of
Holding Company common stock for each share of PCIS stock. Approximately 134,000
shares of Holding Company common stock were issued in the exchange.
Competition
First Financial encounters strong competition both in the attraction of
deposits and in the making of real estate and other loans. Its most direct
competition for deposits has historically come from commercial banks, other
savings and loan associations, savings banks and credit unions conducting
business in its primary market area. The Bank also encounters competition for
deposits from money market and other mutual funds, as well as corporate and
government securities and insurance companies. The principal methods used by the
Bank to attract deposit accounts include offering a variety of services and
interest rates and providing convenient office locations and expanded banking
hours. The Bank's competition for real estate and other loans comes principally
from other savings institutions, credit unions, commercial banks, mortgage
banking companies, insurance companies, and other institutional lenders. First
Financial competes for loans through interest rates, loan maturities, loan fees
and the quality of service extended to borrowers and real estate brokers.
29
Employees
The Company had 123 full-time employees and 29 part-time employees as
of June 30, 2000. None of these employees are represented by a collective
bargaining agent and the Company believes that it enjoys good relations with its
personnel.
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of the Company and the Bank in effect as of the
date of this Form 10-K. The description of these laws and regulations, as well
as descriptions of laws and regulations contained elsewhere herein, does not
purport to be complete and is qualified in its entirety by reference to
applicable laws and regulations.
Regulation of the Company
Federal Regulation-General. The Company is a registered savings and
loan holding company within the meaning of the Home Owners' Loan Act. As such,
the Company is subject to OTS regulations, examinations, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.
The Holding Company operates as a unitary savings and loan holding
company. Generally, there are only limited restrictions on the activities of a
unitary savings and loan holding company which applied to become or was a
unitary savings and loan holding company prior to May 4, 1999 (which the Holding
Company was) and its non-savings institution subsidiaries. Under the enacted
Gramm-Leach-Bliley Act of 1999 (the "GBLA"), companies which applied to the OTS
subsequent to such date to become unitary savings and loan holding companies
will be restricted to engaging in those activities traditionally permitted to
multiple savings and loan holding companies. If the Director of the OTS
determines that there is reasonable cause to believe that the continuation by a
savings and loan holding company of an activity constitutes a serious risk to
the financial safety, soundness or stability of its subsidiary savings
institution, the Director may impose such restrictions as deemed necessary to
address such risk, including limiting (i) payment of dividends by the savings
institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of grandfathered unitary savings and
loan holding companies under the GBLA, if the savings institution subsidiary of
such a holding company fails to meet the QTL test, as discussed under " -
Regulation of the Bank - Qualified Thrift Lender Test," then such unitary
holding company also shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings institution requalifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company. See "- regulation of the Bank - Qualified Thrift Lender Test."
30
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings associations) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings association shall commence
or continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof any business activity, upon prior
notice to, and no objection by the OTS, other than: (i) furnishing or performing
management services for a subsidiary savings association; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing or liquidating
assets owned by or acquired from a subsidiary savings association; (iv) holding
or managing properties used or occupied by a subsidiary savings association; (v)
acting as trustee under deeds of trust; (vi) those activities authorized by
regulation as of March 5, 1987 to be engaged in by multiple savings and loan
holding companies; or (vii) unless the Director of the OTS by regulation
prohibits or limits such activities for savings and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies. Those activities described in (vii) above also must be
approved by the Director of the OTS prior to being engaged in by a multiple
savings and loan holding company.
Federal Limitations on Transactions with Affiliates. Transactions
between savings associations and any affiliate are governed by Sections 23A and
23B of the Federal Reserve Act. An affiliate of a savings association is any
company or entity which controls, is controlled by or is under common control
with the savings association. As a result, the Company and PCIS are affiliates
of the Bank. Generally, Sections 23A and 23B (i) limit the extent to which the
savings association or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such association's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the association or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.
31
In addition, Sections 22(g) and (h) of the Federal Reserve Act places
restrictions on loans by savings associations to executive officers, directors
and principal stockholders of the Company and the Bank. Under Section 22(h),
loans to a director, an executive officer and to a greater than 10% stockholder
of a savings association or the company that controls the savings association,
and certain affiliated interests of such insiders (i) may not exceed, together
with all other outstanding loans to such person and affiliated interests, the
association's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus) (ii) must be made on terms
substantially the same as offered in comparable transactions to other persons,
provided the Bank is not prohibited from extending credit pursuant to a benefit
or compensation program widely available to employees of the Bank and the
Company and that does not give preference to any officer, director or principal
stockholder over other employees thereof, and (iii) may in certain cases,
require prior board approval. In addition, the aggregate amount of extensions of
credit by a savings association to all insiders cannot exceed the association's
unimpaired capital and surplus. Furthermore, Section 22(g) places certain
additional restrictions on loans to executive officers. At June 30, 2000, the
Bank was in compliance with the above restrictions.
Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (i) control of any other savings
association or savings and loan holding company or substantially all the assets
thereof or (ii) more than 5% of the voting shares of a savings association or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
association, other than a subsidiary savings association, or of any other
savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state if (i) the multiple savings and loan holding
company involved controls a savings association which operated a home or branch
office located in the state of the association to be acquired as of March 5,
1987, (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA)", or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by the state-chartered associations or savings and loan holding
companies located in the state where the acquiring entity is located (or by a
holding company that controls such state-chartered savings associations).
Regulation of PCIS
General. In the United States, a number of federal regulatory agencies
are charged with safeguarding the integrity of the securities and other
financial markets and with protecting the interest of customers participating in
those markets. The SEC is the federal agency that is primarily responsible for
the regulation of broker-dealers and investment advisers doing business in the
United States, and the Federal Reserve Board promulgates regulations applicable
to securities credit transactions involving broker-dealers and certain other
institutions in the Unites States. Much of the regulation of broker-dealers,
32
however, has been delegated to self-regulatory organizations ("SROs"),
principally the National Association of Securities Dealers, Inc. ("NASD") (and
its subsidiaries NASD Regulation, Inc. and the Nasdaq Stock Market), and the
national securities exchanges. These SROs and exchanges adopt rules (which are
subject to approval by the SEC) that govern the industry, monitor daily activity
and conduct periodic examinations of member broker-dealers. While PCIS is not a
member of the New York Stock Exchange (the "NYSE"), PCIS' business is impacted
by the NYSE rules.
Securities firms are also subject to regulation by state securities
commissions in the states in which they are required to be registered. PCIS is
registered as a broker-dealer with the SEC and in all 50 states and in the
District of Columbia, and is a member of, and subject to regulation by, a number
of SROs, including the NASD.
As a result of federal and state registration and SRO memberships, PCIS
is subject to overlapping schemes of regulation which cover all aspects of its
securities business. Such regulations cover matters including capital
requirements, uses and safe-keeping of clients' funds, conduct of directors,
officers and employees, record-keeping and reporting requirements, supervisory
and organizational procedures intended to assure compliance with securities laws
and to prevent improper trading on material nonpublic information,
employee-related matters, including qualification and licensing of supervisory
and sales personnel, limitations on extensions of credit in securities
transactions, clearance and settlement procedures, requirements for the
registration, underwriting, sale and distribution of securities, and rules of
the SROs designed to promote high standards of commercial honor and just and
equitable principles of trade. A particular focus of the applicable regulations
concerns the relationship between broker-dealers and their customers. As a
result, the many aspects of the broker-dealer customer relationship are subject
to regulation including, in some instances, "suitability" determinations as to
certain customer transactions, limitations on the amounts that may be charged to
customers, timing of proprietary trading in relation to customers' trades and
disclosures to customers.
PCIS also is subject to "Risk Assessment Rules" imposed by the SEC
which require, among other things, that certain broker-dealers maintain and
preserve certain information, describe risk management policies and procedures
and report on the financial condition of certain affiliates whose financial and
securities activities are reasonably likely to have a material impact on the
financial and operational condition of the broker-dealers. Certain "Material
Associated Persons" (as defined in the Risk Assessment Rules) of the
broker-dealers and the activities conducted by such Material Associated Persons
may also be subject to regulation by the SEC.
PCIS is registered as an investment adviser with the SEC. As an
investment adviser registered with the SEC, it is subject to the requirements of
the Investment Advisers Act of 1940 and the SEC's regulations thereunder, as
well as certain state securities laws and regulations. Such requirements relate
to, among other things, limitations on the ability of an investment adviser to
charge performance-based or non-refundable fees to clients, record-keeping and
reporting requirements, disclosure requirements, limitations on principal
transactions between an adviser or its affiliates and advisory clients, as well
as general anti-fraud prohibitions. The state securities law requirements
33
applicable to registered investment advisers are in certain cases more
comprehensive than those imposed under the federal securities laws.
In the event of non-compliance with an applicable regulation,
governmental regulators and the NASD may institute administrative or judicial
proceedings that may result in censure, fine, civil penalties (including treble
damages in the case of insider trading violations), the issuance of
cease-and-desist orders, the deregistration or suspension of the non-compliant
broker-dealer or investment adviser, the suspension or disqualification of the
broker-dealer's officers or employees or other adverse consequences. The
imposition of any such penalties or orders on PCIS could have a material adverse
effect on PCIS' (and thus the Company's) operating results and financial
condition.
Additional legislation and regulations, including those relating to the
activities of broker-dealers and investment advisers, changes in rules
promulgated by the SEC or other United States foreign governmetal regulatory
authorities and SROs or changes in the interpretation or enforcement of existing
laws and rules may adversely affect PCIS' manner of operation and profitability.
Its business may be materially affected not only by regulations applicable to it
as a financial market intermediary, but also by regulations of general
application. For example, the volume of PCIS' securities trading and asset
management activities in any year could be affected by, among other things,
existing and proposed tax legislation, antitrust policy and other governmental
regulations and policies (including the interest rate policies of the Federal
Reserve Board) and changes in interpretation or enforcement of existing laws and
rules that affect the business and financial communities.
