EXHIBIT 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The Corporation's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions, and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported. The most significant accounting policies
followed by the Corporation are presented in the Notes to Consolidated Financial
Statements. These policies, along with the disclosures presented in the Notes to
Consolidated Financial Statements, provide information on how significant assets
and liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions, and estimates
underlying those amounts, management has identified the following accounting
areas that require the most subjective or complex judgments, and as such could
be most subject to revision as new information becomes available.
The allowance for loan losses represents management's estimate of probable
credit losses inherent in the loan portfolio. Determining the amount of the
allowance for loan losses is considered a critical accounting estimate because
it requires significant judgment and the use of estimates related to the amount
and timing of expected future cash flows on impaired loans, estimated losses on
pools of homogeneous loans based on historical loss experience, and
consideration of current economic trends and conditions, all of which may be
susceptible to significant change.
The loan portfolio represents the largest asset type on the consolidated
balance sheet. Leases are carried at the aggregate of the lease payments and the
estimated residual value of the leased property, less unearned income.
Loans are classified as held for sale based on management's intent to sell
them. At the date a loan is determined to be sold, the loan is recorded at the
lower of cost or market. Any subsequent adjustment as a result of the lower of
cost or market analysis is recognized as a valuation adjustment with changes
included in non-interest income. These market value assumptions include but are
not limited to the timing of a sale, the market conditions for the particular
credit and overall investor demand for these assets. Changes in market
conditions, interest rate environment, and actual liquidation experience may
result in additional valuation adjustments that could adversely impact earnings
in future periods.
Goodwill arising from business acquisitions represents the value
attributable to unidentifiable intangible elements in the business acquired. The
majority of the Corporation's goodwill relates to value inherent in its banking
and insurance businesses. The value of this goodwill is dependent upon the
Corporation's ability to provide quality, cost effective services in the face of
competition. As such, goodwill value is supported ultimately by revenue which is
driven by the volume of business transacted and the market value of the assets
under administration. A decline in earnings as a result of a lack of growth or
the Corporation's inability to deliver cost effective services over sustained
periods can lead to impairment of goodwill which could result in additional
expense and adversely impact earnings in future periods.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Net income was $58.8 million for 2003 compared to net income of $63.3
million for 2002. Basic earnings per share were $1.27 and $1.37 for 2003 and
2002, respectively, while diluted earnings per share were $1.25 and $1.35,
respectively, for those same periods. Income from continuing operations was
$27.0 million for 2003 compared to $31.3 million for 2002. Basic earnings per
share from continuing operations were $.58 and $.68 for 2003 and 2002,
respectively, while diluted earnings per share from continuing operations were
$.57 and $.67, respectively, for those same periods. Diluted earnings from
continuing operations for 2003 and 2002 were reduced by $.55 and $.58 per share,
respectively, due to pre-tax merger and restructuring expenses of $39.2 million
and $42.0 million, respectively.
1
The following table provides information regarding the average balances
and yields and rates on interest earning assets and interest bearing liabilities
(dollars in thousands):
TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------
2003 2002
------------------------------------------- ---------------------------------------
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------------- ------------- ------ ------------- ------------- ------
ASSETS
Interest earning assets:
Interest bearing deposits with
banks ......................... $ 2,925 $ 27 .92% $ 1,957 $ 44 2.25%
Federal funds sold ............... -- -- -- 26,619 506 1.90
Taxable investment securities (1) 771,856 34,000 4.40 456,121 26,221 5.75
Non-taxable investment
securities (2) ................ 89,434 5,397 6.03 173,951 11,153 6.41
Loans (3) ........................ 3,233,291 220,072 6.81 3,183,456 243,174 7.64
------------- ------------- ------------- -------------
Total interest earning assets .... 4,097,506 259,496 6.33 3,842,104 281,098 7.32
------------- ------------- ------------- -------------
Cash and due from banks .......... 99,757 109,994
Allowance for loan losses ........ (47,049) (47,902)
Premises and equipment ........... 85,365 85,693
Other assets ..................... 231,835 230,227
Assets of discontinued
operations .................... 3,479,929 2,567,608
------------- -------------
$ 7,947,343 $ 6,787,724
============= =============
LIABILITIES
Interest bearing liabilities:
Deposits:
Interest bearing demand ........ $ 789,864 6,293 .80 $ 649,742 6,402 .99
Savings ........................ 535,152 3,538 .66 519,174 4,701 .91
Other time ..................... 1,459,406 47,879 3.28 1,595,245 61,875 3.88
Short-term borrowings ............ 346,659 7,437 2.15 213,759 8,884 4.16
Long-term debt ................... 512,795 21,843 4.26 319,885 16,510 5.16
------------- ------------- ------------- -------------
Total interest bearing
liabilities ............ 3,643,876 86,990 2.39 3,297,805 98,372 2.98
------------- ------------- ------------- -------------
Non-interest bearing demand ...... 576,666 529,760
Other liabilities ................ 39,804 68,887
Liabilities of discontinued
operations ................... 3,078,604 2,313,699
------------- -------------
7,338,950 6,210,151
------------- -------------
