EXHIBIT 13
EXCERPTS FROM:
1997 ANNUAL REPORT TO STOCKHOLDERS
Selected Financial Data
Codorus Valley Bancorp, Inc.
5 YEAR
(in thousands) 1997 1996 1995 1994 1993 CGR(1)
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SUMMARY OF OPERATIONS
Total interest income $19,513 $18,523 $18,346 $16,053 $15,696 3.2%
Total interest expense 9,096 8,756 8,722 6,940 7,283 1.0%
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Net interest income 10,417 9,767 9,624 9,113 8,413 5.3%
Provision for loan losses 275 134 228 1,229 441 1.3%
Noninterest income 1,227 1,090 912 880 1,348 13.5%
Noninterest expense 7,729 6,755 6,559 6,322 6,330 6.0%
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Income before income taxes 3,640 3,968 3,749 2,442 2,990 6.3%
Provision for income taxes 1,161 1,261 1,155 712 713 (2) 11.1%
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Net income $ 2,479 $ 2,707 $ 2,594 $ 1,730 $ 2,277 4.5%
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RATIOS (in percentage)
Return on average
stockholders' equity 10.4 12.4 13.3 9.5 13.5
Return on average assets 1.00 1.14 1.14 0.81 1.12
Tier I risk-based capital 12.4 13.6 13.4 13.1 13.0
Total risk-based capital 13.5 14.9 14.6 14.3 14.3
Average stockholders' equity
to average assets 9.7 9.2 8.6 8.5 8.2
PER COMMON SHARE (3)
Net income, basic and diluted $1.13 $1.23 $1.18 $0.79 $1.04
Cash dividends paid $0.38 $0.34 $0.30 $0.27 $0.25
Stock dividend paid 5% 5% 5% 0% 5%
Book value $11.13 $10.35 $9.58 $8.14 $8.03
Dividend payout ratio 33.7% 27.8% 25.4% 34.4% 24.1%
Weighted average shares outstanding 2,194,518 2,194,518 2,190,266 2,194,448 2,194,362
SUMMARY OF FINANCIAL CONDITION
AT YEAR END (in thousands)
Securities (4) $40,303 $56,859 $61,679 $53,717 $55,424 -6.8%
Loans 191,342 166,651 160,008 150,637 140,557 7.6%
Assets 255,058 237,329 234,747 215,997 211,534 4.8%
Deposits 226,263 209,460 212,440 196,896 192,725 4.1%
Borrowings 2,802 4,000 0 0 0 nm
Equity (5) 24,425 22,706 21,032 17,872 17,616 9.0%
Trust and investment services
Assets (market value) 59,863 49,292 40,215 32,229 31,418 20.2%
Income 441 321 311 291 170 33.2%
NON-FINANCIAL DATA
Number of bank offices 8 7 7 7 6
Number of employees
(full-time equivalent) 140 129 128 121 126
(1) Compound growth rate (CGR) is the average annual growth over the five year
period which began in 1992.
(2) Amount is comprised of an $883,000 provision for income taxes less a
one-time $170,000 tax benefit caused by the cumulative effect of a change
in accounting principle.
(3) Adjusted, as applicable, for stock dividends, including the 100% stock
dividend declared December 9, 1997 and paid January 26, 1998.
(4) Securities are reflected at fair value for all periods except 1993 which is
at amortized cost.
(5) Total equity includes net unrealized gains or losses on securities
available for sale, net of taxes, for all periods except 1993.
13
Consolidated Statements of Financial Condition
Codorus Valley Bancorp, Inc.
December 31,
(dollars in thousands) 1997 1996
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Assets
Cash and due from banks:
Interest bearing deposits with banks $ 123 $ 337
Noninterest bearing deposits and cash 7,721 7,012
Federal funds sold 5,350 300
Securities available for sale 40,303 56,859
Loans 191,342 166,651
Less-allowance for loan losses (2,098) (2,110)
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Total net loans 189,244 164,541
Premises and equipment 9,797 5,025
Interest receivable 1,538 1,642
Other assets 982 1,613
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Total assets $ 255,058 $ 237,329
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Liabilities
Deposits:
Noninterest bearing demand $ 21,152 $ 19,142
NOW 22,041 22,237
Insured money fund 28,901 25,651
Savings 19,992 20,652
Time CDs less than $100,000 112,874 106,283
Time CDs $100,000 and above 21,303 15,495
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Total deposits 226,263 209,460
Short-term borrowings 0 4,000
Long-term borrowings 2,802 0
Interest payable 820 796
Other liabilities 748 367
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Total liabilities 230,633 214,623
Stockholders' Equity
Series preferred stock, par value $2.50 per
share; 1,000,000 shares authorized;
0 shares issued and outstanding 0 0
Common stock, par value $2.50 per share;
10,000,000 shares authorized; 1,097,259 shares issued
and outstanding for 1997, and 1,045,296 for 1996 2,743 2,613
Common stock distributable, par value $2.50 per share;
1,097,259 shares payable 2,743 0
Additional paid-in capital 8,063 6,556
Retained earnings 10,444 13,191
Net unrealized gains on securities available for sale, net of taxes 432 346
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Total stockholders' equity 24,425 22,706
Total liabilities & stockholders' equity $ 255,058 $ 237,329
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See accompanying notes.
14
Consolidated Statements of Income
Codorus Valley Bancorp, Inc.
Years ended December 31,
(dollars in thousands, except per share data) 1997 1996 1995
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Interest Income
Interest and fees from loans $16,356 $14,447 $14,545
Interest from deposits with banks 15 21 13
Interest from federal funds sold 162 92 168
Interest and dividends from investment securities:
Taxable interest income 2,725 3,660 3,278
Tax-exempt interest income 201 252 291
Dividend income 54 51 51
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Total interest income 19,513 18,523 18,346
Interest Expense
Interest on deposits:
NOW 381 459 504
Insured money fund 869 762 800
Savings 472 538 560
Time CDs less than $100,000 6,103 6,051 6,012
Time CDs $100,000 and above 1,010 859 843
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Total interest expense on deposits 8,835 8,669 8,719
Interest on short-term borrowings 73 87 3
Interest on long-term borrowings 188 0 0
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Total interest expense 9,096 8,756 8,722
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Net interest income 10,417 9,767 9,624
Provision for Loan Losses 275 134 228
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Net interest income after provision for loan losses 10,142 9,633 9,396
Noninterest Income
Trust and investment services fees 441 321 311
Service charges on deposit accounts 432 410 415
Other service charges and fees 275 250 248
Gain (loss) from the sale of securities (17) 102 (62)
Gains, other 96 7 0
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Total noninterest income 1,227 1,090 912
Noninterest Expense
Salaries and benefits 4,002 3,669 3,510
Occupancy of premises 604 426 428
Furniture and equipment 856 585 588
FDIC assessment 26 2 232
Postage, stationery and supplies 413 317 292
Professional and legal 223 190 185
Marketing and advertising 341 235 206
Acquired real estate, net 50 195 64
Other 1,214 1,136 1,054
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Total noninterest expense 7,729 6,755 6,559
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Income before income taxes 3,640 3,968 3,749
Provision for income taxes 1,161 1,261 1,155
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Net income $2,479 $2,707 $2,594
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Net income per share, basic and diluted $1.13 $1.23 $1.18
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See accompanying notes.
15
Consolidated Statements of Cash Flows
Codorus Valley Bancorp, Inc.
Years ended December 31,
(dollars in thousands) 1997 1996 1995
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Cash Flows From Operating Activities
Net Income $ 2,479 $ 2,707 $ 2,594
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation 674 431 369
Provision for loan losses 275 134 228
Provision for losses on assets acquired in foreclosure 18 129 30
Deferred federal income tax expense (benefit) 153 138 (299)
Loss (gain) on sales of securities 17 (102) 62
Gains, other (96) (7) 0
Gain on the sale of assets acquired in foreclosure (17) (13) (3)
Decrease (increase) in interest receivable 104 61 (64)
Decrease (increase) in other assets 39 (250) 403
Increase (decrease) in interest payable 24 (69) 13
Increase (decrease) in other liabilities 381 (43) 33
Other, net (145) (27) 16
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Net cash provided by operating activities 3,906 3,089 3,382
Cash Flows From Investing Activities
Proceeds from the sale of securities available for sale 5,240 8,481 2,345
Proceeds from maturities and calls of securities available for sale 17,712 18,464 14,392
Purchase of securities available for sale (6,246) (22,537) (22,602)
Net increase in loans made to customers (29,553) (15,238) (10,380)
Proceeds from loan sales 4,487 7,718 626
Proceeds from the sale of premises and equipment 151 0 0
Purchases of premises and equipment (5,560) (1,933) (591)
Proceeds from the sale of assets acquired in foreclosure 649 500 224
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Net cash used in investing activities (13,120) (4,545) (15,986)
Cash Flows From Financing Activities
Net increase (decrease) in demand, NOW,
insured money fund and savings deposits 4,404 1,972 (1,686)
Net increase (decrease) in time deposits 12,399 (4,952) 17,230
Net (decrease) increase in short-term borrowings (4,000) 4,000 0
Net increase in long-term borrowings 2,802 0 0
Dividends paid (836) (754) (659)
Cash paid in lieu of fractional shares (10) (8) (6)
Payment to repurchase common stock 0 0 (270)
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Net cash provided by financing activities 14,759 258 14,609
Net increase (decrease) in cash and cash equivalents 5,545 (1,198) 2,005
Cash and cash equivalents at beginning of year 7,649 8,847 6,842
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Cash and cash equivalents at end of year $13,194 $ 7,649 $ 8,847
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Supplemental Disclosures:
Interest payments $ 8,811 $ 8,738 $ 8,709
Income tax payments $ 930 $ 1,300 $ 1,310
See accompanying notes.
16
Consolidated Statements of Changes in Stockholders' Equity
Codorus Valley Bancorp, Inc.
Common Additional Unrealized
Common Stock Paid-in Retained Gains and Treasury Total
(dollars in thousands) Stock Distributable Capital Earnings (Losses) Stock Equity
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Balance, December 31, 1994 $ 2,396 $ 0 $ 4,428 $ 11,932 $(884) $ 17,872
Net income 2,594 2,594
Cash dividends (659) (659)
Acquisition of treasury stock (270) (270)
5% stock dividend - 47,161 shares at fair value
(includes 9,994 shares from treasury stock) 94 766 (1,136) 270 (6)
Change in unrealized gains (losses) on securities,
net of $773 income tax 1,501 1,501
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Balance, December 31, 1995 2,490 0 5,194 12,731 617 0 21,032
Net income 2,707 2,707
Cash dividends (754) (754)
5% stock dividend - 49,503 shares at fair value 123 1,362 (1,493) (8)
Change in unrealized gains (losses) on securities,
net of $140 income tax benefit (271) (271)
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Balance, December 31, 1996 2,613 0 6,556 13,191 346 0 22,706
Net income 2,479 2,479
Cash dividends (836) (836)
5% stock dividend - 51,963 shares at fair value 130 1,507 (1,647) (10)
100% stock dividend - 1,097,259 shares at par value 2,743 (2,743) 0
Change in unrealized gains (losses) on securities,
net of $44 income tax 86 86
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Balance, December 31, 1997 $2,743 $2,743 $8,063 $10,444 $432 $0 $24,425
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See accompanying notes.
17
Notes to Consolidated Financial Statements
NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation
The accounting and reporting policies of Codorus Valley Bancorp, Inc. and
subsidiaries (the Corporation) conform with generally accepted accounting
principles (GAAP) and prevailing practices of the commercial banking industry.
Principles of Consolidation
The consolidated financial statements include the accounts of Codorus Valley
Bancorp, Inc. and its wholly owned bank subsidiary, PEOPLESBANK, and its wholly
owned nonbank subsidiary, SYC Realty Company, Inc. All significant intercompany
account balances and transactions have been eliminated in consolidation.
Securities Available for Sale
Securities available for sale are carried at fair value, with unrealized gains
and losses, net of taxes, recorded as a component of stockholders' equity, in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." Realized gains and
losses from the sale of securities are computed on the basis of specific
identification of the adjusted cost of each security, and shown net as a
separate line item in the statement of income.
Loans
Interest on loans is credited to income based upon the principal amount
outstanding. Loan fees are generally considered to be adjustments of interest
rate yields and are amortized to interest income over the terms of the related
loans. The accrual of interest income is discontinued, and unpaid interest on a
loan is reversed and charged against current income, when circumstances indicate
that collection is doubtful. Loans are returned to accrual status when
management determines that circumstances have improved to the extent that both
principal and interest are deemed collectible. In those cases where collection
of principal is in doubt, additions are made to the allowance for loan losses.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by
management, based on information currently available, to absorb potential losses
in the loan portfolio. Recognized loan losses are charged, and recoveries
credited, to the allowance. The Corporation's loan loss provision, charged to
operating income, is determined by management based on such factors as changes
in local economic conditions, prior loss experience, adequacy of collateral, and
risk characteristics of the loan portfolio.
The Corporation accounts for loan impairment in accordance with Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment
of a Loan," as amended by Statement No. 118, "Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosure." Under Statement No.
114, a loan is considered impaired when, based on current information and
events, it is probable that a creditor will be unable to collect all amounts
due. The Statement requires that loans be measured based on the present value of
expected future cash flows, discounted at the loan's effective interest rate, or
as a practical expedient, at the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent. If the measure of
the impaired loan is less than its recorded investment, the Corporation
recognizes an impairment by adjusting a valuation allowance. Statement No. 114
does not apply to large groups of homogeneous loans such as consumer
installment, and bank credit card loans, which are collectively evaluated for
impairment. Smaller balance commercial loans are also excluded from the
application of the Statement. At December 31, 1997 and 1996, impaired loans
consisted solely of non-accrual, collateral dependent loans.
Loans are charged-off when there is permanent impairment of the related recorded
investment. The cash method of recognizing interest income was used for impaired
loans for all reported periods as is consistent with the Corporation's
non-accrual policy.
18
Notes to Consolidated Financial Statements
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation expense is calculated principally on the straight-line method. The
depreciation methods are designed to allocate the cost of the assets over their
estimated useful lives. Estimated useful lives are ten to forty years for
buildings and improvements, and three to ten years for furniture and equipment.
Maintenance and repairs are charged to expense as incurred. The cost of
significant improvements to existing assets is capitalized. When facilities are
retired or otherwise disposed of, the cost is removed from the asset accounts
and any gain or loss is reflected in the statement of income.
Assets Acquired in Foreclosure
Foreclosed assets, included in other assets, are comprised of property acquired
through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure.
Foreclosed assets initially are recorded at fair value at the date of
foreclosure establishing a new cost basis. After foreclosure, valuations are
periodically performed by management and the asset is carried at the lower of
(1) cost or (2) fair value minus estimated costs to sell. If the fair value of
the asset minus the estimated costs to sell the asset is less than the cost of
the asset, the deficiency is immediately recognized as a valuation allowance.
If, however, the fair value minus the costs to sell the asset subsequently
increases above the asset's cost, the valuation allowance is reduced, but not
below zero. Costs related to the improvement of acquired real estate assets are
capitalized until the real estate reaches a saleable condition. Revenue and
expenses from operations and changes in the valuation allowance are included in
acquired real estate expense.
Trust and Investment Services Assets and Income
Assets held by the Bank in a fiduciary or agency capacity for its customers are
not included in the consolidated financial statements since such items are not
assets of the Bank. Trust and Investment Services income is reported on a cash
basis, which is not materially different from the accrual basis.