Net Capital Requirements. As a broker-dealer registered with the SEC
and as a member firm of the NASD, PCIS is subject to the capital requirements of
the SEC and the NASD. These capital requirements specify minimum levels of
capital, computed in accordance with regulatory requirements, that PCIS is
required to maintain and also limit the amount of leverage that each firm is
able to obtain in its respective business.
"Net capital" is essentially defined as net worth (assets minus
liabilities, as determined under generally accepted accounting principles), plus
qualifying subordinated borrowings, less the value of all of a broker-dealer's
assets that are not readily convertible into cash (such as goodwill, furniture,
prepaid expenses and unsecured receivable), and further reduced by certain
percentages (commonly called "haircuts") of the market value of a
broker-dealer's positions in securities and other financial instruments.
Compliance with regulatory net capital requirements could limit those operations
that require the intensive use of capital, such as underwriting and trading
activities.
The SEC's capital rules also (i) require that broker-dealers notify it,
in writing, two business days prior to making withdrawals or other distributions
of equity capital or lending money to certain related persons if those
withdrawals would exceed, in any 30-day period, 30% of the broker-dealer's
excess net capital, and that they provide such notice within two business days
after any such withdrawal or loan that would exceed, in any 30-day period, 20%
of the broker-dealer's excess net capital, (ii) prohibit a broker-dealer from
withdrawing or otherwise distributing equity capital or making related party
loans if after such distribution or loan, the broker-dealer has net capital of
less than $300,000 or if the aggregate indebtedness of the broker-dealer's
consolidated entities would exceed 1,000% of the broker-dealer's net capital and
in certain other circumstances, and (iii) provide that the SEC may, by order,
prohibit withdrawals of capital from a broker-dealer for a period of up to 20
business days, if the withdrawals would exceed, in any 30-day period, 30% of the
broker-dealer's excess net capital and if the SEC believes such withdrawals
would be detrimental to the financial integrity of the firm or would unduly
jeopardize the broker-dealer's ability to pay its customer claims or other
liabilities.
34
As of June 30, 2000, PCIS was required to maintain minimum net capital,
in accordance with SEC rules, of $250,000 and had total net capital of $954,400,
or $704,400 in excess of the minimum amount required. PCIS is required to
maintain a net capital ratio, in accordance with SEC rules, not to exceed 15 to
1. At June 30, 2000 PCIS' net capital ratio was .15 to 1.
A failure of a broker-dealer to maintain its minimum required net
capital or net capital ratio would require it to cease executing customer
transactions until it came back into compliance, and could cause it to lose its
NASD membership, its registration with the SEC or require its liquidation.
Further, the decline in a broker-dealer's net capital below certain "early
warning levels," even though above minimum net capital requirements, could cause
material adverse consequences to the broker-dealer.
PCIS is a member of the Securities Investor Protection Corporation
("SIPC") which is a non-profit corporation that was created by the United States
Congress under the Securities Protection Act of 1970. SIPC protects customers of
member broker-dealers against losses caused by the financial failure of the
broker-dealer but not against a change in the market value of securities in
customers' accounts at the broker-dealer. In the event of the inability of a
member broker-dealer to satisfy the claims of its customers in the event of its
failure, the SIPC's funds are available to satisfy the remaining claims up to
maximum of $500,000 per customer, including up to $100,000 on claims for cash.
In addition, PCIS' clearing broker carries private insurance which provides
similar coverage up to $25 million per customer.
Regulation of the Bank
General. The OTS has extensive authority over the operations of savings
associations. As part of this authority, savings associations are required to
file periodic reports with the OTS and are subject to periodic examinations by
the OTS and the FDIC. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations such as the Bank. Such regulation and supervision is
primarily intended for the protection of depositors.
The OTS's enforcement authority over all savings associations and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
Insurance of Accounts. The deposits of the Bank are insured up to
$100,000 per depositor (as defined by law and regulation) by the SAIF, which is
administered by the FDIC, and are backed by the full faith and credit of the
United States Government. As insurer, the FDIC is authorized to conduct
examinations of, and to require reporting by, FDIC-insured institutions, such as
the Bank. It also may prohibit any FDIC-insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious threat to
the FDIC. The FDIC also has the authority to initiate enforcement actions where
the OTS has failed or declined to take such action after receiving a request to
do so from the FDIC.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
35
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.
In October 1996, the FDIC imposed a one-time special assessment equal
to 65.7 basis points for all SAIF-assessable deposits as of March 31, 1995. The
Bank's one-time special assessment amounted to $832,000 net of related tax
benefits. The payment of the special assessment reduced the Bank's capital by
the amount of the assessment during fiscal 1997.
Following the imposition of the one-time special assessment, the FDIC
lowered assessment rates for SAIF members to reduce the disparity in the
assessment rates paid by Bank Insurance Fund ("BIF") and SAIF members. Beginning
October 1, 1996, effective SAIF rates range from zero basis points to 27 basis
points which is the same range of premiums as paid by insured institutions
insured by the BIF administered by the FDIC. From 1997 through 1999,
SAIF-insured institutions paid 6.4 basis points of their SAIF-assessable
deposits to fund the Financing Corporation. Beginning January 1, 2000, all
FDIC-insured institutions are assessed at the same rate of 2.1 basis points of
this SAIF and BIF assessable deposits to fund the financing corporations.