STOCKHOLDER'S EQUITY ............. 608,393 577,573
------------- -------------
$ 7,947,343 $ 6,787,724
============= =============
Excess of interest earning assets
over interest bearing
liabilities .................. $ 453,630 $ 544,299
============= =============
Net interest income .............. $ 172,506 $ 182,726
============= =============
Net interest spread .............. 3.95% 4.33%
==== ====
Net interest margin (4) .......... 4.21% 4.76%
==== ====
TWELVE MONTHS ENDED DECEMBER 31,
---------------------------------------
2001
---------------------------------------
Interest
Average Income/ Yield/
Balance Expense Rate
------------- ------------- ------
ASSETS
Interest earning assets:
Interest bearing deposits with
banks .......................... $ 5,181 $ 130 2.51%
Federal funds sold ................ 62,535 2,105 3.37
Taxable investment securities (1).. 559,833 34,602 6.18
Non-taxable investment
securities (2) ................ 157,078 9,802 6.24
Loans (3) ......................... 3,056,539 261,142 8.54
------------- -------------
Total interest earning assets ..... 3,841,166 307,781 8.01
------------- -------------
Cash and due from banks ........... 109,721
Allowance for loan losses ......... (40,243)
Premises and equipment ............ 75,244
Other assets ...................... 174,756
Assets of discontinued
operations .................... 2,134,010
-------------
$ 6,294,654
=============
LIABILITIES
Interest bearing liabilities:
Deposits:
Interest bearing demand ......... $ 477,634 $ 9,022 1.89
Savings ......................... 645,106 11,163 1.73
Other time ...................... 1,685,933 90,911 5.39
Short-term borrowings ............. 204,091 9,959 4.88
Long-term debt .................... 245,205 13,929 5.68
-------------
Total interest bearing
liabilities ............. 3,257,969 134,984 4.14
------------- -------------
Non-interest bearing demand ....... 461,415
Other liabilities ................. 74,036
Liabilities of discontinued
operations .................... 1,961,039
-------------
5,754,459
-------------
STOCKHOLDER'S EQUITY .............. 540,195
-------------
$ 6,294,654
==============
Excess of interest earning assets
over interest bearing
liabilities .................... $ 583,197
=============
Net interest income ............... $ 172,797
=============
Net interest spread ............... 3.87%
====
Net interest margin (4) ........... 4.50%
====
(1) The average balances and yields earned on securities are based on
historical cost.
(2) The amounts are reflected on a fully taxable equivalent basis using the
federal statutory tax rate of 35%, adjusted for certain federal tax
preferences.
(3) Average balances include non-accrual loans. Loans consist of average total
loans less average unearned income. The amount of loan fees included in
interest income on loans is immaterial.
(4) Net interest margin is calculated by dividing the difference between total
interest earned and total interest paid by total interest earning assets.
2
Net Interest Income
Net interest income, the Corporation's primary source of earnings, is the
amount by which interest and fees generated by interest earning assets,
primarily loans and securities, exceed interest expense on deposits and borrowed
funds. Net interest income, on a fully taxable equivalent basis, totaled $172.5
million for 2003 versus $182.7 million in 2002, a decrease of $10.2 million or
5.6%. Net interest income consisted of interest income of $259.5 million and
interest expense of $87.0 million for 2003 compared to $281.1 million and $98.4
million, respectively, for 2002. The Corporation's net interest margin decreased
55 basis points to 4.21% in 2003, as the yield on interest earning assets
decreased by 99 basis points and the rate paid on interest bearing liabilities
decreased by 59 basis points.
During 2003, in order to help revive economic growth, the Federal Reserve
Board reduced its target federal funds rate to the lowest level in nearly 45
years. During the first and second quarter of 2003, concerns about continued
economic weakness and possible disinflation drove mid-term and long-term
treasury yields down significantly. This, in turn, sparked the refinancing of
mortgages in the Corporation's loan and mortgage-backed security portfolio.
Thus, the lower interest rate levels experienced during 2003 contributed to the
decline in the net interest margin as the yield on earning assets declined by
more than the rate on interest-bearing liabilities. The impact of future rate
changes on the Corporation's net income is discussed further within the
"Liquidity and Interest Rate Sensitivity" section.
The following table sets forth certain information regarding changes in
net interest income attributable to changes in the volumes of interest earning
assets and interest bearing liabilities and changes in the rates for the periods
indicated (in thousands):
Year Ended December 31 2003 2002
-------------------------------- --------------------------------
Volume Rate Net Volume Rate Net
-------- -------- -------- -------- -------- --------
Interest Income
Interest bearing deposits with
banks $ 16 $ (33) $ (17) $ (74) $ (12) $ (86)
Federal funds sold (253) (253) (506) (909) (690) (1,599)
Securities 9,875 (7,852) 2,023 (5,015) (2,015) (7,030)
Loans 3,746 (26,848) (23,102) 10,472 (28,440) (17,968)
-------- -------- -------- -------- -------- --------
13,384 (34,986) (21,602) 4,474 (31,157) (26,683)
-------- -------- -------- -------- -------- --------
Interest Expense
Deposits:
Interest bearing demand 1,249 (1,358) (109) 2,575 (5,195) (2,620)
Savings 144 (1,307) (1,163) (1,885) (4,577) (6,462)
Other time (4,970) (9,026) (13,996) (4,677) (24,359) (29,036)
Short-term borrowings 4,021 (5,468) (1,447) 453 (1,528) (1,075)
Long-term debt 8,603 (3,270) 5,333 3,945 (1,364) 2,581
-------- -------- -------- -------- -------- --------
9,047 (20,429) (11,382) 411 (37,023) (36,612)
-------- -------- -------- -------- -------- --------
Net Change $ 4,337 $(14,557) $(10,220) $ 4,063 $ 5,866 $ 9,929
======== ======== ======== ======== ======== ========
The amount of change not solely due to rate or volume changes was
allocated between the change due to rate and the change due to volume based on
the net size of the rate and volume changes.
