SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE FISCAL YEAR ENDED: JUNE 30, 2002
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________ to _________
COMMISSION FILE NO: 0-18833
CHESTER VALLEY BANCORP INC.
---------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2598554
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 E. Lancaster Ave., Downingtown PA 19335
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(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 269-9700
Securities registered pursuant to Section 12(b) of the Act:
NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $1.00 PAR VALUE PER SHARE
---------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. X
-----
As of September 1, 2002, the aggregate value of the 3,656,359 shares of Common
Stock of the registrant which were issued and outstanding on such date,
excluding 654,582 shares held by all directors and officers of the registrant as
a group, was approximately $59.42 million. This figure is based on the closing
sales price of $16.25 per share of the registrant's Common Stock on September 1,
2002.
Number of shares of Common Stock outstanding as of September 1, 2002: 4,310,941
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the 2002 annual meeting of
shareholders are incorporated into Part III, Items 10-13 of this Form 10-K.
INDEX
PAGE
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PART I
Item 1. Business.......................................................... 1
Item 2. Properties........................................................28
Item 3. Legal Proceedings.................................................30
Item 4. Submission of Matters to a Vote of Security Holders...............30
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters...........................................................30
Item 6. Selected Financial Data...........................................31
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........43
Item 8. Financial Statements and Supplementary Data.......................46
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..........................................73
PART III
Item 10. Directors and Executive Officers of the Registrant................73
Item 11. Executive Compensation............................................73
Item 12. Security Ownership of Certain Beneficial Owners and Management....73
Item 13. Certain Relationships and Related Transactions....................73
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..73
Signatures ..................................................................75
Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934,
as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 ...........................................................76
FORWARD LOOKING STATEMENTS
In this Annual Report on Form 10-K (the "Form-10-K"), the Company has
included certain "forward looking statements", either express or implied, which
concern anticipated future operations of the Company. It is management's desire
to take advantage of the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. This statement is for the express purpose of
availing the Company of the protections of such safe harbor with respect to all
"forward looking statements" contained in this Form 10-K. The Company may have
used "forward looking statements" to describe certain of its future plans and
strategies including management's current expectations of the Company's future
financial results. Management's ability to predict results or the effect of
future plans and strategy involve certain risks, uncertainties, estimates, and
assumptions, which are subject to factors beyond the Company's control.
Consequently, the Company's actual results could differ materially from
management's expectations. Factors that could affect results include, but are
not limited to, interest rate trends, competition, the general economic climate
in Chester County, the mid-Atlantic region and the United States as a whole,
loan demand, loan delinquency rates and changes in asset quality, changes in
monetary and fiscal policies of the United States Government, changes in federal
and state regulation, changes in accounting policies and practices as may be
adopted by bank regulatory agencies and the Financial Accounting Standards Board
and other uncertainties described in the Company's filings with the Securities
and Exchange Commission (the "Commission"), including this Form 10-K. These
factors should be considered in evaluating the "forward looking statements", and
undue reliance should not be placed on such statements. The Company undertakes
no obligation to update or revise any forward-looking statements, whether
written or oral, that may be made from time to time by or on the Company's
behalf.
PART I.
ITEM 1. BUSINESS
GENERAL
Chester Valley Bancorp Inc. (the "Holding Company") was incorporated in the
Commonwealth of Pennsylvania in August 1989. The business of the Holding Company
and its subsidiaries (collectively, the "Company") consists of the operations of
First Financial Bank ("First Financial" or the "Bank"), a Pennsylvania-chartered
commercial bank founded in 1922 as a savings association, and Philadelphia
Corporation for Investment Services ("PCIS"), a full-service investment advisory
and securities brokerage firm. Effective September 1, 2001, the Bank converted
to a Pennsylvania-chartered commercial bank from a Pennsylvania-chartered
savings association. As a consequence of such charter conversion, the Holding
Company became a bank holding company that has also been designated as a
financial holding company. Prior to such conversion, the Holding Company was a
unitary thrift holding company. The Bank provides a wide range of banking
services to individual and corporate customers through its nine full-service
branch offices located in Chester County, Pennsylvania. The Bank provides
residential real estate, commercial real estate, commercial and consumer lending
services, funding these activities primarily with retail and business deposits
and borrowings. PCIS is a registered broker/dealer in all 50 states and the
District of Columbia and it is also registered as an investment advisor with the
Commission. PCIS provides many additional services, including self-directed and
managed retirement accounts, safekeeping, daily sweep money market funds,
portfolio and estate valuations, life insurance and annuities, and margin
accounts, to individuals and smaller corporate accounts. PCIS' offices are
located in Wayne and Philadelphia, Pennsylvania.
References to the Company include its wholly owned subsidiaries, the Bank
and PCIS, unless the context of the reference indicates otherwise.
1
MARKET AREA AND COMPETITION
The Bank's primary market area includes Chester County and sections of the
four contiguous counties (Delaware, Montgomery, Berks, and Lancaster) in
Pennsylvania. Chester County, in which all of the Bank's offices are located,
continues to grow in terms of economic development and population growth. The
segment of the market served by the Company from a business perspective is
primarily industrially oriented and demographically is comprised of middle and
upper income households.
Customer deposits with First Financial are insured to the maximum extent
provided by law by the Federal Deposit Insurance Corporation ("FDIC") through
the Savings Association Insurance Fund ("SAIF"). The Bank is subject to
examination and comprehensive regulation by the FDIC and the Pennsylvania
Department of Banking ("Department"). Prior to the Bank's conversion to a
commercial bank, it was also subject to regulation and examination by the Office
of Thrift Supervision ("OTS"). It is a member of the Federal Home Loan Bank
("FHLB") of Pittsburgh ("FHLBP"), which is one of the 12 regional banks
comprising the FHLB System. The Bank is further subject to regulations of the
Board of Governors of the Federal Reserve System ("Federal Reserve Board")
governing reserves required to be maintained against deposits and certain other
matters. The Holding Company, as a registered bank holding company, is subject
to examination and regulation of the Federal Reserve Board.
COMPETITION
First Financial encounters strong competition both in the attraction of
deposits and in the making of real estate and other loans. Its most direct
competition for deposits has historically come from commercial banks, savings
associations, savings banks and credit unions conducting business in its primary
market area. The Bank also encounters competition for deposits from money market
and other mutual funds, as well as corporate and government securities and
insurance companies. The principal methods used by the Bank to attract deposit
accounts include offering a variety of services and interest rates and providing
convenient office locations and expanded banking hours. The Bank's competition
for real estate and other loans comes principally from other savings
institutions, credit unions, commercial banks, mortgage banking companies,
insurance companies, and other lenders. First Financial competes successfully
for loans through interest rates, loan maturities, loan fees and the quality of
service extended to borrowers and real estate brokers.
PCIS is engaged in securities brokerage and asset management activities all
of which are extremely competitive businesses. Competitors include all of the
member organizations of the New York Stock Exchange and other registered
securities exchanges, all members of the National Association of Securities
Dealers, Inc. (the "NASD"), commercial banks and savings associations, insurance
companies, investment companies, and financial consultants. PCIS competes
effectively against other firms in its brokerage and asset management services
because of its quality service, its excellent reputation, the results produced
and its competitive pricing.
EMPLOYEES
The Company had 139 full-time employees and 30 part-time employees as of
June 30, 2002. None of these employees are represented by a collective
bargaining agent and the Company believes that it enjoys good relations with its
personnel.
2
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION
The Company's net loan portfolio (net of undisbursed proceeds, deferred
fees and allowance for loan losses) totaled $363.70 million at June 30, 2002,
representing approximately 64.3% of the Company's total assets of $566.03
million at that date.
The following table presents information regarding the composition of the
Company's loan portfolio at the dates indicated.
AT JUNE 30,
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2002 2001 2000
------------------ ------------------ --------------------
% OF % OF % OF
TOTAL TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
------------------ ------------------ ---------------------
(Dollars in Thousands)
Real estate loans:
Residential:
Single-family $127,072 32.4% $148,805 40.2% $167,451 46.8%
Multi-family 6,679 1.7% -- 0.0% -- 0.0%
Commercial 103,985 26.5% 82,890 22.4% 66,221 18.5%
Construction and land
acquisition(1) 48,470 12.3% 46,243 12.5% 42,372 11.8%
----------------- ----------------- -----------------
Total real estate loans 286,206 72.9% 277,938 75.1% 276,044 77.1%
Commercial business loans(2) 36,774 9.4% 27,653 7.4% 19,358 5.4%
Consumer loans(3) 69,538 17.7% 64,756 17.5% 62,433 17.5%
----------------- ----------------- -----------------
Total loans receivable 392,518 100.0% 370,347 100.0% 357,835 100.0%
Less:
Loans in process (22,833) (20,528) (20,908)
Allowance for loan losses (4,588) (4,264) (3,908)
Deferred loan fees (1,533) (1,592) (1,713)
-------- -------- --------
Net loans receivable 363,564 343,963 331,306
Loans held for sale, single-family
residential mortgages 138 2,350 --
-------- -------- --------
Net loans receivable and loans held
for sale $363,702 $346,313 $331,306
======== ======== ========
AT JUNE 30,
----------------------------------------
1999 1998
----------------- -----------------
% OF % OF
TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS
----------------- -----------------
(Dollars in Thousands)
Real estate loans:
Residential:
Single-family $156,514 50.8% $154,755 53.3%
Multi-family 828 0.3% 873 0.3%
Commercial 55,197 17.9% 41,002 14.1%
Construction and land
acquisition(1) 29,339 9.5% 30,646 10.5%
----------------- -----------------
Total real estate loans 241,878 78.5% 227,276 78.2%
Commercial business loans(2) 14,708 4.8% 11,437 3.9%
Consumer loans(3) 51,416 16.7% 51,829 17.9%
----------------- -----------------
Total loans receivable 308,002 100.0% 290,542 100.0%
Less:
Loans in process (11,393) (12,380)
Allowance for loan losses (3,651) (3,414)
Deferred loan fees (1,570) (1,620)
-------- --------
Net loans receivable 291,388 273,128
Loans held for sale, single-family
residential mortgages -- 1,101
-------- --------
Net loans receivable and loans held
for sale $291,388 $274,229
======== ========
- ---------------
(1) Includes construction loans for both residential and commercial real estate
properties.
(2) Consists primarily of loans secured by accounts receivable, inventory,
equipment and general corporate assets.
(3) Consists primarily of home equity loans and lines of credit, home
improvement, automobile and other personal loans.
3
CONTRACTUAL MATURITIES
The following table sets forth the contractual principal repayments of the
total loan portfolio, including loans in process, of the Company as of June 30,
2002, by categories of loans. Loans are included in the period in which they
mature. Loans held for sale are not included.
PRINCIPAL REPAYMENTS
CONTRACTUALLY DUE IN YEAR(S) ENDED JUNE 30,
-------------------------------------------
(In Thousands)
TOTAL
OUTSTANDING
AT 2008
JUNE 30, 2004- AND
2002 2003 2007 THEREAFTER
----------- ---------- ---------- -----------
Real estate loans:
Residential $133,751 $ 19,541 $ 16,790 $ 97,420
Commercial 103,985 18,270 61,481 24,234
Construction and land acquisition 48,470 24,568 19,749 4,153
Commercial business loans 36,774 18,414 12,940 5,420
Consumer loans 69,538 26,579 16,988 25,971
-------- -------- -------- --------
TOTAL LOANS RECEIVABLE $392,518 $107,372 $127,948 $157,198
======== ======== ======== ========
The following table sets forth, as of June 30, 2002, the dollar amount of
all loans contractually due after June 30, 2003, which have fixed interest rates
and floating or adjustable rates.
CONTRACTUAL OBLIGATIONS
DUE AFTER JUNE 30, 2003
--------------------------------------------
FLOATING/
FIXED ADJUSTABLE
RATES RATES TOTAL
--------------------------------------------
(In Thousands)
Real estate loans:
Residential $ 90,973 $ 23,237 $114,210
Commercial 18,015 67,700 85,715
Construction and land acquisition 335 23,567 23,902
Commercial business loans 12,693 5,667 18,360
Consumer loans 42,959 -- 42,959
------------------------------------------
TOTAL LOANS $164,975 $120,171 $285,146
==========================================
Contractual principal repayments of loans do not necessarily reflect the
actual term of the Company's loan portfolio. The average life of mortgage loans
is substantially less than their contractual terms because of loan prepayments
and because of enforcement of due-on-sale clauses, which give the Company the
right to declare a loan immediately due and payable in the event, among other
things, that the borrower sells the real property subject to the mortgage and
the loan is not repaid. The average life of mortgage loans tends to increase,
however, when current mortgage loan rates substantially exceed rates on existing
mortgage loans and, conversely, decrease when rates on existing mortgage loans
substantially exceed current mortgage loan rates.
4
ORIGINATION, PURCHASE AND SALE OF LOANS
Commercial, multi-family residential real estate and consumer loans are
originated directly by the Bank through salaried loan officers. Salaried
employees originated single-family residential real estate loans during part of
fiscal 2002 but starting in the second quarter of fiscal 2002, the Bank stopped
originating these loans in house and began using a third party to handle all
originations, processing and sales of single-family residential real estate
loans. All of the residential real estate loans originated by the Bank using the
third party are immediately sold and the Bank recognizes a gain or loss on the
sale.
Prior to changing its method of origination single-family residential loans
in 2002, the Bank had periodically identified certain loans as held for sale at
the time of origination. These loans consist primarily of fixed-rate,
single-family residential mortgage loans. See Loans Held for Sale within Note -
1 of Notes to the Consolidated Financial Statements.
LOAN PRODUCTS
The Bank offers a broad array of loan products with competitive terms and
conditions to both individuals and to businesses. In prior years, loan activity
has been primarily focused on the origination of mortgage loans collateralized
by single-family residential properties. However, in recent years, the Bank has
substantially expanded its involvement in commercial real estate lending as well
as commercial business lending as part of its strategic shift, which shift
culminated in the Bank's conversion to a commercial bank in September 2001. As a
result of the changing composition of the Bank's loan portfolio, loans secured
by single-family properties have declined as a percentage of the portfolio from
53.3% at June 30, 1998 to 32.4% at June 30, 2002. Commercial real estate and
commercial business loans in the aggregate increased from 18.0% to 35.9% at such
dates, respectively. The Bank has also continued to remain an active
construction and land acquisition loan originator, with such loans accounting
for 12.3% of the Bank's total loan portfolio as of June 30, 2002. In order to
meet the wide-ranging needs of its customers, the Bank has also marketed
aggressively a variety of consumer loans, including home equity loans and lines
of credit.
The Bank originates residential real estate loans secured by properties
located primarily in southeastern Pennsylvania. These loans are generally to
first time homebuyers and are both fixed-rate and adjustable-rate loans with
amortization periods up to 30 years.
The Bank provides a wide range of commercial lending products. These
products include commercial and multi-family real estate construction,
residential development and land acquisition loans and commercial business
loans. Commercial real estate loans normally are secured by properties located
in Chester County or the four counties contiguous to it. The substantial
majority of such loans bear adjustable interest rates with amortization terms of
20 years or less.
Commercial business loans are generally made to small and medium sized
companies located in the Bank's primary market area. Although the Bank makes
both secured and unsecured loans, the majority of these loans are on a secured
basis. New commercial business loans are typically secured by accounts
receivable, inventory, equipment, and/or general corporate assets of the
borrowers. Commercial business loans are originated with both fixed and
adjustable rates with the adjustable interest rates being prime-based. These
loans typically are originated for terms ranging from one to five years.
The Bank's consumer loans are primarily loans to individuals originated
through its branch network. The majority of its originations are home equity
credit lines secured by a second mortgage on the primary residence of the
borrower. These lines of credit generally have a prime-based interest rate. The
5
Bank also originates home equity loans that bear fixed interest rates and
generally have terms of 15 years or less. Home equity loans and lines of credits
aggregated $61.7 million at June 30, 2002.
REGULATORY REQUIREMENTS AND UNDERWRITING POLICIES
Under the Financial Institutions Reform, Recovery, and Enforcement Act of
1989 ("FIRREA") and pursuant to the parity provisions of the Pennsylvania
Banking Code of 1965 ("Banking Code"), the aggregate loans that the Company may
make to any borrower and its affiliates is limited to 15% of unimpaired capital
for unsecured loans and 25% of capital for loans secured by readily marketable
collateral. At June 30, 2002, pursuant to such provisions, the Bank was
permitted to extend credit to any one borrower totaling $8.27 million. At June
30, 2002, the Bank's largest loan or group of loans to one borrower, including
related entities, aggregated $5.87 million, and is in conformity with the
current loans to one borrower regulations described above.
The Bank is currently permitted to lend up to 100% of the appraised value
of the real property securing a loan; however, if the amount of a residential
loan originated or refinanced exceeds 90% of the appraised value, the Bank is
required by federal regulations, the Bank Code and Department regulations to
obtain private mortgage insurance on the portion of the principal amount of the
loan that exceeds 80% of the appraised value of the security property. Pursuant
to underwriting guidelines adopted by the Board of Directors, private mortgage
insurance must be obtained on all residential loans whose loan-to-value ratios
exceed 80%. The Bank will generally lend up to 97% of the appraised value of
one-to four-family owner-occupied residential dwellings when the required
private mortgage insurance is obtained. The Bank generally originates loans of
up to 75% of the appraised value of the properties securing its commercial real
estate and commercial business loans and 75% of the appraised value upon
completion or sale price, whichever is lower, for construction loans. With
respect to construction loans for owner-occupied properties made in connection
with the providing of the permanent financing, the Bank will lend up to 90% of
the appraised value when the required private mortgage insurance is obtained.
LOAN FEE AND SERVICING INCOME
In addition to interest earned on loans, the Bank receives income through
servicing of loans and fees in connection with loan originations, loan
modifications, late payments, prepayments, repayments and changes of property
ownership and for miscellaneous services related to its loans. Income from these
activities varies from period to period with the volume and type of loans made.
At June 30, 2002, the Bank was servicing $23.7 million of loans for others,
substantially all of which were whole loans sold by the Bank to the FHLMC.
Loan origination fees and certain direct loan origination costs are
deferred and amortized over the life of the related loans as an adjustment to
the yield of such related loans. However, in the event the related loan is sold
or repaid prior to maturity, any deferred loan fees or costs remaining with
respect to such loan are taken into income.
NON-PERFORMING LOANS AND REAL ESTATE OWNED
If the delinquency on a mortgage loan exceeds 90 days and is not cured
through the Bank's normal collection procedures, or an acceptable arrangement is
not worked out with the borrower, the Company will institute measures to remedy
the default, including commencing a foreclosure action or, in special
circumstances, accepting from the mortgagor a voluntary deed of the secured
property in lieu of foreclosure. However, under Pennsylvania law, a lender is
prohibited from accelerating the maturity of a residential mortgage loan,
commencing any legal action (including foreclosure proceedings) to collect on
6
such loan, or taking possession of any loan collateral until the lender has
first provided the delinquent borrower with at least 30 days prior written
notice specifying the nature of the delinquency and the borrower's right to
correct such delinquency. This provision of Pennsylvania law, as well as others,
may delay for several months the Bank's ability to foreclose upon residential
loans secured by real estate located in the Commonwealth of Pennsylvania. In
addition, the uniform FNMA/FHLMC lending documents used by the Bank, as well as
most other residential lenders in Pennsylvania, require notice and a right to
cure similar to that provided under Pennsylvania law.
Non-accrual loans are loans on which the accrual of interest ceases
when the collection of principal or interest payments is determined to be
doubtful by management. It is the policy of the Company to discontinue the
accrual of interest when principal or interest payments are delinquent 90 days
or more (unless the loan principal and interest are determined by management to
be fully secured and in the process of collection), or earlier, if the financial
condition of the borrower raises significant concern with regard to the ability
of the borrower to service the debt in accordance with the current loan term.
Interest income is not accrued until the financial condition and payment record
of the borrower once again demonstrate the ability to service the debt. When a
loan is placed on non-accrual status, previously accrued but unpaid interest is
deducted from interest income.
If foreclosure is effected, and the Bank acquires the real estate, it is
included in the Company's real estate owned account until it is sold. When
property is acquired, it is recorded at the lower of carrying value or fair
value less disposal cost at the date of acquisition and any write-down resulting
therefrom is charged to the allowance for loan losses. Interest accrual ceases
on the date of acquisition and all costs incurred in maintaining the property
from that date forward are expensed. Costs incurred for the improvement or
development of such property are capitalized to the extent they do not exceed
the property's fair value. No loss reserves are maintained on REO and future
write-downs for cost beyond the fair value are expensed.
For purposes of applying the measurement criteria for impaired loans, the
Company excludes large groups of smaller-balance homogeneous loans, primarily
consisting of residential real estate loans and consumer loans as well as
commercial loans with balances of less than $100,000. For applicable loans, the
Company evaluates the need for impairment recognition when a loan becomes
non-accrual or earlier if, based on management's assessment of the relevant
facts and circumstances, it is probable that the Company will be unable to
collect all proceeds due according to the contractual terms of the loan
agreement. At June 30, 2002, the Company did not have any impaired loans. The
Company's policy for the recognition of interest income on impaired loans is the
same as for non-accrual loans discussed above. Impaired loans or a portion
thereof are charged off when the Company determines that foreclosure is probable
and the fair value of the collateral is less than the recorded investment of the
impaired loan.
The following table sets forth information regarding non-accrual loans and
REO held by the Company at the dates indicated. The Company did not have, at any
of the dates presented any (i) loans which are 90 days or more delinquent but on
which interest is being accrued or (ii) loans which were classified as
restructured troubled debt.
7
AT JUNE 30,
-----------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------ ------ -------
(Dollars in Thousands)
NON-ACCRUAL LOANS:
Residential real estate loans $ 858 $ 952 $ 735 $ 568 $ 771
Commercial and multi-family
residential real estate loans -- -- -- -- --
Construction and land loans -- -- -- -- 55
Commercial business loans -- -- -- 258 --
Consumer loans 86 220 207 107 420
------- ------ ------ ------ ------
Total non-accrual loans $ 944 $1,172 $ 942 $ 933 $1,246
======= ====== ====== ====== ======
Total non-accrual loans
to total assets 0.17% 0.22% 0.19% 0.21% 0.33%
Total REO 40 -- -- -- --
Total non-accrual loans and
REO to total assets 0.17% 0.22% 0.19% 0.21% 0.33%
At June 30, 2002, non-accrual real estate loans included eleven residential
mortgage loans aggregating $858,000, all secured by single-family residential
properties.