Regulatory Capital Requirements - General. Federally insured savings
associations are required to maintain minimum levels of regulatory capital.
These standards generally must be no less stringent than the capital
requirements applicable to national banks. The OTS also is authorized to impose
capital requirements in excess of these standards on individual associations on
a case-by-case basis.
Federally-insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets. For purposes of the regulation,
tangible capital is core capital less all intangibles other than qualifying
mortgage servicing rights, and any investment in non-permissible subsidiaries,
which are subsidiaries which are not engaged in permissible activities. Core
capital includes common stockholders' equity, non-cumulative perpetual preferred
stock and related surplus, minority interest in the equity accounts of fully
consolidated subsidiaries and certain non-withdrawable accounts and pledged
36
deposits. Core capital generally is reduced by the amount of a savings
association's intangible assets other than qualifying mortgage servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital, including subordinated debt which meets specified
requirements and general valuation loan and lease loss allowances up to a
maximum of 1.25% of risk-weighted assets. In determining the required amount of
risk-based capital, total assets, including certain off-balance sheet items, are
multiplied by a risk-weight based on the risk inherent in the type of assets.
The risk weights assigned by the OTS for principal categories of assets
currently range from 0% to 100%, depending on the type of asset.
OTS policy imposes a limitation on the amount of net deferred tax
assets under SFAS No. 109 that may be included in regulatory capital. (Net
deferred tax assets represent deferred tax assets, reduced by an valuation
allowances, in excess of deferred tax liabilities.) Application of the limit
depends on the possible sources of taxable income available to an institution to
realize deferred tax assets. Deferred tax assets that can be realized from the
following generally are not limited: taxes paid in prior carryback years and
future reversals of existing taxable temporary differences. To the extent that
the realization of deferred tax assets depends on an institution's future
taxable income (exclusive of reversing temporary differences and carryforwards),
or its tax-planning strategies, such deferred tax assets are limited for
regulatory capital purposes to the lesser of the amount that can be realized
within one year of the quarter-end report date or 10% of core capital. The
foregoing considerations did not affect the calculation of the Bank's regulatory
capital at June 30, 2000.
In August 1993, the OTS adopted a final rule incorporating an
inters-rate risk component into the risk-based capital regulation. Under the
rule, an institution with greater that "normal" interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating its risk-based capital. As a result, such an
institution will be required to maintain additional capital in order to comply
with the risk-based capital requirement. An institution has greater than
"normal" interest rate risk if it would suffer a loss of net portfolio value
exceeding 2.0% of the estimated market value of its assets in the event of a 200
basis point increase or decrease in interest rates. The interest rate risk
37
component will be calculated, on a quarterly basis, as one-half of the
difference between an institution's measured interest rate risk and 2.0%
multiplied by the market value of its assets. The rule also authorizes the OTS
to waive or defer an institution's interest rate risk component on a
case-by-case basis. The final rule was originally effective as of January 1,
1994, subject however to a two quarter "lag" time between the reporting date of
the data used to calculate an institution's interest rate risk and the effective
date of each quarter's interest rate risk component. However, in October 1994
the OTS indicated that it would waive the capital deductions for institutions
with greater than "normal" risk until the OTS published an appeals process. On
August 21, 1995, the OTS established (1) an appeals process to handle "requests
for adjustments" to the interest rate risk component and (2) a process by which
"well-capitalized" institutions may obtain authorization to use their own
interest rate risk model to determine their interest rate risk component.
However, due to continuing delays by the OTS, the interest rate risk component
has never been operative.
The following table sets forth a reconciliation between the Bank's
stockholder's equity and each of its three capital requirements at June 30,
2000.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- ----------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of June 30, 2000:
Total Capital
(to Risk Weighted Assets) $38,662 12.80% $24,104 8.00% $30,130 10.00%
Tier 1 Capital
(to Risk Weighted Assets) $34,894 11.58% $12,052 4.00% $18,078 6.00%
Tier 1 Capital
(to Average Assets) $34,894 6.88% $20,276 3.00% $25,345 5.00%
Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations and
the appointment of a conservator or receiver. The OTS' capital regulation
provides that such actions, through enforcement proceedings or otherwise, could
require one or more of a variety of corrective actions. See "- Prompt Corrective
Regulatory Action."
Liquidity Requirements. All savings associations are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required liquid
asset ratio is 4%. At June 30, 2000, the Bank's liquidity ratio was 15.24%.