Total interest income, on a fully taxable equivalent basis, for 2003
decreased $21.6 million or 7.7% from 2002. This decrease was a result of lower
yield, partially offset by higher earning assets. The impact of lower yield was
$35.0 million while the impact of higher earning assets was $13.4 million. The
decrease in yield was caused primarily by loan refinancing activity and
scheduled repricing of adjustable rate loans to lower market rates, coupled with
accelerated prepayments of mortgage-backed securities.
The growth in earning assets was driven by increases loans and investment
securities. The increase of $49.8 million in loans was driven primarily by
organic growth in commercial and consumer loans. The increase of $231.2 million
in securities related to growth in mortgage-backed securities resulting from
leveraged transactions totaling $164.0 million during 2003.
3
Total interest expense decreased $11.4 million or 11.6% in 2003. This
decrease was driven primarily by the lower rate paid on interest bearing
liabilities, partially offset by an increase in interest bearing liabilities.
The impact of a lower rate paid was $34.7 million while the impact of higher
interest bearing liabilities was $23.3 million. The decrease in rate paid was
driven primarily by actions taken by the Corporation to reduce rates paid on
deposits and a reduction in the cost of debt, which was partially due to the
early retirement of $220.3 million of higher cost Federal Home Loan Bank (FHLB)
borrowings during the third quarter of 2003. In addition, the Corporation
continued to successfully generate non-interest bearing deposits, which
increased $46.9 million or 8.9% in 2003.
The growth in interest bearing liabilities was driven by increases of
$20.3 million or .7% in interest bearing deposits, $132.9 million or 62.2% in
short-term borrowings and $192.9 million or 60.3% in long-term debt. The
increase in long-term debt is primarily the result of the debentures due to
Statutory Trust, which were issued in early 2003. Additionally, the Corporation
seized on the opportunity to lock-in long-term funding at relatively low rates
through 2012.
Provision for Loan Losses
The provision for loan losses increased 25.9% to $17.2 million in 2003.
(See the "Non-Performing Loans" and "Allowance for Loan Losses" sections of this
report).
Non-Interest Income
Total non-interest income increased 3.0% from $66.1 million in 2002 to
$68.2 million in 2003. Service charges increased $1.1 million or 3.3%, while
insurance premiums, commissions and fees increased $.4 million or 4.9% to $9.1
million in 2003. These higher levels of fee income are attributable to the
Corporation's success in generating core deposit fees and a continued focus on
non-banking products and services such as consumer and commercial insurance
services. Gains on the sale of mortgage loans for 2003 increased 114.2% to $2.9
million as compared to $1.3 million for the same period in 2002. The increase in
gains on the sale of mortgage loans was a direct result of increases in
homeowner refinancing driven by mortgage interest rates declining to historical
low levels. As mortgage interest rates increase, we anticipate this level of
growth in gains to decline.
Non-Interest Expense
Total non-interest expense remained relatively flat at $185.0 million in
2003. During 2003, the Corporation recorded restructuring charges related to the
spin-off of its Florida operations totaling $39.2 million. These were primarily
a prepayment penalty in connection with the early retirement of higher cost FHLB
borrowings, involuntary separation costs associated with terminated employees,
other employment related expenses, professional fees and data processing
charges. In addition, during 2002 the Corporation recorded merger and
consolidation charges of $42.0 million related to the acquisition of Promistar
Financial Corporation (Promistar). These expenses were primarily involuntary
separation costs associated with terminated employees, other employment related
expenses, professional fees and data processing conversion charges.
Salary and employee benefits expense of $87.4 million in 2003 increased
17.0% from 2002. This increase includes restructuring charges of $12.0 million
in 2003 and higher costs associated with employee medical insurance. Combined
occupancy and equipment expense of $28.6 million in 2003 increased $3.6 million
or 14.3% from 2002, mainly the result of $2.0 million of fixed asset expenses
relating to the spin-off of the Florida operations. The increase in other
expenses of $5.3 million or 14.7% from 2002 to 2003 includes $4.5 million in
restructuring charges related to the spin-off of the Florida operations.
Income Taxes
The Corporation's income tax expense was $9.0 million for 2003 compared to
$13.7 million for 2002. The 2003 effective tax rate of 24.9% was lower than the
35.0% federal statutory tax rate due to the tax benefits resulting from
tax-exempt instruments and excludable dividend income. Additional information
relating to income taxes is furnished in the Notes to Consolidated Financial
Statements.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net income increased 19.5% to $63.3 million in 2002. Diluted earnings per
share were $1.35 and $1.17 for 2002 and 2001, respectively. Income from
continuing operations was $31.3 million for 2002 and $31.8 million for 2001.
Diluted earnings per share from continuing operations were $.67 and $.70 for
2002 and 2001, respectively. Diluted earnings for 2002 were reduced $.58 per
share due to pre-tax merger expenses of $42.0 million associated with the
acquisition of Promistar and the charter consolidation. These expenses were
primarily involuntary separation costs associated with terminated employees,
early retirement and other employee related expenses, professional fees and data
processing conversion costs.
4
Net Interest Income
Net interest income, on a fully taxable equivalent basis, increased by
5.7% to $182.7 million in 2002. Net interest income consisted of interest income
of $281.1 million and interest expense of $98.4 million in 2002, compared to
$307.8 million and $135.0 million for each, respectively, in 2001. The
Corporation's net interest margin increased 26 basis points to 4.76% in 2002.