The total amount of non-performing loans was $944,000, $1,172,000 and
$942,000 at June 30, 2002, 2001, and 2000, respectively. If these non-performing
loans had been current in accordance with their original terms and had been
outstanding throughout the respective periods, the gross amount of interest
income for fiscal 2002, 2001, and 2000 that would have been recorded for these
loans would have been $194,800, $159,900, and $82,000, respectively. Interest
income on these non-performing loans included in income for fiscal 2002, 2001,
and 2000 amounted to $113,800, $22,500, and $24,000, respectively.
ALLOWANCES FOR LOSSES ON LOANS AND CLASSIFIED LOANS
The allowance for loan losses is maintained at a level that represents
management's best estimate of known and inherent losses, which are probable and
reasonably determinable based upon an evaluation of the loan portfolio.
Homogeneous portfolios of loans, which include residential mortgage, home equity
and other consumer loans, are evaluated as a group. Commercial business,
commercial mortgage and construction loans are evaluated individually. Specific
portions of the allowance are developed by analyzing individual loans for
adequacy of collateral, cash flow and other risks which may be unique to that
particular loan. General portions of the allowance are developed by grading
individual loans in the commercial and construction portfolios and applying loss
factors by grade. The general portion of the allowance also includes loss
factors applied to the homogeneous portfolios as a group. The loss factors
applied to graded loans were developed based on the Company's loss history for
loans with similar attributes as well as input from the Company's primary
banking regulators. Loss factors are applied to homogeneous loans based upon
prior loss experience of the portfolio, delinquency trends and the volume of
non-performing loans. Although management believes it has used the best
information available to it in making such determinations, and that the present
allowance for loan losses is adequate, future adjustments to the allowance may
be necessary, and net income may be adversely affected if circumstances differ
substantially from the assumptions used in determining the level of the
allowance.
8
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for losses on
loans. Such agencies may require the Bank to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination. The allowance is increased by the provision for loan
losses, which is charged to operations. Loan losses, other than those incurred
on loans held for sale, are charged directly against the allowance and
recoveries on previously charged-off loans are added to the allowance.
For purposes of applying the measurement criteria for impaired loans, the
Company excludes large groups of smaller balance homogeneous loans, primarily
consisting of residential real estate loans and consumer loans as well as
commercial business loans with balances of less than $100,000. For applicable
loans, the Company evaluates the need for impairment recognition when a loan
becomes non-accrual or earlier if, based on management's assessment of the
relevant facts and circumstances, it is probable that the Company will be unable
to collect all proceeds under the contractual terms of the loan agreement. At
and during the years ended June 30, 2002, 2001 and 2000, the recorded investment
in impaired loans was not significant. The Company's policy for the recognition
of interest income on impaired loans is the same as for non-accrual loans. A
portion of an impaired loan is charged off when the Company determines that
foreclosure is probable and the fair value of the collateral is less than the
recorded investment of the impaired loan.
At June 30, 2002, the Bank's allowance for loan losses was $4.59 million or
1.26% of total net loans receivable and 486.0% of total non-performing loans
compared to $4.26 million or 1.23% of net loans receivable and 363.8% of total
non-performing loans at June 30, 2001. The following table summarizes activity
in the Company's allowance for loan losses during the periods indicated.
AS OF JUNE 30,
---------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(In Thousands)
Allowance at beginning of period $4,264 $3,908 $3,651 $3,414 $2,855
Loans charged off against the allowance:
Residential real estate (142) (29) (8) (58) (12)
Commercial business -- -- (131) -- --
Consumer (87) (75) (32) (119) (69)
------ ------ ------ ------ ------
Total charge-offs (229) (104) (171) (177) (81)
Recoveries:
Residential real estate -- 4 -- -- 21
Commercial business -- 2 2 -- --
Consumer 6 9 6 24 13
------ ------ ------ ------ ------
Total recoveries 6 15 8 24 34
Net charge-offs (223) (89) (163) (153) (47)
Provision for loan losses charged to
operating expenses 547 445 420 390 606
------ ------ ------ ------ ------
Allowance at year end $4,588 $4,264 $3,908 $3,651 $3,414
====== ====== ====== ====== ======
Ratio of net charge-offs to
average loans outstanding 0.06% 0.03% 0.05% 0.05% 0.02%
====== ====== ====== ====== ======
Ratio of allowance to period-end
net loans 1.26% 1.23% 1.18% 1.24% 1.23%
====== ====== ====== ====== ======
9
The following table presents information regarding the Company's total
allowance for losses on loans as well as the allocation of such amounts to the
various categories of the loan portfolio.
AT JUNE 30,
---------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ----------------- ----------------- ----------------- -----------------
% OF % OF % OF % OF % OF
LOANS LOANS LOANS LOANS LOANS
TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
----------------- ----------------- ----------------- ----------------- -----------------
(In Thousands)
Residential real estate loans $ 402 34.1% $ 537 40.2% $ 700 46.8% $ 638 53.6% $ 789 53.6%
Commercial real estate loans 1,707 26.5% 1,547 22.4% 1,553 18.5% 1,415 14.1% 1,050 14.1%
Construction and land loans 279 12.3% 200 12.5% 241 11.8% 194 10.5% 201 10.5%
Commercial business loans 1,450 9.4% 1,267 7.4% 632 5.4% 726 3.9% 357 3.9%
Consumer loans 750 17.7% 713 17.5% 782 17.5% 678 17.9% 1,017 17.9%
--------------- --------------- --------------- --------------- ----------------
Total allowance for loan losses $ 4,588 100.0% $ 4,264 100.0% $ 3,908 100.0% $ 3,651 100.0% $ 3,414 100.0%
=============== =============== =============== =============== ================
Total allowance for loan losses
to total non-performing loans 486.0% 363.8% 414.9% 391.3% 274.0%
------- ------ ------- ------ -------
Total non-performing loans $ 944 $1,172 $ 942 $ 933 $ 1,246
======= ====== ======= ====== =======
10
The Company monitors the quality of its loans on a regular basis and
classifies them under a classification system that has three categories: (i)
substandard, (ii) doubtful and (iii) loss. A loan may fall within more than one
category and a portion of the asset may remain unclassified. The Company is
required to review the classification of its loans on a regular basis. In
addition, in connection with the examinations of First Financial by the FDIC and
the Department, the examiners have the authority to identify problem loan and,
if appropriate, classify them and/or require adjustments to the carrying value
of such assets.
Loans classified substandard are considered inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Loans so classified must have a well-defined weakness or
weaknesses. They are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Loans classified doubtful are considered to have all the weaknesses
inherent in those classified substandard with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions, and values, highly questionable and improbable.
Loans classified loss are considered uncollectable and of such little value
that their continuance as assets is not warranted. After charging off a loan,
the Company continues its efforts to obtain a recovery on the loan.
At June 30, 2002, the Company's classified loans, which consisted of loans
classified as substandard or doubtful, totaled $6.24 million. Included in the
loans classified substandard at June 30, 2002 were all loans 90 days past due
and loans which are less than 90 days delinquent but inadequately protected by
the current paying capacity of the borrower or of the collateral pledged, and
have a well-defined weakness that may jeopardize the liquidation of the debt.
The loans designated as special mention by the Company amounted to
$3.88 million at June 30, 2002. Although special mention loans are not
considered or classified as substandard, doubtful or loss, they do have a
potential weakness which may, if not corrected, result in increased risk of loss
at some future date.
SECURITIES ACTIVITIES
Historically, interest and dividends on securities have provided the
Company with a significant source of revenue. At June 30, 2002, the Company's
securities portfolio and interest-bearing deposits aggregated $171.75 million or
30.3% of its total assets.
The Company divides its securities portfolio into three segments: (a) held
to maturity; (b) available for sale; and (c) trading. Securities in the held to
maturity category are accounted for at amortized cost. Trading securities are
accounted for at quoted market prices with changes in market values being
recorded as gain or loss in the income statement. All other securities are
included in the available for sale category and are accounted for at fair value
with unrealized gains or losses, net of taxes, being reflected as adjustments to
equity. At June 30, 2002, the Company had a net unrealized loss on securities
available for sale, net of taxes, of $649,000. The following table sets forth
the Company's securities portfolio and interest-earning deposits at carrying
value at the dates indicated.
11
AT JUNE 30,
------------------------------
2002 2001 2000
-------- ------- --------
Interest-bearing deposits $ 29,163 $ 19,698 $ 8,164
Trading account securities(1) 16 16 12,838
Investment securities held to maturity:
U.S. Government and agency obligations 6,376 36,681 25,110
Municipal notes and bonds(2) 8,215 -- 8,332
Mortgage-backed securities 21,310 503 640
Other 5,279 4,190 5,739
-------- -------- --------
Total investment securities held to maturity 41,180 41,374 39,821
-------- -------- --------
Investment securities available for sale:
U.S. Government and agency obligations 3,401 31,714 26,639
Municipal notes and bonds(2) 30,195 34,624 34,160
Mortgage-backed securities 24,696 11,814 13,804
Equity securities 1,346 1,048 858
Debt securities 18,436 15,634 14,798
Agency-backed securities(3) 23,319 18,516 2,209
-------- -------- --------
Total investment securities available for sale 101,393 113,350 92,468
-------- -------- --------
Total securities and interest-bearing deposits $171,752 $174,438 $153,291
======== ======== ========
(1) During the first quarter of fiscal 2001, the Bank discontinued the use of
its trading account.
(2) The income from municipal notes and bonds is generally non-taxable for
federal and state purposes. The $7.9 million or 18.5% decrease in municipal
notes and bonds in fiscal 2001 is primarily the result of the sale of $4.1
million of bonds in January 2001 and the redemption of $2.6 million of
bonds in May 2001.
(3) Includes agency-backed collateralized mortgage obligations and student loan
securities.
The contractual maturity or repricing characteristics of the Company's
investment portfolio is considerably more interest rate sensitive than that of
its loan portfolio. Consequently, the investment portfolio provides a
significant source of liquidity and protection against interest rate risk. The
weighted average term to maturity or repricing of the Company's investment
securities held to maturity was 13.2 years at June 30, 2002.
Investments include three Municipal Authority Revenue Bond investments that
had an aggregate balance of $7.1 million at June 30, 2002, after a write-down on
two of the bonds totaling $955,000. After the write-down, two of the bonds have
a carrying value of $5.6 million and both of these bonds involve buildings and
related property that are leased to various agencies of the Commonwealth of
Pennsylvania under long term lease arrangements with renewal options. Of the
total balance of $5.6 million, $865 thousand are interest bearing bonds and the
remainder of $4.7 million are zero coupon bonds with maturities extending up to
June 2034.
The third classified bond has a balance, after write-down, of $1.5 million,
an interest rate of 6% and matures in June 2019. This bond involves low-income
scattered housing in Chester County under a Housing and Urban Development
Program. The Office of Housing and Urban Development (HUD) has indicated that it
will provide funds to build additional housing which would be donated to this
bond issue and, when sold, would reduce the losses incurred on the bonds.
12
These classified investments are closely monitored and fairly stated at
June 30, 2002 based on available information. There can be no assurance that
further subsequent adverse or positive developments may occur; in which case,
additional adjustments to these investments may be forthcoming.
The amortized cost and estimated fair value of investment securities at
June 30, 2002, by contractual maturity, are shown below.
WEIGHTED
AMORTIZED ESTIMATED AVERAGE
COST FAIR VALUE YIELD
--------- ---------- --------
(Dollars in Thousands)
HELD TO MATURITY
Due in one year or less $ 3,300 $ 3,329 6.70%
Due after one year through five years 1,801 1,800 6.07%
Due after five years through ten years 988 953 5.00%
Due after ten years 29,812 30,078 5.83%
No stated maturity 5,279 5,279 0.00%
-------- -------- ----
TOTAL HELD TO MATURITY $ 41,180 $ 41,439 5.14%
-------- -------- ----
AVAILABLE FOR SALE
Due in one year or less $ 4,403 $ 4,410 4.56%
Due after one year through five years 6,899 7,022 4.76%
Due after five years through ten years 11,022 11,128 4.09%
Due after ten years 78,655 77,487 5.13%
No stated maturity 1,429 1,346 0.00%
-------- -------- ----
TOTAL AVAILABLE FOR SALE $102,408 $101,393 4.90%
-------- -------- ----
TOTAL INVESTMENT SECURITIES $143,588 $142,832 4.97%
======== ======== ====
The weighted average yield, based on amortized cost, is presented on a
taxable equivalent basis.
As of June 30, 2002, investments in the debt and/or equity securities of
any one issuer (excluding U.S. Government and federal agencies) did not exceed
10% of the Company's stockholders' equity.
SOURCES OF FUNDS
GENERAL
Deposits obtained through branch offices have traditionally been the
principal source of the Company's funds for use in lending and for other general
business purposes. The Company also derives funds from amortization and
prepayments of outstanding loans and investments and sales of loans. From time
to time, the Company also may borrow funds from the FHLBP and other sources.
Borrowings may be used on a short-term basis to compensate for seasonal or other
reductions in deposits or other inflows at less than projected levels, as well
as on a longer term basis to support expanded lending and investment activities.
13
DEPOSITS
The Company obtains deposits primarily from residents of Chester County,
and to a lesser extent Berks, Delaware, Lancaster and Montgomery Counties,
Pennsylvania. Currently, the principal methods used by First Financial to
attract deposit accounts include the offering of services and a wide variety of
accounts, competitive interest rates, and convenient office locations and
service hours. Other than during times of inverse or flat yield curves, the Bank
has adopted a pricing program for its certificate accounts which provides for
higher rates of interest on its longer term certificates in order to encourage
depositors to invest in certificates with longer maturities, thus reducing the
interest rate sensitivity of the Company's deposit portfolio. First Financial
also offers a tiered money market account that pays higher interest on higher
balances so as to maintain a relatively stable core of deposits even when its
certificate accounts mature.
First Financial's current deposit products include non-interest-bearing
accounts, passbook/statement savings accounts, NOW checking accounts, money
market deposit accounts, certificates of deposit ranging in terms from 30 days
to seven years and certificates of deposit in denominations of $100,000 or more
("jumbo certificates"). Included among these deposit products are individual
retirement account certificates ("IRA certificates") and Keogh accounts.
The following table shows the balances of the Company's deposits as of the
dates indicated:
AT JUNE 30,
-----------------------------------------------------------------------------
2002 2001 2000
----------------------- ---------------------- -----------------------
(Dollars in Thousands)
% OF % OF % OF
AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS
-------- -------- -------- -------- -------- --------
Non-interest-bearing accounts $ 44,890 11.6% $ 38,840 9.4% $ 38,192 10.1%
NOW checking accounts 55,307 14.3% 43,467 10.5% 38,652 10.2%
Savings accounts 31,560 8.2% 26,414 6.4% 26,636 7.0%
Money market accounts 65,411 17.0% 60,430 14.6% 41,690 11.0%
Certificates of deposit less than
$100,000 120,810 31.3% 124,601 30.2% 126,910 33.6%
Certificates of deposit with
$100,000 minimum balance 68,002 17.6% 119,600 28.9% 106,398 28.1%
-------------------- -------------------- --------------------
Total deposits $385,980 100.0% $413,352 100.0% $378,478 100.0%
==================== ==================== ====================
The following table shows the balances of certificates of deposit with
balances of $100,000 or greater which mature during the periods indicated and
the balance at June 30, 2002.
BALANCES AT JUNE 30, 2002 MATURING
------------------------------------------------
(In Thousands)
AT WITHIN THREE SIX TO AFTER
JUNE 30, THREE TO SIX TWELVE TWELVE
2002 MONTHS MONTHS MONTHS MONTHS
------- ------- ------ ------ -------
Certificates of deposit with $100,000
minimum balance $68,002 $15,473 $3,722 $9,165 $39,642
======= ======= ====== ====== =======
14
The following table presents the average balance by type of deposit and the
average rate paid by type of deposit for the periods indicated.
YEAR ENDED JUNE 30,
----------------------------------------------------------------------------
2002 2001 2000
----------------------- ------------------------- -------------------------
(Dollars in Thousands)
AVERAGE AVERAGE AVERAGE
AVERAGE RATE AVERAGE RATE AVERAGE RATE
BALANCE PAID BALANCE PAID BALANCE PAID
-------- -------- -------- -------- -------- --------
NOW Checking accounts $ 48,644 0.89% $ 41,218 1.55% $ 37,667 1.57%
Savings accounts 27,524 1.16% 25,142 1.96% 27,017 1.74%
Money market accounts 63,651 2.25% 54,494 4.49% 43,178 3.99%
Certificates of deposit less than
$100,000 119,072 4.49% 126,608 5.99% 130,335 5.35%
Certificates of deposit with
$100,000 minimum balance 88,105 4.15% 119,955 5.39% 75,845 5.23%
The greater variety of deposit accounts offered by First Financial has
increased its ability to retain deposits and has allowed it to be more
competitive in obtaining new funds, although the threat of disintermediation
(the flow of funds away from savings institutions into direct investment
vehicles such as government and corporate securities) still exists. However,
these types of accounts have been and continue to be more costly than
traditional accounts. In addition, First Financial has become much more
susceptible to short-term fluctuations in deposit flows, as customers have
become more rate conscious and willing to move funds into higher-yielding
accounts. Thus, both the ability of First Financial to attract and maintain
deposits as well as its cost of funds have been, and will continue to be,
affected significantly by economic market conditions.
First Financial attempts to control the flow of deposits by pricing its
accounts to remain generally competitive with other financial institutions in
its primary market area, but does not necessarily seek to match the highest
rates paid by competing institutions.
First Financial's deposits are obtained primarily from persons who are
residents of Pennsylvania and, to a much lesser degree, from governmental
entities. First Financial does not advertise for deposits outside of
Pennsylvania or accept brokered deposits, and management believes that at June
30, 2002, an insignificant amount of First Financial's deposits were held by
non-residents of Pennsylvania.
BORROWINGS
First Financial may obtain advances from the FHLBP upon the security of the
common stock it owns in that bank and certain of its residential mortgage and
other loans, provided certain standards related to credit worthiness have been
met. See "Regulation - Regulation of the Bank - Federal Home Loan Bank System."
Such advances are made pursuant to several different credit programs, each of
which has its own interest rate and range of maturities. FHLBP advances are
generally available to meet seasonal and other withdrawals of deposit accounts
and to expand lending and investment activities, as well as to aid the efforts
of members to establish better asset and liability management through the
extension of maturities of liabilities. At June 30, 2002 the Company had $102.45
million in FHLBP advances outstanding. In addition to its ability to obtain
advances from the FHLBP under several different credit programs, the Company has
established a line of credit with the FHLBP, in an amount not to exceed 10% of
the Company's maximum borrowing capacity, which credit line at June 30, 2002 was
$16.39 million, and is subject to certain conditions, including the holding of a
predetermined amount of FHLBP stock as collateral. At June 30, 2002, there was
no balance outstanding on the line of credit.
15
The following table presents certain information regarding short-term
borrowings (borrowings with a maturity of one year or less) for the periods
indicated:
YEAR ENDED JUNE 30,
------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in Thousands)
SHORT-TERM BORROWINGS:
Balance outstanding at end of period $28,750 $22,815 $46,948
Weighted average interest rate at end of period 5.88% 5.96% 6.61%
Average balance outstanding 28,606 27,911 55,753
Maximum amount outstanding at any month-end
during the period 35,250 42,448 79,059
Weighted average interest rate during the period 5.63% 6.14% 5.96%
YIELDS EARNED AND RATES PAID
The largest components of the Company's total income and total expense are
interest income and interest expense. As a result, the Company's earnings are
dependent primarily upon net interest income, which is determined by the
Company's net interest rate spread (i.e., the difference between the yields
earned on interest-earning assets and the rates paid on interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities.
16
INTEREST INCOME AND INTEREST SPREAD ANALYSIS
The following table sets forth, for the periods indicated, information
regarding (1) the total dollar amount of interest income of the Company from
interest-earning assets and the resultant average yields; (2) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average cost; (3) net interest income; (4) interest rate spread; and (5) net
interest-earning assets and their net yield. Average balances are determined on
a daily basis for 2002 and 2001 and on a monthly basis for 2000 which is
representative of operations.
YEAR ENDED JUNE 30,
--------------------------------------------------------------------------------------------
2002 2001 2000
------------------------------- ------------------------------ -----------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE(1) INTEREST(2) RATE(2) BALANCE(1) INTEREST(2) RATE(2) BALANCE(1) INTEREST(2) RATE(2)
---------- ----------- -------- ---------- ----------- ------- ---------- ----------- -------
(Dollars in thousands)
Assets:
Loans and loans held for sale $359,725 $ 26,756 7.44% $343,368 $ 27,231 7.93% $313,378 $ 24,689 7.88%
Securities and other investments 156,800 8,520 5.43% 162,723 11,141 6.85% 145,687 10,298 7.07%
-------- -------- -------- -------- -------- --------
Total interest-earning assets 516,525 35,276 6.83% 506,091 38,372 7.58% 459,065 34,987 7.62%
-------- -------- --------
Non-interest earning assets 31,436 23,902 23,277
-------- -------- --------
Total assets $547,961 $529,993 $482,342
======== ======== ========
Liabilities and Stockholders' Equity:
Deposits and repurchase agreements $369,600 $ 11,340 3.07% $379,057 $ 17,621 4.65% $315,962 $ 13,700 4.34%
FHLB advances and other
borrowings 93,153 5,024 5.39% 76,761 4,597 5.99% 90,184 5,275 5.85%
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities 462,753 16,364 3.54% 455,818 22,218 4.87% 406,146 18,975 4.67%
-------- -------- -------- -------- -------- --------
Non-interest-bearing liabilities 43,085 36,069 42,033
Stockholders' equity 42,123 38,106 34,163
-------- -------- --------
Total liabilities and stockholders'
equity $547,961 $529,993 $482,342
======== ======== ========
Net interest income/interest rate spread $ 18,912 3.29% $ 16,154 2.71% $ 16,012 2.95%
======== ==== ======== ==== ======== ====
Net interest-earning assets/net yield
on interest-earning assets $ 53,772 3.66% $ 50,273 3.19% $ 52,919 3.49%
======== ==== ======== ==== ======== ====
Ratio of average interest-earning
assets to interest-bearing liabilities 112% 111% 113%
=== === ===
- ---------------
(1) Non-accruing loans are included in the average blance.