Income Taxes
The Corporation and its subsidiaries file a consolidated federal income tax
return. Consolidated income tax expense is allocated based on their respective
earnings to total earnings. The Corporation accounts for income taxes in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." Under Statement No. 109, the liability method is used in
accounting for income taxes. Under this method, deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax basis of assets and liabilities. These differences are then subject to
the enacted tax rates and laws that will be in effect when the differences are
expected to reverse. Statement No. 109 requires the recognition of future tax
benefits, measured by enacted tax rates, attributable to deductible temporary
differences between the financial statement and income tax basis of assets and
liabilities. In order to realize the deferred tax asset, the Corporation
considered a number of factors, including its recent earnings history and its
expectation of future earnings. Based on these factors the Corporation has
concluded that it is more likely than not the deferred tax asset will be
realized. Accordingly, a deferred tax asset valuation allowance was not
established as of December 31, 1997. On a quarterly basis, the Corporation will
assess whether a valuation allowance for the deferred tax asset account will be
required.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Net Income and Dividends Per Common Share
The Corporation computes net income per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share." All net income per
share amounts for all periods have been presented to conform to Statement 128.
Dividends per common share are computed by dividing total dividends by the
weighted average number of shares of common stock outstanding, adjusted for
stock dividends, including the 100% stock dividend declared December 9, 1997 and
paid January 26, 1998. The weighted average number of shares of common stock
outstanding used for both net income per share and dividends per common share
was approximately 2,194,518 for 1997, 2,194,518 for 1996, and 2,190,226 for
1995.
19
Notes to Consolidated Financial Statements
Stock-Based Compensation
The Corporation has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for employee stock options. APB 25 is followed
since the alternative fair value accounting provided for under FASB Statement
No. 123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee stock
options (see also Note 13). Under APB 25, since the exercise price of the
Corporation's employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, and federal funds sold. Non-cash financing transactions for the
years ended December 31, 1997, 1996 and 1995 consisted of certificates of
deposit which matured and were renewed for new terms. These transactions
amounted to approximately $45,071,000 for 1997, $27,487,000 for 1996 and
$40,132,000 for 1995. Non-cash investing transactions for the years ended
December 31, 1997, 1996 and 1995 consisted of the transfer of loans to assets
acquired in satisfaction of debt. These transfers amounted to approximately
$297,000 for 1997, $705,000 for 1996 and $291,000 for 1995.
Fair Value of Financial Instruments
The following methods and assumptions were used by the Corporation in estimating
its fair value disclosures (see Note 17) for financial instruments.
Cash and short-term investments: The carrying amounts reported in the
balance sheet for cash and short-term investments approximates their
fair value at the reporting date.
Investment securities (including mortgage-backed securities): Fair
values for investment securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values
are based on quoted market prices of comparable instruments.
Loans receivable: For variable-rate and adjustable-rate loans that
reprice frequently and show no significant change in credit risk, fair
values are based on carrying values. For fixed-rate loans, fair values
are estimated using quoted market prices.
Demand and Savings deposits: The fair value of demand and savings
deposits is the amount payable on demand at the reporting date.
Time deposits: The carrying value of time certificates of deposit (CDs)
less than $100,000 with an original term of six months or less and
variable rate CDs of less than $100,000 is assumed to approximate market
value. The fair value of all other CDs is estimated by discounting the
future cash flows, using rates offered for deposits of similar remaining
maturities at the reporting date.
Short-term borrowings: The carrying amount reported in the balance sheet
approximates their fair value at the reporting date due to the short
duration of these instruments.
Long-term borrowings: The fair value of long-term borrowings is
estimated by discounting the future cash flows, using rates available
for borrowings of similar maturities at the reporting date.
Off-balance sheet instruments: The fair value of off-balance sheet
instruments, such as commitments to extend credit and standby letters of
credit, are based on fees currently charged to enter into similar
agreements. Generally, fees charged on standby letters of credit and
selected commitments to extend credit, principally for commercial loans,
outstanding at December 31, 1997 are not considered material.
20
Notes to Consolidated Financial Statements
NOTE 2-CURRENT ACCOUNTING DEVELOPMENTS
Effective January 1, 1996, the Corporation adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of." Statement No. 121 addresses
the accounting for the impairment (i.e., the carrying amount of the assets might
not be recoverable) of long-lived assets, such as property, plant and equipment,
identifiable intangibles including patents and trademarks, and goodwill related
to those assets. It specifies when assets should be reviewed for impairment, how
to determine if an asset is impaired, how to measure an impairment loss, and
what disclosures are necessary in the financial statements. The Statement also
requires that long-lived assets and identifiable intangibles (except for assets
of a discontinued operation) held for disposal be accounted for at the lower of
cost or fair value less cost to sell. Adoption of this Statement did not affect
the assets, earnings or capital of the Corporation.
Effective January 1, 1996, the Corporation also adopted Statement of Financial
Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights an
Amendment of Statement No. 65." Statement No. 122 requires that mortgage banking
enterprises recognize a separate asset for mortgage servicing rights, regardless
of how they were acquired. If the mortgage banking enterprise sells or
securitizes mortgage loans and retains the mortgage servicing rights, the total
cost of the mortgage loans is to be allocated to the loan and the servicing
rights based on their relative fair values if it is practical to estimate those
values. The Statement also specifies how mortgage servicing rights and excess
servicing rights should be evaluated for impairment. In June 1996, Statement No.
122 was superseded by SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" as described more fully
below. Adoption of Statement No. 122 did not materially affect the assets,
earnings or capital of the Corporation.
On June 30, 1996, the FASB issued Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" which supersedes SFAS No. 122, "Accounting for
Mortgage Servicing Rights," and amends SFAS No. 65, "Accounting for Certain
Mortgage Banking Activities." This Statement provides accounting and reporting
guidance for transfers and servicing of financial assets and extinguishments of
liabilities based on the application of a "financial- components approach" that
focuses on control. Under this approach, when an entity transfers financial
assets, it recognizes the financial and servicing asset it controls and the
liabilities it has incurred, and derecognizes liabilities when extinguished. The
Statement is effective for specified transactions occurring after December 31,
1996. On October 31, 1996, the FASB issued SFAS No. 127, "Deferral of the
Effective Date of Certain Provisions of SFAS No. 125," which defers until
January 1, 1998, the effective date of paragraph 9-12 for the following specific
transactions: securities lending, repurchase agreements, dollar rolls, and other
similar secured transactions. Additionally, the FASB agreed to defer for one
year paragraph 15 for all transactions. Statement No. 125 must be applied
prospectively. Adoption of this Statement did not, and is not expected to have a
material impact on the assets, earnings or capital of the Corporation.
In February 1997, the FASB issued Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" which supersedes APB Opinion No. 15. Statement No.
128, effective for financial statements issued after December 15, 1997,
simplifies the computation of earnings per share (EPS) by replacing the
presentation of primary EPS with a presentation of basic EPS. Under this
Statement the dilutive effect of stock options will be excluded when calculating
basic EPS. Statement No. 128 requires dual presentation of basic and diluted EPS
by entities with complex capital structures. Adoption of Statement No. 128 did
not have a material impact on the EPS calculations of the Corporation.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income." The Statement establishes standards for
the reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. Comprehensive income includes net
income plus all other non-owner changes in equity currently excluded from net
income. These other non-owner changes in equity currently include transactions
specified in SFAS No. 52, "Foreign Currency Translation," SFAS No. 80,
"Accounting for Futures Contracts," SFAS No. 87, "Employers' Accounting for
Pensions," and SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Statement No. 130 is effective for fiscal years beginning
after December 15, 1997, with earlier application permitted. Management is
currently reviewing this Statement and the impact it may have on the
Corporation.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for the reporting of financial information from
the operating segments in annual and interim financial statements. This
Statement requires that financial information be reported on the basis that it
is reported internally for evaluating segment performance and deciding how to
allocate resources to segments. Because this Statement addresses how
supplemental financial information is disclosed in annual and interim reports,
the adoption will have no material impact on the financial statements. Statement
No. 131 is effective for financial statements for fiscal years beginning after
December 15, 1997 with early adoption encouraged.
21
Notes to Consolidated Financial Statements
NOTE 3-RESTRICTIONS ON CASH AND DUE FROM BANKS
Cash balances reserved to meet regulatory requirements of the Federal Reserve
Board and balances maintained at other banks for compensating balance
requirements amounted to $1,392,000 at December 31, 1997 and $1,308,000 at
December 31, 1996.
NOTE 4-SECURITIES
The amortized cost and estimated market values of investments in debt and equity
securities, classified as available for sale, as of December 31, 1997 and 1996
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(dollars in thousands) Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------------
1997
Debt Securities
U.S. Treasuries $ 9,545 $106 $ 0 $ 9,651
U.S. Agencies 20,649 335 (4) 20,980
States and political subdivisions 3,557 149 (1) 3,705
Mortgage-backed securities 5,036 13 (3) 5,046
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Total debt securities 38,787 603 (8) 39,382
Equity Securities 861 60 0 921
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Total securities $39,648 $663 $ (8) $40,303
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1996
Debt Securities
U.S. Treasuries $22,076 $ 99 $ (46) $22,129
U.S. Agencies 22,030 281 (48) 22,263
States and political subdivisions 4,225 136 (1) 4,360
Mortgage-backed securities 6,927 75 (11) 6,991
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Total debt securities 55,258 591 (106) 55,743
Equity Securities 1,075 41 0 1,116
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Total securities $56,333 $632 $(106) $56,859
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The amortized cost and estimated fair value of debt securities as of December
31, 1997, by contractual maturity, are shown below. Mortgage-backed securities
are included in the maturity categories based on average expected life. Actual
maturities may differ from contractual maturities if put/call options on
selected debt issues are exercised in the future.
December 31, 1997
Amortized Fair
(dollars in thousands) Cost Value
- ---------------------------------------------------------------------------------------------------------------------------
Due in one year or less $13,483 $13,513
Due after one year through five years 21,435 21,681
Due after five years through ten years 3,869 4,188
Due after ten years 0 0
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities $38,787 $39,382
- ---------------------------------------------------------------------------------------------------------------------------
Securities with an amortized cost of $21,080,000 on December 31, 1997 and
$18,624,000 on December 31, 1996 were pledged to secure public deposits and for
other purposes.
22
Notes to Consolidated Financial Statements
NOTE 5-LOANS
The composition of the loan portfolio at December 31, is as follows:
(dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Commercial, industrial and agricultural $111,074 $ 91,744
Real estate - construction and land development 21,456 15,449
- ---------------------------------------------------------------------------------------------------------------------------
Total commercial related loans 132,530 107,193
Real estate - residential mortgages 34,029 35,444
Installment 24,783 24,014
- ---------------------------------------------------------------------------------------------------------------------------
Total consumer related loans 58,812 59,458
- ---------------------------------------------------------------------------------------------------------------------------
Total loans $191,342 $166,651
===========================================================================================================================
Concentrations of credit risk arise when a number of customers are engaged in
similar business activities in the same geographic region, or have similar
economic features that could cause their ability to meet contractual obligations
to be similarly affected by changes in economic conditions. Most of the
Corporation's business is with customers in southern York County, Pennsylvania.
Although this may pose a concentration risk geographically, it is believed the
diverse local economy and detailed knowledge about the customer base minimizes
this risk. At year end 1997, approximately $36.5 million or 19% of total loans
were concentrated in the commercial facility leasing industry, and approximately
$21.5 million or 11% of total loans were concentrated in the real estate
development industry. Loans to borrowers within these industries are usually
collateralized by real estate.
The aggregate amount of loans to directors, executive officers, principal
shareholders and any associates of such persons was $3,444,000 at December 31,
1997 and $3,197,000 for 1996. During 1997, total new loan additions amounted to
$1,353,000 and total payments collected amounted to $1,106,000. Related party
loans are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
unrelated persons and do not involve more than normal risk of collection. As of
year end 1997, all loans to this group were current and performing in accordance
with original contractual terms.
The Corporation originates and classifies loans as long-term investments;
accordingly, the cost method of accounting is used. Periodically, a portion of
fixed rate residential mortgage loans are sold, without recourse, as a means of
managing interest rate risk. A determination is made as to whether any loans are
held-for-sale at reporting periods. Generally, the Corporation retains servicing
rights, which currently are immaterial, on the loans it sells. The volume of
loans serviced by the Corporation for others was $16,820,000 at December 31,
1997; $15,721,000 at December 31, 1996 and $10,850,000 at December 31, 1995.
NOTE 6-IMPAIRED AND PAST DUE LOANS
Impaired and past due loans as of December 31, were as follows:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Impaired loans $2,842 $2,063 $3,583
Loans past due 90 days or more and still accruing interest 107 524 1,755
Amount of impaired loans that have a related allowance $2,842 $2,063 $3,583
Amount of impaired loans with no related allowance 0 0 0
Allowance for impaired loans 500 371 485
Average investment in impaired loans $2,255 $3,259 $2,730
Interest income recognized on impaired loans (all cash-basis method) 103 18 120
23
Notes to Consolidated Financial Statements
NOTE 7-ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for each of the three years ended
December 31, were as follows:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Balance-beginning of year $2,110 $2,286 $2,249
Provision charged to operating expense 275 134 228
Loans charged off (406) (387) (342)
Recoveries 119 77 151
- ---------------------------------------------------------------------------------------------------------------------------
Balance-end of year $2,098 $2,110 $2,286
- ---------------------------------------------------------------------------------------------------------------------------
NOTE 8-ASSETS ACQUIRED IN FORECLOSURE
Foreclosed assets, net of reserve, amounted to $380,000 at December 31, 1997,
compared to $780,000 at December 31, 1996, and $695,000 at December 31, 1995.
The net expenses associated with these assets were approximately $50,000 for
1997, $195,000 for 1996, and $64,000 for 1995.
Changes in the allowance for assets acquired in foreclosure, for each of the
three years ended December 31, were as follows:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Balance-beginning of year $108 $ 23 $10
Provision charged to operating expense 18 129 30
Write-downs to fair value and losses incurred on sales (83) (44) (27)
Recoveries 5 0 10
- ---------------------------------------------------------------------------------------------------------------------------
Balance-end of year $ 48 $108 $23
- ---------------------------------------------------------------------------------------------------------------------------
NOTE 9-PREMISES AND EQUIPMENT
The following is a summary of the premises and equipment accounts at December
31,
(dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Land $ 1,153 $ 724
Buildings and improvements 7,921 4,216
Equipment 4,723 3,500
- ---------------------------------------------------------------------------------------------------------------------------
13,797 8,440
Less-accumulated depreciation (4,000) (3, 415)
- ---------------------------------------------------------------------------------------------------------------------------
Net premises and equipment $ 9,797 $ 5,025
- ---------------------------------------------------------------------------------------------------------------------------
24
Notes to Consolidated Financial Statements
NOTE 10-EMPLOYEE BENEFIT PLANS
Defined Benefit Plan:
On January 14, 1997, the Board of Directors of PEOPLESBANK announced that all
Defined Benefit Plan (Plan) benefit accruals be suspended as of March 1, 1997,
and the Plan terminated as of April 30, 1997. Plan termination was in accordance
with ERISA, and necessary approvals were obtained from the Pension Benefit
Guaranty Corporation and the Internal Revenue Service. The settlement of
$2,488,000 in accumulated benefit obligations by purchase of annuity contracts
for, lump sum payments to, or rollover to a qualified IRA plan for each covered
employee was completed in 1997.