Interest income on loans, on a fully taxable equivalent basis, decreased
6.9% to $243.2 million in 2002. This decrease occurred despite favorable loan
volumes as average loans increased by $126.9 million.
Interest expense on deposits decreased $38.1 million, or 34.3%, in 2002
while average interest bearing deposits decreased by $44.5 million. The average
balance in interest bearing demand increased $172.1 million, while the average
balances in savings and time deposits decreased $125.9 million and $90.7
million, respectively, during 2002. The Corporation continued to successfully
generate non-interest bearing deposits successfully as such deposits increased
by $68.3 million, or 14.8%, in 2002. Interest expense on short-term borrowings
decreased by $1.1 million and the interest rate paid decreased by 72 basis
points in 2002. Interest expense on long-term debt increased $2.6 million in
2002 due to a $74.7 million increase in average long-term debt. The increase in
long-term debt was a result of the Corporation's use of low cost FHLB advances
to fund the purchase of certain investment securities and mortgage loans. The
interest rates on these advances ranged from 1.82% to 7.19%.
Provision for Loan Losses
The provision for loan losses decreased 49.0% to $13.6 million in 2002.
This decrease was influenced by the level of net charge-offs and provisions
taken by Promistar prior to its acquisition by the Corporation.
Non-Interest Income
Total non-interest income increased 27.2% to $66.1 million in 2002.
Insurance premiums, commissions and fees increased 7.5% to $8.7 million in 2002.
Service charges increased 33.4% during 2002. Income from wealth management
services increased $1.9 million or 20.8% to $11.3 million during 2002. These
higher levels of fee income are attributable to the Corporation's expansion of
banking services and continued focus on providing a wide array of wealth
management services, such as annuities, mutual funds and trust services.
Non-Interest Expense
Total non-interest expense increased $35.7 million to $185.0 million in
2002. During 2002, the Corporation recorded merger costs associated with the
Promistar merger of $41.4 million. These expenses were primarily involuntary
separation costs associated with terminated employees, early retirement and
other employee related expenses, professional fees and data processing
conversion costs. In addition, the Corporation recognized $510,000 in costs
relating to the consolidation of Metropolitan National Bank into First National
Bank of Pennsylvania.
Salary and employee benefits increased 2.8% to $74.7 million in 2002. This
was due to increased pension costs and the acquisition of First National Bank of
Herminie, a bank acquired by Promistar in August of 2001.
Income Taxes
The Corporation's income tax expense was $13.7 million for 2002 compared
to $10.9 million for 2001. The 2002 effective tax rate of 30.5% was lower than
the 35.0% federal statutory tax rate due to the tax benefits resulting from
tax-exempt instruments and excludable dividend income. Additional information
relating to income taxes is furnished in the Notes to Consolidated Financial
Statements.
5
LIQUIDITY AND INTEREST RATE SENSITIVITY
The Corporation's goal in liquidity management is to meet the cash flow
requirements of depositors and borrowers as well as the operating cash needs of
the Corporation, with cost-effective funding. Liquidity is centrally managed on
a daily basis by treasury personnel. In addition, our Corporate Asset/Liability
Committee (ALCO), which includes members of executive management, reviews
liquidity on a periodic basis and approves significant changes in strategies
which affect balance sheet or cash flow positions. The Board of Directors has
established an Asset/Liability Policy in order to achieve and maintain earnings
performance consistent with long-term goals while maintaining acceptable levels
of interest rate risk, a "well-capitalized" balance sheet and adequate levels of
liquidity. This policy designates the ALCO as the body responsible for meeting
this objective.
Liquidity sources from assets include payments from loans and investments
as well as the ability to securitize or sell loans and investment securities.
Liquidity sources from liabilities are generated through growth in core deposits
and, to a lesser extent, the use of wholesale sources which include federal
funds purchased, repurchase agreements and public deposits. In addition, the
banking affiliate has the ability to borrow from the FHLB. The FHLB advances are
a competitively priced and reliable source of funds. The Corporation has made
limited use of FHLB advances and has a large reserve available for contingency
funding purposes. As of December 31, 2003, outstanding advances were $431.1
million, or 5.2% of total assets, while FHLB availability was $1.6 billion, or
19.7% of total assets.
Core deposits grew $367.5 million during 2003 providing the primary source
of financing for the Corporation's lending activities, including origination of
mortgage loans held for sale in the secondary market. The Corporation continued
to expand its activities in originating mortgage loans for resale in the
secondary market rather than keeping these loans in the portfolio. Mortgage loan
originations volumes increased due to the decline in mortgage rates during 2003.
Originations of mortgage loans totaled $82.3 million for 2003 and compared to
$74.4 million for 2002. The proceeds from the sale of mortgage loans were used
to fund the growth in mortgage loan origination.
The Corporation has repurchased shares of its common stock for re-issuance
under various employee benefit plans and the Corporation's dividend reinvestment
plan since 1991. In addition, the Corporation has repurchased shares for
specific re-issuance in connection with certain business combinations accounted
for as purchase transactions. During 2003, the Corporation purchased treasury
shares totaling $33.9 million and received $33.4 million upon re-issuance. In
2002 and 2001, the Corporation purchased treasury shares totaling $30.3 million
and $12.1 million, respectively, and received $23.2 million and $12.6 million,
respectively, as a result of re-issuance.
The principal source of cash for the parent company is dividends from its
subsidiaries. The parent also has approved lines of credit with several major
domestic banks, which were unused as of December 31, 2003. The Corporation also
issues subordinated debt on a regular basis and has access to the Federal
Reserve Bank as well as to the capital markets.