(2) The indicated interest and annual yield and rate are presented on a taxable
equivalent basis using the Federal marginal income tax rate of 34%
adjusted for the 20% interest expense disallowance (27.2%) for 2002, 2001,
and 2000.
17
RATE/VOLUME ANALYSIS
The following table presents certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
Interest income and the annual rate are calculated on a taxable equivalent basis
using the Federal marginal income tax rate of 34% adjusted for the 20% interest
expense disallowance (27.2%). For each category of interest-earning assets and
interest-bearing liabilities, information is provided with respect to changes
attributable to (1) changes in volume (change in volume multiplied by old rate),
(2) changes in rate (change in rate multiplied by old volume) and (3) changes in
rate/volume (change in rate multiplied by change in volume). The changes in
rate/volume (3) are allocated to the change in volume variance and the change in
the rate variance on a pro rated basis.
2002 COMPARED TO 2001 2001 COMPARED TO 2000
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
----------------------------- ------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Interest income on interest-
earning assets:
Loans and loans
Loans and loans held for sale $ 1,102 $(1,577) $ (475) $ 2,400 $ 142 $ 2,542
Securities and other investments (426) (2,195) (2,621) 1,172 (329) 843
------- ------- ------- ------- ------- -------
Total interest income 676 (3,772) (3,096) 3,572 (187) 3,385
------- ------- ------- ------- ------- -------
Interest expense on interest-
bearing liabilities:
Deposits and repurchase
agreements (452) (5,829) (6,281) 3,890 31 3,921
FHLB advances and other
borrowings 918 (491) 427 (808) 130 (678)
------- ------- ------- ------- ------- -------
Total interest expense 466 (6,320) (5,854) 3,082 161 3,243
------- ------- ------- ------- ------- -------
Net change in net interest income $ 210 $ 2,548 $ 2,758 $ 1,490 $(1,348) $ 142
======= ======= ======= ======= ======= =======
18
RATIOS
The following table shows certain income and financial condition ratios for
the periods indicated. All averages are based on month-end balances which are
representative of operations.
YEAR ENDED JUNE 30,
--------------------------------
2002 2001 2000
------ ------ ------
Return on average assets
(income divided by average
total assets) 1.02% 0.76% 0.94%
Return on average equity
(income divided by average equity) 13.24% 10.50% 13.34%
Equity-to-assets ratio
(average equity divided by
average assets) 7.69% 7.19% 7.08%
Dividend pay-out ratio 30.65% 36.55% 30.35%
SUBSIDIARIES OF FIRST FINANCIAL
The Bank operates (as a wholly owned subsidiary) D & S Service Corporation
("D & S Service"), which has participated in the development for sale of
residential properties, in particular condominium conversions and also the
development of commercial properties in order for the Bank to expand its
facilities to accommodate its growth. All of such projects have either been
located in or within close proximity to the Bank's primary market area. D & S
Service operates two wholly owned subsidiaries: Wildman Projects and D & F
Projects, Inc. As of June 30, 2002, the Bank had invested $1.90 million in D & S
Service and its wholly owned subsidiaries.
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of the Company and the Bank in effect as of the
date of this Annual Report on Form 10-K. The description of these laws and
regulations, as well as descriptions of laws and regulations contained elsewhere
herein, does not purport to be complete and is qualified in its entirety by
reference to applicable laws and regulations.
REGULATION OF THE COMPANY
GENERAL
The Holding Company, as a bank holding company as a result of the
conversion effective September 1, 2001 of the Bank from a federally-chartered
thrift to a Pennsylvania-chartered commercial bank, is subject to regulation and
supervision by the Federal Reserve Board. Under the Bank Holding Company Act
("BHCA"), a bank holding company is required to file annually with the Federal
Reserve Board a report of its operations and, with its subsidiaries, is subject
to examination by the Federal Reserve Board.
19
ACTIVITIES AND OTHER LIMITATIONS
The BHCA generally prohibits a bank holding company from acquiring direct
or indirect ownership or control of more than 5% of the voting shares of any
bank, or increasing such ownership or control of any bank, without prior
approval of the Federal Reserve Board. The Federal Reserve Board generally may
approve an application by a bank holding company that is adequately capitalized
and adequately managed to acquire control of, or to acquire all or substantially
all of the assets of, a bank located in a state other than the home state of
such bank holding company, without regard to whether such transaction is
prohibited under the law of any state, provided, however, that the Federal
Reserve Board may not approve any such application that would have the effect of
permitting an out-of-state bank holding company to acquire a bank in a host
state that has not been in existence for any minimum period of time, not to
exceed five years, specified in the statutory law of the host state.
The BHCA also generally prohibits a bank holding company, with certain
exceptions, from acquiring more than 5% of the voting shares of any company that
is not a bank and from engaging in any business other than banking or managing
or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to
approve the ownership of shares by a bank holding company in any company the
activities of which the Federal Reserve Board had determined, by regulation or
by order, to be so closely related to banking or to managing or controlling
banks as to be a proper incident thereto as of November 11, 2000, the day before
the date of enactment of the Gramm-Leach-Bliley Act, discussed below. In making
such determinations, the Federal Reserve Board is required to weigh the expected
benefit to the public, such as greater convenience, increased competition or
gains in efficiency, against the possible adverse effects, such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices.
CAPITAL REQUIREMENTS
The Federal Reserve Board has issued risk-based and leverage capital
guidelines applicable to bank holding companies. In addition, the Federal
Reserve Board may from time to time require that a bank holding company maintain
capital above the minimum levels, whether because of its financial condition or
actual or anticipated growth. The Federal Reserve Board's risk-based guidelines
define a three-tier capital framework. Tier 1 capital consists of common and
qualifying preferred shareholders' equity, less certain intangibles and other
adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1
capital, subordinated and other qualifying debt, and the allowance for credit
losses up to 1.25 percent of risk-weighted assets. Tier 3 capital includes
subordinated debt that is unsecured, fully paid, has an original maturity of a
least two years, is not redeemable before maturity without prior approval by the
Federal Reserve Board and includes a lock-in clause precluding payment of either
interest or principal if the payment would cause the issuing entity's risk-based
capital ratio to fall or remain below the required minimum. The sum of Tier 1
and Tier 2 capital less investments in unconsolidated subsidiaries represents
qualifying total capital, at least 50 percent of which must consist of Tier 1
capital. Risk-based capital ratios are calculated by dividing Tier 1 and total
capital by risk-weighted assets. Assets and off-balance sheet exposures are
assigned to one of four categories of risk-weights, based primarily on relative
credit risk. The minimum Tier 1 capital ratio is 4 percent and the minimum total
capital ratio is 8 percent. The leverage ratio is determined by dividing Tier 1
capital by adjusted average total assets. Although the stated minimum ratio is 3
percent, most banking organizations are required to maintain ratios of at least
100 to 200 basis points above 3 percent.
As of June 30, 2002, the Company's capital ratios exceeded applicable
requirements. See Note 12 to the Consolidated Financial Statements included in
Item 8 hereof.
20
AFFILIATED INSTITUTIONS
Under Federal Reserve Board policy, the Holding Company is expected to act
as a source of financial strength to the Bank and to commit resources to support
the Bank in circumstances when it might not do so absent such policy. The
Federal Reserve Board takes the position that in implementing this policy it may
require bank holding companies to provide such support when the holding company
otherwise would not consider itself able to do so.
A bank holding company is a legal entity separate and distinct from its
subsidiary bank. Normally, the major source of a holding company's revenue is
dividends a holding company receives from its subsidiary bank. The right of a
bank holding company to participate as a stockholder in any distribution of
assets of its subsidiary bank upon its liquidation or reorganization or
otherwise is subject to the prior claims of creditors of such subsidiary bank.
The subsidiary bank is subject to claims by creditors for long-term and
short-term debt obligations, including substantial obligations for federal funds
purchased and securities sold under repurchase agreements, as well as deposit
liabilities. Under FIRREA, in the event of a loss suffered by the FDIC in
connection with a banking subsidiary of a bank holding company (whether due to a
default or the provision of FDIC assistance), other banking subsidiaries of the
holding company could be assessed for such loss.
Federal laws limit the transfer of funds by a subsidiary bank to its
holding company in the form of loans or extensions of credit, investments or
purchases of assets. Transfers of this kind are limited to 10% of a bank's
capital and surplus with respect to each affiliate and to 20% in the aggregate,
and are also subject to certain collateral requirements. These transactions, as
well as other transactions between a subsidiary bank and its holding company,
also must be on terms substantially the same as, or at least as favorable as,
those prevailing at the time for comparable transactions with non-affiliated
companies or, in the absence of comparable transactions, on terms or under
circumstances, including credit standards, that would be offered to, or would
apply to, non-affiliated companies.
FINANCIAL MODERNIZATION
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act, which permits bank holding companies to become financial
holding companies and thereby affiliate with securities firms and insurance
companies and engage in other activities that are financial in nature.
A bank holding company may become a financial holding company if its
subsidiary bank is "well capitalized" and "well managed," as defined, and has at
least a satisfactory rating under the Community Reinvestment Act by filing a
declaration that the bank holding company wishes to become a financial holding
company. No regulatory approval is required for a financial holding company to
acquire a company, other than a bank or savings association, engaged in
activities that are financial in nature or incidental to activities that are
financial in nature, as determined by the Federal Reserve Board.
The Gramm-Leach-Bliley Act defines "financial in nature" to include
securities underwriting, dealing and market making; sponsoring mutual funds and
investment companies; insurance underwriting and agency; merchant banking
activities; and activities that the Federal Reserve Board has determined to be
closely related to banking. Subsidiary banks of a financial holding company must
continue to be well capitalized and well managed in order to continue to engage
in activities that are financial in nature without regulatory actions or
restrictions, which could include divestiture of the financial in nature
subsidiary or subsidiaries. In addition, a financial holding company or a bank
may not acquire a company that is engaged in activities that are financial in
nature unless each of the subsidiary banks of the financial holding company or
the bank has a Community Reinvestment Act rating of satisfactory or better.
21
In connection with the Holding Company's application to become a bank
holding company as a result of the conversion of the Bank to a
Pennsylvania-chartered commercial bank, the Company elected to become a
financial holding company.
STATE REGULATION
The Company is registered as a Pennsylvania financial institution holding
company under Pennsylvania law and as such is subject to regulation and
examination by the Superintendent of Banking of the Commonwealth of
Pennsylvania.
REGULATION OF PCIS
GENERAL
In the United States, a number of federal regulatory agencies are charged
with safeguarding the integrity of the securities and other financial markets
and with protecting the interest of customers participating in those markets.
The SEC is the federal agency that is primarily responsible for the regulation
of broker-dealers and investment advisers doing business in the United States,
and the Federal Reserve Board promulgates regulations applicable to securities
credit transactions involving broker-dealers and certain other institutions in
the Unites States. Much of the regulation of broker-dealers, however, has been
delegated to self-regulatory organizations ("SROs"), principally the NASD (and
its subsidiaries NASD Regulation, Inc. and the Nasdaq Stock Market), and the
national securities exchanges. These SROs and exchanges adopt rules (which are
subject to approval by the SEC) that govern the industry, monitor daily activity
and conduct periodic examinations of member broker-dealers. While PCIS is not a
member of the New York Stock Exchange (the "NYSE"), PCIS' business is impacted
by the NYSE rules.
PCIS is also subject to the USA Patriot Act adopted on November 1999. (See
"Recent Legislation") The USA Patriot Act requires financial institutions to
adopt and implement policies and procedures designed to prevent and defeat money
laundering. PCIS believes it is in compliance with the USA Patriot Act.
Securities firms are also subject to regulation by state securities
commissions in the states in which they are required to be registered. PCIS is
registered as a broker-dealer with the SEC and in all 50 states and in the
District of Columbia, and is a member of, and subject to regulation by, a number
of SROs, including the NASD.
As a result of federal and state registration and SRO memberships, PCIS is
subject to overlapping schemes of regulation which cover all aspects of its
securities business. Such regulations cover matters including capital
requirements, uses and safe-keeping of clients' funds, conduct of directors,
officers and employees, record-keeping and reporting requirements, supervisory
and organizational procedures intended to assure compliance with securities laws
and to prevent improper trading on material nonpublic information,
employee-related matters, including qualification and licensing of supervisory
and sales personnel, limitations on extensions of credit in securities
transactions, clearance and settlement procedures, requirements for the
registration, underwriting, sale and distribution of securities, and rules of
the SROs designed to promote high standards of commercial honor and just and
equitable principles of trade. A particular focus of the applicable regulations
concerns the relationship between broker-dealers and their customers. As a
result, the many aspects of the broker-dealer customer relationship are subject
to regulation including, in some instances, "suitability" determinations as to
certain customer transactions, limitations on the amounts that may be charged to
customers, timing of proprietary trading in relation to customers' trades and
disclosures to customers.
22
PCIS also is subject to "Risk Assessment Rules" imposed by the SEC which
require, among other things, that certain broker-dealers maintain and preserve
certain information, describe risk management policies and procedures and report
on the financial condition of certain affiliates whose financial and securities
activities are reasonably likely to have a material impact on the financial and
operational condition of the broker-dealers. Certain "Material Associated
Persons" (as defined in the Risk Assessment Rules) of the broker-dealers and the
activities conducted by such Material Associated Persons may also be subject to
regulation by the SEC.
PCIS is registered as an investment adviser with the SEC. As an investment
adviser registered with the SEC, it is subject to the requirements of the
Investment Advisers Act of 1940 and the SEC's regulations thereunder, as well as
certain state securities laws and regulations. Such requirements relate to,
among other things, limitations on the ability of an investment adviser to
charge performance-based or non-refundable fees to clients, record-keeping and
reporting requirements, disclosure requirements, limitations on principal
transactions between an adviser or its affiliates and advisory clients, as well
as general anti-fraud prohibitions. The state securities law requirements
applicable to registered investment advisers are in certain cases more
comprehensive than those imposed under the federal securities laws.
In the event of non-compliance with an applicable regulation, governmental
regulators and the NASD may institute administrative or judicial proceedings
that may result in censure, fine, civil penalties (including treble damages in
the case of insider trading violations), the issuance of cease-and-desist
orders, the deregistration or suspension of the non-compliant broker-dealer or
investment adviser, the suspension or disqualification of the broker-dealer's
officers or employees or other adverse consequences. The imposition of any such
penalties or orders on PCIS could have a material adverse effect on PCIS' (and
thus the Company's) operating results and financial condition.
NET CAPITAL REQUIREMENTS
As a broker-dealer registered with the SEC and as a member firm of the
NASD, PCIS is subject to the capital requirements of the SEC and the NASD. These
capital requirements specify minimum levels of capital, computed in accordance
with regulatory requirements, that PCIS is required to maintain and also limit
the amount of leverage that each firm is able to obtain in its respective
business.
As of June 30, 2002 PCIS was required to maintain minimum net capital, in
accordance with SEC rules, of $250,000 and had total net capital of $1.25
million or $998 thousand in excess of the minimum amount required. PCIS is
required to maintain a net capital ratio, in accordance with SEC rules, not to
exceed 15 to 1. At June 30, 2002 PCIS' net capital ratio was .20 to 1.
A failure of a broker-dealer to maintain its minimum required net capital
or net capital ratio would require it to cease executing customer transactions
until it came back into compliance, and could cause it to lose its NASD
membership, its registration with the SEC or require its liquidation. Further,
the decline in a broker-dealer's net capital below certain "early warning
levels," even though above minimum net capital requirements, could cause
material adverse consequences to the broker-dealer.
23
PCIS is a member of the Securities Investor Protection Corporation ("SIPC")
which is a non-profit corporation that was created by the United States Congress
under the Securities Protection Act of 1970. SIPC protects customers of member
broker-dealers against losses caused by the financial failure of the
broker-dealer but not against a change in the market value of securities in
customers' accounts at the broker-dealer. In the event of the inability of a
member broker-dealer to satisfy the claims of its customers in the event of its
failure, the SIPC's funds are available to satisfy the remaining claims up to
maximum of $500,000 per customer, including up to $100,000 on claims for cash.
In addition, PCIS' clearing broker carries private insurance which provides
similar coverage up to $25 million per customer.
REGULATION OF THE BANK
GENERAL
As a Pennsylvania-chartered commercial bank, the Bank is subject to
regulation and examination by the FDIC, which insures the deposits of the Bank
to the maximum extent permitted by law, certain requirements established by the
Federal Reserve Board and by the Pennsylvania Department of Banking. The federal
laws and regulations which are applicable to state-chartered banks regulate,
among other things, the scope of their business, their investments, their
reserves against deposits, the timing of the availability of deposited funds and
the nature and amount of and collateral for loans. Prior to the Bank's
conversion from a state-chartered savings association to a commercial bank, it
was subject also to regulation and examination by the Office of Thrift
Supervision ("OTS").
CAPITAL REQUIREMENTS
The Bank is subject to regulatory capital requirements of the FDIC which
are substantially comparable to the regulatory capital requirements of the
Federal Reserve Board applicable to bank holding companies such as the Holding
Company, as discussed above. At June 30, 2002, the Bank's regulatory capital
substantially exceeded applicable requirement. See Note 12 to the Consolidated
Financial Statements included in Item 8 hereof.
PROMPT CORRECTIVE ACTION
Section 38 of the Federal Deposit Insurance Act ("FDIA") provides the
federal banking regulators with broad power to take "prompt corrective action"
to resolve the problems of undercapitalized institutions. The extent of the
regulators' powers depends on whether the institution in question is "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Under regulations adopted by
the federal banking regulators, an institution shall be deemed to be (i) "well
capitalized" if it has total risk-based capital ratio of 10.0% or more, has a
Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital
ratio of 5.0% or more and is not subject to specified requirements to meet and
maintain a specific capital level for any capital measure; (ii) "adequately
capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier
I risk-based capital ratio of 4.0% or more a Tier I leverage capital ratio of
4.0% or more (3.0% under certain circumstances) and does not meet the definition
of "well capitalized"; (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 2.0%. The
regulations also provide that a federal banking regulator may, after notice and
an opportunity for a hearing, reclassify a "well capitalized" institution as
"adequately capitalized" and may require an "adequately capitalized" institution
or an "undercapitalized" institution to comply with supervisory actions as if it
were in the next lower category if the institution is in an unsafe or unsound
condition or engaging in an unsafe or unsound practice. The federal banking
regulator may not, however, reclassify a "significantly undercapitalized"
institution as "critically undercapitalized."
24
At June 30, 2002, the Bank's capital levels qualified it as a "well
capitalized" institution under applicable laws and regulations.
FDIC INSURANCE PREMIUMS
The Bank is a member of the Savings Association Insurance Fund ("SAIF")
administered by the FDIC rather than the Bank Insurance Fund ("BIF") since it
was formerly a savings association.
As an FDIC-insured institution, the Bank is required to pay deposit
insurance premiums to the FDIC. Effective January 1, 1997, the assessment
schedule for both BIF and SAIF ranges from 0 basis points (subject to a $2,000
annual minimum) to 27 basis points of the balance of insured deposits. In
addition, both BIF-insured institutions and SAIF-insured institutions are
assessed amounts in order for a federally-chartered Finance Corporation to make
payments on it bonds.
BROKERED DEPOSITS
The Federal Deposit Insurance Act ("FDIA") restricts the use of brokered
deposits by certain depository institutions. Under the FDIA and applicable
regulations, (i) a "well capitalized insured depository institution" may solicit
and accept, renew or roll over any brokered deposit without restriction, (ii) an
"adequately capitalized insured depository institution" may not accept, renew or
roll over any brokered deposit unless it has applied for and been granted a
waiver of this prohibition by the FDIC and (iii) an "undercapitalized insured
depository institution" may not (s) accept, renew or roll over any brokered
deposit or (y) solicit deposits by offering an effective yield that exceeds by
more than 75 basis points the prevailing effective yields on insured deposits of
comparable maturity in such institution's normal market area or in the market
area in which such deposits are being solicited. The term "undercapitalized
insured depository institution" is defined to mean any insured depository
institution that fails to meet the minimum regulatory capital requirement
prescribed by its appropriate federal banking agency. The FDIC may, on a
case-by-case basis and upon application by an adequately capitalized insured
depository institution, waive the restriction on brokered deposits upon a
finding that the acceptance of brokered deposits does not constitute an unsafe
or unsound practice with respect to such institution. At June 30, 2002, the Bank
did not have any brokered deposits.
COMMUNITY INVESTMENT AND CONSUMER PROTECTION LAWS
In connection with its lending activities, the Bank is subject to a variety
of federal laws designed to protect borrowers and promote lending to various
sectors of the economy and population. Included among these are the Federal Home
Mortgage Disclosure Act, Real Estate Settlement Procedures Act, Truth-in-Lending
Act, Equal Credit Opportunity Act, Fair Credit Reporting Act and Community
Reinvestment Act ("CRA").
The CRA requires insured institutions to define the communities that they
serve, identify the credit needs of those communities and adopt and implement a
"Community Reinvestment Act Statement" pursuant to which they offer credit
products and take other actions that respond to the credit needs of the
community. The responsible federal banking regulator must conduct regular CRA
examinations of insured financial institutions and assign to them a CRA rating
of "outstanding," "satisfactory," "needs improvement" or "unsatisfactory." In
last CRA rating of the Bank dated February 22, 2000, the Bank was rated
"outstanding".
LIMITATIONS ON DIVIDENDS
The Holding Company is a legal entity separate and distinct from its
banking and other subsidiaries. The Holding Company's principal source of
revenue consists of dividends from its subsidiaries, including the Bank. The
payment of dividends by the Bank is subject to various regulatory requirements.