Prior to 1997, the Corporation had a noncontributory defined benefit plan
covering substantially all of its employees. Benefits under the plan were based
on years of service, age at retirement and the employee's average annual
compensation over the most recent ten years. The Corporation's funding policy
was to annually contribute amounts not to exceed the maximum amount deductible
for federal income tax purposes, to an irrevocable trust. Contributions were
intended to provide not only for benefits attributed to service to date, but
also for those expected to be earned in the future.
The following table sets forth the plan's funded status and amounts recognized
in the Corporation's consolidated financial statements at December 31,
(dollars in thousands) 1996
- ---------------------------------------------------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested benefits of $1,018 in 1996 $1,109
- ---------------------------------------------------------------------------------------------------------------------------
Projected benefit obligation for service rendered to date (1,852)
Plan assets at fair value 2,395
- ---------------------------------------------------------------------------------------------------------------------------
Plan assets in excess of projected benefit obligation 543
Prior service cost 3
Unrecognized net gain from past experience different from that assumed (380)
Unrecognized net transition asset (219)
- ---------------------------------------------------------------------------------------------------------------------------
Accrued pension cost included in other liabilities $ (53)
- ---------------------------------------------------------------------------------------------------------------------------
Net periodic pension cost for years ended December 31, included the following
components:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Service cost benefits earned during the period $ 20 $ 131 $ 86
Interest cost on projected benefit obligation 22 120 97
Actual return on plan assets (84) (291) (463)
Net amortization and deferral 50 100 279
Gain on settlement (61) 0 0
- ---------------------------------------------------------------------------------------------------------------------------
Net periodic pension cost (income) $(53) $ 60 $ (1)
- ---------------------------------------------------------------------------------------------------------------------------
In determining the projected benefit obligation, the weighted average assumed
discount rate used was 7.25 percent at December 31, 1996, while the rate of
increase in future salary levels was 5 percent at December 31, 1996. The
expected long-term rate of return on assets, used in determining net periodic
pension cost, was 9 percent for 1997, 1996 and 1995.
Plan assets consisted primarily of investments in Evergreen Funds managed by
First Union National Bank. Throughout 1996, and part of 1997, plan assets were
divided between a capital appreciation equity fund and a fixed income fund.
During 1997, the Evergreen Funds were liquidated and the proceeds were invested
in an overnight money market account, until the benefit obligation was settled
in late 1997.
Defined Contribution Plan:
The Corporation maintains an employee 401(k) savings and investment plan,
covering substantially all employees. Under the plan, employees can contribute a
percentage of their gross salary. The Corporation matches a percentage of the
employee contributions. In 1997, 1996 and 1995, the Corporation matched 50% of
the first 6% of the employee's contribution. The Corporation's expense for the
401(k) deferred contribution plan was $51,000 for 1997, $44,000 for 1996, and
$44,000 for
1995.
25
Notes to Consolidated Financial Statements
NOTE 11-SHORT-TERM AND LONG-TERM BORROWINGS
The schedule below provides a three year summary of short-term borrowings
comprised of federal funds purchased and other borrowings. Federal funds
purchased from correspondent banks usually mature in one business day. Other
short-term borrowings consist of credit available through Federal Home Loan Bank
of Pittsburgh (FHLBP). At December 31, 1997, total credit available from the
FHLBP, for both short and long-term credit needs, was approximately $62.5
million, which is based on, and collateralized by, the Bank's investment
securities portfolio. Interest is calculated daily based on the federal funds
rate or the open repo market depending on the borrowing program. At December 31,
1997, total unused credit with the FHLBP was approximately $59.7 million.
A summary of aggregate short-term borrowings is as follows for the three years
ended December 31,
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Amount outstanding at end of year $ 0 $4,000 $ 0
Weighted average interest rate at end of year 0.00% 6.75% 0.00%
Maximum amount outstanding at any month-end $8,542 $5,500 $500
Daily average amount outstanding $1,281 $1,540 $ 65
Approximate weighted average interest rate for the year 5.71% 5.61% 5.71%
In January 1997, the Bank borrowed $3 million from Federal Home Loan Bank of
Pittsburgh under a ten year, 6.82% fixed rate amortizing note arrangement with a
final maturity date of January 22, 2007. The proceeds were used to help fund the
residential mortgage loan program. Long-term borrowings amounted to $2,802,000
as of December 31, 1997.
NOTE 12-DIVIDEND PAYMENT RESTRICTIONS
The Corporation is subject to restrictions on the payment of dividends to its
shareholders pursuant the Pennsylvania Business Corporation Law of 1988, as
amended (the BCL). The BCL operates generally to preclude dividend payments if
the effect thereof would render the Corporation insolvent and result in negative
net worth, as defined. Payment of dividends to the Corporation by the Bank is
subject to restrictions set forth in the Pennsylvania Banking Code of 1965, as
amended. Accordingly, the Bank's Additional Paid-In Capital (Surplus) account
balance of $3,424,000, was restricted as of December 31, 1997.
26
Notes to Consolidated Financial Statements
NOTE 13-STOCKHOLDERS' EQUITY
The Corporation declared a five percent stock dividend in April 1997 which was
paid on June 12, 1997. The stock dividend resulted in the issuance of 51,963
common shares. On December 9, 1997, the Corporation declared a one hundred
percent stock dividend which was paid January 26, 1998. This stock dividend
resulted in the issuance of 1,097,259 common shares. All per share amounts were
retroactively adjusted for stock dividends.
The Corporation maintains a Dividend Reinvestment and Stock Purchase Plan (the
Plan). Shareholders of common stock may participate in the Plan, which provides
that additional shares of common stock may be purchased with reinvested
dividends at prevailing market prices. To the extent that shares are not
available in the open market, the Corporation has reserved 115,762 shares of
common stock to be issued under the Plan. The number of shares available for
issuance under the Plan are adjusted for stock dividends and stock splits. Open
market purchases are usually made by an independent purchasing agent retained to
act as agent for Plan participants, and the purchase price to participants will
be the actual price paid, excluding brokerage commissions and other expenses
which will be paid by the Corporation. The Plan permits participants to make
additional voluntary cash payments toward the purchase of shares of the
Corporation's common stock.
A 1996 Stock Incentive Plan, administered by disinterested members of the
Corporation's Board of Directors, was approved by the shareholders at the annual
meeting held on May 21, 1996. Under the plan, 70,600 shares of common stock are
reserved for possible issuance, subject to future adjustment in the event of
specified changes in the Corporation's capital structure. In accordance with the
terms of the plan, the option exercise price for Qualified Options cannot be
less than the fair market value of the stock on the date granted. For
Non-Qualified Options, the option exercise price shall be determined by the
Committee and cannot be less than the par value of the stock on the date
granted. Options granted cannot be exercised before six months and expire in ten
years. As of December 31, 1997, 40,600 qualified stock options were granted, as
depicted in the schedule below. Options outstanding as of December 31, 1997, had
a weighted average exercise price of $17.16 and a weighted average remaining
contractual life of 9.5 years. Exercisable stock options amounted to 2,100 as of
December 31, 1997.
Stock options, adjusted for stock dividends, are as follows:
Shares Option Price
Under Option Range per share
- ---------------------------------------------------------------------------------------------------------------------------
Balance, May 21, 1996 0 0
Granted 12,600 $13.57-$13.87
Exercised 0 0
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 12,600 $13.57-$13.87
Granted 28,000 $18.75
Exercised 0 0
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 40,600 $13.57-$18.75
27
Notes to Consolidated Financial Statements
The Corporation is subject to the disclosure rules, but not accounting rules, of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." In accordance with Statement No. 123, pro forma information
regarding net income and net income per share has been determined as if the
Corporation had accounted for its employee stock options under the fair value
method of that Statement. The fair value for these options was estimated as of
the grant date using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1997 and 1996: risk-free interest rate of 5.5%,
dividend yield of 2.2%, a volatility factor of the expected market price of the
Corporation's common stock of .13 and a weighted average expected life of ten
years. No options were granted prior to 1996. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In addition, option
valuation models require input of highly subjective assumptions including the
expected stock price volatility. Since the Corporation's employee stock options
have characteristics different from those of traded options, and changes in
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of fair value of its employee stock options. For purposes of pro
forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period. The effect of applying Statement No.
123's fair value method to the Corporation's stock-based awards results in pro
forma net income and earnings per share as follows:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Net income $2,479 $2,707 $2,594
Option value compensation expense 28 4 0
- ---------------------------------------------------------------------------------------------------------------------------
Pro forma net income $2,451 $2,703 $2,594
- ---------------------------------------------------------------------------------------------------------------------------
Pro forma net income per share, basic and diluted $ 1.12 $ 1.23 $ 1.18
- ---------------------------------------------------------------------------------------------------------------------------
Stockholders' equity, or capital, is evaluated in relation to total assets and
the risk associated with those assets. There are currently three federal
regulatory definitions of capital adequacy that take the form of minimum ratios.
As of December 31, 1997, the Corporation is in compliance with all capital
adequacy requirements. The following table discloses capital adequacy
requirements and the Corporation's corresponding ratios as of December 31, 1997
and 1996:
(dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Tier I risk-based capital $23,988 $22,354
Tier II risk-based capital 2,098 2,053
- ---------------------------------------------------------------------------------------------------------------------------
Total risk-based capital $26,086 $24,407
- ---------------------------------------------------------------------------------------------------------------------------
Ratios:
Tier I risk-based capital 12.38% 13.61%
Federal minimum required 4.00 4.00
Total risk-based capital ratio 13.46% 14.86%
Federal minimum required 8.00 8.00
Leverage ratio 9.73% 9.45%
Federal minimum required 4.00 4.00
28
Notes to Consolidated Financial Statements
NOTE 14-INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Corporation's deferred tax assets and liabilities as of December 31, 1997
and December 31, 1996 are as follows:
(dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Deferred tax assets
Loan loss $ 554 $ 559
Deferred loan fees 26 105
- ---------------------------------------------------------------------------------------------------------------------------
Total deferred tax assets 580 664
- ---------------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities
Depreciation 207 188
Net unrealized losses on loans (13) 38
Net unrealized gains on securities available for sale 222 178
Other 126 39
- ---------------------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities 542 443
- ---------------------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ 38 $ 221
===========================================================================================================================
Analysis of federal income taxes reflected in the income statements is as
follows:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Current tax provision $1,008 $1,123 $1,454
Deferred tax provision 153 138 (299)
- ---------------------------------------------------------------------------------------------------------------------------
Total tax provision $1,161 $1,261 $1,155
===========================================================================================================================
The reasons for the difference between the provision for income taxes and the
amount computed by applying the statutory federal income tax rate to income
before income taxes are as follows:
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes $3,640 $3,968 $3,749
===========================================================================================================================
Computed tax at 34% $1,238 $1,349 $1,275
Increase (reduction) in taxes resulting from:
Tax exempt interest income (88) (106) (141)
Interest expense disallowance 10 13 18
Other - net 1 5 3
- ---------------------------------------------------------------------------------------------------------------------------
Provision for income taxes $1,161 $1,261 $1,155
===========================================================================================================================
The provision for income taxes includes ($6,000), $35,000, and ($21,000) of
applicable income tax (benefit) expense related to investment security (losses)
gains of ($17,000), $102,000, and ($62,000) in 1997, 1996, and 1995,
respectively.
29
Notes to Consolidated Financial Statements
NOTE 15-FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business the Corporation's banking subsidiary is a party
to various financial transactions that are not funded as of the balance sheet
date. Off-balance sheet financial instruments, which enable bank customers to
meet their financing needs, are comprised mainly of commitments to extend credit
and letters of credit.
To varying degrees, these instruments contain elements of credit and market risk
similar to those on-balance sheet financial instruments. To manage these risks
the Corporation uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments. Normally,
off-balance sheet instruments have fixed expiration dates or termination
clauses, at specific rates and for specific purposes. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Off-balance sheet instruments do not represent unusual risks for the Corporation
and management does not anticipate any significant losses as a result of these
transactions. As of December 31, 1997, outstanding commitments to extend credit
were comprised of approximately $25,218,000 in variable rate instruments, and
$11,637,000 of fixed rate instruments with rates varying from 7.15% to 10.00%.
Standby letters of credit were comprised of approximately $1,380,000 in variable
rate instruments, and $352,000 of fixed rate instruments with rates ranging from
8.50% to 9.00%.
The following is a summary of significant commitments:
December 31,
(dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Commitments to extend credit $36,855 $24,827
Standby letters of credit 1,732 3,337
NOTE 16-CONTINGENT LIABILITIES
Various legal actions or proceedings, arising in the ordinary course of
business, are pending involving the Corporation or its subsidiaries. In the
opinion of management, these matters are without merit or, if determined
adversely to the Corporation, will not have a material impact on the
Corporation's liquidity, capital resources, or results of operations.
30
Notes to Consolidated Financial Statements
NOTE 17-FAIR VALUE OF FINANCIAL INSTRUMENTS
FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments,
whether or not recognized on the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. In that regard, derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. Statement No. 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Corporation.
An analysis of financial instruments is as follows:
December 31, 1997 December 31, 1996
Carrying Fair Carrying Fair
(dollars in thousands) Amount Value Amount Value
- ---------------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and due from banks $ 7,844 $ 7,844 $ 7,349 $ 7,349
Federal funds sold 5,350 5,350 300 300
Securities 40,303 40,303 56,859 56,859
Loans 191,342 188,401 166,651 163,456
Less: allowance for loan losses (2,098) (2,098) (2,110) (2,110)
Interest receivable 1,538 1,538 1,642 1,642
- ---------------------------------------------------------------------------------------------------------------------------
Total financial assets $244,279 $241,338 $230,691 $227,496
- ---------------------------------------------------------------------------------------------------------------------------
Financial liabilities:
Demand and savings deposits $ 92,086 $ 92,086 $ 87,682 $ 87,682
Time deposits 134,177 134,884 121,778 122,328
Short-term borrowings 0 0 4,000 4,000
Long-term borrowings 2,802 2,864 0 0
Interest payable 820 820 796 796
- ---------------------------------------------------------------------------------------------------------------------------
Total financial liabilities $229,885 $230,654 $214,256 $214,806
- ---------------------------------------------------------------------------------------------------------------------------
The methods and assumptions used to estimate fair value can be found in the
"Fair Value of Financial Instruments" section of Note 1 to the Financial
Statements.
31
Notes to Consolidated Financial Statements
NOTE 18-CONDENSED FINANCIAL INFORMATION--PARENT COMPANY ONLY
Codorus Valley Bancorp, Inc.
Condensed Statements of Financial Condition
December 31,
(dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 186 $ 127
Investment in subsidiaries 19,382 21,070
Premises and equipment 5,020 1,410
Other assets 153 108
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $24,741 $22,715
- ---------------------------------------------------------------------------------------------------------------------------
Liabilities - Other $ 316 $ 9
Stockholders' Equity
Series preferred stock 0 0
Common stock 2,743 2,613
Common stock distributable 2,743 0
Additional paid-in capital 8,063 6,556
Retained earnings 10,444 13,191
Net unrealized gains on securities available for sale,
net of taxes 432 346
- ---------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 24,425 22,706
Total liabilities & stockholders' equity $24,741 $22,715
- ---------------------------------------------------------------------------------------------------------------------------
Codorus Valley Bancorp, Inc.