The ALCO regularly monitors various liquidity ratios and forecasts of cash
position. Management believes the Corporation has sufficient liquidity available
to meet its normal operating and contingency funding cash needs.
The financial performance of the Corporation is at risk from interest rate
fluctuations. This interest rate risk arises due to differences between the
amount of interest earning assets and interest bearing liabilities subject to
repricing over a period of time, the difference between the change in various
interest rates and the embedded options in certain financial instruments. The
Corporation utilizes an asset/liability model to support its balance sheet
strategies. The Corporation uses gap analysis, net interest income simulations
and the economic value of equity to measure interest rate risk.
The following gap analysis measures the interest rate risk of the
Corporation by comparing the difference between the amount of interest earning
assets and interest bearing liabilities subject to repricing over a period of
time. The ratio of rate sensitive assets to rate sensitive liabilities maturing
over a one year period was .91 at December 31, 2003, as compared to 1.14 at
December 31, 2002. A ratio of less than one indicates a higher level of
repricing liabilities over assets liabilities over the next twelve months,
assuming the current interest rate environment.
6
Following is the gap analysis as of December 31, 2003 (dollars in
thousands):
WITHIN 4-12 1-5 OVER
3 MONTHS MONTHS YEARS 5 YEARS TOTAL
----------- ----------- ----------- ----------- -----------
INTEREST EARNINGS ASSETS
Interest bearing deposits with banks $ 1,052 $ 100 -- -- $ 1,152
Securities 53,468 127,629 $ 488,751 $ 232,849 902,697
Loans, net of unearned income 856,549 626,299 1,431,345 346,439 3,260,632
----------- ----------- ----------- ----------- -----------
911,069 754,028 1,920,096 579,288 4,164,481
Other assets -- -- -- 392,693 392,693
Assets of discontinued operations -- -- -- 3,751,136 3,751,136
----------- ----------- ----------- ----------- -----------
$ 911,069 $ 754,028 $ 1,920,096 $ 4,723,117 $ 8,308,310
=========== =========== =========== =========== ===========
INTEREST BEARING LIABILITIES
Deposits:
Interest checking $ 332,326 -- -- $ 384,308 $ 716,634
Savings 294,786 -- -- 505,789 800,575
Time deposits 355,101 $ 543,061 $ 428,240 3,104 1,329,506
Borrowings 254,167 50,997 272,328 240,282 817,774
----------- ----------- ----------- ----------- -----------
1,236,380 594,058 700,568 1,133,483 3,664,489
Other liabilities -- -- -- 650,891 650,891
Liabilities of discontinued operations -- -- -- 3,386,021 3,386,021
Stockholders' equity -- -- -- 606,909 606,909
----------- ----------- ----------- ----------- -----------
$ 1,236,380 $ 594,058 $ 700,568 $ 5,777,304 $ 8,308,310
=========== =========== =========== =========== ===========
Period Gap $ (325,311) $ 159,970 $ 1,219,528 $(1,054,187)
=========== =========== =========== ===========
Cumulative Gap $ (325,311) $ (165,341) $ 1,054,187
=========== =========== ===========
Cumulative Gap as a Percent of
Total Assets (3.92)% (1.99)% 12.69%
=========== =========== ===========
Rate Sensitive Assets/Rate Sensitive
Liabilities .74 .91 1.42 1.14
=========== =========== =========== ===========
Net interest income simulations measure the short-term earnings exposure
from changes in market rates of interest. The Corporation's current financial
position is combined with assumptions regarding future business to calculate net
interest income under varying hypothetical rate scenarios. The economic value of
equity (EVE) measures the Corporation's long-term earnings exposure from changes
in market rates of interest. EVE is defined as the present value of assets minus
the present value of liabilities at a point in time. A decrease in EVE due to a
specified rate change indicates a decline in the long-term earnings capacity of
the current balance sheet assuming that the rate change remains in effect over
the life of the current balance sheet. The following table presents an analysis
of the potential sensitivity of the Corporation's annual net interest income and
EVE to sudden and sustained changes in market rates:
December 31 2003 2002
---- ----
Net interest income change (12 months):
- 100 basis points (3.4)% (2.4)%
+ 200 basis points (2.3)% 3.0 %
Economic value of equity:
- 100 basis points (12.7)% (5.4)%
+ 200 basis points (6.4)% 3.8 %
7
The above measures reveal the challenges created by the continued decrease
in interest rates during 2003. Should rates decline by an additional large
amount, the net margin would compress due to a limited ability to lower certain
deposit rates. Such a rate change might also spur additional loan refinancing
and mortgage-backed security prepayments at those lower rates. At this point in
the rate cycle, the ALCO does not feel substantially lower rates are probable.
As discussed under the "Net Interest Income" section, the lower interest rates
during 2003 resulted in the refinancing of certain loans and the prepayment of
certain securities. The replacement of those instruments has effectively
lengthened the duration of assets somewhat. In addition, there has been a
significant movement of deposit balances from time deposits to non-maturity
deposits. This movement reflects depositors' preference for liquidity during
periods of low interest rates. These combined balance sheet changes have made
substantially higher interest rates less beneficial to net interest income.
The preceding measures assumed no change in asset/liability compositions.
Thus, the measures do not reflect actions the ALCO may undertake in response to
such changes in interest rates. While these measures are within the limits set
forth in the Corporation's Asset/Liability Policy, the ALCO is evaluating
strategies to position itself better for an environment with substantially
higher interest rates.