25
MISCELLANEOUS
The Bank is subject to certain restrictions on loans to the Holding Company
or its non-bank subsidiary, on investments in the stock or securities thereof,
on the taking of such stock or securities as collateral for loans to any
borrower, and on the issuance of a guarantee or letter of credit on behalf of
the Holding Company or its non-bank subsidiary. The Bank is subject to certain
restrictions on most types of transactions with the Holding Company or its
non-bank subsidiary, requiring that the terms of such transactions be
substantially equivalent to terms of similar transactions with non-affiliated
firms.
REGULATORY ENFORCEMENT AUTHORITY
The enforcement powers available to federal banking regulators is
substantial and includes, among other things, the ability to assess civil money
penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLBP, which is one of 12 regional FHLBs that
administers the home financing credit function of savings associations and
commercial banks. Each FHLB serves as a source of liquidity for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures established
by its Board of Directors. As of June 30, 2002, the Bank's advances from the
FHLBP amounted to $102.45 million.
As a member, the Bank is required to purchase and maintain stock in the
FHLBP in an amount equal to the greater of 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of total advances. At June 30, 2002, the Bank
had $5.24 million in FHLB stock, which was in compliance with this requirement.
RECENT LEGISLATION
THE USA PATRIOT ACT
In response to the events of September 11, 2001, President George W. Bush
signed into law the Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA
PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal
government new powers to address terrorist threats through enhanced domestic
security measures, expanded surveillance powers, increased information sharing,
and broadened anti-money laundering requirements. By way of amendments to the
Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to
encourage information sharing among bank regulatory agencies and law enforcement
bodies. Further, certain provisions of Title III impose affirmative obligations
on a broad range of financial institutions, including banks, thrifts, brokers,
dealers, credit unions, money transfer agents and parties registered under the
Commodity Exchange Act. Among other requirements, Title III of the USA PATRIOT
Act imposes the following requirements with respect to financial institutions:
26
(a) Pursuant to Section 352, all financial institutions must establish
anti-money laundering programs that include, at minimum:
(1) internal policies, procedures, and controls,
(2) specific designation of an anti-money laundering compliance
officer,
(3) ongoing employee training programs, and
(4) an independent audit function to test the anti-money laundering
program. Rules promulgated under Section 352 were required to be
adopted by April 24, 2002.
(b) Section 326 authorizes the Secretary of the Department of Treasury, in
conjunction with other bank regulators, to issue regulations by
October 26, 2002 that provide for minimum standards with respect to
customer identification at the time new accounts are opened.
(c) Section 312 requires financial institutions that establish, maintain,
administer, or manage private banking accounts or correspondent
accounts in the United States for non-United States persons or their
representatives (including foreign individuals visiting the United
States) to establish appropriate, specific, and, where necessary,
enhanced due diligence policies, procedures, and controls designed to
detect and report money laundering. Rules promulgated under Section
312 were due by April 24, 2002, to be effective by July 23, 2002.
(d) Effective December 25, 2001, financial institutions are prohibited
from establishing, maintaining, administering or managing
correspondent accounts for foreign shell banks (foreign banks that do
not have a physical presence in any country), and will be subject to
certain recordkeeping obligations with respect to correspondent
accounts of foreign banks.
(e) Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger Act applications.
SARBANES-OXLEY ACT OF 2002
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of
2002 implementing legislative reforms intended to address corporate and
accounting fraud. In addition to the establishment of a new accounting oversight
board which will enforce auditing, quality control and independence standards
and will be funded by fees from all publicly traded companies, the bill
restricts provision of both auditing and consulting services by accounting
firms. To ensure auditor independence, any non-audit services being provided to
an audit client will require preapproval by the company's audit committee
members. In addition, the audit partners must be rotated. The bill requires
chief executive officers and chief financial officers, or their equivalent, to
certify to the accuracy of periodic reports filed with the SEC, subject to civil
and criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under the Act, counsel will be required to report
evidence of a material violation of the securities laws or a breach of fiduciary
duty by a company to its chief executive officer or its chief legal officer,
and, if such officer does not appropriately respond, to report such evidence to
the audit committee or other similar committee of the board of directors or the
board itself.
Longer prison terms will also be applied to corporate executives who
violate federal securities laws, the period during which certain types of suits
can be brought against a company or its officers has been extended, and bonuses
issued to top executives prior to restatement of a company's financial
27
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives are
restricted. In addition, a provision directs that civil penalties levied by the
SEC as a result of any judicial or administrative action under the Act be
deposited to a fund for the benefit of harmed investors. The Federal Accounts
for Investor Restitution ("FAIR") provision also requires the SEC to develop
methods of improving collection rates. The legislation accelerates the time
frame for disclosures by public companies, as they must immediately disclose any
material changes in their financial condition or operations. Directors and
executive officers must also provide information for most changes in ownership
in a company's securities within two business days of the change.
The Act also increases the oversight of, and codifies certain requirements
relating to audit committees of public companies and how they interact with the
company's "registered public accounting firm" ("RPAF"). Audit Committee members
must be independent and are barred from accepting consulting, advisory or other
compensatory fees from the issuer. In addition, companies must disclose whether
at least one member of the committee is a "financial expert" (as such term will
be defined by the SEC) and if not, why not. Under the Act, a RPAF is prohibited
from performing statutorily mandated audit services for a company if such
company's chief executive officer, chief financial officer, comptroller, chief
accounting officer or any person serving in equivalent positions has been
employed by such firm and participated in the audit of such company during the
one-year period preceding the audit initiation date. The Act also prohibits any
officer or director of a company or any other person acting under their
direction from taking any action to fraudulently influence, coerce, manipulate
or mislead any independent public or certified accountant engaged in the audit
of the company's financial statements for the purpose of rendering the financial
statement's materially misleading. The Act also requires the SEC to prescribe
rules requiring inclusion of a disclosure control report and assessment by
management in the annual report to shareholders. The Act requires the RPAF that
issues the audit report to attest to and report on management's assessment of
the company's internal controls. In addition, the Act requires that each
financial report required to be prepared in accordance with (or reconciled to)
generally accepted accounting principles and filed with the SEC reflect all
material correcting adjustments that are identified by a RPAF in accordance with
generally accepted accounting principles and the rules and regulations of the
SEC.
TAXATION
The Holding Company and its subsidiaries are subject to those rules of
federal income taxation generally applicable to corporations under the Internal
Revenue Code of 1986, as amended (the "Code"). The Holding Company and its
subsidiaries, as members of an affiliated group of corporations within the
meaning of Section 1504 of the Code, file a consolidated federal income tax
return, which has the effect of eliminating or deferring the tax consequences of
inter-company distributions, including dividends, in the computation of
consolidated taxable income.
The Holding Company and the Bank are also subject to various forms of state
taxation under the laws of Pennsylvania.
ITEM 2. PROPERTIES
OFFICES AND OTHER MATERIAL PROPERTIES
At June 30, 2002, the Bank conducted its business from its main office in
Downingtown, Pennsylvania, which is also a branch office, and eight other
full-service branch offices. PCIS conducts its business from two offices.
28
The following table sets forth certain information with respect to the
offices of the Company as of June 30, 2002:
NET BOOK VALUE OF
LEASE PROPERTY AND LEASEHOLD
OWNED OR EXPIRATION IMPROVEMENTS AT
LEASED DATE JUNE 30, 2002 DEPOSITS
-------------------------------------------------------------------
FIRST FINANCIAL BANK: (DOLLARS IN THOUSANDS)
MAIN OFFICE
100 E. Lancaster Avenue
Downingtown, PA 19335 Own -- $ 5,046 $ 100,597
BRANCH OFFICES:
Exton-Lionville
- -------------------------------------
601 N. Pottstown Pike
Exton, PA 19341 Own -- 349 64,900
Frazer-Malvern
- -------------------------------------
200 W. Lancaster Avenue
Frazer, PA 19335 Own -- 1,182 39,865
Thorndale
- -------------------------------------
3909 Lincoln Highway
Downingtown, PA 19335 Lease 09/30/05 39 45,730
Westtown
- -------------------------------------
1197 Wilmington Pike
West Chester, PA 19382 Lease 11/30/05 100 55,879
Airport Village
- -------------------------------------
102 Airport Road Own Bldg.
Coatesville, PA 19320 Lease Land 11/30/04 269 24,556
Brandywine Square
- -------------------------------------
82 Quarry Road
Downingtown, PA 19335 Lease 08/14/11 72 25,751
Devon
- -------------------------------------
414 Lancaster Avenue
Devon, PA 19333 Own -- 1,337 15,551
Kennett Square
- -------------------------------------
838 E. Baltimore Pike
Kennett Square, PA 19348 Lease 01/31/12 601 13,151
-------- ---------
Total $ 8,995 $ 385,980
======== =========
PCIS
Philadelphia
- -------------------------------------
One Liberty Place, Suite 3050
1650 Market Street
Philadelphia, PA 19103 Lease 05/31/04 -- --
Wayne
- -------------------------------------
485 Devon Park Drive, Suite 109
Wayne, PA 19087 Lease 11/30/02 -- --
29
In addition, the Company currently owns four developed properties adjacent
to its main office. One of these properties is used as the Bank's data center
and approximately 25% of another property is rented to a third party. The
remaining two properties are currently being leased to other users and may be
used for future banking facilities. The net book value of four properties at
June 30, 2002 was approximately $914 thousand.
In September 1989, the Bank entered into a 10-year operating lease for the
Bank's Westtown office. The lease contains two five-year options to renew. The
lease has been extended to 2004.
In October 1990, the Bank entered into a 10-year lease agreement in
connection with the relocation of its existing branch in Thorndale to a new site
in the Thorndale area. The lease includes two five-year options to extend the
lease. The lease has been extended to 2005.
In May 1994, the Bank entered into a 10-year lease agreement for land in
connection with the construction of the Airport Village branch. The lease
includes three five-year options to extend the lease.
In April 1995, the Bank entered into a 15-year lease agreement for the
Bank's Brandywine Square office.
In February 2002, the Bank entered into a 10-year lease agreement for the
Bank's Kennett Square office.
In December 1997, PCIS entered into a five-year lease agreement for PCIS's
Wayne office.
In June 1999, PCIS entered into a five-year lease agreement for PCIS's
Philadelphia office.
First Financial operates and participates in the STAR (formerly
MAC[registered]) Money Access Service shared Automated Teller Machine ("ATM")
network system. In addition, First Financial operates nine office ATMs under the
STAR[registered] system and one remote ATM location.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
routine, non-material legal proceedings occurring in the ordinary course of
business which management believes will not have a material adverse effect on
the financial condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
As of September 1, 2002, the Holding Company's Common Stock was held by
approximately 1,802 shareholders of record not including the number of persons
or entities holding stock in nominee or street name through various brokers and
banks. Any broker or any NASD member can be contacted for the latest quotations
of the Holding Company's Common Stock. The Holding Company's Nasdaq Stock Market
symbol is "CVAL". The transfer agent for the stock is American Stock Transfer
and Trust Company, New York, New York. During fiscal 2002 and 2001 the Holding
30
Company paid aggregate annual dividends of $0.40 and $0.36 respectively,
adjusted for stock dividends and stock splits during those periods.
The following table sets forth the high and low closing prices for the
periods described. For comparability purposes, the closing prices shown below
have been adjusted to reflect the 5% stock dividends paid in fiscal 2002 and
2001.
FISCAL 2002 LOW HIGH
--------------------------------------------------------------------------
FIRST QUARTER $13.00 $14.76
SECOND QUARTER 13.25 15.00
THIRD QUARTER 14.25 15.99
FOURTH QUARTER 15.30 16.11
Fiscal 2001 Low High
--------------------------------------------------------------------------
First Quarter $14.97 $26.90
Second Quarter 16.19 22.86
Third Quarter 16.19 21.90
Fourth Quarter 12.06 21.43
ITEM 6. SELECTED FINANCIAL DATA
AT OR FOR THE YEAR ENDED JUNE 30,
-----------------------------------------------------------------------------
2002 2001 2000 1999 1998
-----------------------------------------------------------------------------
(Dollars in Thousands Except per Share Data)
SELECTED FINANCIAL CONDITION DATA
Total assets $566,032 $544,705 $507,150 $451,158 $377,012
Net loans receivable(1) 363,702 346,313 331,306 291,388 273,128
Investment securities 142,589 154,740 145,127 126,622 74,255
Deposits and repurchase
agreements 385,980 413,352 378,478 359,514 298,191
Borrowings 120,703 82,906 87,151 51,028 41,791
Stockholders' equity 44,171 40,098 35,502 33,853 31,849
Book value per common share(2) 10.27 9.25 8.24 7.90 7.51
SELECTED OPERATIONS DATA 2002 2001 2000 1999 1998
-----------------------------------------------------------------------------
Interest income $34,470 $37,330 $33,837 $ 29,385 $ 25,753
Interest expense 16,364 22,218 18,975 15,682 13,409
-----------------------------------------------------------------------------
Net interest income 18,106 15,112 14,862 13,703 12,344
Provision for loan losses 547 445 420 390 606
Non-interest income 5,348 5,930 5,536 5,197 4,618
Non-interest expense 15,977 16,030 14,164 12,730 11,643
Net income 5,575 4,003 4,557 4,213 3,626
Basic earnings per share 1.29 0.93 1.06 0.99 0.86
Diluted earnings per share 1.28 0.92 1.05 0.98 0.86
Dividends per share(2) .40 .34 .32 .28 .27
-----------------------------------------------------------------------------
(1) Includes loans held for sale
(2) Adjusted to reflect 5% stock dividends paid in September 2001, 2000, 1999,
1998, and 1997, and the three-for-two stock split effected in the form of a
dividend in December 1998.
31
AT OR FOR THE YEAR ENDED JUNE 30,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ------------ ------------ ------------ -----------
OTHER SELECTED DATA
Average interest rate spread 3.29% 2.71% 2.95% 3.03% 3.28%
Net yield on average interest-
earning assets 3.66% 3.19% 3.49% 3.64% 3.94%
Ratio of non-performing loans and
REO to total assets at end of
period .17% .22% .19% .21% .33%
Number of full-service bank offices
at end of period 9 8 8 8 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company's results of operations depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, which consists principally of loans and investment securities, and
interest expense on interest-bearing liabilities, which consist of deposits and
borrowings. Net interest income is determined by the Company's interest rate
spread (the difference between the yields earned on its interest-earning assets
and the rates paid on its interest-bearing liabilities) and the relative amounts
of interest-earning assets and interest-bearing liabilities.
The Company's results of operations also are affected by the provision for
loan losses resulting from management's assessment of the adequacy of the
allowance for loan losses; the level of its non-interest income, including
investment service fees, account service fees and related income and gains and
losses from the sales of loans and securities; the level of its non-interest
expense, including salaries and employee benefits, occupancy and equipment
expense, data processing services, deposit insurance premiums, advertising,
other operating costs; and income tax expense.
The Bank is a community-oriented bank, which emphasizes customer service
and convenience. As part of this strategy, the Bank offers products and services
designed to meet the needs of its customers. The Company generally has sought to
achieve long-term financial growth and strength by increasing the amount and
stability of its net interest income and non-interest income and by maintaining
a high level of asset quality. In pursuit of these goals, the Company has
adopted a business strategy emphasizing growth in basic financial services. The
focus is on commercial and construction lending, commercial deposits and
treasury management, consumer deposits and loans and trust and investment
management.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Discussion and analysis of the financial condition and results of
operations are based on the consolidated financial statements of the Bank, which
are prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires the Bank
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. The Bank evaluates estimates on an on-going basis, including
those related to the allowance for loan losses, non-accrual loans, other real
estate owned, other-than-temporary investment impairments, pension and
post-retirement benefits, the stock option plan, recourse liabilities and income
taxes. The Bank bases its estimates on historical experience and various other
32
factors and assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
The Bank believes the following critical accounting policies affect its
more significant judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, income taxes, and
other-than-temporary investment security impairment. Each estimate is discussed
below. The financial impact of each estimate is discussed in the applicable
sections of Management's Discussion and Analysis.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that represents
management's best estimate of known and inherent losses, which are probable and
reasonably determinable based upon an evaluation of the loan portfolio.
Homogeneous portfolios of loans, which include residential mortgage, home equity
and other consumer loans, are evaluated as a group. Commercial business,
commercial mortgage and construction loans are evaluated individually. Specific
portions of the allowance are developed by analyzing individual loans for
adequacy of collateral, cash flow and other risks which may be unique to that
particular loan. General portions of the allowance are developed by grading
individual loans in the commercial and construction portfolios and applying loss
factors by grade. The general portion of the allowance also includes loss
factors applied to the homogeneous portfolios as a group. The loss factors
applied to graded loans were developed based on the Company's loss history for
loans with similar attributes as well as input from the Company's primary
banking regulators. Loss factors are applied to homogeneous loans based upon
prior loss experience of the portfolio delinquency trends and the volume of
non-performing loans. Although management believes it has used the best
information available to it in making such determinations, and that the present
allowance for loan losses is adequate, future adjustments to the allowance may
be necessary, and net income may be adversely affected if circumstances differ
substantially from the assumptions used in determining the level of the
allowance. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for losses
on loans. Such agencies may require the Bank to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination. The allowance is increased by the provision for loan
losses, which is charged to operations. Loan losses, other than those incurred
on loans held for sale, are charged directly against the allowance and
recoveries on previously charged-off loans are added to the allowance.
For purposes of applying the measurement criteria for impaired loans, the
Company excludes large groups of smaller balance homogeneous loans, primarily
consisting of residential real estate loans and consumer loans as well as
commercial business loans with balances of less than $100,000. For applicable
loans, the Company evaluates the need for impairment recognition when a loan
becomes non-accrual or earlier if, based on management's assessment of the
relevant facts and circumstances, it is probable that the Company will be unable
to collect all proceeds under the contractual terms of the loan agreement. At
and during the years ended June 30, 2002, 2001 and 2000, the recorded investment
in impaired loans was not significant. The Company's policy for the recognition
of interest income on impaired loans is the same as for non-accrual loans. A
portion of an impaired loan is charged off when the Company determines that
foreclosure is probable and the fair value of the collateral is less than the
recorded investment of the impaired loan.
33
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to difference between the financial statement carrying
amounts of existing assets and liabilities and their respective tax base, as
well as tax credit carry forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is established against deferred tax assets when in the
judgment of management, it is more likely than not that such deferred tax assets
will not become available. Based on management's evaluation of the likelihood of
realization, no valuation allowance has been established. Because the judgment
about the level of future taxable income is dependent to a great extent on
matters that may, at least in part, be beyond the Bank's control, it is at least
reasonably possible that management's judgment about the need for a valuation
allowance for deferred taxes could change in the near term.
OTHER THAN TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES
Securities are evaluated periodically to determine whether a decline in
their value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term "other than temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospects for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support
realizable value equal to or greater than carrying value of the investment. Once
a decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized.
BUSINESS STRATEGY
GROWTH. The Company seeks to increase its assets through internal growth
and by expanding its operations. During fiscal 2003, the Company expects to open
two new branches in fiscal 2003 to broaden its deposit base and to introduce
several new commercial lending and deposits products.
In 2002 the Company's assets increased by $21.33 million, or 3.92% from
$544.71 million at June 30, 2001 to $566.03 million at June 30, 2002 resulting
mainly from the $19.6 million growth in the loan portfolio. Such loan growth was
funded primarily by borrowings.
EMPHASIS ON COMMERCIAL LENDING. The Company has been and will continue to
expand its higher yielding portfolios of commercial real estate and commercial
business lending. This strategy is reflected in the shifting composition of the
Company's loan portfolio. The Company's commercial real estate, commercial
business and construction and land acquisition loans comprised 45.00% of its
total loan portfolio at June 20, 2002 compared to 38.69% at June 30, 2001.
Single-family and multi-family residential loans comprised 36.20% of the
Company's loan portfolio at June 30, 2002 as compared to 42.92% at June 30,
2001.
MAINTAIN LOAN QUALITY. Management believes that maintaining high loan
quality is key to achieving and sustaining long-term financial success.
Accordingly, the Company has sought to maintain a high level of asset quality
and moderate credit risk by using underwriting standards which management
believes are conservative and by generally limiting its origination of loans to
its market area. The Company's non-accrual loans decreased by $228 thousand to
34
$944 thousand at June 30, 2002 with the decrease primarily related to consumer
loans. The Company's ratio of non-performing assets to total assets at June 30,
2002 was 0.17% and its allowance for loan losses to non-performing loans was
486.0%, while at June 30, 2001 the percentages were 0.22% and 363.8%,
respectively.
STABLE SOURCE OF LIQUIDITY. The Company purchases investment securities
that management believes to be appropriate for liquidity, yield and credit
quality in order to achieve a managed and more predictable source of liquidity
to meet loan demand and, to a lesser extent, a stable source of interest income.
The portfolio totaled, in the aggregate, $142.6 million at June 30, 2002
compared to $154.7 million at June 30, 2001. In addition, the Company had
short-term interest-bearing deposits of $29.2 million at June 30, 2002 compared
to $19.7 million at June 30, 2001.
EMPHASIS ON DEPOSITS AND CUSTOMER SERVICE. THE COMPANY, AS A
community-based financial institution, is largely dependent upon its base of
competitively priced core deposits to provide a stable source of funding. The
Company has retained many loyal customers over the years through a combination
of high quality service, relatively low service fees, customer convenience, an
experienced staff and a strong commitment to the communities in which it serves.
Lower costing deposits, which exclude time deposits, totaled $197.17 million or
51.1% of the Company's total deposits at June 30, 2002, as compared to $169.15
million at June 30, 2001, a $28.0 million or 16.6% increase. This increase in
lower costing deposits is primarily attributable to the continuing effort to
grow core deposits. Pursuant to the Company's strategy, the major focus in 2003
will continue to be on increasing commercial and consumer core deposits and
relying less on higher rate municipal certificates. In addition, the Company has
not used brokered deposits as a source of funds and presently has no plans to do
so in the future.
ASSET/LIABILITY MANAGEMENT
The primary asset/liability management goal of the Company is to manage and
control its interest rate risk of the bank subsidiary, thereby reducing its
exposure to fluctuations in interest rates, and achieving sustainable growth in
net interest income over the long term. Other objectives of asset/liability
management include: (1) ensuring adequate liquidity and funding, (2) maintaining
a strong capital base and (3) maximizing net interest income opportunities.