Condensed Statements of Income
Years ended December 31,
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Income
Dividends from PEOPLESBANK, A Codorus Valley Company $ 4,392 $ 1,746 $ 1,431
Rental income 128 19 26
Gains from sales of fixed assets 22 0 0
Other 7 9 6
- ---------------------------------------------------------------------------------------------------------------------------
Total income 4,549 1,774 1,463
Expenses - Other 377 136 84
- ---------------------------------------------------------------------------------------------------------------------------
Income before applicable income tax benefit and
undistributed earnings of subsidiaries 4,172 1,638 1,379
Applicable income tax benefit 81 36 17
- ---------------------------------------------------------------------------------------------------------------------------
Income before undistributed earnings of subsidiaries 4,253 1,674 1,396
Undistributed earnings of subsidiaries 0 1,033 1,198
Distributions of subsidiaries in excess of earnings (1,774) 0 0
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 2,479 $ 2,707 $ 2,594
- ---------------------------------------------------------------------------------------------------------------------------
32
Codorus Valley Bancorp, Inc.
Condensed Statements of Cash Flows
Years ended December 31,
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities:
Net income $ 2,479 $ 2,707 $ 2,594
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation 74 9 9
Undistributed earnings of subsidiaries 0 (1,033) (1,198)
Distributions of subsidiaries in excess of earnings 1,774 0 0
Gain on sale of premises and equipment (22) 0 0
Other, net 262 (13) (50)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 4,567 1,670 1,355
Cash Flows From Investing Activities:
Purchase of available for sale securities 0 (5) (1)
Payments for investment in subsidiary 0 0 (33)
Purchases of premises and equipment (3,789) (906) (344)
Proceeds from sales of premises and equipment 127 0 0
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (3,662) (911) (378)
Cash Flows Used For Financing Activities:
Dividends paid (836) (754) (659)
Cash paid in lieu of fractional shares (10) (8) (6)
Payment to repurchase common stock 0 0 (270)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (846) (762) (935)
- ---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalent 59 (3) 42
Cash and cash equivalents at beginning of year 127 130 88
- ---------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 186 $ 127 $ 130
===========================================================================================================================
33
Report of Independent Auditors
[ERNST & YOUNG LOGO]
Central Pennsylvania Practice Phone: 717 651 7300
Commerce Court, Suite 200 610 320 3600
2601 Market Place Fax: 717 651 7444
Harrisburg, Pennsylvania 17110-9359
Report of Independent Auditors
The Stockholders and Board of Directors
Codorus Valley Bancorp, Inc.
We have audited the consolidated statements of financial condition of Codorus
Valley Bancorp, Inc. as of December 31, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Codorus
Valley Bancorp, Inc. at December 31, 1997 and 1996, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
January 15, 1998
Ernst & Young LLP is a member of Ernst & Young International, Ltd.
34
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
The following is management's discussion and analysis of the significant changes
in the results of operations, capital resources and liquidity presented in its
accompanying consolidated financial statements for Codorus Valley Bancorp, Inc.,
a bank holding company (the Corporation), and its wholly-owned subsidiary,
PEOPLESBANK, A Codorus Valley Company (PEOPLESBANK or the Bank), formerly
Peoples Bank of Glen Rock until February 1997. The Corporation's consolidated
financial condition and results of operations consist almost entirely of the
Bank's financial condition and results of operations. Current performance does
not guarantee, assure, or may not be indicative of similar performance in the
future.
In addition to historical information, this Annual Report to Shareholders
contains forward-looking statements. The forward-looking statements contained
herein are subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected. Important factors that might
cause such a difference include, but are not limited to, those discussed in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Corporation undertakes no obligation to publicly revise or
update these forward-looking statements to reflect events or circumstances that
arise after the date hereof. Readers should carefully review the risk factors
described in other documents the Corporation files periodically with the
Securities and Exchange Commission.
OVERVIEW
................................................................................
The Economy
The national economy continued to expand in 1997 for the seventh consecutive
year, one of the longest expansions on record. The 1997 stock market was
propelled to record heights by the same factors as in the two previous years:
low inflation, low interest rates, low unemployment, strong corporate profits
and a continuous flow of money into stock market mutual funds. While most of the
economic news was positive, volatility in the capital markets increased due in
part to a financial crisis in Southeast Asia. The year 1997 ended with growing
national concern about how the Asian situation might affect future corporate
sales and profits.
Market interest rates, based on the US treasury yield curve, ended the year 1997
at lower levels, particularly at the long end of the curve. By December 1997 the
30 year treasury bond rate declined to less than 6 percent in response to low
inflation reports. The NY Prime Rate increased 25 basis points in March 1997 to
8.5 percent and remained at that level throughout 1997. Comparatively, interest
rates fluctuated throughout 1996 in response to published economic statistics.
Both ends of the yield curve moved in tandem and ended the year higher than
where they began. In the fourth quarter of 1996 rates began to decline
moderately in response to favorable inflation reports. The 30 year treasury bond
rate was less than 7 percent throughout most of the year and the NY Prime Rate
was 8.25 percent since February 1996. During 1995, market interest rates peaked
in January and began a steady descent throughout the remainder of that year. The
decline throughout 1995 was in sharp contrast to the rapid rise in rates which
characterized 1994.
The Industry
Based on information provided by the FDIC for the first three quarters of 1997,
the commercial banking industry appears to be headed toward achieving record
profits for the sixth consecutive year. The growth in commercial bank earnings
is attributable to several factors, such as: growth in interest-earning assets,
higher noninterest income, and improved asset quality, with the notable
exception of credit card loans.
As a result of legal and industry changes, it is probable the industry will
continue to experience an increase in consolidations and mergers as the
financial services industry strives to increase profits and market share. It is
equally likely the industry will increase the diversity of financial products
and services. Management believes that such consolidations and mergers, and
diversification of products and services may enhance its competitive position as
a community bank.
Business Strategies
Throughout 1997, management and the Board of Directors continued to implement a
series of initiatives, as guided by the Corporation's long-range strategic plan.
The more significant initiatives included: completion and occupancy of the
Codorus Valley Corporate Center (Corporate Center), addition of the East York
Community Banking Office, change of the Corporation's subsidiary's name
(PEOPLESBANK, A Codorus Valley Company), installation of telephone banking and
platform automation systems, and quotation of the Corporation's common stock on
the NASDAQ National Market System.
During 1996, PEOPLESBANK installed state-of-the-art computer systems, both in
the Bank and for the Trust and Investment Services Division, to provide the
capacity and flexibility needed to better support present and future clients.
For 1998 and beyond, the focus will be on franchise growth and profitability.
Franchise growth will take both a traditional path, through growth of the branch
banking network, and a more strategic path, through acquisitions of financial
services companies. Recently, PEOPLESBANK committed to a comprehensive two year
sales and product training program for its retail banking staff. Implementation
will begin in the first quarter of 1998 under the direction of a specialized
consulting firm. The purpose of the sales training program is twofold: first, to
increase sales through improved skills, knowledge and confidence; secondly, to
hasten the transformation to a client-focused corporate culture based on sales
and service.
35
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
The many strategic initiatives that were implemented over the past two years to
enhance corporate infrastructure were deemed necessary to improve the
organization's ability to compete, and to create long-term value for its clients
and shareholders. The reader should be mindful of the aforementioned strategic
initiatives, and future strategies, relative to their impact on the financial
results of the Corporation.
Corporate Performance
The Corporation earned $2,479,000 or $1.13 per share for 1997, compared to
$2,707,000 or $1.23 for 1996, and $2,594,000 or $1.18 per share for 1995.
Earnings per share amounts were retroactively adjusted for stock dividends,
including the two-for-one stock split effected in the form of a 100 percent
stock dividend paid in January 1998. As anticipated, 1997 net income was down
from the previous year due primarily to a higher level of noninterest operating
expense. The increase in operating expense for 1997 was due to increased
investment in technology, the Codorus Valley Corporate Center and the branch
banking network. Comparatively, net income increased in 1996 above 1995 due
primarily to a larger volume of average earning assets, a reduction in FDIC
assessment expense, and gains from the sale of investment securities.
Annual cash dividends per share were $.38 for 1997, compared to $.34 for 1996,
and $.30 for 1995. Additionally, a 5 percent stock dividend was paid in 1997,
1996 and 1995. Book value per share was $11.13 for 1997, compared to $10.35 for
1996 and $9.58 for 1995. Per share amounts were retroactively adjusted for stock
dividends.
Net income as a percentage of average stockholders' equity, or return on equity
(ROE), was 10.4 percent for 1997, compared to 12.4 percent for 1996, and 13.3
percent for 1995. Net income as a percentage of total average assets, or return
on assets (ROA), was 1.00 percent for 1997, compared to 1.14 percent for 1996
and 1995.
At December 31, 1997, nonperforming assets as a percentage of total loans and
net assets acquired in foreclosure was approximately 1.68 percent, compared to
1.70 percent for 1996, and 2.66 percent for 1995. Information regarding
nonperforming assets is provided in the Nonperforming Assets Section of this
Report, including Table 8.
Throughout 1997, a capital level well above regulatory requirements was
maintained. Currently there are three federal regulatory definitions of capital
that take the form of minimum ratios. Table 7 depicts that the Corporation
exceeds all current federal minimum regulatory standards.
The allowance (reserve) for possible loan losses as a percentage of total loans
was 1.10 percent at December 31, 1997, compared to 1.27 percent at December 31,
1996, and 1.43 percent at December 31, 1995. The decline in the loan loss
reserve ratio reflected improving asset quality. Additional information is
provided in the Allowance for Loan Losses Section of this commentary, including
Tables 9 and 10. Based on a recent evaluation of potential loan losses and the
current loan portfolio, management believes that the allowance is adequate to
support any reasonably foreseeable level of losses that may arise.
A more detailed analysis of the factors and trends affecting Corporate earnings
follows.
INCOME STATEMENT ANALYSIS
................................................................................
Net Interest Income
Net interest income is the Corporation's principal source of revenue,
representing the difference between interest income earned on loans and
investment securities, and interest expense incurred on deposits. The change in
net interest income from year to year is caused by changes in interest rates,
changes in volume, and changes in the composition or mix of interest sensitive
assets and liabilities.
TABLE 1-NET INTEREST INCOME (taxable equivalent basis)
December 31, 5-yr
(dollars in thousands) 1997 1996 1995 1994 1993 CGR
- -----------------------------------------------------------------------------------------------------------------------------
Total interest income $ 19,513 $ 18,523 $ 18,346 $ 16,053 $ 15,696 3.2%
Tax equivalent adjustment 118 144 197 189 233 n/a
- ------------------------------------------------------------------------------------------------------------------
Adjusted total interest income 19,631 18,667 18,543 16,242 15,929 2.9%
Total interest expense 9,096 8,756 8,722 6,940 7,283 1.0%
- ------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent basis) $ 10,535 $ 9,911 $ 9,821 $ 9,302 $ 8,646 4.8%
==================================================================================================================
Average earning assets $ 229,047 $ 223,203 $ 216,429 $ 203,399 $ 193,972 4.4%
Average interest bearing liabilities 203,831 196,860 191,701 179,756 173,727 4.0%
Yield on earning assets 8.57% 8.36% 8.57% 7.99% 8.21%
Rate on interest bearing liabilities 4.46% 4.45% 4.55% 3.86% 4.19%
- ------------------------------------------------------------------------------------------------------------------
Interest rate spread 4.11% 3.91% 4.02% 4.13% 4.02%
Net yield on average earning assets 4.60% 4.44% 4.54% 4.57% 4.46%
- -----------------------------------------------------------------------------------------------------------------------------
36
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
TABLE 2-RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(taxable equivalent basis)
Year ended 1997 vs. 1996
December 31, ----------------------------------------
Increase Change due to
(dollars in thousands) 1997 1996 (Decrease) Volume Rates
- ---------------------------------------------------------------------------------------------------------------------------
Interest Income
Interest bearing deposits with banks $ 15 $ 21 $ (6) $ (7) $ 1
Federal funds sold 162 92 70 69 1
Securities, taxable 2,779 3,711 (932) (1,018) 86
Securities, tax-exempt 305 382 (77) (80) 3
Loans, taxable (1) 16,329 14,421 1,908 2,051 (143)
Loans, tax-exempt 41 40 1 20 (19)
- ---------------------------------------------------------------------------------------------------------------------------
Total interest income 19,631 18,667 964 1,035 (71)
Interest Expense
Deposits:
Interest bearing demand 1,250 1,221 29 72 (43)
Savings 472 538 (66) (27) (39)
Time deposits under $100,000 6,103 6,051 52 18 34
Time deposits $100,000 and above 1,010 859 151 128 23
Short-term borrowings 73 87 (14) (15) 1
Long-term borrowings 188 0 188 188 0
- ---------------------------------------------------------------------------------------------------------------------------
Total interest expense 9,096 8,756 340 364 (24)
Net interest income $10,535 $ 9,911 $ 624 $ 671 $ (47)
===========================================================================================================================
Year ended 1996 vs. 1995
December 31, -----------------------------------------
Increase Change due to
(dollars in thousands) 1996 1995 (Decrease) Volume Rates
- ---------------------------------------------------------------------------------------------------------------------------
Interest Income
Interest bearing deposits with banks $ 21 $ 13 $ 8 $ 6 $ 2
Federal funds sold 92 168 (76) (69) (7)
Securities, taxable 3,711 3,329 382 450 (68)
Securities, tax-exempt 382 441 (59) (52) (7)
Loans, taxable (1) 14,421 14,453 (32) 215 (247)
Loans, tax-exempt 40 139 (99) (102) 3
- ---------------------------------------------------------------------------------------------------------------------------
Total interest income 18,667 18,543 124 448 (324)
Interest Expense
Deposits:
Interest bearing demand 1,221 1,304 (83) 32 (115)
Savings 538 560 (22) 3 (25)
Time deposits under $100,000 6,051 6,012 39 74 (35)
Time deposits $100,000 and above 859 843 16 62 (46)
Short-term borrowings 87 3 84 68 16
- ---------------------------------------------------------------------------------------------------------------------------
Total interest expense 8,756 8,722 34 239 (205)
Net interest income $ 9,911 $ 9,821 $ 90 $ 209 $ (119)
===========================================================================================================================
(1) Includes loan fees of $329,000 in 1997, $307,000 in 1996, and $324,000 in
1995.