The computation of the prospective effects of hypothetical interest rate
changes requires numerous assumptions regarding characteristics of new business
and the behavior of existing positions. These business assumptions are based
upon our experience, business plans and published industry experience. Key
assumptions employed in the model include asset prepayment speeds, the relative
price sensitivity of certain assets and liabilities and the expected life of
non-maturity deposits. Because these assumptions are inherently uncertain,
actual results will differ from simulated results.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF-BALANCE SHEET ARRANGEMENTS
The following table sets forth contractual obligations of the Corporation,
which represent required and potential cash outflows as of December 31, 2003 (in
thousands):
WITHIN ONE TO THREE TO AFTER
ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS TOTAL
-------- ----------- ---------- ---------- --------
Operating leases $ 2,466 $ 3,794 $ 2,671 $ 14,109 $ 23,040
Long-term debt 20,191 107,724 174,555 282,338 584,808
-------- -------- -------- -------- --------
$ 22,657 $111,518 $177,226 $296,447 $607,848
======== ======== ======== ======== ========
The following table sets forth the amounts and expected maturities of
commitments to extend credit and other off-balance sheet items as of December
31, 2003 (in thousands):
WITHIN ONE TO THREE TO AFTER
ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS TOTAL
-------- ----------- ---------- ---------- --------
Commitments to extend credit $538,961 $ 8,298 $ 2,259 $ 43,244 $592,762
Standby letters of credit 25,879 7,768 12,360 2,494 48,501
-------- -------- -------- -------- --------
$564,840 $ 16,066 $ 14,619 $ 45,738 $641,263
======== ======== ======== ======== ========
Commitments to extend credit and standby letters of credit do not
necessarily represent future cash requirements in that the borrower has the
ability to draw upon these commitments at any time and these commitments often
expire without being drawn upon.
8
FINANCIAL CONDITION
LENDING ACTIVITY
The loan portfolio consists principally of loans to individuals and small-
and medium-sized businesses within the Corporation's primary market area of
western and central Pennsylvania and northeastern Ohio. Additionally, the
portfolio contains consumer finance loans to individuals in Pennsylvania, Ohio
and Tennessee.
Following is a summary of loans (dollars in thousands):
December 31 2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
Real Estate:
Residential $ 1,348,326 $ 1,284,141 $ 1,187,991 $ 1,159,032 $ 1,105,383
Commercial 773,167 721,246 675,089 605,083 654,558
Construction 40,795 24,941 42,908 38,720 20,681
Installment loans to individuals 676,630 787,865 686,599 722,803 671,786
Commercial, financial and agricultural 434,574 416,045 494,415 454,739 443,084
Lease financing 17,277 39,590 67,159 99,519 124,764
Unearned income (31,572) (38,620) (45,880) (59,845) (60,044)
----------- ----------- ----------- ----------- -----------
$ 3,259,197 $ 3,235,208 $ 3,108,281 $ 3,020,051 $ 2,960,212
=========== =========== =========== =========== ===========
Total loans excluding unearned income increased slightly to $3.3 billion
at December 31, 2003. The Corporation focused on growing commercial and real
estate loans which contributed to a strong growth of $140.5 million or 6.2% as
depicted in the real estate and commercial, financial and agricultural
categories. Installment loans to individuals and lease financing decreased
$111.2 million or 14.1% and $22.3 million or 56.4%, respectively, as the
Corporation ceased to originate automobile leases in 2000 and continues to
de-emphasize its presence in the indirect lending business.
The Corporation's loan portfolio is well-diversified with a significant
portion of the portfolio being made up of loans secured by real estate.
Residential, commercial and construction loans secured by real estate accounted
for 66.3% of the loan portfolio at December 31, 2003. Historically, these
relationships experienced the fewest loan losses as compared to any other
category of loan.
As of December 31, 2003, no concentrations of loans exceeding 10% of total
loans existed which were not disclosed as a separate category of loans.
Following is a summary of the maturity distribution of certain loan
categories based on remaining scheduled repayments of principal (in thousands):
WITHIN 1-5 OVER
December 31, 2003 1 YEAR YEARS 5 YEARS TOTAL
-------- -------- -------- --------
Commercial, financial and agricultural $ 27,767 $164,043 $242,764 $434,574
Real estate - construction 375 1,419 39,001 40,795
-------- -------- -------- --------
$ 28,142 $165,462 $281,765 $475,369
======== ======== ======== ========
The total amount of loans due after one year includes $336.8 million with
floating or adjustable rates of interest and $110.5 million with fixed rates of
interest.
NON-PERFORMING LOANS
Non-performing loans include non-accrual loans and restructured loans.
Non-accrual loans represent loans on which interest accruals have been
discontinued. Restructured loans are loans in which the borrower has been
granted a concession on the interest rate or the original repayment terms due to
financial distress.