In general, interest rate risk is mitigated by closely matching the
maturities or repricing periods of interest-sensitive assets and liabilities to
ensure a favorable interest rate spread. Management regularly reviews the Bank's
interest-rate sensitivity, and uses a variety of strategies as needed to adjust
that sensitivity within acceptable tolerance ranges established by management.
Changing the relative proportions of fixed-rate and adjustable-rate assets and
liabilities is one of the primary strategies utilized by the Company to
accomplish this objective.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest-rate sensitive" and by
monitoring an institution's interest-sensitivity gap. An interest-sensitivity
gap is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities repricing within a
defined period and is considered negative when the amount of interest-rate
sensitive liabilities exceeds the amount of interest-rate sensitive assets
repricing within a defined period.
35
To provide a more accurate one-year gap position of the Company, certain
deposit classifications are based on the interest-rate sensitive attributes and
not on the contractual repricing characteristics of these deposits. Management
estimates, based on historical trends of the Bank's deposit accounts, that a
portion of money market, NOW accounts and savings deposits are partially
sensitive to interest rate changes. Accordingly, the interest-sensitive portions
of these deposits are classified in the less than one-year categories with the
remainder in the over five years category. Deposit products with interest rates
based on a particular index, if any, are classified according to the specific
repricing characteristic of the index. Deposit rates other than time deposit
rates are variable, and changes in deposit rates are typically subject to local
market conditions and management's discretion and are not indexed to any
particular rate.
Generally, during a period of rising interest rates, a positive gap would
result in an increase in net interest income while a negative gap would
adversely affect net interest income. However, the interest-sensitivity table
that follows does not provide a comprehensive representation of the impact of
interest rate changes on net interest income. Each category of assets or
liabilities will not be affected equally or simultaneously by changes in the
general level of interest rates. Even assets and liabilities, which
contractually reprice within the same period may not, in fact, reprice at the
same price or the same time or with the same frequency. It is also important to
consider that the table represents a specific point in time. Variations can
occur as the Company adjusts its interest-sensitivity position for the Bank
throughout the year.
36
INTEREST RATE SENSITIVITY ANALYSIS AT JUNE 30, 2002 FOR THE BANK
(Dollars in thousands)
More More More
More Than Than Than Than
Three Six One Year Three More
Three Months Months Through Years Than
Months Through Through Three Through Five
or Less Six Months One Year Years Five Years Years Total
-------- ---------- -------- -------- ---------- -------- --------
INTEREST-EARNING ASSETS
Loans (1)
Real estate (2) $ 60,869 $ 20,638 $ 35,001 $ 77,162 $ 43,764 $ 24,544 $261,978
Commercial 22,743 1,826 2,869 7,667 1,669 -- 36,774
Consumer 28,336 4,532 6,480 12,950 7,915 9,325 69,538
Securities and interest-bearing deposits 82,828 6,581 8,221 13,717 8,526 49,542 169,415
-------- -------- -------- -------- -------- -------- --------
TOTAL INTEREST-EARNING ASSETS 194,776 33,577 52,571 111,496 61,874 83,411 537,705
-------- -------- -------- -------- -------- -------- --------
INTEREST-BEARING LIABILITIES
Savings accounts 750 752 1,510 6,118 6,245 16,185 31,560
NOW accounts 1,329 1,331 2,671 10,792 10,969 28,215 55,307
Money market accounts 64,944 -- -- -- -- -- 64,944
Certificate accounts 49,749 17,905 43,236 65,056 7,390 5,476 188,812
Borrowings 18,499 653 7,864 7,276 4,263 82,148 120,703
-------- -------- -------- -------- -------- -------- --------
TOTAL INTEREST-BEARING LIABILITIES 135,271 20,641 55,281 89,242 28,867 132,024 461,326
-------- -------- -------- -------- -------- -------- --------
Cumulative excess of interest-earning assets
to interest-bearing liabilities $ 59,505 $ 72,441 $ 69,731 $ 91,985 $124,992 $ 76,379 $ 76,379
======== ======== ======== ======== ======== ======== ========
Cumulative ratio of interest rate-sensitive
assets to interest rate-sensitive liabilities 114.0% 146.5% 133.0% 130.6% 138.0% 116.6% 116.6%
======== ======== ======== ======== ======== ======== ========
CUMULATIVE DIFFERENCE AS A PERCENTAGE
OF TOTAL ASSETS 10.6% 12.9% 12.4% 16.4% 22.2% 13.6% 13.6%
======== ======== ======== ======== ======== ======== ========
(1) Net of undisbursed loan proceeds.
(2) Includes commercial mortgage loans.
37
OPERATING RESULTS
INTEREST INCOME (TAXABLE-EQUIVALENT BASIS)
Interest income is analyzed on a tax-equivalent basis, i.e., an adjustment
is made for analysis purposes only, to increase interest income by the amount of
savings of Federal income taxes, which the Company realizes by investing in
certain tax-free municipal securities and by making loans to certain tax-exempt
organizations. In this way, the ultimate economic impact of earnings from
various assets can be more readily compared.
Total interest income decreased to $35.28 million during fiscal 2002, a
$3.10 million or 8.1% decrease over the prior fiscal year. This was due to a
$3.77 million decrease in interest income because of lower average rates during
the period which was offset, in part, by a $10.34 million increase in the
average balance of interest-earning assets which contributed $676 thousand of
additional interest income. Total interest income increased to $38.37 million
during fiscal 2001, a $3.38 million or 9.7% increase over fiscal 2000. This
increase was due to a $47.03 million increase in the average balance of
interest-earning assets, which contributed $3.55 million and was offset in part
by a decline of $0.16 million due to lower average rates. The yield on average
interest earning assets was 6.83%, 7.58% and 7.62% for fiscal year 2002, 2001
and 2000, respectively, reflecting the decline in general market rates of
interest.
INTEREST EXPENSE
Total interest expense decreased to $16.36 million during fiscal 2002, a
$5.85 million or 26.3% decrease over the prior fiscal year. The decrease in
interest expense was primarily due to a significant decrease in rates resulting
in a $6.32 million decrease in interest expense which was offset, in part, by an
increase in average balances for deposits and borrowings resulting in an
increase in interest expense of $.47 million. The average rate paid on deposits
and repurchase agreements decreased to 3.07% for fiscal 2002 from 4.65% for the
previous fiscal year while the average rate paid on borrowings decreased 60
basis points to 5.39% for fiscal 2002.
Total interest expense increased to $22.22 million during fiscal 2001, a
$3.24 million or 17.1% increase over fiscal 2000. The increase in interest
expense was primarily due to a $63.09 million increase in the average balance of
deposits and repurchase agreements, which was partially offset by a decrease of
$13.4 million in borrowings for the year ended June 30, 2001. The increase in
average balances resulted in a $3.08 million increase; however, such increases
were partially offset by a 31 basis point increase to 4.65% in the average rate
paid on deposits during fiscal 2001. The average rate paid on borrowings
increased 14 basis points to 5.99%.
NET INTEREST INCOME
Net interest income is the difference between interest income on
interest-earning assets and interest expense on interest-bearing liabilities.
Net interest income, on a fully tax equivalent basis, increased 17.1%, or $2.76
million to $18.91 million in fiscal 2002 from $16.15 million in fiscal 2001,
compared to a 1.0% increase of $0.14 million from fiscal 2001 to fiscal 2000.
Net interest margin, on a fully tax equivalent basis, was 3.66% for the year
ended June 30, 2002, compared to 3.19% in fiscal 2001 and 3.49% during fiscal
2000 as the Company's interest margin was compressed in 2001 by declining market
rates on interest earning assets while interest-bearing liability rates
increased from 4.67% to 4.87%.
38
PROVISION FOR LOAN LOSSES
The Company's provision for loan losses was $547,000, $445,000 and
$420,000, during fiscal 2002, 2001 and 2000, respectively. These additions to
the allowance for loan losses are due to the Company's focus on building a
larger loan portfolio of commercial and industrial loans which typically carry a
greater risk of loss than the Company's traditional loan portfolios, such as
mortgages and real estate loans. This change in the character of the loan
portfolio, the current depressed economic conditions and management's assessment
of the inherent risk of loss existing in the loan portfolio determined the
amount necessary to increase the allowance for loan losses to an appropriate
level. At June 30, 2002, the allowance for loan losses totaled $4.59 million or
1.26% of net loans compared to $4.26 million or 1.23% of net loans at June 30,
2001.
The Company establishes provisions for loan losses, which are charged to
operations, in order to maintain the allowance for loan losses at a level which
management believes covers all known and inherent losses in the loan portfolio.
In establishing the provision, management considers among other things, the mix
of loans being booked, the delinquency trends, the volume of non-performing
loans, prior loss experience of the portfolio, current economic conditions, and
other relevant factors. Although management believes it has used the best
information available to it in making such determinations, and that the present
allowance for loan losses is adequate, future adjustments to the allowance may
be necessary, and net income may be adversely affected if the circumstances
differ substantially from the assumptions used in determining the level of the
allowance for loan losses. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Company's
allowance for losses on loans. Such agencies may require the Company to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.
NON-INTEREST INCOME
Total non-interest income decreased $582,000 or 9.8% to $5.35 million for
the year ended June 30, 2002, compared to the prior fiscal year. The principal
reason for this decrease was a $500,000 impairment loss on a low-income housing
revenue bond and a $455,000 impairment loss on a revenue bond involving a
building and related property that are leased to various agencies of the
Commonwealth of Pennsylvania. These losses totaling $955,000 were offset by the
following: investment services income increased $52,000 or 1.4% to $3.82
million; service charges and fees increased $188,000 or 10.9% because of
increased activity; gains on the sale of loans increased $18,000; gains on
available for sale securities increased $65,000; and other income increased
$19,000. These security gains were offset by a decrease in gains on trading
account securities of $260,000.
Total non-interest income increased $394,000 or 7.1% to $5.93 million for
the year ended June 30, 2001, from the prior fiscal year. Investment services
income increased $68,000 or 1.8% to $3.77 million. An increase in checking
account fees, as the result of an increased number of accounts, and an increase
in the fees earned on the Bank's debit card due to increased usage and also an
increased number of cardholders, contributed to the increase of $71,000 or 4.3%
in service charges and fees in fiscal 2001. Also contributing were increases in
gains on the sale of loans of $100,000, gains on trading account securities of
$202,000, gains on the sale of available for sale securities of $216,000 and
other income of $28,000. These gains were offset by a loss on impaired
securities of $291,000.
39
OPERATING EXPENSES
Total operating expenses decreased $53,000 or 0.3% to $15.98 million for
the year ended June 30, 2002 compared to fiscal 2001. The decrease in operating
expenses over the prior fiscal year was primarily due to a decrease of $375,000
or 69.2% in advertising expenses relating to print advertising because the
Company moved to a more cost effective, proactive direct sales approach. Other
expenses decreased by $388,000 or 11.2% due to decreases in consulting,
printing, donations, supplies and other expenses. These decreases were offset in
part by an increase of $544,000 or 6.33% in salaries and employee benefits
resulting from normal salary adjustments effective July 1, 2001, additional
officer level staff, bonuses and the general increase in employee benefit costs.
Also, occupancy and equipment expense increased $164,000 or 12.3% resulting from
the expansion of the Company's corporate headquarters and the addition of a new
branch office in Kennett Square.
Total operating expenses increased $1.87 million or 13.2% to $16.03 million
for the year ended June 30, 2001 compared to fiscal 2000. The increase in
operating expenses in fiscal 2001 over the prior fiscal year was due to the
following: (a) salary and employee benefits increased $788,000 or 10.1%. Salary
and incentive payments increased $494,000 because of annual salary increases to
existing employees, additional employees and for incentives to employees who
achieve their goals; retirement plan contributions increased $86,000; group
health insurance increased $50,000; payroll taxes, because of higher payroll
costs and more employees increased $40,000; and directors compensation and
education expenses increase $78,000, (b) occupancy and equipment expense
increased $132,000 or 5.9% consisting primarily of an increase of $42,000 in
computer related expenses, a $45,000 increase in utilities and insurance, and a
$40,000 increase in repairs and maintenance make up a majority of the increase,
(c) data processing increased $117,000 or 13.8% due principally to the
introduction of our new eServices products (eBank for internet banking, eVoice
for 24-hour telephone banking, and eCorp for business banking), (d) deposit
insurance premiums decreased $63,000 or 46% because of regulatory changes, (e)
advertising increased $125,000 or 30%, resulting primarily from a bank image
campaign and the marketing of our new electronic internet banking products
discussed above, (f) other expenses increased $767,000 or 28.3% due to the
significant increases in legal fees of $122,000 which include the cost of the
interim president for approximately five months, audit and accounting services
of $31,000 because of special projects including our initial FDICIA compliance
work, consulting expenses of $197,000 for various non-recurring special
projects, printing expense of $61,000 because of new promotion and explanatory
material related to eServices, donations of $119,000 resulting from increased
community involvement including approximately $40,000 to a local school,
$152,000 for expenses related to the relocation of the new President, and
$69,000 for increases in other operating expenses.
INCOME TAXES
The Company incurred income tax expense of $1.36 million during fiscal
2002. The primary reason for the increase in income tax expense in fiscal 2002
compared to fiscal 2001 of $564,000 was due to higher pre-tax income and a lower
portion of the Company's pre-tax income being comprised of tax-free interest
income. The effective tax rate was 19.6% for the year ended June 30, 2002.
The Company incurred income tax expense of $564,000 for the year ended June
30, 2001, compared to $1.26 million during fiscal 2000. The primary reasons for
the decrease in income tax expense was a decrease in pretax income, an increase
in tax free income and an increase in federal low income housing tax credits for
qualified federally approved projects in fiscal 2001. The effective tax rate was
12.3% for the year ended June 30, 2001.
40
CAPITAL RESOURCES
The Company's assets totaled $566.03 million at June 30, 2002, as compared
with $544.71 million as of June 30, 2001, principally due to a $19.60 million
increase in loans receivable, net to $363.56 million from $343.96 million at
June 30, 2001 combined with a $15.48 million increase in cash and cash
equivalents from $23.91 million at June 30, 2001 to $39.40 million at June 30,
2002. These increases were partially offset by a $17.23 million decrease in
investment securities from $154.72 million at June 30, 2001 to $142.57 million
at June 30, 2002. Liabilities increased $17.25 million. Borrowings increased
$38.03 million from $82.67 at June 30, 2001 to $120.70 million at June 30, 2002
and the Company issued $10.00 million of Trust Preferred Securities. These
increases were used to replace deposits as a funding source by $27.37 million as
deposits decreased from $413.35 million at June 30, 2001 to $385.98 million at
June 30, 2002 as well as to fund the increase in assets noted above. The decline
in deposits primarily resulted from decreases in higher rate municipal deposits
in connection with the implementation of the Company's business plan.
Stockholders' equity increased $4.1 million to $44.17 million at June 30,
2002, from $40.10 million at June 30, 2001, as a result of net income earned of
$5.58 million during fiscal 2002, and proceeds totaling $162,000 from the
issuance of common stock upon the exercise of stock options. The increase in
stockholders' equity also reflected the effect of a decrease in the net
unrealized loss on the value of securities available for sale of $714,000. The
net unrealized loss of $1.36 million at June 30, 2001 declined to a net
unrealized loss of $649,000 at June 30, 2002. The increases in equity were
offset in part by the payment of cash dividends of $1.71 million as well as the
cost of repurchasing shares of our common stock totaling of $664,000 and the
payment of cash in lieu of fractional shares in connection with the 5% stock
dividend paid during fiscal 2002.
ASSET QUALITY
Classified assets include non-performing loans which are comprised of loans
and REO and totaled $984,000 at June 30, 2002, compared to $1.17 million at June
30, 2001. Non-performing loans to total assets was .17% at June 30, 2002,
compared to .22% at June 30, 2001. Non-performing loans at June 30, 2002,
consisted of eleven residential mortgage loans in the amount of $858,000, and
eight consumer loans totaling $86,000. The Company has one REO property recorded
at fair value less selling costs at $40,000 at June 30, 2002.
At June 30, 2002 and 2001, the Company's classified loans, which consisted
of loans classified as substandard, doubtful, loss, and REO, totaled $6.24
million and $4.84 million, respectively. Included in the assets classified
substandard at June 30, 2002 and 2001, were all loans 90 days past due and loans
which are less than 90 days delinquent, but inadequately protected by the
current paying capacity of the borrower or of the collateral pledged, as well as
a well-defined weakness that may jeopardize the liquidation of the debt.
Included as substandard at June 30, 2001 are two loans totaling approximately
$3.41 million, which are current but have been listed as substandard and are
being closely monitored.
In addition to non-performing loans and REO, classified assets include
three Municipal Authority Revenue Bond investments that had an aggregate balance
of $7.1 million at June 30, 2002, after a write-down on two of the bonds
totaling $955,000. After the write-down, two of the Bonds have a carrying value
of $5.6 million and both of these bonds involve buildings and related property
that are leased to various agencies of the Commonwealth of Pennsylvania under
long term lease arrangements with renewal options. Of the total balance of $5.6
million, $865 thousand are interest bearing bonds and the remainder of $4.7
million are zero coupon bonds with maturities extending up to June 2034.
41
The third classified bond has a balance, after write-down, of $1.5 million,
an interest rate of 6% and matures in June 2019. This bond involves low-income
scattered housing in Chester County under a Housing and Urban Development
Program. The Office of Housing and Urban Development (HUD) has indicated that it
will provide funds to build additional housing which would be donated to this
bond issue and, when sold, would reduce the losses incurred on the bonds.
These classified investments are closely monitored and fairly stated at
June 30, 2002 based on available information. There can be no assurance that
further subsequent adverse or positive developments may occur; in which case,
additional adjustments to these investments may be forthcoming.
LIQUIDITY AND CAPITAL RESOURCES
Management monitors liquidity daily and maintains funding sources to meet
unforeseen changes in cash requirements. The Company's primary sources of funds
are deposits, borrowings, repayments, prepayments and maturities of outstanding
loans and mortgage-backed securities, sales of assets available for sale,
maturities and calls of investment securities and other short-term investments,
and funds provided from operations. While scheduled loan and mortgage-backed
securities repayments and maturing investment securities and short-term
investments are relatively predictable sources of funds, deposit flows, loan
prepayments and callable investments are greatly influenced by the movement of
interest rates in general, economic conditions and competition. The Company
manages the pricing of its deposits to maintain a deposit balance deemed
appropriate and desirable. Although the Company's deposits represent the
majority of its total liabilities, the Company has also utilized other borrowing
sources, namely FHLBP advances. In addition to its ability to obtain advances
from the FHLBP under several different credit programs, the Company has
established a line of credit with the FHLBP, in an the amount $10 million. This
line of credit is available for liquidity purposes. At June 30, 2002 there was
no outstanding balance on this line of credit.
Liquidity management is both a daily and long-term function. Excess
liquidity is generally invested in short-term investments such as FHLBP
overnight deposits. On a longer-term basis, the Company maintains a strategy of
investing in various lending and investment securities products. During the year
ended June 30, 2002, the Company used its sources of funds to primarily fund
loan commitments and maintain a substantial portfolio of investment securities,
and to meet its ongoing commitments to pay maturing savings certificates and
savings withdrawals. As of June 30, 2002, the Company had $1.99 million in
commitments to fund loan originations. The majority of these commitments are
anticipated to be funded by December 31, 2002. In addition, as of June 30, 2002,
the Company had undisbursed loans in process for construction loans of $22.83
million and $37.07 million in undisbursed lines of credit. The Company has also
issued $2.55 million in commercial letters of credit fully secured by deposit
accounts or real estate at June 30, 2002. The management of the Company believes
that the Company has adequate resources, including principal prepayments and
repayments of loans and investment securities and borrowing capacity, to fund
all of its commitments to the extent required.
For regulatory purposes, liquidity is defined as a ratio of cash and
certain marketable securities that can be readily converted into cash to total
deposits and short-term borrowings. At June 30, 2002, liquidity for the Bank as
defined under these guidelines was 31.84%.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related Notes presented elsewhere
herein have been prepared in accordance with generally accepted accounting
principles ("GAAP") which generally require the measurement of financial
position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to
inflation. Unlike many industrial companies, substantially all of the assets and
liabilities of the Company on a consolidated basis are monetary in nature. As a
result, interest rates have a more significant impact on the Company's
performance than the general level of inflation. Over a short period of time,
interest rates may not necessarily move in the same direction or with the same
magnitude as inflation.
42
OTHER INFORMATION
DESCRIPTION OF STOCK
The holders of the Common Stock of the Holding Company possess exclusive
voting rights in the corporation. Each holder of shares of Common Stock is
entitled to one vote for each share held, in accordance with the articles of
incorporation and bylaws, including voting on the election of directors. Of the
10.00 million shares of Common Stock authorized by the Holding Company, 5.66
million shares remain unissued. In addition, none of the 5.00 million shares of
Preferred Stock authorized has been issued.
DIVIDEND POLICY
The Board of Directors of the Holding Company intends to continue the
policy of paying dividends when the directors deem it prudent to do so. The
Board of Directors will consider payment of dividends on a quarterly basis,
after giving consideration to all relevant factors. On August 21, 2002 the Board
of Directors of the Holding Company declared a $.10 per share cash dividend and
a 5% stock dividend based on the their review and evaluation of financial
results of the quarter ended June 30, 2002. The cash dividend will be calculated
on shares held before the issuance of the stock dividend. During fiscal 2001,
2000, and 1999 the Holding Company paid a total of $1.46 million, $1.38 million,
and $1.15 million, respectively, in cash dividends and a 5% stock dividend in
each year. Cash dividends from the Holding Company are primarily dependent upon
dividends paid to it by the Bank, which, in turn, are subject to certain
restrictions established by federal regulators and Pennsylvania law. (See Notes
to Consolidated Financial Statements.)
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises primarily from the interest rate risk
inherent in its lending, investment and deposit taking activities. To that end,
management actively monitors and manages its interest rate risk exposure.
Interest rates declined from January 2001 through December 2001 but there
has been no movement in rates since December 2001. As a result, loans, which are
linked to an index such as the London Interbank Offered Rate ("Libor") or Prime
Rate, were repriced at lower interest rates and deposit products have repriced
as deposits rates are adjusted. The principal source of deposits, the
certificates of deposit, will adjust only when they mature and are renewed by
the customers.