Real Estate Lending Standards. Effective March 19, 1993, all financial
institutions were required to adopt and maintain comprehensive written real
38
estate lending policies that are consistent with safe and sound banking
practices. These lending policies must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies adopted by the federal banking
agencies, including the OTS, in December 1992 ("Guidelines"). The Guidelines set
forth, pursuant to the mandates of the Federal Deposit Insurance Corporation
Improvement Act ("FDICIA"), uniform regulations prescribing standards for real
estate lending which is defined as extension of credit secured by liens on
interests in real estate or made for the purpose of financing the construction
of a building or other improvements to real estate, regardless of whether a lien
has been taken on the property.
The policies must address certain lending considerations set forth in
the Guidelines, including loan-to-value ("LTV") limits, loan administration
procedures, underwriting standards, portfolio diversification standards, and
documentation, approval and reporting requirements. These policies must also be
appropriate to the size of the institution and the nature and scope of its
operations, and must be reviewed and approved by the institution's board of
directors at least annually. The Guidelines, among other things, establish the
following supervisory LTV limits: raw land (65%); land development (75%);
construction (commercial, multi-family and nonresidential) (80%); improved
property (85%) and one-to-four family residential (owner occupied) (no maximum
ratio, although any LTV ratio in excess of 90% should require appropriate
insurance or readily marketable collateral).
Certain institutions can make real estate loans that do not conform
with the established LTV ratio limits up to 100% of the institution's total
capital. Within this aggregate limit, total loans for all commercial,
agricultural, multi-family and other non-one-to-four family residential
properties should not exceed 30% of total capital. An institution will come
under increased supervisory scrutiny as the total of such loans approaches these
levels. Certain loans are exempt from the LTV ratios (e.g. those guaranteed by a
government agency, loans to facilitate the sale of REO, loans renewed,
refinanced or restructured by the original lender(s) to the same borrower(s)
where there is no advancement of new funds, etc.).
Accounting Requirements. Applicable OTS accounting and reporting
requirements incorporates the following standards: (i) regulatory reports will
incorporate generally accepted accounting principles ("GAAP") when GAAP is used
by federal banking agencies; (ii) savings association transactions, financial
condition and regulatory capital must be reported and disclosed in accordance
with OTS regulatory reporting requirements that will be at least as stringent as
for national banks; and (iii) the director of the OTS may prescribe regulatory
reporting requirements more stringent than GAAP whenever the director determines
that such requirements are necessary to ensure the safe and sound reporting and
operation of savings association.
Prompt Corrective Regulatory Action. Under Section 38 of the FDIA, as
added by Federal Deposit Insurance Corporation Insurance Act ("FDICIA"), each
appropriate agency and the FDIC is required to take prompt corrective action to
resolve the problems of insured depository institutions that do not meet minimum
capital ratios. Such action must be accomplished at the least possible long-term
cost to the appropriate deposit insurance fund.
39
The federal banking agencies, including the OTS, adopted substantially
similar regulations in order to implement Section 38 of the FDIA, which
regulations became effective in December 1992. Under the regulations, an
institution shall be deemed to be (i) "well capitalized" if it has total
risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio of
6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure; (ii) "adequately capitalized" if it has a
total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital
ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0%
under certain circumstances) and does not meet the definition of "well
capitalized," (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less
than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital
ratio that is less than 3.0% or a Tier I leverage capital ratio that is less
than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%. Section 38 of the
FDIA and the regulations promulgated thereunder also specify circumstances under
which a federal banking agency may reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category (except that the FDIC may not reclassify a
significantly undercapitalized institution as critically undercapitalized).
The Bank complies with the requirements to be classified as well
capitalized.
Safety and Soundness.
The OTS and the other federal bank regulatory agencies have established
guidelines for safety and soundness, addressing operational and managerial
standards, as well as compensation matters for insured financial institutions.
Institutions failing to meet these standards are required to submit compliance
plans to their appropriate federal regulators. The OTS and the other agencies
have also established guidelines regarding asset quality and earnings standards
for insured institutions. The Bank believes that it is in compliance with these
guidelines and standards.
40
Qualified Thrift Lender Test. In general, savings associations are
required to maintain at least 65% of their portfolio assets in certain qualified
thrift investments (which consist primarily of loans and other investments
related to residential real estate and certain other assets). A savings
association that fails the qualified thrift lender test is subject to
substantial restrictions on activities and to other significant penalties.
In 1996, legislation was adopted which permits a savings association to
qualify as a qualified thrift lender not only by maintaining 65% of portfolio
assets in qualified thrift investments (the "QTL test") but also, in the
alternative, by qualifying under the Code as a "domestic building and loan
association." The Bank is a domestic building and loan association as defined in
the Code.
Subsequent legislation also expanded the QTL test to provide savings
associations with greater authority to lend and diversify their portfolios. In
particular, credit card, small business and educational loans may now be made by
savings associations without regard to any percentage-of-assets limit, and
commercial loans may be made in an amount up to 10 percent of total assets.
Loans for personal, family and household purposes (other than credit card, small
business and education loans) are now included without limit with other assets
that, in the aggregate, may account for up to 20% of total assets. At June 30,
2000, under the expanded QTL test, approximately 73.01% of the Bank's portfolio
assets were qualified thrift investments.
Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings institutions, which include cash dividends, stock
repurchases and other transactions charged to the capital account of a savings
institution to make capital distributions. Under new regulations effective April
1, 1999, a savings institution must file an application for OTS approval of the
capital distribution if either (1) the total capital distributions for the
applicable calendar year exceed the sum of the institution's net income for that
year to date plus the institution's retained net income less capital
distribution for the preceding two years, (2) the institution would not be at
least adequately capitalized following the distribution, (3) the distribution
would violate any applicable statute, regulation, agreement or OTS-imposed
condition, or (4) the institution is not eligible for expedited treatment of its
filings. If an application is not required to be filed, savings institutions
which are a subsidiary of a holding company (as well as certain other
institutions) must still file a notice with the OTS at least 30 days before the
board of directors declares a dividend or approves a capital distribution.
Federal Home Loan Bank System. The Bank is a member of the FHLBP, which
is one of 12 regional FHLBs that administers the home financing credit function
of savings associations and commercial banks. Each FHLB serves as a source of
liquidity for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by its Board of Directors. As of June 30, 2000, the
Bank's advances from the FHLBP amounted to $86.78 million.
41
As a member, the Bank is required to purchase and maintain stock in the
FHLBP in an amount equal to the greater of 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of total advances. At June 30, 2000, the Bank
had $5.7 million in FHLB stock, which was in compliance with this requirement.
As a result of FIRREA, the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to affordable
housing programs through direct loans or interest subsidies on advances targeted
for community investment and low- and moderate-income housing projects. These
contributions have adversely affected the level of FHLB dividends paid and could
continue to do so in the future. These contributions also could have an adverse
effect on the value of FHLB stock in the future. For the year ended June 30,
2000, dividends paid by the FHLBP to the Bank totaled approximately $337,000.
Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain reserves against their transaction accounts
(primarily NOW and super NOW checking accounts) and non-personal time deposits.
At June 30, 2000, the Bank was in compliance with such requirements.
The balances maintained to meet the reserve requirements imposed by the
Federal Reserve Board may be used to satisfy applicable liquidity requirements.
Because required reserves must be maintained in the form of vault cash or a
non-interest bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce an association's earning assets. The amount of
funds necessary to satisfy this requirement has not had a material affect on the
Bank's operations.
Interstate Acquisitions
The Commonwealth of Pennsylvania adopted legislation on 1986 ("1986
Act") regarding the acquisition of financial institutions located in
Pennsylvania by institutions located outside of Pennsylvania. The 1986 Act: (1)
permits federal or state savings and loan associations, federal savings banks
and bank or savings and loan holding companies (collectively, "Thrift Entities")
that are "located" (as defined below) in a state that offers reciprocal rights
to similar Thrift Entities located in Pennsylvania, to acquire 5% or more of a
Pennsylvania Thrift Entity's voting stock, merge or consolidate with a
Pennsylvania Thrift Entity or purchase the assets and assume the liabilities of
the Pennsylvania Thrift Entity and (2) permits a federal or state savings and
loan association or federal savings bank to establish and maintain branches in
Pennsylvania, provided that the state where such foreign Thrift Entity is
located offers reciprocal rights to similar entities located in Pennsylvania and
provided that each state where any bank holding company or savings and loan
holding company owning or controlling 5% or more of the foreign Thrift Entity's
shares is also located in a state that offers reciprocal rights. Under the
Pennsylvania Act, a depository is "located" where its deposits are largest and a
holding company is generally "located" where the aggregate deposits of its
subsidiaries are largest. Whether a foreign state's laws are "reciprocal" is
determined by the Pennsylvania Department, which may impose limitations and
conditions on the branching and acquisition activities of a Thrift Entity
located in a foreign state in order to make the laws of such state reciprocal to
Pennsylvania law with respect to the type of transaction at issue.
42
TAXATION
Federal and State Taxation
General. The Company and the Bank are subject to the corporate tax
provisions of the Internal Revenue Code of 1986 (the "Code"), as well as certain
additional provisions of the Code which apply to thrift and other types of
financial institutions. The following discussion of tax matters is intended only
as a summary and does not purport to be a comprehensive description of the tax
rules applicable to the Company and the Bank.