9
Following is a summary of non-performing loans (dollars in thousands):
December 31 2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Non-accrual loans $22,449 $18,329 $16,876 $17,719 $15,452
Restructured loans 5,719 5,915 5,578 2,883 3,684
------- ------- ------- ------- -------
$28,168 $24,244 $22,454 $20,602 $19,136
======= ======= ======= ======= =======
Non-performing loans as a
percentage of total loans .86% .75% .72% .68% .65%
Following is a table showing the amounts of contractual interest income
and actual interest income recorded on non-accrual and restructured loans (in
thousands):
December 31 2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Gross interest income:
In accordance with their original
terms $2,961 $2,647 $2,027 $2,499 $2,010
Interest income recorded during
the year 1,593 1,299 912 798 768
Following is a summary of loans 90 days or more past due, on which
interest accruals continue (dollars in thousands):
December 31 2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
Loans 90 days or more past due $ 5,100 $ 6,924 $ 5,117 $ 4,470 $ 3,229
As a percentage of total loans .16% .21% .16% .15% .11%
ALLOWANCE AND PROVISION FOR LOAN LOSSES
The allowance for loan losses consists of an allocated and an unallocated
component. Management's analysis of the allocated portion of the allowance for
loan losses includes the evaluation of the loan portfolio based upon the
Corporation's internal loan grading system, evaluation of portfolio industry
concentrations and the historical loss experience of the remaining balances of
the various homogeneous loan pools which comprise the loan portfolio. Specific
factors used in the internal loan grading system include the previous loan loss
experience with the customer, the status of past due interest and principal
payments on the loan, the collateral position and residual value of the loan,
the quality of financial information supplied by the borrower and the general
financial condition of the borrower.
The unallocated portion of the allowance is determined based on
management's assessment of historical loss on the remaining portfolio segments
in conjunction with the current status of economic conditions, loan loss trends,
delinquency and non-accrual trends, credit administration, portfolio growth,
concentrations of credit risk and other factors, including regulatory guidance.
This determination inherently involves a higher degree of uncertainty and
considers current risk factors that may not have yet occurred in the
Corporation's historical loss factors used to determine the allocated component
of the allowance, and it recognizes that knowledge of the portfolio may be
incomplete.
The Corporation strives to minimize credit losses by utilizing credit
approval standards, diversifying its loan portfolio by industry and borrower and
conducting ongoing review and management of the loan portfolio.
The Corporation has allocated the allowance according to the amount deemed
to be reasonably necessary to provide for the possibility of losses being
incurred within each of the categories shown in the table below. Management's
allocation considers amounts necessary for concentrations and changes in the
portfolio mix and volume. The allocation of the allowance should not be
interpreted as an indication that loan losses in future years will occur in the
same proportions or that the allocation indicates future loan loss trends.
10
Following is a summary of the allocation of the allowance for loan losses
(dollars in thousands):
% OF % OF % OF % OF
LOANS IN LOANS IN LOANS IN LOANS IN
EACH EACH EACH EACH
CATEGORY CATEGORY CATEGORY CATEGORY
DEC 31, TO TOTAL DEC. 31, TO TOTAL DEC. 31, TO TOTAL DEC. 31, TO TOTAL
2003 LOANS 2002 LOANS 2001 LOANS 2000 LOANS
------- -------- -------- -------- -------- -------- -------- --------
Commercial, financial and
agricultural $13,508 13% $10,590 13% $ 7,518 16% $ 6,420 15%
Real estate - construction 514 1 230 1 216 1 297 1
Real estate - mortgage 10,661 65 12,945 62 12,664 60 11,533 59
Installment loans to
Individuals 19,144 20 15,885 23 11,159 21 8,997 22
Lease financing 939 1 2,293 1 3,629 2 744 3
Unallocated portion 1,373 5,041 11,159 11,812
------- ------- ------- -------
$46,139 100% $46,984 100% $46,345 100% $39,803 100%
======= ======= ======= =======
% OF
LOANS IN
EACH
CATEGORY
DEC. 31, TO TOTAL
1999 LOANS
-------- --------
Commercial, financial and
agricultural $ 7,198 15%
Real estate - construction 326 1
Real estate - mortgage 9,734 59
Installment loans to
Individuals 8,322 21
Lease financing 581 4
Unallocated portion 12,490
-------
$38,651 100%
=======
Following is a summary of changes in the allowance for loan losses
(dollars in thousands):
Year Ended December 31 2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Balance at beginning of period $ 46,984 $ 46,345 $ 39,803 $ 38,651 $ 33,343
Addition due to acquisitions -- -- 3,400 767 2,813
Charge-offs:
Real estate - mortgage (571) (849) (4,598) (2,929) (2,330)
Installment loans to individuals (15,769) (12,577) (11,483) (9,616) (7,813)
Lease financing (1,457) (1,548) (1,441) (940) (272)
Commercial, financial and agricultural (2,447) (1,583) (8,282) (1,039) (1,142)
-------- -------- -------- -------- --------
(20,244) (16,557) (25,804) (14,524) (11,557)
Recoveries:
Real estate - mortgage 53 57 254 879 572
Installment loans to individuals 1,482 1,635 1,471 1,287 1,317
Lease financing 204 81 211 147 52
Commercial, financial and agricultural 505 1,799 283 203 216
-------- -------- -------- -------- --------
2,244 3,572 2,219 2,516 2,157
Net charge-offs (18,000) (12,985) (23,585) (12,008) (9,400)
Provision for loan losses 17,155 13,624 26,727 12,393 11,895
-------- -------- -------- -------- --------
Balance at end of period $ 46,139 $ 46,984 $ 46,345 $ 39,803 $ 38,651
======== ======== ======== ======== ========
Net charge-offs as a percent of average loans, net
of unearned income .56% .41% .77% .40% .34%
Allowance for loan losses as a percent of total
loans, net of unearned income 1.42% 1.45% 1.49% 1.32% 1.31%
Allowance for loan losses as a percent of
non-performing loans 163.80% 193.80% 206.40% 193.20% 201.98%
The provision for loan losses charged to operations is a direct result of
management's analysis of the adequacy of the allowance for loan losses which
takes into consideration factors, including qualitative factors, relevant to the
collectibility of the existing portfolio. The provision for loan losses
increased from $13.6 million in 2002 to $17.2 million in 2003.