The Company's profitability is affected by fluctuations in interest rates.
A sudden and substantial change in interest rates may adversely impact the
Company's earnings to the extent that the yields on interest-sensitive assets
and interest-sensitive liabilities do not change at the same speed, to the same
extent, or on the same basis. The Company monitors the impact of changes in
interest rates between assets and liabilities as discussed in the
"Asset/Liability Management" in Item 7 hereof. Although interest rate
sensitivity gap analysis is a useful measurement tool and contributes towards
effective asset liability management, it is difficult to predict the effect of
changing interest rates based solely on that measure.
43
The Company utilizes an income simulation modeling to measure the Company's
interest rate risk and to manage its interest rate sensitivity. Income
simulation considers not only the impact of changing market interest rates on
forecasted net interest income, but also other factors such as yield curve
relationships, the volume and mix of assets and liabilities, customer
preferences and general market conditions.
Through the use of income simulation modeling the Company is able to
calculate an estimate of net interest income for the year ending June 30, 2003,
based upon the assets, liabilities and off-balance sheet financial instruments
in existence at June 30, 2002. The Company has also estimated changes to that
estimated net interest income based upon interest rates rising or falling in
monthly increments ("rate ramps"). Rate ramps assume that all interest rates
increase or decrease in monthly increments evenly throughout the period modeled.
Economic value of equity (EVE) estimates the discounted present value of
asset and liability cash flows. Discount rates are based upon market prices for
comparable assets and liabilities. Upward and downward rate shocks are used to
measure volatility in relation to such interest rate movements in relation to an
unchanged environment. This method of measurement primarily evaluates the longer
term repricing risks and options in the Company's balance sheet. The following
table reflects the estimated economic value of equity at risk and the ratio of
EVE adjusted equity to EVE adjusted assets at June 30, 2002, resulting from
shocks to interest rates.
YEAR ENDED JUNE 30, 2002
- -------------------------------------------------------------------------------------------------
CHANGE IN INTEREST ECONOMIC VALUE
RATES IN BASIS POINTS OF EQUITY EVE RATIO
- -------------------------------------------------------------------------------------------------
EVE EQUITY/
(RATE SHOCK) AMOUNT $ CHANGE % CHANGE EVE ASSETS/ CHANGE
- -------------------------------------------------------------------------------------------------
(Dollars in Thousands)
300 $ 53,850 $ (9,446) -15% 9.54% (128)
200 59,122 (4,174) -7% 10.34% (47)
100 61,760 (1,536) -2% 10.67% (15)
Static 63,296 -- -- 10.82% --
(100) 58,085 (5,211) -8% 9.89% (93)
(200) 49,411 (13,885) -22% 8.44% (238)
(300) 40,235 (23,061) -36% 6.91% (391)
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in net present value ("NPV")
require the making of certain assumptions which may or may not reflect the
manner in which actual yields and costs respond to changes in market interest
rates. In this regard, the NPV table presented above assumes that the
composition of the Company's interest sensitive assets and liabilities existing
at the beginning of a period remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Accordingly, although the NPV table provides an
indication of the Company's interest rate risk exposure at a particular point in
time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in market interest rates on the Company's net
interest income and will differ from actual results.
44
The Company's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset/liability
structure to obtain the maximum yield/cost spread on that structure. The Company
relies primarily on its asset/liability structure to control interest rate risk.
The Company continually evaluates interest rate risk management
opportunities, including the use of derivative financial instruments. Management
believes that hedging instruments currently available are not cost-effective
and, therefore, has focused its efforts on increasing the Company's yield/cost
spread through wholesale and retail opportunities.
45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT'S STATEMENT ON FINANCIAL REPORTING
To Our Shareholders:
The management of Chester Valley Bancorp Inc. (the "Company") is responsible for
the preparation, integrity and fair presentation of its published financial
statements. The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America and, as such, include amounts that are based on and are estimates of
management.
There are inherent limitations in the effectiveness of any system of internal
control including the possibility of human error and the circumvention or
overriding the controls. Accordingly, even an effective internal control
structure can only provide reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the degree of
effectiveness of an internal control structure may vary over time.
Management assessed the Company's internal control structure over financial
reporting presented in conformity with generally accepted accounting principles
as of June 30, 2002. This assessment was based on criteria for effective
internal control over financial reporting described in "Internal
Control-Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that, as of June 30, 2002, the Company maintained an effective internal
control structure over financial data presented in accordance with accounting
principles generally accepted in the United States of America.
Management is also responsible for compliance with the federal laws and
regulations concerning dividend restrictions and loans to insiders designated by
the Federal Deposit Insurance Corporation as safety and soundness laws and
regulations.
The Company assessed its compliance with the designated laws and regulations
relating to safety and soundness. Based on this assessment, management believes
that Chester Valley Bancorp Inc. complied, in all material respects, with the
designated laws and regulations related to safety and soundness as of June 30,
2002.
/s/ Donna M. Coughey
- -------------------------------------
Donna M. Coughey
President and Chief Executive Officer
/s/ Albert S. Randa
- -------------------------------------
Albert S. Randa
Chief Financial Officer
46
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Chester Valley Bancorp Inc.
We have audited the accompanying consolidated statements of financial condition
of Chester Valley Bancorp Inc. and subsidiaries (the "Bank") as of June 30, 2002
and 2001, and the related consolidated statements of operations, changes in
stockholders' equity and comprehensive income, and cash flows for each of the
years in the three-year period ended June 30, 2002. These consolidated financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 financial position of Chester Valley
Bancorp Inc. and subsidiaries as of June 30, 2002 and 2001, and the results of
their operations and their cash flows for each of the years in the three year
period ended June 30, 2002 in conformity with accounting principles generally
accepted in the United States of America.
/s/ KPMG LLP
Philadelphia, Pennsylvania
July 26, 2002
47
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
AT JUNE 30,
--------------------
2002 2001
-------- --------
ASSETS
$ 10,232 $ 4,214
Cash in banks
Interest-bearing deposits 29,163 19,698
-------- --------
TOTAL CASH AND CASH EQUIVALENTS 39,395 23,912
-------- --------
Trading account securities 16 16
Investment securities available for sale 101,393 113,350
Investment securities held to maturity (fair value -
June 30, 2002, $41,439
June 30, 2001, $41,639) 41,180 41,374
Loans held for sale 138 2,350
Loans receivable 369,685 349,819
Deferred fees (1,533) (1,592)
Allowance for loan losses (4,588) (4,264)
-------- --------
Loans receivable, net 363,564 343,963
-------- --------
Accrued interest receivable 2,543 3,553
Property and equipment - net 12,765 10,340
Other assets 5,038 5,847
-------- --------
TOTAL ASSETS $566,032 $544,705
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $385,980 $413,352
Securities sold under agreements to repurchase 18,249 2,428
Advance payments by borrowers for taxes and insurance 2,831 2,687
Federal Home Loan Bank advances 102,454 80,237
Other borrowings -- 241
Accrued interest payable 882 1,818
Trust preferred securities 10,000 --
Other liabilities 1,465 3,844
-------- --------
TOTAL LIABILITIES 521,861 504,607
-------- --------
Commitments and contingencies (Note 9)
Stockholders' Equity:
Preferred stock - $1.00 par value;
5,000,000 shares authorized; none issued -- --
Common stock - $1.00 par value;
10,000,000 shares authorized;
4,335,183 and 4,123,164 shares issued and outstanding
at June 30, 2002 and June 30, 2001, respectively 4,335 4,123
Additional paid-in capital 26,885 24,207
Retained earnings - partially restricted 14,115 13,136
Treasury stock (33,753 and 296 shares at June 30, 2002 and 2001,
respectively, at cost) (515) (5)
Accumulated other comprehensive loss (649) (1,363)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 44,171 40,098
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $566,032 $544,705
======== ========
See accompanying notes to consolidated financial statements.
48
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Data)
YEAR ENDED JUNE 30,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
INTEREST INCOME:
Loans $ 26,658 $ 27,116 $ 24,581
Mortgage-backed securities 1,116 933 1,042
Interest-bearing deposits 459 466 153
Investment securities:
Taxable 4,341 6,335 5,272
Non-taxable 1,896 2,480 2,789
---------- ---------- ----------
TOTAL INTEREST INCOME 34,470 37,330 33,837
---------- ---------- ----------
INTEREST EXPENSE:
Deposits 11,182 17,621 13,700
Securities sold under agreements to repurchase 158 2 --
Short-term borrowings 1,613 1,717 3,317
Long-term borrowings 3,411 2,878 1,958
---------- ---------- ----------
TOTAL INTEREST EXPENSE 16,364 22,218 18,975
---------- ---------- ----------
NET INTEREST INCOME 18,106 15,112 14,862
Provision for loan losses 547 445 420
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 17,559 14,667 14,442
---------- ---------- ----------
NON-INTEREST INCOME:
Investment services income, net 3,818 3,766 3,698
Service charges and fees 1,911 1,723 1,652
Gain (loss) on the sale of loans 115 97 (3)
Gain on sale of trading account securities, net 4 264 62
Gain on sale of available for sale securities, net 289 224 8
Loss for impairment of securities (955) (291) --
Other 166 147 119
---------- ---------- ----------
TOTAL NON-INTEREST INCOME 5,348 5,930 5,536
---------- ---------- ----------
OPERATING EXPENSES:
Salaries and employee benefits 9,136 8,592 7,804
Occupancy 1,501 1,337 1,175
Equipment 977 1,042 1,072
Data processing 1,035 966 849
Advertising 167 542 417
Deposit insurance premiums 72 74 137
Other 3,089 3,477 2,710
---------- ---------- ----------
TOTAL OPERATING EXPENSES 15,977 16,030 14,164
---------- ---------- ----------
Income before income taxes 6,930 4,567 5,814
Income tax expense 1,355 564 1,257
---------- ---------- ----------
NET INCOME $ 5,575 $ 4,003 $ 4,557
========== ========== ==========
EARNINGS PER SHARE
Basic $ 1.29 $ 0.93 $ 1.06
========== ========== ==========
Diluted $ 1.28 $ 0.92 $ 1.05
========== ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 4,324,246 4,318,045 4,291,076
========== ========== ==========
Diluted 4,354,927 4,370,502 4,321,888
========== ========== ==========
(*) Earnings per share and weighted average shares outstanding have been
restated to reflect the effects of the 5% stock dividends paid in September
2001, 2000, and 1999.
See accompanying notes to consolidated financial statements.
49
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME STATEMENT
RETAINED ACCUMULATED
ADDITIONAL EARNINGS OTHER TOTAL
COMMON PAID-IN PARTIALLY TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK CAPITAL RESTRICTED STOCK INCOME (LOSS) EQUITY
- ----------------------------------------------------------------------------------------------------------------
Balance as of June 30, 1999 $ 3,707 $ 17,904 $ 13,794 $ -- $ (1,552) $ 33,853
Net income -- -- 4,557 -- -- 4,557
Cash dividends paid ($0.32 per share) -- -- (1,383) -- -- (1,383)
Issuance of stock dividend 185 2,829 (3,014) -- -- --
Cash payment for fractional shares -- -- (7) -- -- (7)
Common stock issued 20 165 -- 531 -- 716
Common stock repurchased -- -- -- (531) -- (531)
Change in unrealized loss on
securities available for sale -- -- -- -- (1,703) (1,703)
- -------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2000 3,912 20,898 13,947 -- (3,255) 35,502
- -------------------------------------------------------------------------------------------------------------
Net income -- -- 4,003 -- -- 4,003
Cash dividends paid ($0.34 per share) -- -- (1,463) -- -- (1,463)
Issuance of stock dividend 195 3,149 (3,344) -- -- --
Cash payment for fractional shares -- -- (7) -- -- (7)
Common stock issued 16 160 -- 214 -- 390
Common stock repurchased -- -- -- (219) -- (219)
Change in unrealized loss on
securities available for sale -- -- -- -- 1,892 1,892
- -------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2001 4,123 24,207 13,136 (5) (1,363) 40,098
- -------------------------------------------------------------------------------------------------------------
Net income -- -- 5,575 -- -- 5,575
Cash dividends paid ($0.40 per share) -- -- (1,709) -- -- (1,709)
Issuance of stock dividend 206 2,676 (2,882) -- -- --
Cash payment for fractional shares -- -- (5) -- -- (5)
Common stock issued 6 2 -- 154 -- 162
Common stock repurchased -- -- -- (664) -- (664)
Change in unrealized loss on
securities available for sale -- -- -- -- 714 714
- -------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2002 $ 4,335 $ 26,885 $ 14,115 $ (515) $ (649) $ 44,171
- -------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME, NET OF TAX: 2002 2001 2000
--------------------------
Net income $ 5,575 $ 4,003 $ 4,557
Net unrealized holding gains (losses) on securities available for sale during the period 277 2,011 (1,695)
Net unrealized loss from the transfer of securities from held to maturity to available for sale -- (163) --
Less reclassification adjustment for losses (gains) included in net income 437 44 (7)
------- ------- -------
COMPREHENSIVE INCOME $ 6,289 $ 5,895 $ 2,855
======= ======= =======
See accompanying notes to consolidated financial statements.
50
CHESTER VALLEY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
TWELVE MONTHS ENDED JUNE 30,
--------------------------------
2002 2001 2000
-------- -------- --------
NET INCOME $ 5,575 $ 4,003 $ 4,557
Add (deduct) items not affecting cash flows from operating activities:
Depreciation 1,010 1,004 917
Provision for loan losses 547 445 420
Gain on trading account securities (4) (264) (62)
(Gain) loss on sale of securities available for sale (289) (224) 8
Loss for impairment of securities 955 291 --
Increase in loans held for sale (12,067) (6,859) --
Proceeds from sale of loans held for sale 14,394 4,606 171
Gain on sale of loans held for sale (115) (97) (11)
Amortization of deferred loan fees, discounts and premiums (649) (936) (628)
Decrease(increase) in trading account securities 4 6,756 (3,679)
Decrease (increase) in accrued interest receivable 1,010 (97) (995)
Decrease (increase) in other assets 381 (2,117) (457)
(Decrease) increase in other liabilities (2,379) 2,435 (726)
(Decrease) increase in accrued interest payable (936) 170 75
- ---------------------------------------------------------------------------------------------------------
Net cash flows from (used in) operating activities 7,437 9,116 (415)
- ---------------------------------------------------------------------------------------------------------
Cash flows from (used in) investment activities:
Capital expenditures (3,435) (2,576) (1,485)
Net increase in loans (19,584) (12,653) (39,990)
Purchase of investment securities held to maturity (34,368) (46,041) (37,998)
Proceeds from maturities, payments and calls of investment
securities held to maturity 34,749 33,596 5,971
Purchase of securities available for sale (65,281) (54,467) (44,328)
Proceeds from sales and calls of securities available for sale 77,612 54,800 58,935
- ---------------------------------------------------------------------------------------------------------
Net cash flows used in investment activities (10,307) (27,341) (58,895)
- ---------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net (decrease) increase in deposits before interest credited (37,384) 18,949 5,089
Interest credited to deposits 10,012 15,925 13,875
Increase in securities sold under agreements to repurchase 15,821 2,428 --
Proceeds from FHLB advances 30,926 37,500 107,052
Repayments of FHLB advances (8,709) (44,041) (70,649)
Net decrease in other borrowings (241) (132) (280)
Increase (decrease) in advance payments by borrowers for taxes and
insurance 144 (275) (93)
Proceeds from trust preferred securities 10,000 -- --
Cash dividends on common stock (1,709) (1,463) (1,383)
Common stock repurchased as treasury stock (664) (219) (531)
Payment for fractional shares (5) (7) (7)
Stock options exercised 162 274 103
Common stock issued -- 116 613
- ---------------------------------------------------------------------------------------------------------
Net cash flows from financing activities 18,353 29,055 53,789
- ---------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 15,483 10,830 (5,521)
CASH AND CASH EQUIVALENTS:
Beginning of period 23,912 13,082 18,603
- ---------------------------------------------------------------------------------------------------------
End of period $ 39,395 $ 23,912 $ 13,082
=========================================================================================================
SUPPLEMENTAL DISCLOSURES:
Cash payments during the year for:
Taxes $ 2,008 $ 805 $ 1,246
Interest $ 17,300 $ 17,099 $ 8,900
NON-CASH ITEMS:
Stock dividend issued $ 2,882 $ 3,344 $ 3,014
Net unrealized (loss) gain on investment securities available for $ 714 $ 1,892 $ (3,845)
sale, net of tax
Transfer of investment securities from held to maturity to available
for sale due to the adoption of FAS 133 $ -- $ 10,807 $ --
Transfer of investment securities from trading account to available $ -- $ 6,596 $ --
for sale
See accompanying notes to consolidated financial statements.
51
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Chester Valley Bancorp Inc. (the "Holding Company") was incorporated in the
Commonwealth of Pennsylvania in August 1989. Effective September 1, 2001, the
Holding Company became a bank holding company as a result of the conversion of
First Financial Bank ("First Financial" or the "Bank") from a Pennsylvania
chartered savings association to a Pennsylvania chartered commercial bank. The
Bank holding company has also been designated as a financial holding company.
The business of the Holding Company and its subsidiaries (collectively the
"Company") consists of the operations of First Financial and Philadelphia
Corporation for Investment Services ("PCIS"), a full service investment advisory
and securities brokerage firm. The Bank provides a wide range of banking
services to individual and corporate customers through its nine branch banks in
Chester County, Pennsylvania. All of the branches are full service and offer
commercial and retail products. These products include checking accounts
(non-interest and interest-bearing), savings accounts, certificates of deposit,
commercial and installment loans, real estate mortgages, and home equity loans.
The Bank also offers ancillary services that complement these products. The Bank
is subject to competition from other financial institutions and other companies
that provide financial services. PCIS is registered as a broker/dealer in all 50
states and Washington, DC and it is also registered as an investment advisor
with the Securities Exchange Commission. PCIS provides many additional services,
including self-directed and managed retirement accounts, safekeeping, daily
sweep money market funds, portfolio and estate valuations, life insurance and
annuities, and margin accounts to individuals and smaller corporate accounts.
The Company is subject to the regulations of various federal and state agencies
and undergoes periodic examinations by those regulatory authorities.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The accompanying consolidated financial statements include the accounts of the
Holding Company and its wholly-owned subsidiaries, First Financial and PCIS. The
accounts of the First Financial include its wholly-owned subsidiary, D & S
Service Corp., which owns D & F Projects and Wildman Projects, Inc., both of
which are wholly-owned subsidiaries. All material intercompany balances and
transactions have been eliminated in consolidation. Prior period amounts are
reclassified when necessary to conform with the current year's presentation.
The Company follows accounting principles and reporting practices, which are in
accordance with accounting principles generally accepted in the United States of
America. In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the statement of financial condition
and revenues and expenses for the period. Actual results could differ
significantly from those estimates. Material estimates that are particularly
susceptible to significant change in the near-term relate to the determination
of the allowance for loan losses, income taxes, and the valuation of investment.
Management believes that the allowance for loan losses, the balances in the
income tax accounts, and the valuation of investments are adequate. Various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses and valuations of real
estate owned. Such agencies may require the Bank to recognize additions to the
allowance or adjustments to the valuations based on their judgments about
information available to them at the time of their examination.
52
RECENT ACCOUNTING PRONOUNCEMENTS
BUSINESS COMBINATIONS
In June 2001, the FASB issued Statement No. 141, "Business Combinations." The
Statement addresses financial accounting and reporting for business combinations
and supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No.
38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All
business combinations in the scope of the Statement are to be accounted for
using the purchase method.
The provisions of the Statement apply to all business combinations initiated
after June 30, 2001. The Statement also applies to all business combinations
accounted for using the purchase method for which the date of acquisition is
July 1, 2001, or later. There was no impact on earnings, financial condition, or
equity upon adoption of Statement No. 141.
GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible
Assets." The Statement addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. It addresses how intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial statements upon their
acquisition. The Statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements.
The provisions of the Statement are required to be applied starting with fiscal
years beginning after December 15, 2001, except that goodwill and intangible
assets acquired after June 30, 2001, will be subject immediately to the
nonamortization and amortization provisions of the Statement. Early application
is permitted for entities with fiscal years beginning after March 15, 2001,
provided that the first interim financial statements have not previously been
issued. The Statement is required to be applied at the beginning of an entity's
fiscal year and to be applied to all goodwill and other intangible assets
recognized in its financial statements at that date. There was no impact on
earnings, financial condition, or equity upon adoption of Statement No. 142.
ASSET RETIREMENT OBLIGATIONS
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This Statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. As used in this
Statement, a legal obligation is an obligation that a party is required to
settle as a result of an existing or enacted law, statute, ordinance, or written
or oral contract or by legal construction of a contract under the doctrine of
promissory estoppel. This Statement requires that the fair value of a liability
for an asset retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset.
This Statement amends FASB Statement No. 19, Financial Accounting and Reporting
by Oil and Gas Producing Companies, and it applies to all entities. It is
effective for financial statements issued for fiscal years beginning after June
15, 2002. The adoption of the Statement did not have an impact on the Company's
earnings, financial condition, or equity.
53
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This Statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of. However, the Statement retains the
fundamental provisions of Statement 121 for (a) recognition and measurement of
the impairment of long-lived assets to be held and used and (b) measurement of
long-lived assets to be disposed of by sale.
This Statement supersedes the accounting and reporting provisions of APB Opinion
No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business. However,
this Statement retains the requirement of Opinion 30 to report discontinued
operations separately from continuing operations and extends that reporting to a
component of an entity that either has been disposed of (by sale, by
abandonment, or in distribution to owners) or is classified as held for sale.
This Statement also amends ARB No. 51, Consolidated Financial Statements, to
eliminate the exception to consolidation for a temporarily controlled
subsidiary.
The provisions of this Statement are effective for financial statements issued
for fiscal years beginning after December 15, 2001, and interim periods within
those fiscal years. The provisions of this Statement generally are to be applied
prospectively. The adoption of the Statement did not have an impact on the
Company's earnings, financial condition, or equity.
RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64
In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This Statement rescinds FASB Statement No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, FASB Statement No.