Bad Debt Reserves. Legislation enacted under the Small Business Job
Protection Act of 1996 (the "Act") provided for the Bank to recapture into
income, over a six-year period, only the portion of its tax bad debt reserves as
of June 30, 1996, that exceed its base year reserves (i.e., tax reserves for
years beginning before 1988). Under the Act, the amount of the excess base year
reserves subject to recapture would be suspended for each of two successive tax
years beginning July 1, 1996, in which the Bank originates a minimum amount of
certain residential loans based upon the average of the principal amounts of
such loans the Bank made during its six preceding tax years. The Bank's total
tax bad debt reserves at June 30, 2000, are approximately $2.96 million, of
which $2.64 million represents the base year amount and $321,000 is subject to
recapture. The Company has previously recorded a deferred tax liability for the
excess base year reserves to be recaptured; therefore, this recapture will not
impact the statement of operations. The base year tax reserves, which may be
subject to recapture if the Bank ceases to qualify as a bank for federal income
tax purposes, are restricted to certain distributions. Under the provisions of
the Act, the Bank is considered a "small bank" (i.e., a bank that has total
assets under $500 million) and may claim its tax bad debt for tax years
beginning after December 31, 1995, using a six-year average of its loan
charge-offs to total loans.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of
20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is
payable to the extent such AMTI is in excess of an exemption amount. The Code
provides that an item of tax preference is the excess of bad debt deduction
allowable for a taxable year over the amount allowable under the experience
method. The other items of tax preference that constitute AMTI include (a)
tax-exempt interest on a newly issued (generally, issued on or after August 8,
1986) private activity bonds other than certain qualified bonds and (b) for
taxable years beginning after 1989, 75% of the excess (if any) of (i) adjusted
current earnings as defined in the Code, over (ii) AMTI (determined without
regard to this preference and prior to reduction by net operating losses). Net
operating losses can offset no more than 90% of AMTI. Certain payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years. In addition, for taxable years after 1986 and beginning before
January 1, 1996, the Company is also subject to an environmental tax equal to
0.12% of the excess of AMTI for the taxable year over $2.0 million.
43
IRS Examinations. The Company's consolidated federal income tax returns
for taxable years through June 30, 1995, have been closed for the purposes of
examination by the IRS.
State Taxation. The Company and its non-thrift Pennsylvania
subsidiaries are subject to the Pennsylvania Corporate Net Income Tax and
Capital Stock and Franchise Tax. The Corporate Net Income Tax rate for 2000 is
9.99% and is imposed on the Company's and its non-thrift subsidiaries'
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock Tax is a property tax imposed at the rate of 1.275%
of a corporation's capital stock value, which is determined in accordance with a
fixed formula.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax
Act (the "MTIT"), as amended to include thrift institutions having capital
stock. Pursuant to the MTIT, the Company's tax rate is 11.5%. The MTIT exempts
the Company from all other taxes imposed by the Commonwealth of Pennsylvania for
state income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with generally accepted
accounting principals ("GAAP") with certain adjustments. The MTIT, in computing
GAAP income, allows for the deduction of interest earned on Pennsylvania and
federal obligations, while disallowing a percentage of a thrift's interest
expense deduction in the proportion of interest income on those obligations to
the overall interest income of the Company. Net operating losses, if any,
thereafter can be carried forward three years for MTIT purposes.
44
ITEM 2. PROPERTIES
Offices and Other Material Properties
At June 30, 2000, the Bank conducted its business from its main office
in Downingtown which is also a branch office, Pennsylvania and eight
full-service branch offices. PCIS conducts its business from two offices.
The following table sets forth certain information with respect to the
offices of the Company as of June 30, 2000:
Net Book Value of
Lease ---------------------------------------
Owned or Expiration Property and Leasehold Improvements at
Leased Date June 30, 2000 Deposits
-------------- -------------------- --------------------------------------- -------------
First Financial Bank: (In Thousands)
Main Office:
100 E. Lancaster Avenue
Downingtown PA 19335 Own -- $ 1,347 $ 136,781
Branch Offices:
Exton-Lionville
601 N. Pottstown Pike
Exton PA 19341 Own -- 397 62,594
Frazer-Malvern
200 W. Lancaster Avenue
Frazer PA 19355 Own -- 1,264 40,679
Thorndale
3909 Lincoln Highway
Downingtown PA 19335 Lease 9/30/05 47 39,958
Westtown
1197 Wilmington Pike
West Chester PA 19382 Lease 11/30/05 112 50,966
Airport Village
102 Airport Road Own Bldg.
Coatesville PA 19320 Lease Land 11/30/04 304 18,501
Brandywine Square
82 Quarry Road
Downingtown PA 19335 Lease 8/14/11 89 20,493
Devon
414 Lancaster Avenue
Devon PA 19333 Own -- 1,461 8,506
------------ ------------
Total $5,021 $378,478
============ ============
PCIS:
Philadelphia
One Liberty Place, Suite 3050
1650 Market Street,
Philadelphia PA 19103 Lease 5/31/04
Wayne
485 Devon Park Dr. Suite 109
Wayne PA 19087 Lease 11/30/02
45
In addition, the Company currently owns two developed properties
adjacent to its main office. These properties are being held for possible use as
future office facilities and expansion of the main office. One of the properties
is currently being leased to other users. The net book value of each of the two
parcels at June 30, 2000 was approximately $10.416 and $81,610.
In September 1989, the Bank entered into a 10-year operating lease for
the Bank's Westtown office. The lease contains two five-year options to renew.
In October 1990, the Bank entered into a 10-year lease agreement in
connection with the relocation of its existing branch in Thorndale to a new site
in the Thorndale area. The lease includes two five-year options to extend the
lease.
In May 1994, the Bank entered into a 10-year lease agreement for land
in connection with the construction of the Airport Village branch. The lease
includes three five-year options to extend the lease.
In April 1995, the Bank entered into a 15-year lease agreement for the
Bank's Brandywine Square office.