37
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
TABLE 3-AVERAGE BALANCES AND INTEREST RATES (taxable equivalent basis)
1997 1996 1995
------------------------- ------------------------- ------------------------
Average Average Average
(dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------
Assets
Interest bearing deposits with banks $237 $15 6.33% $346 $21 6.07% $236 $13 5.51%
Federal funds sold 2,938 162 5.51 1,675 92 5.49 2,856 168 5.88
Investment securities:
Taxable 44,005 2,779 6.32 60,632 3,711 6.12 53,406 3,329 6.23
Tax-exempt 3,709 305 8.22 4,689 382 8.15 5,322 441 8.29
- -----------------------------------------------------------------------------------------------------------------------------
Total investment securities 47,714 3,084 6.46 65,321 4,093 6.27 58,728 3,770 6.42
Loans:
Taxable (1) 177,609 16,329 9.19 155,492 14,421 9.27 153,218 14,453 9.43
Tax-exempt 549 41 7.47 369 40 10.84 1,391 139 9.99
- -----------------------------------------------------------------------------------------------------------------------------
Total loans 178,158 16,370 9.19 155,861 14,461 9.28 154,609 14,592 9.44
- -----------------------------------------------------------------------------------------------------------------------------
Total earning assets 229,047 19,631 8.57 223,203 18,667 8.36 216,429 18,543 8.57
Other assets (2) 17,385 13,258 10,838
Total assets $246,432 $236,461 $227,267
=============================================================================================================================
Liabilities and Stockholders' Equity
Interest bearing deposits:
Interest bearing demand $50,851 1,250 2.46 $48,005 1,221 2.54 $46,850 1,304 2.78
Savings 20,776 472 2.27 21,854 538 2.46 21,742 560 2.58
Time deposits under $100,000 109,769 6,103 5.56 109,438 6,051 5.53 108,116 6,012 5.56
Time deposits $100,000 and above 18,410 1,010 5.49 16,023 859 5.36 14,928 843 5.65
- -----------------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 199,806 8,835 4.42 195,320 8,669 4.44 191,636 8,719 4.55
Short-term borrowings 1,281 73 5.70 1,540 87 5.65 65 3 4.62
Long-term borrowings 2,744 188 6.85 0 0 0.00 0 0 0.00
- -----------------------------------------------------------------------------------------------------------------------------
Total interest bearing
liabilities 203,831 9,096 4.46 196,860 8,756 4.45 191,701 8,722 4.55
Noninterest bearing deposits 17,493 16,504 14,871
Other liabilities 1,234 1,276 1,126
Stockholders' equity 23,874 21,821 19,569
Total liabilities and
stockholders' equity $246,432 $236,461 $227,267
=============================================================================================================================
Interest rate spread 4.11% 3.91% 4.02%
- -----------------------------------------------------------------------------------------------------------------------------
Net yield on earning assets 4.60% 4.44% 4.54%
- -----------------------------------------------------------------------------------------------------------------------------
(1) Includes loan fees of $329,000 in 1997, $307,000 in 1996, and $324,000 in
1995.
(2) Includes average nonaccrual loans of $2,255,000 in 1997, $3,259,000 in
1996, and $2,730,000 in 1995.
38
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
For analytical purposes, Table 1-Net Interest Income, Table 2- Rate/Volume
Analysis of Changes in Net Interest Income, and Table 3- Average Balances and
Interest Rates, are all presented on a taxable equivalent basis and are used in
the analysis of net interest income. Income from tax-exempt assets, primarily
loans to or securities issued by state and local governments, is increased by an
amount equivalent to the federal income taxes which would have been incurred if
the income was taxable at the statutory rate of 34 percent. Such an adjustment
facilitates comparison between taxable and tax-exempt assets.
Net interest income increased $624,000 or 6.3 percent, on a taxable equivalent
basis, in 1997 vs. 1996 due primarily to a larger volume of average earning
assets, principally commercial loans. Comparatively, net interest income
increased $90,000 or 0.9 percent, on a taxable equivalent basis, in 1996 vs.
1995 due primarily to a larger volume of average earning assets, principally
investment securities.
The net yield on average earning assets, ie., net interest
margin, was 4.60 percent for 1997, compared to 4.44 percent for 1996 and 4.54
percent for 1995. For 1997, the margin widened slightly due to improved yields
on earning assets.
For 1997, total interest income, on a taxable equivalent basis, was $19,631,000,
up $964,000 or 5.2 percent above 1996. This increase was due primarily to a
larger volume of average earning assets, principally commercial loans. Total
earning assets averaged $229 million to yield 8.57 percent for 1997, compared to
$223 million and 8.36 percent for 1996. As a result of improved loan demand in
the current period, the average volume of loans increased $22.3 million or 14
percent in 1997. The proceeds from matured bonds were used to partially fund
loan growth, accordingly the average volume of investment securities declined
$17.6 million or 27 percent. In July 1997, the Bank sold a $3.7 million
portfolio of held-for-sale residential mortgage loans. The loan sale generated a
pretax gain of $54,000. Servicing rights were retained by the Bank.
For 1996, total interest income, on a taxable equivalent basis, was $18,667,000,
up $124,000 or 0.7 percent above 1995. This increase was due primarily to a
larger average volume of earning assets, principally investment securities. In
1996, total earning assets averaged $223 million to yield 8.36 percent, compared
to $216 million and 8.57 percent for 1995. In April 1996, the Bank sold a $7
million portfolio of held-for-sale, fixed rate mortgage loans in an effort to
manage interest rate risk. A small gain was realized on the sale and servicing
rights were retained by the Bank. In light of weak loan demand and competitive
pressures, the proceeds from the loan sale were invested primarily in investment
securities. In December 1996, the Bank sold $6 million of available-for-sale
investment securities, at a gain, to generate liquidity and enhance net income.
For 1997, total interest expense was $9,096,000, up $340,000 or 3.9 percent
above 1996. This increase was due to a larger average volume of interest bearing
liabilities, principally time deposits and long-term borrowings. Total interest
bearing liabilities averaged $204 million for 1997, up $7 million or 3.5 percent
above 1996. In January 1997, the Bank borrowed $3 million from the Federal Home
Loan Bank of Pittsburgh (FHLBP) under a ten year, 6.82 percent fixed rate note
arrangement to help fund its residential mortgage loan program. The average cost
of interest bearing deposits for 1997 was 4.42 percent compared to 4.44 percent
for 1996. Robust stock market performance over the past several years has
constrained deposit growth for PEOPLESBANK, and the commercial banking industry,
as households and businesses increased their investment in the stock and mutual
fund markets. In light of this trend, and competitive pressures in general,
borrowed funds will become an increasingly important source of funding.
For 1996, total interest expense was $8,756,000, up $34,000 or 0.4 percent above
1995. This increase was due primarily to a larger average volume of interest
bearing liabilities, principally time deposits and short-term borrowings. Total
interest bearing liabilities averaged $197 million for 1996, up $5 million or
2.7 percent above 1995. In light of weak loan demand in the local marketplace,
the Bank did not aggressively price deposits during 1996. Funding was achieved
in part, particularly during the second half of 1996, through short-term
advances from the FHLBP. The average cost of interest bearing deposits was 4.44
percent for 1996 compared to 4.55 percent for 1995.
Based on the results of a recent point-in-time analysis of interest rate risk
(one year horizon), the repricing characteristics of the Corporation's assets
and liabilities are generally in line with interest rate risk policy guidelines.
Provision for Loan Losses
The provision for possible loan losses is an estimated expense charged to
earnings in anticipation of losses attributable to uncollectible loans. The
provision reflects management's judgement of an appropriate level for the
allowance (reserve) for loan losses.
The provision expense was $275,000 for 1997 compared to $134,000 for 1996. The
increase in the loan loss provision during 1997 was due to loan growth and net
charge-offs. Comparatively, the provision expense for 1995 was $228,000. Table 9
provides details concerning the reserve and provision for loan losses over the
past five years.
Noninterest Income
Total noninterest income for 1997 was $1,227,000, up $137,000 or 12.6 percent
above 1996. The increase in noninterest income was primarily attributable to an
increase in trust and investment service fees due to business growth and
appreciation in the value of assets managed.
39
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
Comparatively, total noninterest income for 1996 was $1,090,000, up $178,000 or
19.5 percent above 1995. To achieve comparability in noninterest income from
normal operations, infrequent gains and losses from the sale of assets should be
excluded. On an adjusted basis, total noninterest income for 1996 was $981,000
representing a slight increase above the prior year. In December 1996 the Bank
sold $6 million in available-for-sale investment securities at a gain of
$102,000. The investment securities were sold to provide liquidity and enhance
net income.
For 1998, noninterest income from normal operations is
projected to exceed the 1997 level due primarily to planned business growth.
Additionally, rental income from leasing space in the Corporate Center is
expected to increase noninterest income.
Noninterest Expense
Total noninterest expense for 1997 was $7,729,000, up $974,000 or 14.4 percent.
The $974,000 increase in noninterest expense reflects the implementation of
strategic initiatives in 1997 and 1996 to expand, staff and equip the
organization. These long-term investments were made to position the Corporation
for future expansion and to increase its service capabilities.
The implementation of strategic initiatives resulted in increases within the
following expense categories: salaries and benefits; occupancy; furniture and
equipment; postage, stationery and supplies; and marketing and advertising.
Salaries and benefits increased $333,000 or 9 percent in 1997 to support planned
business growth. The increase included staffing the eighth full service
community banking office which opened in April 1997. Occupancy expense increased
$178,000 or 42 percent in 1997 due to increased depreciation, maintenance and
property taxes associated with the newest branch office addition, and the
Corporate Center which was operational in August 1997. The cost to purchase,
renovate and furnish the branch office addition was approximately $825,000.
Total investment in the Corporate Center was approximately $5.7 million, which
includes land, construction and furnishing costs. The building will be
depreciated over a forty year estimated useful life for financial reporting
purposes. Seventy-five percent of the space is leased to the Bank, the remaining
twenty-five percent is available for lease to nonaffiliated parties. To date,
approximately one fourth of the space available for lease to nonaffiliated
parties has been leased. Furniture and equipment expense increased $271,000 or
46 percent due to depreciation and maintenance costs from increased investment
in computer systems and equipment purchased in 1997 and the latter half of 1996.
Current period furniture depreciation expense increased as a result of
furnishing the Corporate Center. Postage, stationery and supplies expense
increased $96,000 or 30 percent due to normal business growth, a branch office
addition, and changing the name of the Corporation's banking subsidiary.
Marketing and advertising increased $106,000 or 45 percent due primarily to
promotional expenses associated with the Bank's name change, the new branch
office and the Corporate Center.
Total noninterest expense for 1996 was $6,755,000, up $196,000 or 3 percent
above the $6,559,000 incurred for 1995. The overall increase was due primarily
to increases within the salaries and benefits, acquired real estate and other
expense categories. Salaries and benefits expense increased $159,000 or 4.5
percent due to normal merit raises and planned staff additions deemed necessary
to support business growth. Acquired real estate expenses increased $131,000 or
205 percent in 1996 due to greater carrying costs and deterioration in the value
of a larger portfolio of acquired assets. Other expenses, an aggregate of many
individual expenditures, increased $107,000 or 7.9 percent due primarily to
system enhancements and normal business growth. The overall increase in
noninterest expense for 1996 was lessened by a significant $230,000 reduction in
FDIC deposit insurance premium expense. During that period, well capitalized and
well managed commercial bank members were charged a minimum membership fee by
the FDIC. An FDIC update is provided later within this section of the report. A
final comment about 1996 expenditures pertains to furniture and equipment
expense. The Bank's host computer system became fully depreciated in 1995 which
reduced depreciation expense from equipment for most of 1996. However, in
September 1996, pursuant to the Strategic Plan, the Bank purchased a new host
computer system and sixty personal computers which totalled approximately
$750,000. The projected annual depreciation expense for the new host system and
personal computers will approximate $175,000.
Noninterest expense is expected to increase in the period ahead due to past and
planned strategic initiatives, and normal business growth.
Year 2000 Compliance
The Year 2000 issue poses significant risks for all businesses, households and
governments. The risk is that on January 1, 2000, date sensitive systems using
two digits to represent the year may not be able to distinguish between the Year
2000 and the Year 1900. The date problem could result in system failures or
miscalculations causing disruptions in normal business and governmental
operations. The problem has broad implications far beyond familiar computer
systems and could adversely impact security systems, telephone systems, climate
control systems, elevators, automobiles and other date sensitive systems.
Unfortunately, there is no universal solution for this problem and resolution of
the Year 2000 issue may be both labor intensive and costly for some companies.
Resolving the Year 2000 issue is one of the Corporation's highest priorities. In
1997, a project team was formed to address the Year 2000 issue. Based on an
internal assessment of the Corporation's systems and software, the project team
40
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
determined that some existing systems and software must be replaced prior to the
millennium. The cost of replacing these systems is not expected to be
significant.
The Corporation has initiated communications with its major vendors to determine
the extent to which these third parties will be Year 2000 compliant. To date,
responses have been positive; however, there are no guaranties that the systems
and software of other companies on which the Corporation relies will be Year
2000 compliant. As a precaution the Corporation will test and develop
contingency plans for mission critical systems.
Finally, the Bank has communicated with its large commercial borrowers. These
borrowers pose a credit risk to the Bank if they are not Year 2000 compliant,
and their businesses are disrupted. Responses from large commercial borrowers
are being evaluated presently.
In accordance with regulatory mandate, the Corporation's goal is to be
substantially Year 2000 compliant by year end 1998. However, uncertainties
remain about whether or not the Corporation's third party vendors and large
commercial borrowers will be Year 2000 compliant. Accordingly, the financial
impact of the Year 2000 issue on the Corporation's assets, earnings and
liquidity cannot be determined at this time.
Insurance Sales
During 1997, Pennsylvania enacted a law to permit State chartered banking
institutions to sell insurance. This followed the U.S. Supreme Court decision in
favor of nationwide insurance sales by banks and barring states from blocking
insurance sales by national banks in towns with populations of no more than
5,000. The Bank is currently evaluating its options regarding the sale of
insurance.
Deposit Insurance Fund Act of 1996
On September 30, 1996, the President signed into law the Deposit Insurance Fund
Act of 1996 (the Act) to recapitalize the Savings Association Insurance Fund
(SAIF) administered by the FDIC and to provide for repayment of the Financial
Institution Collateral Obligation Bonds (FICO) issued by the Treasury
Department. Under the Act, SAIF members, ie., thrifts, will pay a one-time
special assessment in 1996 estimated at 65.7 cents per $100 of insured deposits
to capitalize the SAIF. For 1997 through 1999, thrifts and commercial banks will
each pay a portion of the interest on FICO bonds estimated at 6.44 cents and
1.26 cents, respectively, per $100 of insured deposits. Beginning in the year
2000, and continuing until the FICO bonds are retired in 2018-2019, thrifts and
commercial banks will pay the same FICO assessment rate. As always, the FDIC
will be able to raise the assessments as necessary to maintain the funds at
their target capital ratios provided by law. On January 1, 1999, the SAIF and
the Bank Insurance Fund (BIF) will merge to form the Deposit Insurance Fund
(DIF) if certain stipulations are met. The Act also provided regulatory relief
to the financial services industry relative to environmental risks, frequency of
examinations, and the simplification of forms and disclosures. For 1997, the
FICO assessment expense for the Bank was approximately $26,000 based on a rate
of 1.26 cents per $100 of insured deposits.
Income Taxes
The provision for federal income taxes was $1,161,000 for 1997 compared to
$1,261,000 for 1996. The decline in the tax provision expense for 1997 was due
to a lower level of income before income taxes. Comparatively, the tax provision
expense for 1996 was greater than 1995 due to a higher level of income before
income taxes.
BALANCE SHEET REVIEW
................................................................................
Investment Securities
The investment securities portfolio is an interest earning asset, second only in
size to the loan portfolio. Investment securities serve as an important source
of revenue, a primary source of liquidity, and as collateral for public
deposits. The total investment securities portfolio is classified as
available-for-sale in accordance with Financial Accounting Statement No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" (Statement
No. 115).
Investment is limited to high quality debt instruments. Direct obligations of
the U.S. Government are full faith and credit obligations of the federal
government. Issues of federal agencies are also directly guaranteed, indirectly
guaranteed, or sponsored, by the federal government. Obligations of states and
political subdivisions, known as "municipals," are also maintained in the
portfolio. In accordance with investment policy, municipal securities are
limited to not more than $1 million per issuer.
At December 31, 1997, maturities, or average expected life, for individual
issues ranged from less than one year to approximately eight years. The weighted
average maturity of the investment security portfolio was 2.1 years for years
ended 1997 and 1996, and 2.2 years at year end 1995. A maturity distribution by
security type, and weighted average yields are presented in Table 4.