64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements, along
with rescinding FASB Statement No. 44, Accounting for Intangible Assets of Motor
Carriers and amending FASB Statement No. 13, Accounting for Leases. This
Statement (1) eliminates an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions, (2) eliminates the extraordinary item treatment of reporting gains
and losses from extinguishment of debt, and (3) makes certain other technical
corrections.
The provisions of this Statement related to the rescission of Statement 4 shall
be applied in fiscal years beginning after May 15, 2002. The provisions of this
Statement related to Statement 13 shall be effective for transactions occurring
after May 15, 2002. All other provisions of this Statement shall be effective
for financial statements issued on or after May 15, 2002. The adoption of this
Statement did not have an impact on the Company's earnings, financial condition
or equity.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities." This Statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)."
The provisions of this Statement are effective for exit or disposal activities
that are initiated after December 31, 2002, with early application encouraged.
The Company does not expect the adoption of this Statement to have an impact on
its earnings, financial condition or equity.
54
CASH AND CASH EQUIVALENTS
For the purpose of the consolidated statements of cash flows, cash and cash
equivalents include cash and interest-bearing deposits with an original maturity
of generally three months or less.
SECURITIES
The Company divides its securities portfolio into three segments: (a) held to
maturity; (b) available for sale; and (c) trading. At the time of purchase, the
Company makes a determination on whether or not it will hold the investments to
maturity, based upon an evaluation of the probability of the occurrence of
future events. Securities classified as held to maturity are accounted for at
amortized cost adjusted for amortization of premiums and accretion of discounts
using a method which approximates a level yield, based on the Company's intent
and ability to hold the securities until maturity. Trading securities are
accounted for at quoted market prices with changes in market values thereof
being recorded as gain or loss in the statement of operations. All other
securities, including investment securities which the Company believes may be
involved in interest rate risk, liquidity, or other asset-liability management
decisions which might reasonably result in such securities not being held until
maturity, are included in the available for sale category and are accounted for
at fair value with unrealized gains or losses, net of taxes, being reflected as
adjustments to equity. If investment securities are sold, any gain or loss is
determined by specific identification and reflected in the operating results for
the period in which the sale occurs.
OTHER THAN TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES
Securities are evaluated periodically to determine whether a decline in their
value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term "other than temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospects for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support
realizable value equal to or greater than carrying value of the investment. Once
a decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that represents
management's best estimate of known and inherent losses, which are probable and
reasonably determinable based upon an evaluation of the loan portfolio.
Homogeneous portfolios of loans, which include residential mortgage, home equity
and other consumer loans, are evaluated as a group. Commercial business,
commercial mortgage and construction loans are evaluated individually. Specific
portions of the allowance are developed by analyzing individual loans for
adequacy of collateral, cash flow and other risks which may be unique to that
particular loan. General portions of the allowance are developed by grading
individual loans in the commercial and construction portfolios and applying loss
factors by grade. The general portion of the allowance also includes loss
factors applied to the homogeneous portfolios as a group. The loss factors
applied to graded loans were developed based on the Company's loss history for
loans with similar attributes as well as input from the Company's primary
banking regulators. Loss factors are applied to homogeneous loans based upon
prior loss experience of the portfolio delinquency trends and the volume of
non-performing loans. Although management believes it has used the best
55
information available to it in making such determinations, and that the present
allowance for loan losses is adequate, future adjustments to the allowance may
be necessary, and net income may be adversely affected if circumstances differ
substantially from the assumptions used in determining the level of the
allowance. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for losses
on loans. Such agencies may require the Bank to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination. The allowance is increased by the provision for loan
losses, which is charged to operations. Loan losses, other than those incurred
on loans held for sale, are charged directly against the allowance and
recoveries on previously charged-off loans are added to the allowance.
For purposes of applying the measurement criteria for impaired loans, the
Company excludes large groups of smaller balance homogeneous loans, primarily
consisting of residential real estate loans and consumer loans as well as
commercial business loans with balances of less than $100,000. For applicable
loans, the Company evaluates the need for impairment recognition when a loan
becomes non-accrual or earlier if, based on management's assessment of the
relevant facts and circumstances, it is probable that the Company will be unable
to collect all proceeds under the contractual terms of the loan agreement. At
and during the years ended June 30, 2002, 2001 and 2000, the recorded investment
in impaired loans was not significant. The Company's policy for the recognition
of interest income on impaired loans is the same as for non-accrual loans. A
portion of an impaired loan is charged off when the Company determines that
foreclosure is probable and the fair value of the collateral is less than the
recorded investment of the impaired loan.
LOANS, LOAN ORIGINATION FEES AND UNCOLLECTED INTEREST
Loans (other than loans held for sale) are recorded at cost net of unearned
discounts, deferred fees and allowances. Discounts and premiums on purchased
loans are amortized using the interest method over the remaining contractual
life of the portfolio, adjusted for actual prepayments. Loan origination fees
and certain direct origination costs are deferred and amortized over the life of
the related loans as an adjustment of the yield on the loans.
Uncollected interest receivable on loans is accrued to income as earned.
Non-accrual loans are loans on which the accrual of interest has ceased because
the collection of principal or interest payments is determined to be doubtful by
management. It is the policy of the Company to discontinue the accrual of
interest when principal or interest payments are delinquent 90 days or more
(unless the loan principal and interest are determined by management to be fully
secured and in the process of collection), or earlier, if the financial
condition of the borrower raises significant concern with regard to the ability
of the borrower to service the debt in accordance with the current loan terms.
Interest income on such loans is not accrued until the financial condition and
payment record of the borrower once again demonstrate the ability to service the
debt.
LOANS HELD FOR SALE
The Company originates certain loans that are designated as held for sale at the
time of their origination. These loans are immediately sold with servicing
released and the company does not retain any interest or obligation after the
loans are sold. These loans consist primarily of fixed-rate, single-family
residential mortgage loans which meet the underwriting characteristics of
certain government-sponsored enterprises (conforming loans). Loans held for sale
are carried at the lower of aggregate cost or fair value, with any resulting
loss included in other income for the period. Realized gains or losses are
included in other income for the period. Loans sold prior to 1990 were sold with
servicing retained. The Company recognizes servicing fee income when payments
are received.
56
REAL ESTATE OWNED ("REO")
Real estate acquired through foreclosure or by deed in lieu of foreclosure is
classified as REO. REO is carried at the lower of cost (lesser of carrying value
of the loan or fair value of the property at date of acquisition) or fair value
less selling expenses. Costs relating to the development or improvement of the
property are capitalized; holding costs are charged to expense.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, which range from 15 to 30 years for property and 3
to 7 years for equipment. When assets are retired or otherwise disposed of, the
cost and related accumulated depreciation are removed from the accounts. The
cost of maintenance and repairs is charged to expense as incurred and renewals
and betterments are capitalized.
DEFERRED INCOME TAXES
The Company accounts for income taxes under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and for operating losses and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
EARNINGS PER SHARE
The dilutive effect of stock options is excluded from basic earnings per share,
but included in the computation of diluted earnings per share. Earnings per
share and weighted average shares outstanding have been adjusted to reflect the
effects of the 5% stock dividends paid in September 2001, 2000, and 1999. The
following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share data):
YEAR ENDED JUNE 30,
-------------------------------------------
2002 2001 2000
------ ------ ------
Numerator:
Net income $5,575 $4,003 $4,557
------ ------ ------
Denominator:
Denominator for basic earnings
per share-weighted average shares 4,324 4,318 4,291
Effect of dilutive securities:
Employee stock options 31 53 31
------ ------ ------
Denominator for diluted
earnings per share-adjusted
weighted average shares and
assumed exercise 4,355 4,371 4,322
====== ====== ======
Basic earnings per share $1.29 $0.93 $1.06
====== ====== ======
Diluted earnings per share $1.28 $0.92 $1.05
====== ====== ======
57
NOTE 2 - INVESTMENT SECURITIES
Investment securities are summarized (in thousands) as follows:
AT JUNE 30, 2002
----------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ---------
HELD TO MATURITY:
U.S. government agency notes and bonds $ 6,376 $ 80 $ (34) $ 6,422
Federal Home Loan Bank of Pittsburgh stock 5,242 -- -- 5,242
Municipal notes and bonds 8,215 81 -- 8,296
Mortgage-backed securities 21,310 167 (35) 21,442
Other 37 -- -- 37
-------- ------- ------- --------
Total held to maturity $ 41,180 $ 328 $ (69) $ 41,439
======== ======= ======= ========
AVAILABLE FOR SALE:
U.S. government agency notes and bonds $ 3,298 $ 103 $ -- $ 3,401
Municipal notes and bonds 30,237 161 (203) 30,195
Mortgage-backed securities 24,419 277 -- 24,696
Equity securities 1,429 94 (177) 1,346
Debt securities 19,899 27 (1,490) 18,436
Agency-backed securities 23,126 202 (9) 23,319
-------- ------- ------- --------
$102,408 $ 864 $ (1,879) $101,393
======== ======= ======== ========
AT JUNE 30, 2001
----------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ---------
HELD TO MATURITY:
U.S. government agency notes and bonds $ 36,681 $ 297 $ (41) $ 36,937
Federal Home Loan Bank of Pittsburgh stock 4,190 -- -- 4,190
Municipal notes and bonds -- -- -- --
Mortgage-backed securities 503 9 -- 512
-------- ------- ------- --------
Total held to maturity $ 41,374 $ 306 $ (41) $ 41,639
======== ======= ======= ========
AVAILABLE FOR SALE:
U.S. government agency notes and bonds $ 31,565 $ 188 $ (39) $ 31,714
Municipal notes and bonds 35,094 143 (613) 34,624
Mortgage-backed securities 11,890 101 (177) 11,814
Equity securities 1,453 56 (461) 1,048
Debt securities 16,934 -- (1,300) 15,634
Agency-backed securities 18,496 32 (12) 18,516
-------- ------- ------- --------
$115,432 $ 520 $(2,602) $113,350
======== ======= ======== ========
58
The amortized cost and estimated fair value of investment securities at June 30,
2002 by contractual maturity, are shown below (in thousands).
WEIGHTED
AMORTIZED ESTIMATED AVERAGE
COST FAIR VALUE YIELD
---------- ---------- ----------
(Dollars in Thousands)
HELD TO MATURITY
Due in one year or less $ 3,300 $ 3,329 6.70%
Due after one year through five years 1,801 1,800 6.07%
Due after five years through ten years 988 953 5.00%
Due after ten years 29,812 30,078 5.83%
No stated maturity 5,279 5,279 0.00%
-------- -------- ----
TOTAL HELD TO MATURITY $ 41,180 $ 41,439 5.14%
-------- -------- ----
AVAILABLE FOR SALE
Due in one year or less $ 4,403 $ 4,410 4.56%
Due after one year through five years 6,899 7,022 4.76%
Due after five years through ten years 11,022 11,128 4.09%
Due after ten years 78,655 77,487 5.13%
No stated maturity 1,429 1,346 0.00%
-------- -------- ----
TOTAL AVAILABLE FOR SALE $102,408 $101,393 4.90%
-------- -------- ----
TOTAL INVESTMENT SECURITIES $143,588 $142,832 4.97%
======== ======== ====
Expected maturities may differ from contractual maturities because borrowers
generally have the right to call or prepay obligations without prepayment
penalties. The weighted average yield, based on amortized cost, is presented on
a taxable equivalent basis using the Federal marginal rate of 34% adjusted for
the 20% interest expense disallowance (27.2%). Proceeds from sales and calls of
investment securities available for sale during fiscal 2002, 2001, and 2000,
were $77.61, $54.80 and $58.94 million, respectively. Gross gains of $454, $253
and $195 thousand, in fiscal 2002 2001 and 2000, respectively, and gross losses,
including impairment losses, of $1.12 million, $320, and $184 thousand, in
fiscal 2002, 2001, and 2000, respectively, were realized on those sales. Accrued
interest receivable on investments amounted to $905 thousand and $1.98 million
at June 30, 2002 and 2001, respectively. At June 30, 2002, $91.88 million of
investment securities were pledged as collateral for Municipal savings deposits
with the Bank, for securities sold under agreements to repurchase, and for the
Bank's treasury, tax and loan account with the Federal Reserve.
Investments include three classified Municipal Authority Revenue Bond
investments that had an aggregate balance of $7.1 million at June 30, 2002,
after a write-down on two of the Bonds totaling $955,000. After the write-down,
two of the Bonds have a carrying value of $5.6 million and both of these bonds
involve buildings and related property that are leased to various agencies of
the Commonwealth of Pennsylvania under long term lease arrangements with renewal
options. Of the total balance of $5.6 million, $865 thousand are interest
bearing bonds and the remainder of $4.7 million are zero coupon bonds with
maturities extending up to June 2034.
The third classified bond has a balance, after write-down, of $1.5 million, an
interest rate of 6% and matures in June 2019. This bond involves low-income
scattered housing in Chester County under a Housing and Urban Development
Program. The Office of Housing and Urban Development (HUD) has indicated that
they will provide funds to build additional housing which would be donated to
this bond issue and, when sold, would reduce the losses incurred on the bonds.
There can be no assurance that further subsequent adverse or positive
developments may occur; in which case, additional adjustments to these
investments may be forthcoming.
59
Debt securities included in available for sale securities at June 30, 2002 and
2000 primarily consist of long term Corporate Debt obligations with ratings of A
and above and most of these obligations are floating rates tied to movements in
the Treasury markets.
In July of fiscal 2001, the Company adopted SFAS 133 resulting in an unrealized
loss of $163 thousand because of the transfer of securities from held to
maturity to available for sale, which was recognized in other comprehensive
income.
NOTE 3 - LOANS RECEIVABLE
Loans receivable, including loans held for sale, (in thousands) are summarized
as follows:
AT JUNE 30,
----------------------------------
2002 2001
----------------------------------
First mortgage loans:
Residential $ 133,889 $ 151,155
Construction - residential 19,190 18,191
Land acquisition and development 16,707 11,492
Commercial 103,985 82,890
Construction - commercial 12,573 16,560
Commercial business 36,774 27,653
Consumer 69,538 64,756
---------- ----------
Total loans 392,656 372,697
Less:
Undisbursed loan proceeds
Construction - residential (17,277) (13,752)
Construction - commercial (5,556) (6,776)
Deferred loan fees (1,533) (1,592)
Allowance for loan losses (4,588) (4,264)
---------- ----------
Net loans $ 363,702 $ 346,313
========== ==========
Accrued interest receivable on loans amounted to $1.62 and $1.58 million at June
30, 2002 and 2001, respectively. At June 30, 2002, 2001, and 2000, the Company
serviced loans for others totaling $23.7, $20.6 and $23.7 million, respectively.
The aggregate amount of loans by the Company to its directors and executive
officers was $1.27 million and $3.95 million at June 30, 2002 and 2001,
respectively. These loans were made in the ordinary course of business at
substantially the same terms and conditions as those with other borrowers. An
analysis of the activity of these loans, in millions, follows:
Balance at July 1, 2001 $3.95
New loans .00
Repayments (0.29)
-----
Balance at June 30, 2002 $3.66
=====
The total amount of non-performing loans was $944 thousand, $1.17 million, and
$942 thousand, at June 30, 2002, 2001 and 2000, respectively. If these
non-performing loans had been current in accordance with their original terms
and had been outstanding throughout the period, the gross interest income for
fiscal 2002, 2001, and 2000 that would have been recorded for these loans was
$195, $160, and $82 thousand. Interest income on these non-performing loans
included in income for fiscal 2002, 2001, and 2000 amounted to $114, $23
thousand, and $24 thousand, respectively. At June 30, 2002, and throughout
fiscal 2001, there were no loans for which impairment was required to be
recognized.
60
The activity in the allowance for loan losses (in thousands) was as follows:
YEAR ENDED JUNE 30,
--------------------------------------------
2002 2001 2000
--------------------------------------------
Balance, beginning of period $ 4,264 $ 3,908 $ 3,651
Provision for loan losses 547 445 420
Loans charged off (229) (104) (171)
Recoveries 6 15 8
------- ------- -------
Balance, end of period $ 4,588 $ 4,264 $ 3,908
======= ======= =======
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment by major classification are summarized (in thousands) as
follows:
2002 2001
---- ----
Land $ 1,521 $ 1,522
Buildings and improvements 11,484 7,345
Furniture, fixtures and equipment 4,511 5,269
-------- --------
Total 17,516 14,136
Less accumulated depreciation (4,751) (3,796)
-------- --------
Net $ 12,765 $ 10,340
======== ========
NOTE 5 - DEPOSITS
Deposits (in thousands) consist of the following major classifications:
AT JUNE 30,
--------------------------------------------------------------------------------
2002 2001
-------------------------------------- --------------------------------------
WEIGHTED PERCENT WEIGHTED PERCENT
AVERAGE OF AVERAGE OF
RATE AMOUNT TOTAL RATE AMOUNT TOTAL
-------- -------- --------- --------- --------- --------
Non-interest bearing -- % $ 44,890 11.6% -- % $ 38,840 9.4%
----- --------- ---- ---- --------- -----
Interest-bearing:
NOW checking accounts 0.81% 55,307 14.3% 1.20% 43,467 10.5%
Money market deposit accounts 1.95% 65,411 17.0% 3.18% 60,430 14.6%
Savings accounts 1.03% 31,560 8.2% 1.70% 26,414 6.4%
Certificates less than $100,000 3.79% 120,810 31.3% 5.38% 124,601 30.2%
Certificates $100,000 and greater 3.34% 68,002 17.6% 5.16% 119,600 28.9%
----- --------- ---- ---- --------- -----
Total interest-bearing deposits 2.61% 341,090 88.4% 4.21% 374,512 90.6%
----- --------- ---- ---- --------- -----
TOTAL DEPOSITS 2.31% $ 385,980 100.0% 3.81% $ 413,352 100.0%
===== ========= ===== ==== ========= =====
At June 30, 2002 and 2001 certificates of deposit include municipal deposits of
$43.1 million and $89.8 million, respectively, which are collateralized with
pledged investments.
While certificates of deposits frequently are renewed at maturity rather than
paid out, a summary of certificates by contractual maturity (in thousands) at
June 30, 2002 is as follows:
YEARS ENDING JUNE 30, AMOUNT
--------------------- -------
2003 $ 110,888
2004 53,635
2005 11,420
2006 2,707
2007 4,683
2008 and thereafter 5,479
---------
$ 188,812
=========
61
Interest expense on deposits (in thousands) is comprised of the following:
YEAR ENDED JUNE 30,
------------------------------------------
2002 2001 2000
------------------------------------------
NOW checking accounts $ 433 $ 641 $ 590
Money market deposit accounts 1,430 2,427 1,662
Savings accounts 320 495 503
Certificates less than $100,000 5,347 7,597 6,978
Certificates $100,000 & greater 3,652 6,461 3,967
-------- -------- --------
$ 11,182 $ 17,621 $ 13,700
======== ======== ========
NOTE 6 - ADVANCES FROM FEDERAL HOME LOAN BANK OF PITTSBURGH ("FHLBP")
Under the terms of its collateral agreement with the FHLBP, the Company
maintains otherwise unencumbered qualifying assets (principally 1-4 family
residential mortgage loans and U.S. Government and Agency notes and bonds) in
the amount of at least as much as its advances from the FHLBP. The Company's
FHLBP stock is also pledged to secure these advances. At June 30, 2002 and 2001,
such advances (dollars in thousands) mature as follows:
WEIGHTED WEIGHTED
AVERAGE JUNE 30, AVERAGE JUNE 30,
DUE BY JUNE 30, RATE 2002 DUE BY JUNE 30, RATE 2001
- --------------------------------------- --------------------------------------
2003 5.56% $ 8,781 2002 6.08% $ 1,832
2004 4.39% 3,099 2003 5.86% 7,369
2005 4.97% 4,045 2004 5.79% 720
2006 4.65% 2,294 2005 5.99% 1,521
2007 5.32% 834 2006 6.33% 372
Thereafter 5.33% 83,401 Thereafter 5.57% 68,423
- --------------------------------------- ---------------------------------------
Total FHLBP advances 5.29% $102,454 Total FHLBP advances 5.62% $ 80,237
======================================= =======================================
Included in the table above at June 30, 2002 are $81.0 million of convertible
advances whereby the FHLBP (Federal Home Loan Bank of Pittsburgh) has the option
at a predetermined time to convert the fixed interest rate to an adjustable rate
tied to LIBOR (London Inter Bank Offering Rate). The Bank has the option to
prepay these advances if the FHLBP converts the interest rate. These advances
are included in the year in which they mature.
The Company has a line of credit of $10 million with the FHLBP. The Company,
from time to time, will use the line of credit to meet liquidity needs. At June
30, 2002 and 2001, there were no balances outstanding on the line of credit.
NOTE 7 - TRUST PREFERRED SECURITIES
On March 26, 2002, the Company issued $10.31 million of Junior Subordinated
Debentures to Chester Valley Statutory Trust, a Pennsylvania Business Trust, in
which the Company owns all of the common equity. The Trust then issued $10.00
million of Trust Preferred Securities which pay interest quarterly at 3 month
Libor plus 3.60 basis points to investors which are secured by the Junior
Subordinated Debentures and the guarantee of the Company. The Junior
Subordinated Debentures are treated as debt of the Company but they qualify as
Tier I capital, subject to certain limitations under the risk-based capital
guidelines of the Federal Reserve. The Trust Preferred Securities are callable
by the Company on March 26, 2007, or at any time in the event the deduction of
related interest for federal income taxes is prohibited, the treatment as Tier I
capital is no longer permitted or under certain other circumstances. The Trust
Preferred Securities must be redeemed by the Company upon maturity of the
debentures in 2032.