In December 1997, PCIS entered into a 5-year lease agreement for PCIS's
Wayne office.
In June 1999, PCIS entered into a 5-year lease agreement for PCIS's
Philadelphia office.
First Financial operates and participates in the MAC(R) Money Access
Service shared Automated Teller Machine ("ATM") network system. In addition,
First Financial operates seven office ATMs under the MAC(R) system.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
routine, non-material legal proceedings occurring in the ordinary course of
business which management believes will not have a material adverse effect on
the financial condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
46
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The information required herein is incorporated by reference from
"Market Information" on page 19 of the Company's 2000 Annual Report to
Stockholders included herein as Exhibit 13 hereto ("Annual Report").
ITEM 6. SELECTED FINANCIAL DATA
The information required herein is incorporated by reference from
page 3 of the Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The information required herein is incorporated by reference from pages
12 to 19 of the Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The information required herein can be found on pages 27 to 28 of this
Form 10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required herein are
incorporated by reference from pages 20 to 36 of the Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from pages
3 to 9 of the Company's Definitive Proxy Statement which will be filed with the
SEC within 120 days of the end of the Company's fiscal year ("Definitive Proxy
Statement").
47
ITEM 11. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference on pages
10 to 12 of the Company's Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required herein is incorporated by reference from pages
3 to 9 of the Company's Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein is incorporated by reference to page 18
of the Definitive proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) The following documents are filed as part of this report:
(1) The following financial statements are incorporated by reference
into Item 8 hereof from pages 20 to 36 of the Annual Report,
Exhibit 13 hereto:
(a) Consolidated Statements of Financial Condition at June 30,
2000 and 1999.
(b) Consolidated Statements of Operations for the Years Ended
June 30, 2000, 1999, and 1998
(c) Consolidated Statements of Stockholders' Equity and
Comprehensive Income Statement for the Years Ended June 30,
2000, 1999, and 1998
(d) Consolidated Statements of Cash Flows for the Years Ended
June 30, 2000, 1999 and 1998.
(e) Notes to Consolidated Financial Statements.
(2) Financial statement schedules for which provision is made in the
applicable accounting regulations of the SEC are omitted because
of the absence of the conditions under which they are required or
because the required information is set forth in the Consolidated
Financial Statements or Notes thereto.
(b) Reports on Form 8-K
None
48
(c) The following exhibits are filed as a part of this form 10-K and this list
includes the Index to Exhibits.
Index to Exhibits
Number Description of Documents
- -------- ------------------------
3a Restated Articles of Incorporation**
3b Bylaws, as amended
4 Specimen Stock Certificate*
10a Key Employee Stock Compensation Program, as amended**
10b Employee Stock Ownership Plan**
10c Employment Agreement By and Between the Holding Company, the Bank
and Ellen Ann Roberts**
10e Employment Agreement By and Between the Holding Company, the Bank
and Colin N. Maropis**
10h Amendment No. 1 to the Employment Agreement By and Between the
Holding Company, the Bank and Ellen Ann Roberts***
10j Amendment No. 1 to the Employment Agreement By and Between the
Holding Company, the Bank and Colin N. Maropis ***
101 1997 Stock Option Plan****
10m 1993 Stock Option Plan as Amended
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant - Reference is made to Item, 1,
Business - Subsidiaries," for the required information
23 Consent of Independent Auditors
27 Financial Statement Schedule (*) Incorporated herein by reference
from the Company's Registration Statement on Form S-4 (33-30433)
dated August 10, 1989
(**) Incorporated herein by reference from the Company's Annual Report
on Form 10-KSB for the year ended June 30, 1990
(***) Incorporated herein by reference from the Company's Annual Report
on Form 10-KSB for the year ended June 30, 1992
(****) Incorporated herein by reference from the Company's Annual Report
on Form 10-KSB for the year ended June 30, 1997
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this amended
report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHESTER VALLEY BANCORP INC.
Dated: September 28, 2000 By: /s/ Ellen Ann Roberts
---------------------------
Ellen Ann Roberts
Director, Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities and
on the dates indicated.
Name Title Date
/s/ Robert J. Bradbury Director September 28, 2000
- ----------------------------
Robert J. Bradbury
/s/ Edward T. Borer Director September 28, 2000
- ----------------------------
Edward T. Borer
/s/ John J. Cunningham, III Director September 28, 2000
- ----------------------------
John J. Cunningham, III
/s/ Gerard F. Griesser Director September 28, 2000
- ----------------------------
Gerard F. Griesser
/s/ James E. McErlane Interim President and Director September 28, 2000
- ----------------------------
James E. McErlane and Secretary
/s/ Richard L. Radcliff Director September 28, 2000
- ----------------------------
Richard L. Radcliff
/s/ Emory S. Todd Director September 28, 2000
- ----------------------------
Emory S. Todd
/s/ William M. Wright Director September 28, 2000
- ----------------------------
William M. Wright
/s/ Albert S. Randa Chief Financial Officer September 28, 2000
- ----------------------------
Albert S. Randa
50