At year end 1997, the total investment securities portfolio had an amortized
cost of $39,648,000 and a fair value of approximately $40,303,000, representing
appreciation of $655,000 or 1.7 percent. Comparatively, at year end 1996 the
total investment securities portfolio had an amortized cost of $56,333,000 and a
fair value of approximately $56,859,000, representing appreciation of $526,000
or 0.9 percent. During 1997, the investment securities portfolio declined as
proceeds from scheduled maturities, bond calls, and cash flow from
mortgage-backed issues were used primarily to fund loan demand. Appreciation in
value for both periods reflected declining market interest rates. Unrealized
holding gains and losses, net of applicable taxes, are recorded in accordance
with Statement No. 115.
41
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
TABLE 4-ANALYSIS OF INVESTMENT SECURITIES
Weighted
U.S. U.S. State & Average
(dollars in thousands) Treasury Agency (1) Municipal Stock Total Yield(2)
- ---------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Maturity
Within one year $ 2,990 $ 9,764 $ 729 $13,483 6.23%
One to five years 6,555 13,466 1,414 21,435 6.66
Five to ten years 2,455 1,414 3,869 8.16
Over ten years
No set maturity 861 861
- ---------------------------------------------------------------------------------------------------------
Amortized cost $ 9,545 $25,685 $3,557 $ 861 $39,648 6.66
=========================================================================================================
Average maturity 2.1 years
DECEMBER 31, 1996
Maturity
Within one year $ 9,530 $ 6,392 $ 884 $ 16,806 5.50%
One to five years 12,546 20,115 1,578 34,239 6.33
Five to ten years 2,450 1,763 4,213 8.26
Over ten years
No set maturity 1,075 1,075
- ---------------------------------------------------------------------------------------------------------
Amortized cost $22,076 $28,957 $4,225 $1,075 $56,333 6.22
=========================================================================================================
Average maturity 2.1 years
DECEMBER 31, 1995
Maturity
Within one year $ 7,499 $ 8,477 $ 374 $16,350 6.42%
One to five years 15,100 22,214 2,442 39,756 6.11
Five to ten years 1,458 2,343 3,801 8.73
Over ten years
No set maturity 838 838
- ---------------------------------------------------------------------------------------------------------
Amortized cost $22,599 $32,149 $5,159 $ 838 $60,745 6.36
=========================================================================================================
Average maturity 2.2 years
(1) Collateralized-mortgage obligations (CMOs) and mortgage-backed securities
(MBSs) are included in the maturity categories based on average expected
life.
(2) Yields on tax-exempt obligations were computed on a taxable equivalent
basis using a 34 percent tax rate.
42
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
Loans
Total average investment in loans for 1997 was $178.2 million, up $22.3 million
or 14.3 percent above 1996, due primarily to growth in the commercial loan
portfolio. Consumer loans, principally installment and home equity loans, also
experienced growth in average balances for 1997. A growing local economy, and
relatively low interest rates and unemployment, were factors which contributed
to loan demand. In July 1997, the Bank sold a $3.7 million portfolio of
held-for-sale residential mortgage loans which generated a pretax gain of
$54,000.
Total average investment in loans for 1996 was $155.9 million, up $1.3 million
or 0.8 percent above 1995. Loan growth in 1996 was affected by the sale of a $7
million portfolio of held-for-sale residential mortgage loans in April. The loan
sale generated a pretax gain of $7,500.
Table 5 presents the composition of total loans on a comparative basis for a
five year period. The table reflects an emphasis on commercial lending, with a
relatively stable mix of commercial and consumer related loans over the past
five years.
Table 6 reveals that the commercial loan portfolio was comprised of $83.0
million or 62.7 percent in fixed rate loans and $49.4 million or 37.3 percent in
floating or adjustable rate loans at year end 1997. Comparatively, for year end
1996 the portfolio was comprised of $62.8 million or 58.6 percent in fixed rate
loans and $44.3 million or 41.4 percent in floating or adjustable rate loans.
Floating rate loans reprice periodically with changes in the Bank's base rate,
or the Prime Rate as reported in the Wall Street Journal. Adjustable rate loans
reprice at annual intervals based on the U.S. treasury yield curve. Both the
volume and percentage of fixed rate commercial loans increased in 1997 due to a
relatively low interest rate environment which induced some customers to
refinance to fixed rate loans.
The Bank serviced loans for others in the amount of $16.8 million at year end
1997, compared to $15.7 million at year end 1996, and $10.9 million at year end
1995. Servicing rights were retained from mortgage loan sales to provide a
source of income and a basis for cross-selling additional financial services.
The relatively low level of market interest rates and the prospect for future
declines due to low inflation and a declining federal deficit, in conjunction
with low unemployment, create a favorable climate for credit services in the
period ahead. To some degree, loan growth will be constrained by increasing
competitive pressures.
- --------------------------------------------------------------------------------
TABLE 5-LOAN PORTFOLIO COMPOSITION
December 31,
(dollars in thousands) 1997 % 1996 % 1995 % 1994 % 1993 %
- ---------------------------------------------------------------------------------------------------------------------------
Commercial, industrial and agricultural $111,074 58.1 $ 91,744 55.0 $ 81,119 50.7 $ 77,984 51.8 $ 78,383 55.8
Real estate - construction and
land development 21,456 11.2 15,449 9.3 19,817 12.4 19,501 12.9 16,811 11.9
- ---------------------------------------------------------------------------------------------------------------------------
Total commercial related loans 132,530 69.3 107,193 64.3 100,936 63.1 97,485 64.7 95,194 67.7
Real estate-residential mortgages 34,029 17.8 35,444 21.3 36,286 22.7 32,240 21.4 26,866 19.1
Installment 24,783 12.9 24,014 14.4 22,786 14.2 20,912 13.9 18,497 13.2
- ---------------------------------------------------------------------------------------------------------------------------
Total consumer related loans 58,812 30.7 59,458 35.7 59,072 36.9 53,152 35.3 45,363 32.3
Total loans $191,342 100.0 $166,651 100.0 $160,008 100.0 $150,637 100.0 $140,557 100.0
- ---------------------------------------------------------------------------------------------------------------------------
TABLE 6-SELECTED LOAN MATURITIES AND INTEREST RATE SENSITIVITY
December 31, 1997
Years to Maturity
(dollars in thousands) 1 or less 1 to 5 over 5 Total
- ---------------------------------------------------------------------------------------------------------------------------
Commercial, industrial and agricultural $14,257 $23,986 $ 72,801 $111,044
Real estate-construction and land development 7,476 8,016 5,964 21,456
- ---------------------------------------------------------------------------------------------------------------------------
Total commercial related $21,733 $32,002 $ 78,765 $132,500
- ---------------------------------------------------------------------------------------------------------------------------
Fixed interest rates $ 4,858 $20,054 $ 58,126 $ 83,038
Floating or adjustable interest rates 16,875 11,948 20,639 49,462
- ---------------------------------------------------------------------------------------------------------------------------
Total commercial related $21,733 $32,002 $ 78,765 $132,500
- ---------------------------------------------------------------------------------------------------------------------------
43
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
FUNDING
................................................................................
Deposits
Deposits are a principal source of funding for loans and investment securities.
For 1997, total average deposits were $217.3 million, up $5.5 million or 2.6
percent above 1996, primarily in the interest-bearing demand and time deposit
($100,000 and above) categories. Deposit growth in 1997 was achieved primarily
through competitive rates on time deposits and new deposits associated with the
addition of a full service banking office in April.
Comparatively, total average deposits for 1996 were $211.8 million, up $5.3
million or 2.6 percent above 1995, and reflected growth in all major deposit
categories. In light of modest loan demand in the local marketplace, the Bank
did not aggressively price deposits during 1996.
At 1997 year end, total certificates of deposit were $134,177,000 and are
scheduled to mature in the following years: $71,616,000 in 1998; $20,520,000 in
1999; $36,250,000 in 2000; $2,150,000 in 2001; and $3,641,000 in 2002. At 1997
year end, the balance of certificates $100,000 and above was $21,303,000. Of
this total: $8,789,000 mature within three months; $3,717,000 mature after three
months but within six months; $3,546,000 mature after six months but within
twelve months; and the remaining $5,251,000 mature beyond twelve months.
In the period ahead, deposit growth is projected to increase at a level above
1997. This projection is based on recent branch expansion, the implementation of
a formal sales and product training program, and planned introduction of new
deposit products. Competitive pressures, particularly the stock and mutual funds
markets, may continue to constrain deposit growth for commercial banks in the
period ahead.
Short-Term and Long-Term Borrowings
To meet day-to-day funding needs the Bank may borrow from larger correspondent
banks, in the form of federal funds purchased. It also utilizes available credit
through the Federal Home Loan Bank of Pittsburgh (FHLBP). The rate is
established daily based on prevailing market conditions for overnight funds.
The Bank's maximum borrowing capacity, as established quarterly by the FHLBP,
was approximately $62.5 million as of September 30, 1997, the most recent
available date. At December 31, 1997, the Bank had $2.8 million outstanding on
its account with the FHLBP.
In January 1997, the Bank borrowed $3 million from the FHLBP under a ten year,
6.82 percent fixed rate amortizing note arrangement with a final maturity date
of January 22, 2007. The proceeds were used to help fund the residential
mortgage loan program. Long-term debt amounted to $2.8 million at December 31,
1997.
In light of competitive pressures and the public allure with the stock and
mutual funds markets, traditional deposit funding, by necessity, will continue
to be supplemented with borrowed funds.
Stockholders' Equity
Stockholders' equity, or capital, is a source of funds which enables the
Corporation to maintain asset growth and to absorb losses. For year end 1997,
total stockholders' equity was $24.4 million, reflecting growth of $1.7 million
or 7.6 percent above year end 1996. Comparatively, for year ended 1996, total
equity grew $1.7 million or 8 percent above year end 1995. The increase in total
equity for both periods was due primarily to earnings retention from profitable
operations.
The Corporation's level of capital at December 31, 1997, remained strong, with
capital ratios well in excess of regulatory guidelines. There are currently
three federal regulatory definitions of capital adequacy that take the form of
minimum ratios. Table 7 depicts that the Corporation exceeds all federal minimum
regulatory standards.
The Corporation generally pays cash dividends on a quarterly basis. The dividend
rate is determined by the Board of Directors (Board) after considering the
Corporation's capital requirements, current and projected net income, and other
factors. Annual cash dividends on a per common share basis were $.38 for 1997,
$.34 for 1996, and $.30 for 1995. All per share amounts were adjusted for stock
dividends.
Periodically, the Corporation pays stock dividends as another means of enhancing
long-term shareholder value. In June of 1997, 1996 and 1995 the Corporation paid
a five percent stock dividend. The five percent stock dividends resulted in the
issuance of 51,963 common shares in 1997, 49,503 shares in 1996, and 47,161
shares in 1995. In January 1998, the Corporation paid a two-for-one stock split
effected in the form of a one hundred percent stock dividend. The stock split
resulted in the issuance of 1,097,259 shares of common stock. The weighted
average number of shares of common stock outstanding was 2,194,518 for 1997 and
1996, and 2,190,266 for 1995.
Capital investments made in 1997 and 1996, and additional planned investment,
relative to physical expansion, technological system solutions, and the possible
acquisition of financial services companies, could reduce net income and capital
growth in the period ahead. However, these investments are necessary to grow
market share and net income over the long-term, and are important components of
the overall strategy of enhancing long-term shareholder value.
A 1996 Stock Incentive Plan was approved by the shareholders at the annual
meeting held on May 21, 1996. Under the Plan, 70,600 common shares are reserved
for possible issuance, subject to future adjustment in the event of specified
changes in the Corporation's capital structure. As of December 31, 1997, 40,600
stock options were granted under the Plan, none
44
of which were exercised. More information about the 1996 Stock Incentive Plan is
provided in Note 13 to the financial statements.
During November 1995, the Board of Directors adopted a Shareholder Rights Plan
(SRP) as previously disclosed in a Form 8-K filed on December 4, 1995. Each
right entitles the registered holder to purchase from the Corporation one share
of common stock at a price of $100.00 per share, subject to adjustment. Rights
are triggered by certain events defined in the SRP, including the acquisition of
a specified percentage of the Corporation's shares. Rights are not exercisable
until the occurrence of such certain specified triggering events and expire on
November 4, 2005, unless earlier redeemed by the Corporation. Rights of
shareholders are specifically enumerated within the SRP.
The Corporation provides a Dividend Reinvestment and Stock Purchase Plan (Plan)
for shareholders. To the extent that shares are not available in the open
market, the Corporation has reserved 115,762 shares of common stock to be issued
under the Plan. Any shares issued from authorized but unissued status will
increase the capital of the Corporation.
The Corporation is subject to restrictions on the payment of dividends to its
shareholders pursuant to the Pennsylvania Business Corporation Law of 1988, as
amended (the BCL). The BCL operates generally to preclude dividend payments if
the effect thereof would render the Corporation insolvent and result in negative
net worth, as defined. As a practical matter, the Corporation's payment of
dividends is contingent upon its ability to obtain funding in the form of
dividends from the Bank. Payment of dividends to the Corporation by the Bank is
subject to restrictions set forth in the Pennsylvania Banking Code of 1965, as
amended. Accordingly, the Bank's Additional Paid-In Capital (Surplus) account
balance of $3,424,000 at December 31, 1997, was restricted.
In January, 1998, Pennsylvania Department of Banking
examiners began a routine examination of the Bank based on a September 30, 1997
examination date. Based on information provided to management, no significant
exceptions were noted as of the date of this report.
TABLE 7-CAPITAL RATIOS
December 31,
(dollars in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Tier I Capital - Total stockholders' equity, as adjusted (1) $ 23,988 $ 22,354 $ 20,415
Tier II Capital - Allowance for loan losses (2) 2,098 2,053 1,911
- ---------------------------------------------------------------------------------------------------------------------------
Total risk-based capital $ 26,086 $ 24,407 $ 22,326
Risk-adjusted on-balance sheet assets (1) $188,075 $158,701 $149,763
Risk-adjusted off-balance sheet exposure (3) 5,675 5,491 3,150
- ---------------------------------------------------------------------------------------------------------------------------
Total risk-adjusted assets including off-balance sheet exposure $193,750 $164,192 $152,913
Ratios:
Tier I risk-based capital ratio 12.38% 13.61% 13.35%
Federal minimum required 4.00 4.00 4.00
Total risk-based capital ratio 13.46% 14.86% 14.60%
Federal minimum required 8.00 8.00 8.00
Leverage ratio (4) 9.73% 9.45% 8.98%
Federal minimum required 4.00 4.00 4.00
(1) Net unrealized gains and losses on securities available for sale, net of
taxes, are disregarded for capital ratio computation purposes. Their effect
is eliminated from stockholders' equity and asset totals in accordance with
federal regulatory banking guidelines.
(2) Allowance for loan losses is limited to 1.25% of total risk-adjusted
assets.
(3) Off-balance sheet exposure is caused primarily by standby letters of credit
and loan committments with a remaining maturity exceeding one year. These
obligations have been converted to on-balance sheet credit equivalent
amounts and adjusted for risk.
(4) Tier I capital divided by average total assets.
45
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
RISK MANAGEMENT
................................................................................