Charge-offs reflect the realization of losses in the portfolio that were
recognized previously through provisions for credit losses. Loans charged off in
2003 increased $3.7 million to $20.2 million. Net charge-offs as a percent of
average loans increased to
11
..56% in 2003 as compared to .41% in 2002. Loans charged off in 2002 decreased
$7.0 million as compared to 2001. Loans charged off in 2001 increased $9.2
million over 2000. The 2001 provision for loan losses was significantly
influenced by the level of net charge-offs taken by Promistar prior to its
acquisition by the Corporation. The weak economy in central Pennsylvania, which
existed in 2001, and the overall economic climate subsequent to September 11
resulted in deterioration in the credit quality of several significant
commercial loans. In addition, Promistar began to experience credit quality
deterioration within the indirect consumer auto loan portfolio as loan loss and
delinquency trends increased. As a result, Promistar charged-off $14.2 million
in loans and recorded a provision for loan losses of $18.3 million during 2001.
INVESTMENT ACTIVITY
Investment activities serve to enhance overall yield on earning assets
while supporting interest rate sensitivity and liquidity positions. Securities
purchased with the intent and ability to retain until maturity are categorized
as securities held to maturity and carried at amortized cost. All other
securities are categorized as securities available for sale and are recorded at
fair market value.
During 2003, securities available for sale increased by $221.1 million and
securities held to maturity decreased by $8.3 million from December 31, 2002.
The following table indicates the respective maturities and
weighted-average yields of securities as of December 31, 2003 (dollars in
thousands):
WEIGHTED
AVERAGE
AMOUNT YIELD
-------- --------
Obligations of U.S. Treasury and other U.S. Government agencies:
Maturing within one year $ 17,149 6.03%
Maturing after one year within five years 89,610 3.47%
Maturing after five years within ten years 20,652 4.18%
Maturing after ten years 513 5.91%
State and political subdivisions:
Maturing within one year 5,511 5.78%
Maturing after one year within five years 28,747 6.26%
Maturing after five years within ten years 24,441 6.51%
Maturing after ten years 814 21.88%
Other securities:
Maturing within one year 392 5.66%
Maturing after one year within five years 3,405 5.62%
Maturing after five years within ten years 527 6.98%
Maturing after ten years 31,139 7.63%
Mortgage-backed securities 634,677 5.01%
Equity securities 45,120 2.85%
--------
Total $902,697 4.94%
========
The weighted average yields for tax exempt securities are computed on a
tax equivalent basis.
12
DEPOSITS AND SHORT-TERM BORROWINGS
As a commercial bank holding company, the Corporation's primary source of
funds is its deposits. Those deposits are provided by businesses and individuals
located within the markets served by the Corporation's subsidiaries.
Total deposits increased $135.4 million to $3.4 billion in 2003. This
increase was due to a $337.9 million or 28.7% increase in savings and interest
checking accounts and a $29.6 million or 5.3% increase in non-interest bearing
deposit accounts. These increases were offset by a decrease of $232.1 million or
14.9% in time deposits.
Short-term borrowings, made up of repurchase agreements, federal funds
purchased, FHLB advances, subordinated notes and other short-term borrowings,
decreased by $22.4 million in 2003 to $233.0 million.
Repurchase agreements are the largest component of short-term borrowings.
At December 31, 2003, repurchase agreements represented 35.0% of total
short-term borrowings. Following is a summary of selected information on
repurchase agreements (dollars in thousands):
2003 2002 2001
------- ------- -------
Balance at period-end $81,444 $43,210 $67,110
Maximum month-end balance 91,786 56,352 64,802
Average balance during period 77,977 60,022 69,056
Weighted average interest rates:
At end of year .63% .39% 2.94%
During the year 1.20% 2.15% 3.20%
CAPITAL RESOURCES
The assessment of capital adequacy depends on a number of factors such as
asset quality, liquidity, earnings performance, changing competitive conditions
and economic forces. The Corporation seeks to maintain a strong capital base to
support our growth and expansion activities, to provide stability to current
operations and to promote public confidence.
The Corporation has an effective $200.0 million shelf registration with
the Securities and Exchange Commission. The Corporation may, from time to time,
issue any combination of common stock, preferred stock, debt securities or trust
preferred securities in one or more offerings up to a total dollar amount of
$200.0 million.
Capital management is a continuous process. Both the Corporation and its
banking affiliate are subject to various regulatory capital requirements
administered by the federal banking agencies. (See the "Regulatory Matters"
section in the notes to our consolidated financial statements). Book value per
share was $13.10 at December 31, 2003 compared to $12.93 at December 31, 2002.
The Corporation issues shares, which were initially acquired through the
acquisition of treasury stock, in connection with its various benefit plans.
The following table summarizes capital ratios as of December 31, 2003 for
the Corporation (dollars in thousands):
WELL CAPITALIZED MINIMUM CAPITAL
ACTUAL REQUIREMENTS REQUIREMENTS
---------------------- ----------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- ----- -------- -----
Total Capital (to risk-weighted assets): $640,697 10.9% $587,226 10.0% $469,781 8.0%
Tier 1 Capital (to risk-weighted assets): 537,916 9.2% 352,336 6.0% 234,891 4.0%
Tier 1 Capital (to average assets): 537,916 6.7% 401,246 5.0% 320,997 4.0%
13