Credit Risk Management
The Corporation emphasizes the minimization of credit risk. To support this
objective a sound lending policy framework has been established. Within this
framework are six basic policies which guide the lending process and minimize
risk. First, the Corporation follows detailed written lending policies and
procedures. Second, loan approval authority is granted commensurate with dollar
amount, loan type, level of risk, and the experience of the loan officer. Third,
loan review committees function at both the senior lending officer level and the
Board of Directors level to review and authorize loans that exceed
preestablished dollar thresholds and/or meet other criteria. Fourth, the
Corporation adheres to making most of its loans within its primary geographical
market area, York County, Pennsylvania. Although this may pose a geographical
concentration risk, the diverse local economy and knowledge of customers
minimizes this risk. Fifth, the loan portfolio is diversified to prevent
dependency upon a single customer or small group of related customers. And
sixth, the Corporation does not make loans to foreign countries or persons
residing therein.
In addition to a comprehensive lending policy, numerous internal reviews and
audits of the loan portfolio occur throughout the year. An important on-going
review mechanism is the lender initiated risk rating system, (LIRRS). The LIRRS
requires personnel with lending authority to systematically evaluate and rate
loans based upon preestablished risk criteria. All potential problem loans and
assets acquired in foreclosure are reviewed quarterly, or more frequently, if
circumstances dictate, by a Special Asset Committee (SAC) comprised of selected
members of senior management. For each loan under review the SAC has the
responsibility of establishing a final risk rating, an action plan for reducing
risk, and a loss reserve. The results of SAC actions are documented and
forwarded to the Board of Directors for their review. In addition to internal
controls, the loan portfolio is reviewed annually by independent auditors in
connection with their audit of the financial statements; and is examined
periodically by bank regulators.
TABLE 8-NONPERFORMING ASSETS AND PAST DUE LOANS
December 31,
(dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
Impaired loans (1) $ 2,842 $ 2,063 $ 3,583 $ 1,766 $ 223
Assets acquired in foreclosure, net of reserve 380 780 695 670 1,050
------- ------- ------- ------- -------
Total nonperforming assets $ 3,222 $ 2,843 $ 4,278 $ 2,436 $ 1,273
======= ======= ======= ======= =======
Loans past due 90 days or more and still accruing interest $ 107 $ 524 $ 1,755 $ 522 $ 734
Ratios:
Impaired loans as a % of total year end loans 1.49% 1.24% 2.24% 1.17% 0.16%
Nonperforming assets as a % of total year end
loans and net assets acquired in foreclosure 1.68% 1.70% 2.66% 1.61% 0.90%
Nonperforming assets as a % of total year end
stockholders' equity 13.19% 12.52% 20.34% 13.63% 7.23%
Allowance for loan losses as a multiple of impaired loans .7x 1.0x .6x 1.3x 9.0x
Interest not recognized on impaired loans at period-end: (2)
Contractual interest due $ 398 $ 246 $ 306 $ 125 $ 24
Interest revenue recognized 103 18 120 23 2
------- ------- ------- ------- -------
Interest not recognized in operations $ 295 $ 228 $ 186 $ 102 $ 22
======= ======= ======= ======= =======
(1) Comprised solely of non-accrual loans.
(2) This table includes interest not recognized on loans which were classified
as impaired at year end. While every effort is being made to collect this
interest revenue, it is probable a portion will never be recovered.
46
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
Nonperforming Assets
A primary measure of loan quality is the percentage of loans that move from an
earnings category to a nonperforming category. Table 8-Nonperforming Assets and
Past Due Loans, depicts asset categories posing the greatest risk of loss. A
loan is considered impaired when, based on current information and events, it is
probable that the Bank will be unable to collect all amounts due. Internal loan
classifications such as nonaccrual, and troubled debt restructurings, are
examples of impaired loans. It is the Bank's policy to reclassify loans to an
impaired status when either principal or interest payments become 90 days past
due, unless the value of the supporting collateral is adequate and the loan is
in the process of collection. An impaired classification may be made prior to 90
days past due if management believes that the collection of interest or
principal is doubtful. Assets acquired in foreclosure are primarily real estate
assets, ie., collateral that supported loans, taken in satisfaction of debt
pursuant to foreclosure. The final category, loans past due 90 days or more and
still accruing interest, are contractually past due but, are well collateralized
and in the process of collection.
Table 8 depicts that total nonperforming assets were $3,222,000 or 1.7 percent
of total loans and net assets acquired in foreclosure at December 31, 1997.
Comparatively, nonperforming assets were $2,843,000 and 1.7 percent,
respectively, at December 31, 1996. The $379,000 increase in nonperforming
assets at year end 1997 was attributable to a $779,000 increase in the impaired
loans category. Impaired loans increased primarily as a result of a $1,043,000
commercial account addition in September 1997. This single account, which
management believes is well collateralized by real estate, comprised 37 percent
of the impaired loan portfolio at 1997 year end. At December 31, 1997, the
impaired loan portfolio was comprised of fourteen unrelated accounts, primarily
commercial loan relationships, ranging in size from $25,000 to $1,043,000. These
loan relationships vary by industry and are generally collateralized with real
estate assets. A loss reserve, which is evaluated quarterly, has been
established for accounts that appear to be under-collateralized. Efforts to
modify contractual terms for individual accounts, based on prevailing market
conditions, or liquidate collateral assets, are proceeding as quickly as
potential buyers can be located and legal constraints permit.
Assets acquired in foreclosure, net of reserve, were $380,000 for year end 1997,
down $400,000 below year end 1996. During 1997, this portfolio was reduced by
approximately $758,000 from sale proceeds and miscellaneous receipts. Asset
additions for the current year totalled $298,000. At December 31, 1997, the
assets acquired portfolio consisted primarily of improved real estate from four
unrelated accounts. The assets from two of these accounts are presently under
contract of sale and awaiting settlement. A loss reserve, which is evaluated
quarterly, has been established for assets acquired whose estimated fair value,
less selling expenses, is below their financial carrying costs. At December 31,
1997, the reserve for assets acquired was approximately $48,000. The provision
expense for assets acquired, due to declines in the fair value of individual
assets, was $18,000 for 1997 compared to $129,000 for 1996 and $30,000 for 1995.
At December 31, 1997, loans past due 90 days or more and still accruing interest
were $107,000, compared to $524,000 for year end 1996. Generally, loans in the
past due category are well collaterized and in the process of collection. The
current level of past due loans is closely monitored and believed to be within a
manageable range.
At December 31, 1997, there were no potential problem loans, as defined by the
Securities and Exchange Commission, identified by management. However,
management was monitoring approximately $7.9 million of loans for which the
ability of the borrower to comply with present repayment terms was uncertain.
These loans were not included in the above disclosure. They are monitored
closely, and management presently believes that the allowance for loan losses is
adequate to cover anticipated losses that may be attributable to these loans.
At year end 1997 approximately $36.5 million or 19 percent of total loans were
concentrated in the commercial facility leasing industry, and approximately
$21.5 million or 11 percent of total loans were concentrated in the real estate
development industry. Real estate development is broadly defined to include
loans to: builders, land developers, building subcontractors, and building
suppliers. Comparatively, at year end 1996 approximately $25.2 million or 15
percent of total loans were concentrated in the commercial facility leasing
industry, and approximately $15.4 million or 9 percent of total loans were
concentrated in the real estate development industry. Loans to borrowers within
these industries are usually collateralized by real estate.
Allowance for loan losses
Although the Corporation maintains sound credit policies, certain loans
deteriorate and are charged off as losses. The allowance (reserve) for loan
losses is maintained to absorb these potential losses. The allowance is
increased by provisions charged to expense and is reduced by loan charge-offs,
net of recoveries. In analyzing the adequacy of the allowance management
considers the results of internal and external credit reviews, past loss
experience, changes in the size and character of the loan portfolio, adequacy of
collateral, general economic conditions and the local business outlook.
Table 9 presents an analysis of the activity in the allowance for loan losses
over a five year period. Commentary is provided below for each period presented.
For 1997, the allowance was $2,098,000, representing a small decline from year
end 1996. The provision expense was $275,000 for 1997 which was $141,000 higher
than the prior
47
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
year due to loan growth and greater net charge-offs. Of the total
$406,000 charged off in 1997, $172,000 or 42 percent was attributable to one
commercial loan borrower whose accounts were deemed uncollectible. The decline
in the reserve level and the ratio of reserves to total loans reflects
improvement in the quality of individual loans within the loan portfolios.
For 1996, the allowance was $2,110,000, reflecting a decrease of $176,000 from
year end 1995 due to a lower level of nonperforming assets. The reduction in the
allowance lowered the unallocated reserve component, depicted in Table 10, which
was deemed sufficient at year end 1996. The provision expense was $134,000 in
the current period which primarily supported loan growth, principally commercial
loans. Of the total $387,000 charged-off for the year, $251,000 was attributable
to one commercial loan borrower whose accounts were deemed uncollectible.
For 1995, the allowance was $2,286,000, slightly above the level for year end
1994. The increase was due to a higher level of nonperforming assets and to
support a larger volume of loans. The provision expense was $228,000 in 1995
which primarily supported loan growth and losses due to charge-offs. Of the
total $342,000 charged-off for the year, $141,000 was attributable to one
commercial loan borrower whose accounts were deemed uncollectible.
For 1994, the allowance was $2,249,000, up slightly from year end 1993 to
support a larger volume of loans. The significant increase in total loan
charge-offs was caused by one event. As previously disclosed on May 5, 1994,
management of the Bank discovered violations of credit policy, internal controls
and loan authorizations in connection with the commercial loan portfolio of a
former Bank officer. Subsequently, the loan officer resigned and the Bank
completed an internal review for the purpose of identifying all unauthorized
loans and evaluating them for collectibility and collateral adequacy. Effective
June 30, 1994, the Bank recorded a $1,005,000 loan loss provision expense, and
on July 12, 1994 charged-off $1,087,000 as loan losses. In December 1994, the
Bank received $270,000 in net insurance proceeds as a partial recovery of the
losses. The former officer was convicted of fraud and sentenced to prison by
federal authorities.
For 1993, the allowance was $2,000,000, reflecting an increase of $200,000 above
year end 1992 due to an increase in the provision expense. The provision expense
was increased above the prior year to support a larger volume of loans, cover
1993 charge-offs, and bolster the reserve for concerns relative to economic
weakness within the local market area. Of the total $261,000 charged off in
1993, $183,000 was attributable to two commercial loan accounts. Both were
written-down to fair value less estimated costs to sell and reclassified to
assets acquired, where collateral for one account was ultimately sold.
TABLE 9-ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
Balance - beginning of year $2,110 $2,286 $2,249 $2,000 $1,800
Provision charged to operating expense 275 134 228 1,229 441
Loans charged off:
Commercial 340 265 276 1,255 223
Real estate-mortgage 0 27 0 0 9
Consumer 66 95 66 24 29
------ ------ ------ ------ ------
Total loans charged off 406 387 342 1,279 261
Recoveries:
Commercial 112 26 134 298 0
Real estate-mortgage 0 0 0 0 0
Consumer 7 51 17 1 20
------ ------ ------ ------ ------
Total recoveries 119 77 151 299 20
------ ------ ------ ------ ------
Net charge-offs 287 310 191 980 241
Balance - end of year $2,098 $2,110 $2,286 $2,249 $2,000
====== ====== ====== ====== ======
Ratios:
Net charge-offs to average total loans 0.16% 0.19% 0.12% 0.68% 0.18%
Allowance for loan losses to total loans at year end 1.10% 1.27% 1.43% 1.49% 1.42%
Allowance for loan losses to impaired
loans and loans past due 90 days or more 71.1% 81.6% 42.8% 98.3% 209.0%
- ---------------------------------------------------------------------------------------------------------------------------
48
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
Based on a recent evaluation of potential loan losses, management believes that
the allowance is adequate to support any reasonably foreseeable level of losses
that may arise. Ultimately, however, the adequacy of the allowance is dependent
upon future economic factors beyond the Corporation's control. With this in
mind, additions to the allowance for loan losses may be required in future
periods.
Table 10 presents an allocation of the allowance for potential loan losses by
major loan category.
Liquidity
Maintaining adequate liquidity provides the Corporation with the ability to meet
financial obligations to its depositors, loan customers, employees, and
stockholders on a timely and cost effective basis in the normal course of
business. Additionally, it provides funds for growth and business opportunities
as they arise. For example, the funding for capital expenditures in 1997 and
1996 for expansion and system improvements was generated from normal Bank
operations.
Liquidity is generated from transactions relating to both the Corporation's
assets and liabilities. The primary sources of asset liquidity are scheduled
investment security maturities and cash inflows, loan receipts from customer
loan payments, and asset sales. The primary sources of liability liquidity are
deposit growth and short and long-term borrowings. Retained earnings from
profitable operations is yet another source of liquidity. The Consolidated
Statement of Cash Flows identifies the three major sources and uses of cash
(liquidity) as operating, investing and financing activities.
The Corporation manages liquidity through the use of ratios and forecasts of
selected cash flows. At year end 1997 the loan-to-deposit ratio was 84.6
percent, compared to 79.6 percent at year end 1996. The ratio for both periods
was within current policy guidelines. In the period ahead the loan-to-deposit
ratio could increase due to competitive forces which may constrain deposit
growth. By necessity, short and long-term borrowings will play an increasingly
important role in funding.
Market Risk Management
During 1997, the Securities and Exchange Commission issued new disclosure rules
for financial instruments and exposures to market risk. The new rules require
quantitative and qualitative disclosures about each type of market risk (eg.,
interest rate, foreign currency, commodity price, equity price) if material,
within trading and other than trading portfolios. The rules take effect for
financial statements for years ending after June 15, 1997, and affect most
financial institutions.
In the normal course of conducting business activities the Corporation is
exposed to market risk, principally interest rate risk, through the operations
of its banking subsidiary. Interest rate risk arises from market driven
fluctuations in interest rates which may affect cash flows, income, expense and
the values of financial instruments. Interest rate risk is managed by an
Asset-Liability Committee (ALCO) comprised of members of senior management and
an outside director. The ALCO's objective is to maximize net interest income
within acceptable levels of liquidity and interest rate risk and
TABLE 10-ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
December 31,
1997 1996 1995 1994 1993
--------------- --------------- --------------- --------------- ---------------
% Total % Total % Total % Total % Total
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- -----------------------------------------------------------------------------------------------------------------------------
Commercial, industrial
and agricultural $1,263 58.1 $1,335 55.0 $1,233 50.7 $1,198 51.8 $1,165 55.8
Real estate - construction
and land development 268 11.2 319 9.3 268 12.4 171 12.9 147 11.9
- ----------------------------------------------------------------------------------------------------------------------------
Total commercial related loans 1,531 69.3 1,654 64.3 1,501 63.1 1,369 64.7 1,312 67.7
Real estate - residential mortgages 95 17.8 86 21.3 94 22.7 51 21.4 73 19.1
Installment 54 12.9 79 14.4 8 14.2 17 13.9 7 13.2
- ----------------------------------------------------------------------------------------------------------------------------
Total consumer related loans 149 30.7 165 35.7 102 36.9 68 35.3 80 32.3
Unallocated 418 n/a 291 n/a 683 n/a 812 n/a 608 n/a
- ----------------------------------------------------------------------------------------------------------------------------
Total $2,098 100.0 $2,110 100.0 $2,286 100.0 $2,249 100.0 $2,000 100.0
- ----------------------------------------------------------------------------------------------------------------------------
Note: The specific allocation for any particular loan category may be
reallocated in the future as risk perceptions change. Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories since the total allowance is a
general allowance applicable to the entire loan portfolio.
49
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
within capital adequacy constraints. Based on the operations of the Bank, it is
not subject to foreign currency or commodity price risk, nor does it own any
trading assets.
The ALCO manages interest rate risk through sensitivity analysis which is
performed periodically. A computer simulation model is used to measure the
potential loss in future net interest income based on hypothetical changes in
interest rates, and the degree of mismatch, or "gap," between repriceable assets
and liabilities over a one year horizon.
The Corporation uses net interest income simulation as the primary tool to
measure interest rate risk. A simulation was recently performed using 1998
budget data as a basis. The baseline budget assumed the NY Prime Rate (NYP), or
driver rate, would remain constant at 8.5 percent for the year. Based on
simulation results the Corporation would expect an increase in net interest
income above budget of approximately $280,000 or 2.7 percent if the NYP
gradually increased by 200 basis points over a 12-month period. This result
indicates that the Corporation's balance sheet is asset-sensitive. Conversely,
net interest income would decline below budget by approximately $360,000 or 3.4
percent if the NYP would gradually decline 200 basis points over a 12-month
period. At year end 1997, the Corporation used a 3 percent reduction in net
interest income as a guideline for interest rate risk tolerance purposes.
Measurement of interest rate risk requires many assumptions, and is as much art
as it is science. These assumptions are inherently uncertain and, as a result,
the model cannot precisely estimate net interest income or precisely predict the
impact of higher or lower rates on net interest income. Actual results will
differ from simulated results due to timing, magnitude and frequency of interest
rate changes and changes in market conditions and management strategies, among
other factors.
A corporate initiative for 1998 is to improve the interest rate risk management
process. This initiative will be accomplished by replacing the income simulation
model and refining interest rate risk practices and policies.
The Corporation also uses gap measurement as a secondary means of managing
interest rate risk. A weighted static gap, which is a refinement of the
traditional or unweighted static gap, is used. One of the key assumptions
pertains to the amount and timing of repriceable cash flows from interest
sensitive assets and liabilities. The Corporation uses the following assumptions
relative to cash flows from interest sensitive assets. The total portfolio
balance of variable rate instruments can reprice daily. Adjustable rate
instruments reprice at the interest maturity date, usually annually. Fixed rate
investment securities reprice at their scheduled maturity date, or call date if
more appropriate. For fixed rate loans, the average historical cash flow for the
preceding twelve months is used in lieu of scheduled maturities because it
includes prepayments and early payoffs. Generally, interest sensitive
liabilities, principally deposits, reprice similarly to interest sensitive
assets with the exception of NOW and savings deposits which do not have
scheduled maturities. Technically, NOW and savings accounts can be repriced at
any time. Historically, however, NOW and savings balances have been relatively
stable in spite of changes in market interest rates. This stability assumption
was made in the current measurement process. When NOW and savings rates are
adjusted they tend to lag behind the market, particularly during a period of
rising interest rates.
A schedule which depicts Balance Sheet repricing characteristics and an estimate
of gap at December 31, 1997, is provided as Table 11. The gap technique begins
by segmenting both assets and liabilities into future time periods, (usually 12
months, or less) based on when repricing can be effected, rather than actual
contractual maturities. Repriceable liabilities are subtracted from repriceable
assets, for a specific time period, to determine a difference, or gap. Once
known, the gap is managed based on predictions of future market interest rates.
Intentional mismatching, or gapping, can enhance net interest income if market
rates move as predicted. However, if market rates behave in a manner contrary to
predictions net interest income will suffer. Gaps, therefore, contain an element
of risk and must be prudently managed. When the gap is positive, with
interest-earning assets in excess of interest-bearing liabilities, net interest
income generally improves if interest rates rise. The opposite occurs in the
case of a negative gap.
Table 11 shows an approximation of the Corporation's interest sensitivity based
on a static gap presentation. This means that volumes are held constant, or
static, at December 31, 1997. The table depicts both the traditional
(unweighted) and "weighted" gaps at December 31, 1997. The weighted gap is a
more realistic approach and will be stressed here because it reflects
adjustments to the repriceable cash flows based on correlation factors. These
factors correlate changes in a base or driver rate, eg., the NY Prime Rate, with
changes in the rates for interest sensitive assets and liabilities. Correlation
factors for interest sensitive assets are based on historical national averages.
Correlation factors for interest sensitive deposits are based on historical
averages unique to the Bank. These factors take into consideration that interest
rate relationships and spreads differ depending on the cycle and level of
external market interest rates.
One way to predict how a change in interest rates will impact net interest
income for specific time frames is through the weighted cumulative gap measure.
For example, the weighted cumulative gap in the "181-365 days" repricing
category represents a one year net asset position of $19.3 million or 8.3
percent of earning assets at December 31, 1997. The asset sensitive gap position
implies that over the next year there will be a positive impact on net interest
income if market interest rates rise. The theory is that more assets will
reprice,
50
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
TABLE 11-INTEREST RATE SENSITIVITY
at December 31, 1997
After After
0-30 31-90 91-180 181-365 1 year to 2 years to After Non-
(dollars in thousands) Days Days Days Days 2 years 5 years 5 years Market Total
- -----------------------------------------------------------------------------------------------------------------------------------
Assets
Federal funds sold $ 5,350 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 5,350
Interest bearing deposits 123 0 0 0 0 0 0 0 123
Securities available for sale (1) 1,501 3,276 2,575 6,838 10,000 11,589 3,869 655 40,303
Loans (2) 49,541 10,441 17,826 36,939 36,414 37,339 0 2,842 191,342
- -----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 56,515 13,717 20,401 43,777 46,414 48,928 3,869
Noninterest earning assets (3) -- -- -- -- -- -- -- 17,940 17,940
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets 56,515 13,717 20,401 43,777 46,414 48,928 3,869 21,437 255,058
Liabilities and Stockholders' Equity
NOW deposits 22,041 0 0 0 0 0 0 0 22,041
Insured money fund deposits 28,901 0 0 0 0 0 0 0 28,901
Savings deposits 19,992 0 0 0 0 0 0 0 19,992
Time deposits less than $100,000 23,403 9,809 14,156 10,996 17,308 37,202 0 0 112,874
Time deposits $100,000 and above 8,994 2,078 2,831 2,738 1,578 3,084 0 0 21,303
Long-term borrowings 19 38 57 114 240 720 1,614 0 2,802
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 103,350 11,925 17,044 13,848 19,126 41,006 1,614 0 207,913
Noninterest bearing liabilities (4) 0 0 0 0 0 0 0 22,720 22,720
Stockholders' equity 0 0 0 0 0 0 0 24,425 24,425
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $103,350 $ 11,925 $ 17,044 $ 13,848 $19,126 $41,006 $ 1,614 $47,145 $255,058
Traditional interest sensitivity gap $(46,835) $ 1,792 $ 3,357 $ 29,929 $27,288 $ 7,922 $ 2,255
Traditional cumulative
interest sensitivity gap $(46,835) $(45,043) $(41,686) $(11,757) $15,531 $23,453 $25,708
Traditional cumulative gap as
a percent of earning
assets at December 31, 1997 -20.0% -19.3% -17.8% -5.0% 6.6% 10.0% 11.0%
Weighted interest sensitivity
gap (5) $(13,181) $ 1,205 $ 2,936 $ 28,366 $24,846 $ 5,441 $ 1,326
Weighted cumulative interest
sensitivity gap (5) $(13,181) $(11,976)$ (9,040) $ 19,326 $44,172 $49,613 $50,939
Weighted cumulative gap
as a percent of earning
assets at December 31, 1997 (5) -5.6% -5.1% -3.9% 8.3% 18.9% 21.2% 21.8%
(1) The non-market column consists of net unrealized holding gains.
(2) The non-market column consists of non-accrual loans.
(3) The non-market column is comprised of: noninterest bearing deposits and
cash, premises and equipment, interest receivable, other assets, and the
allowance for loan losses.
(4) The non-market column is comprised of: noninterest bearing demand deposits,
interest payable, and other liabilities.
(5) Weighted interest sensitivity gaps are considered more reliable
point-in-time indicators of interest rate risk than traditional or
unweighted gaps. Weighted interest sensitivity gaps reflect adjustments to
the repriceable cash flows in the above table, based on correlation
factors, which take into consideration that interest rate relationships and
spreads differ depending on the cycle and level of external market interest
rates.
51
Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations
at higher market interest rates, than the liabilities that support them.
Conversely, a decline in market interest rates would have a negative impact on
net interest income.
A gap analysis is limited in its usefulness as it represents a one-day position,
which is continually changing and not necessarily indicative of the
Corporation's position at any other time. Additionally, the gap analysis does
not consider the many factors accompanying interest rate movements. Generally,
management believes the Corporation is reasonably well positioned to respond
expeditiously to market interest rate changes.
Impact of Inflation and Changing Prices
The majority of assets and liabilities of a financial institution are monetary
in nature and therefore differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories.
However, inflation does have an important impact on the growth of total assets
in the banking industry and the resulting need to increase equity capital at
higher than normal rates in order to maintain an appropriate equity-to-assets
ratio. Another significant effect of inflation is on noninterest expenses, which
tend to rise during periods of general inflation. The level of inflation, as
measured by the annual average percentage change in the Consumer Price Index
(CPI) for all urban consumers, trended down in 1997. This downward trend,
influenced by increasing global competition, productivity gains, and a declining
U.S. federal budget deficit, has prompted reports about the possibility of
deflation, or falling prices, in the future. The CPI for 1997 was 2.3 percent
compared to 2.9 percent for 1996 and 2.8 percent for 1995.
Management believes the most significant impact on financial results is the
Corporation's ability to react to changes in market interest rates. As discussed
previously, Management strives to structure the balance sheet to increase net
interest income by managing interest rate sensitive assets and liabilities in
such a way that they reprice in response to changes in market interest rates.
Other Risks
Periodically, various types of federal and state legislation is proposed that
could result in additional regulation of, or restrictions on, the business of
the Corporation and its subsidiaries. It cannot be predicted whether such
legislation will be adopted or, if adopted, how such legislation would affect
the business of the Corporation and its subsidiaries. Except as disclosed
herein, the Corporation is not currently aware of any other trends, events or
uncertainties which may materially and adversely affect capital, results of
operations or liquidity.
TABLE 12-SUMMARY OF QUARTERLY FINANCIAL DATA
1997 1996
(dollars in thousands, Fourth Third Second First Fourth Third Second First
except per share data) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------------------------------
Interest income $5,044 $5,029 $4,797 $4,643 $4,632 $4,680 $4,640 $4,571
Interest expense 2,362 2,338 2,270 2,126 2,163 2,190 2,218 2,185
- --------------------------------------------------------------------------------------------------------------------------
Net interest income 2,682 2,691 2,527 2,517 2,469 2,490 2,422 2,386
Provision for loan losses 73 68 67 67 1 25 50 58
Noninterest income 322 310 235 281 255 275 223 228
Noninterest expense 2,141 1,940 1,849 1,799 1,939 1,685 1,593 1,550
- --------------------------------------------------------------------------------------------------------------------------
Net operating income 790 993 846 932 784 1,055 1,002 1,006
Gain(loss) securities sales 0 (17) 0 0 100 0 2 0
Gains other 37 56 3 0 0 0 7 12
- --------------------------------------------------------------------------------------------------------------------------
Pretax income 827 1,032 849 932 884 1,055 1,011 1,018
Provision for income taxes 267 321 281 292 279 334 334 314
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 560 $ 711 $ 568 $ 640 $ 605 $ 721 $ 677 $ 704
- --------------------------------------------------------------------------------------------------------------------------
Net income per share, basic and diluted $ 0.26 $ 0.32 $ 0.26 $ 0.29 $ 0.28 $ 0.32 $ 0.31 $ 0.32
(1) Net income per share was retroactively adjusted for stock dividends
declared through December 31, 1997.
52
Corporate Information
A CORPORATE PROFILE
Codorus Valley Bancorp, Inc. is a Pennsylvania business incorporated in 1986. On
March 2, 1987, Codorus Valley Bancorp, Inc. became effective as a bank holding
company, pursuant to the Bank Holding Company Act of 1956, as amended.
PEOPLESBANK, A Codorus Valley Company, is its wholly-owned banking subsidiary
and SYC Realty Co., Inc. is its wholly-owned nonbank subsidiary. Organized in
1934, PEOPLESBANK, formerly Peoples Bank of Glen Rock until February 1997,
offers a full range of commercial and consumer banking services through eight
full service banking office locations in York County, Pennsylvania. The deposits
of PEOPLESBANK are fully insured by the Federal Deposit Insurance Corporation
(FDIC) to the maximum extent provided by law. PEOPLESBANK also offers trust and
investment services at the Codorus Valley Corporate Center.
HEADQUARTERS Codorus Valley Bancorp, Inc., Codorus Valley Corporate Center, 105
Leader Heights Road, York, PA 17403
STOCK, DIVIDEND AND BROKER INFORMATION
Common stock issued by Codorus Valley Bancorp, Inc. is quoted under the symbol
"CVLY" on the NASDAQ National Market System. At December 31, 1997, there were
approximately 1,013 stockholders of record.
Prices presented below for June through December 1997, represent those as listed
and quoted on the NASDAQ National Market System. Prices presented in the table
below for January through May 1997, and the year 1996, are based on bid prices
between broker-dealers which do not include retail mark-ups or mark-downs or any
commission to the broker-dealer and therefore, do not necessarily reflect prices
in actual transactions. Cash dividends paid for the most recent eight quarters
are provided in the table below. Cash dividends per share and market prices are
adjusted for stock dividends.
1997 1996
Dividends Dividends
Quarter High Low per share High Low per share
- ---------------------------------------------------------------------------------------------------------------
First $14.84 $13.66 $0.09 $13.31 $12.64 $0.10
Second 18.25 14.25 0.09 13.31 12.41 0.08
Third 19.38 17.75 0.10 13.66 13.42 0.08
Fourth 23.13 17.88 0.10 13.66 13.42 0.08
For further information, we refer you to:
Ryan, Beck & Co. Janney, Montgomery, Scott, Inc. Hopper Soliday & Co., Inc.
(800) 223-8969 (717) 845-5611 (800) 456-9234
F.J. Morrissey & Co., Inc. Sandler O'Neil & Partners, L.P.
(800) 842-8928 (800) 635-6851
NOTICE OF ANNUAL MEETING
The Annual Meeting of Shareholders will be held Tuesday, May 19, 1998 at 10:00
a.m. eastern daylight savings time, at The Inn at Heritage Hills, Links Center,
2700 Mount Rose Avenue, York, Pennsylvania.
TRANSFER AGENT
Registrar and Transfer Company, Transfer Agent, Codorus Valley
Bancorp, Inc., 10 Commerce Drive, Cranford, NJ 07016-3572
FORM 10-K REQUEST
The form 10-K Report filed with the Securities and Exchange
Commission (SEC) may be obtained, without charge, by writing to: Mr. Jann Allen
Weaver, CPA, Chief Financial Officer, Codorus Valley Bancorp, Inc., P.O. Box
2887, York, PA 17405-2887
The Annual Report and other reports are also filed electronically with the SEC
through its Electronic Data Gathering, Analysis, and Retrieval System (EDGAR).
This information is available to the public through the Bank's Internet website
by accessing the SEC link on the Investor Information page at:
www.peoplesbnk.com
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
Information regarding the Corporation's Dividend Reinvestment and Stock Purchase
Plan may be obtained by calling 1-800-368-5948 or by writing to: Registrar and
Transfer Company, Plan Administrator, Codorus Valley Bancorp, Inc., Dividend
Reinvestment and Stock Purchase Plan, 10 Commerce Drive, Cranford, NJ 07016-3572
Codorus Valley Bancorp, Inc. and its subsidiaries are Equal Employment
Opportunity/Affirmative Action Employers.
56