62
NOTE 8 -INCOME TAXES
The provision (and benefit) for income taxes is summarized as follows (in
thousands):
AT JUNE 30,
------------------------------------
2002 2001 2000
---- ---- ----
Current:
Federal $ 1,471 $ 893 $ 1,065
State 97 126 203
Deferred - Federal (213) (455) (11)
------- ------ -------
Total $ 1,355 $ 564 $ 1,257
======= ====== =======
The provision for income taxes differs from the statutory rate due to the
following (in thousands):
AT JUNE 30,
-------------------------------------
2002 2001 2000
---- ---- ----
Federal income taxes at statutory rate $ 2,356 $ 1,553 $ 1,977
Tax exempt interest and dividends, net (796) (768) (847)
State taxes net, of deferral benefit 64 83 134
Low income housing tax credits (270) (311) --
Other, net 1 7 (7)
------- ------- -------
$ 1,355 $ 564 $ 1,257
======= ======= =======
The deferred tax assets and liabilities at June 30, 2002 and 2001 consisted of
the following (in thousands):
AT JUNE 30,
----------------------------
2002 2001
---- ----
Deferred tax assets:
Tax credit carry-forward $ 378 $ 371
Allowance for loan losses 1,560 1,450
Deferred loan fees -- 30
Uncollected interest 34 34
Net unrealized loss on securities
available for sale 392 857
Investment in joint ventures 56 2
Other 22 22
------ ------
Gross deferred tax assets 2,442 2,766
Deferred tax liabilities:
Tax bad debt reserves 55 82
Loan discount 74 88
Depreciation 141 172
------ ------
Gross deferred tax liabilities 270 342
------ ------
Net deferred tax assets $2,172 $2,424
====== ======
The realizability of deferred tax assets is dependent upon a variety of factors,
including the generation of future taxable income, the existence of taxes paid
and recoverable, the reversal of deferred tax liabilities and tax planning
strategies. Based upon these and other factors, management believes it is more
likely than not that the Company will realize the benefits of these deferred tax
assets.
63
The Small Business Job Protection Act of 1996 ("Act"), enacted on August 20,
1996, provides for the repeal of the tax bad debt deduction computed under the
percentage of taxable income method. The repeal of the use of this method is
effective for tax years beginning after December 31, 1995. Prior to the change
in law, the Bank had qualified under the provisions of the Code which permitted
it to deduct from taxable income an allowance for bad debts based on 8% of
taxable income.
Upon repeal, the Bank is required to recapture into income, over a six-year
period, the portion of its tax bad debt reserves that exceed its base year
reserves (i.e., tax reserves for tax years beginning before 1988). The base year
tax reserves, which may be subject to recapture if the Bank ceases to qualify as
a bank for federal income tax purposes, are restricted with respect to certain
distributions. The Bank's total tax bad debt reserves at June 30, 2002, are
approximately $2.8 million of which $2.64 million represents the base year
amount and $160 thousand is subject to recapture. The Company has previously
recorded a deferred tax liability for the excess base year reserves to be
recaptured; therefore, this recapture will not impact the statement of
operations.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Financial instruments with off-balance-sheet risk:
- --------------------------------------------------
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk which meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
Commitments to originate loans amounted to $1.99 million as of June 30, 2002,
which represent fixed-rate loans with interest rates ranging 6.13% to 7.50%. At
June 30, 2002, the Company had undisbursed loans in process for construction
loans of $22.83 and $37.07 million in undisbursed lines of credit. In addition,
at such date the Company has issued $2.55 million in commercial letters of
credit fully secured by deposit accounts or real estate.
Concentration of credit risk:
- ----------------------------
The Company is principally a local lender and therefore has a significant
concentration of residential and commercial real estate loans as well as
consumer and commercial business loans to borrowers who reside in and/or which
are collateralized by real estate located primarily in Chester County,
Pennsylvania. The ability of such customers to honor these obligations is
dependent, in varying degrees, on the overall economic performance of this
diversified area.
Other commitments:
- ------------------
The Bank and PCIS have entered into operating leases for several of their branch
and office facilities. The minimum annual rental payments under these leases at
June 30, 2002, (in thousands) are as follows:
MINIMUM LEASE
YEAR PAYMENTS
---- --------
2003 $586
2004 559
2005 454
2006 361
2007 240
2008 and thereafter 911
Rent expense under these leases for each of the years ended June 30, 2002, 2001,
and 2000, was $639, $498, and $573 thousand, respectively.
64
NOTE 10 - AFFILIATED TRANSACTIONS
During fiscal 2001 and 2000 the Company entered into an agreement with one of
the directors of the Company to perform reviews of appraisals in connection with
the origination of residential mortgage loans. The Board of Directors approved
the agreements and the Bank paid $2 thousand, and $3 thousand in 2001 and 2000,
respectively. No fees were paid in 2002.
Two directors of the Company are a principal and a partner in law firms which
the Company retained during fiscal years 2002, 2001, and 2000, and which the
Company intends to retain during fiscal year 2003. During the year ended
December 31, 2001, the amount of legal fees paid to the law firms did not exceed
5% of those firms' gross revenues for such year.
A director of the Company is an executive officer, director and principal of an
investment banking firm from which the Company purchased and sold investment
securities during fiscal years 2002, 2001, and 2000. The Company intends to
continue the business relationship during fiscal 2003. The purchases of
investment securities from the investment banking firm amounted to $39.90,
$90.11, and $162.08 million, and the sales amounted to $85.54, $98.69, and
$131.68 million, during fiscal years 2002, 2001, and 2000, respectively. These
securities were purchased and sold at market rates and on terms no more
favorable to the investment banking firm than those obtainable on an
arm's-length basis. The investment banking firm receives income on these
transactions as a result of a spread differential (on a net yield basis). During
the year ended December 31, 2001, the amount of income earned by the investment
banking firm related to the investment activity with the Company did not exceed
5% of that firm's gross revenues for such year.
A director of the Company is a director and president of a mortgage banking firm
from which the Company purchased single-family residential mortgage loans during
fiscal year 2000, and the Company intends to continue the business relationship
during fiscal year 2003. During fiscal 2000, the purchases of loans from the
mortgage banking firm amounted to $1.61 million with fees of $24 thousand paid
to the firm. The loans were purchased at market rates and terms no more
favorable to the mortgage banking firm than those obtainable on an arm's-length
basis.
NOTE 11 - STOCKHOLDERS' EQUITY
At the time of its conversion from a state-chartered mutual association to a
state-chartered capital stock association, the Bank established a liquidation
account in an amount equal to $4.8 million at September 30, 1986. The
liquidation account is maintained for the benefit of eligible savings account
holders who have maintained their savings account in the Bank after conversion.
In the unlikely event of a complete liquidation, each eligible savings account
holder will be entitled to receive a liquidation distribution from the
liquidation account, in the amount of the then current adjusted sub-account
balance for savings accounts held, before any liquidation distribution may be
made with respect to capital stock.
Except for the repurchase of stock and payment of dividends by the Bank, the
existence of the liquidation account does not restrict the use or application of
such net worth. The Company may not declare or pay a cash dividend on, or
repurchase, any of its common stock if the effect thereof would cause the net
worth of the Bank to be reduced below the amount required for the liquidation
account.
In September 2001 and 2000, the Company paid 5% common stock dividends in the
amounts of 205,890 and 274,108 shares, respectively, from authorized but
unissued common stock with fractional shares being paid in the form of cash.
65
NOTE 12 - REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. As a result of the Holding Company's designation
as a bank holding company, it will also become subject to regulatory capital
requirements. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company's and the Bank's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets, liabilities,
and certain off balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). At June 30, 2002 and 2001 the Bank was in compliance with
all such requirements and is deemed a "well-capitalized" institution for
regulatory purposes. There are no conditions or events since June 30, 2002 that
management believes have changed the institution's category.
The Bank's actual capital amounts and ratios as calculated under OTS regulations
for June 30, 2001 are presented in the table as follows (dollars in thousands).
As a result of the Bank's conversion to a Pennsylvania-chartered commercial
bank, as of September 1, 2001, it is now subject to the regulatory capital
requirements of the FDIC rather than the OTS, which requirements at June 30,
2002 are presented below.
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------- ------------------------ -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ---------- ----------- --------- ----------- ----------
AS OF JUNE 30, 2002:
Total Capital
(to Risk-Weighted Assets) $55,582 15.04% $29,558 8.00% $36,947 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $50,994 13.80% $14,779 4.00% $22,168 6.00%
Tier 1 Capital
(to Average Assets) $50,994 9.35% $21,807 4.00% $27,259 5.00%
AS OF JUNE 30, 2001:
Total Capital
(to Risk-Weighted Assets) $41,319 12.61% $26,220 8.00% $32,775 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $37,220 11.36% $13,110 4.00% $19,665 6.00%
Tier 1 Capital
(to Average Assets) $37,220 6.85% $21,725 4.00% $27,157 5.00%
NOTE 13 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company is required to disclose estimated fair values for its financial
instruments.
Limitations
- -----------
Estimates of fair value are made at a specific point in time, based upon, where
available, relevant market prices and information about the financial
instrument. Such estimates do not include any premium or discount that could
result from offering for sale at one time the Company's entire holdings of a
particular financial instrument. For a substantial portion of the Company's
financial instruments, no quoted market exists. Therefore, estimates of fair
value are necessarily based on a number of significant assumptions (many of
which involve events outside the control of management). Such assumptions
include assessments of current economic conditions, perceived risks associated
with these financial instruments and their counterparts, future expected loss
experience and other factors. Given the uncertainties surrounding these
assumptions, the reported fair values represent estimates only, and therefore
cannot be compared to the historical accounting model. Use of different
assumptions or methodologies are likely to result in significantly different
fair value estimates.
66
The estimated fair values presented neither include nor give effect to the
values associated with the Company's banking, or other businesses, existing
customer relationships, extensive branch banking network, property, equipment,
goodwill or certain tax implications related to the realization of unrealized
gains or losses. Also, the fair values of non-interest-bearing demand deposits,
savings and NOW accounts and money market deposit accounts are equal to the
carrying amount because these deposits have no stated maturity. This approach to
estimating fair value excludes the significant benefit that results from the
low-cost funding provided by such deposit liabilities, as compared to
alternative sources of funding. As a consequence, the fair value of individual
assets and liabilities may not be reflective of the fair value of a financial
services organization that is a going concern.
The following methods and assumptions were used to estimate the fair value of
each major classification of financial instrument at June 30, 2002 and 2001:
Cash and cash equivalents:
- -------------------------
Current carrying amounts approximate estimated fair value.
Trading account securities, securities held to maturity and securities available
- --------------------------------------------------------------------------------
for sale:
- ---------
Current quoted market prices were used to determine fair value.
Loans:
- ------
Fair values were estimated for portfolios of loans with similar financial
characteristics. Loans were segregated by type, and each loan category was
further segmented by fixed- and adjustable-rate interest terms. The estimated
fair value of the segregated portfolios was calculated by discounting cash flows
through the estimated maturity and prepayment speeds while using estimated
market discount rates that reflected credit and interest risk inherent in the
loans. The estimate of the maturities and prepayment speeds was based on the
Company's historical experience.
Deposits:
- ---------
The fair value of deposits with no stated maturity, such as non-interest-bearing
deposits, savings, NOW and money market accounts, as well as repurchase
agreements, is equal to the amount payable on demand. The fair value of
certificates of deposit was estimated by discounting the contractual cash flows
using current market rates offered in the Company's market area for deposits
with comparable terms and maturities.
Borrowed Funds:
- ---------------
The fair value of borrowings was estimated using rates currently available to
the Company for debt with similar terms and remaining maturities.
67
Off-Balance Sheet Instruments:
- ------------------------------
The fair value of off-balance sheet instruments, including commitments to extend
credit and stand-by letters of credit, is estimated using the fees currently
charged to enter into similar agreements with comparable remaining terms and
reflects the present creditworthiness of the counterparties.
The carrying amounts and estimated fair values of the Company's financial
instruments were as follows (in thousands):
AT JUNE 30,
-------------------------------------------------------------------------
2002 2001
------------------------------------ -----------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------ ---------- ------ ----------
Financial Assets:
Cash and cash equivalents $ 39,395 $ 39,395 $ 23,912 $ 23,912
Trading account securities 16 16 16 16
Investments securities available for sale 101,393 101,393 113,350 113,350
Investment securities 41,180 41,439 41,374 41,639
Loans receivable, net 363,702 371,385 346,313 346,670
Accrued interest receivable 2,543 2,543 3,553 3,553
---------- --------- ---------- ---------
Total financial assets $ 548,229 $ 556,171 $ 528,518 $ 529,140
========== ========= ========== =========
Financial Liabilities:
Deposits and repos $ 404,229 $ 396,723 $ 415,780 $ 417,817
Borrowed funds 102,454 109,761 80,478 77,885
Trust preferred securities 10,000 10,000 -- --
Accrued interest payable 1,465 1,465 1,818 1,818
---------- --------- ---------- ---------
Total financial liabilities $ 518,148 $ 517,949 $ 498,076 $ 497,520
========== ========= ========== =========
The estimated fair value of the Company's off-balance sheet financial
instruments is as follows (in thousands):
AT JUNE 30,
-------------------------------------------------------------------------
2002 2001
------------------------------------ -----------------------------------
NOTIONAL ESTIMATED NOTIONAL ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------ ---------- ------ ----------
Commitments to extend credit $37,066 $ 371 $21,690 $ 217
Standby letters of credit 2,551 26 993 10
NOTE 14 - EMPLOYEE BENEFITS
Stock Compensation Program
- --------------------------
The Company has two stock option plans (collectively, the "Plans") -- the 1993
Plan and the 1997 Plan. At June 30, 2002, an aggregate of 0 and 146,447,
respectively, authorized but unissued shares of common stock of the Company,
adjusted for the stock dividends and stock splits effected by the Company
subsequent to the effective date of each of the Plans were reserved for issuance
under the 1993 Plan and the 1997 Plan. As of June 30, 2002, there were 269,951
and 517,257 options granted under the 1993 and 1997 Plan, respectively. Under
the Plans, the option price per share for options granted may not be less than
the fair market value of the common stock on the date of grant. Options may be
granted under the 1993 Plan and the 1997 Plan during the ten-year periods ending
2003 and 2007, respectively, and options granted under the Plans are exercisable
up to ten years from the date of grant. Rights to exercise options under the
Plans may be limited by imposition of vesting schedules at the time the options
are granted.
68
The following table is a summary of option transactions since June 30, 1999.
These options and option prices for the years 2002, 2001, and 2000 have been
adjusted to reflect the stock dividends.
2002 2001 2000
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Number of outstanding at
beginning of year 373,416 $ 14.47 355,314 $ 14.12 183,293 $ 13.40
Granted 236,840 15.35 58,144 15.73 204,233 14.53
Exercise (16,308) 8.24 (15,126) 9.24 (12,949) 7.33
Forfeited (28,665) 14.05 (24,916) 15.65 (19,263) 16.14
------- ------- -------
Outstanding at end of year 565,283 15.04 373,416 14.47 355,314 14.12
Exercisable at end of year 317,213 14.82 215,452 14.06 166,328 13.49
Weighted-average fair
value of options granted $ 4.66 $ 5.51 $ 4.97
At June 30, 2002, the range of exercise prices was $7.27 to $17.62 and the
weighted average remaining contractual life of the outstanding options is 7.9
years. The Black-Scholes option-pricing model was used to determine the
grant-date fair value of options. Significant assumptions used in the model
included a weighted average risk free rate of return of 5.09% in 2002, 5.89% in
2001, and 5.86% in 2000; expected option life of 6 years for 2002, 2001, and
2000 options; expected stock price volatility of 32.37% for 2002, 33.61% for
2001, and 29.91% for 2000 and expected dividends of 2.55%, 2.59%, and 2.12%, for
2002, 2001, and 2000, respectively.
The Company, as permitted, has elected not to adopt the fair value accounting
provisions of SFAS 123 "Accounting for Stock-based Compensation", and has
instead continued to apply APB Opinion 25 and related Interpretations in
accounting for plans and provide the required proforma disclosures of SFAS 123.
Had the grant-date fair-value provisions of SFAS 123 been adopted, the Company
would have recognized the following:
PROFORMA
OPTIONS COMPENSATION PROFORMA DILUTED EARNINGS
JUNE 30, OUTSTANDING EXPENSE NET INCOME PER SHARE
- -------------------------------------------------------------------------------------------------------------------
2000 355,314 $269,000 $4,290,000 $0.99
2001 373,416 306,000 3,700,000 0.85
2002 565,283 504,000 5,170,000 1.19
The effects of proforma net income and diluted earnings per share of applying
the disclosure requirements of SFAS 123 for past fiscal years may not be
representative of the future proforma effects on net income and earnings per
share due to the vesting provisions of the options and future awards that are
available to be granted.
Employee Stock Ownership Plan (ESOP)
- ------------------------------------
The Bank maintains an ESOP for all employees of the Bank with at least one year
of credited service. Benefits become 20% vested after three years of service,
increasing to 100% after seven years. Forfeitures are reallocated among
remaining participating employees. Vested benefits are generally payable upon
retirement, disability or separation from service.
The ESOP is subject to the requirements of the Employee Retirement Income
Security Act of 1974, as amended, and the regulations of the Internal Revenue
Service and the Department of Labor.
69
The ESOP has been funded by contributions from the Bank, and benefits to
participants are normally paid in cash or whole shares of common stock.
The ESOP plan was established in October 1987. Contributions to the ESOP and
forfeited shares were allocated among members on the basis of compensation.
Dividends received on the ESOP shares are allocated to participants based on the
number of shares held by each participant. A total of 13,466, 13,024 and 57,901
shares were allocated in fiscal 2002, 2001 and 2000, respectively. The shares of
stock allocated by the ESOP during the three years ended June 30, 2002 were
purchased by the plan from Company contributions and dividends received on the
ESOP shares.
Contributions by the Bank to the ESOP in fiscal 2002, 2001 and 2000 amounted to
$50 thousand, $110 thousand and $122 thousand, respectively, and are included in
the accompanying consolidated statements of operations in salaries and employee
benefits. The ESOP loans matured and were paid in April 1999.
Pension Plan
- ------------
The Bank has a noncontributory defined benefit pension plan which is fully
funded through a multi-employer investment trust covering qualified salaried
employees. Costs recognized for the years ended June 30, 2002, 2001, and 2000,
totaled $209 thousand, $82 thousand, and $6 thousand, respectively. Information
relative to the financial status of the Bank's portion of the Plan is not
currently available.
NOTE 15 - SEGMENT REPORTING
The Company has two reportable segments: the Bank and PCIS. The Bank operates a
branch bank network with nine full-service banking offices and provides deposits
and loan services to customers. Additionally, the Bank offers trust services at
its Downingtown headquarters. PCIS operates a full service investment advisory
and securities brokerage firm through two offices. Both segments operate
primarily in southeastern Pennsylvania.
The Company evaluates performance based on profit or loss from operations after
income taxes not including nonrecurring gains and losses. There are no material
intersegment sales or transfers. The Company's reportable segments have
traditionally been two independent financial services institutions. The two
segments are managed separately. All senior officers from PCIS prior to the
acquisition have been retained to manage the segment.
70
The following table highlights income statement and balance sheet information
for each of the segments at or for the years ended June 30, 2002, 2001, and 2000
(in thousands):
FOR THE YEAR ENDED JUNE 30, 2002: FFB PCIS TOTAL
- --------------------------------------------------------------------------------
Net interest income $ 18,073 $ 33 $ 18,106
Other income 1,826 3,522 5,348
Total Net income 5,214 361 5,575
Total assets 564,368 1,664 566,032
Total interest-bearing deposits 27,862 1,301 29,163
Total trading securities -- 16 16
FOR THE YEAR ENDED JUNE 30, 2001: FFB PCIS TOTAL
- --------------------------------------------------------------------------------
Net interest income $ 15,031 $ 81 $ 15,112
Other income 2,338 3,592 5,930
Total Net income 3,594 409 4,003
Total assets 542,979 1,726 544,705
Total interest-bearing deposits 18,328 1,370 19,698
Total trading securities -- 16 16
FOR THE YEAR ENDED JUNE 30, 2000: FFB PCIS TOTAL
- --------------------------------------------------------------------------------
Net interest income $ 14,774 $ 88 $ 14,862
Other income 2,016 3,520 5,536
Total Net income 4,198 359 4,557
Total assets 505,743 1,407 507,150
Total interest-bearing deposits 7,247 917 8,164
Total trading securities 12,708 130 12,838
NOTE 17 - SUMMARIZED QUARTERLY FINANCIAL DATA FOR FISCAL 2002 AND 2001
(UNAUDITED)
(Dollars in thousands except per share data)
2002 2001
------------------------------------------ -----------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Interest income $ 9,205 $ 8,648 $ 8,327 $ 8,290 $ 9,022 $ 9,307 $ 9,457 $ 9,544
Interest expense 4,919 4,130 3,675 3,640 5,503 5,784 5,554 5,377
------- ------- ------- ------- ------- ------- ------- -------
Net interest income 4,286 4,518 4,652 4,650 3,519 3,523 3,903 4,167
Provision for loan losses 131 147 149 120 105 105 105 130
------- ------- ------- ------- ------- ------- ------- -------
Net interest income after
provision for loan losses 4,155 4,371 4,503 4,530 3,414 3,418 3,798 4,037
Other income 1,555 1,718 1,560 515 1,562 1,234 1,379 1,755
Operating expenses 3,768 4,116 4,128 3,965 3,842 4,212 3,719 4,257
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes 1,942 1,973 1,935 1,080 1,134 440 1,458 1,535
Income tax expense
(benefit) 480 496 456 (77) 139 (121) 278 268
------- ------- ------- ------- ------- ------- ------- -------
NET INCOME $ 1,462 $ 1,477 $ 1,479 $ 1,157 $ 995 $ 561 $ 1,180 $ 1,267
======= ======= ======= ======= ======= ======= ======= =======
EARNINGS PER COMMON SHARE (1)
Basis $ 0.34 $ 0.34 $ 0.34 $ 0.27 $ 0.23 $ 0.12 $ 0.28 $ 0.30
======= ======= ======= ======= ======= ======= ======= =======
Diluted $ 0.34 $ 0.34 $ 0.34 $ 0.27 $ 0.23 $ 0.12 $ 0.27 $ 0.30
======= ======= ======= ======= ======= ======= ======= =======
(1) Earnings per share have been restated to reflect the effects of the 5%
stock dividends paid in September 2001 and 2000.
71
NOTE 16 - PARENT COMPANY FINANCIAL INFORMATION (in thousands) Financial
information of Chester Valley Bancorp Inc. (parent company only) follows:
STATEMENTS OF FINANCIAL CONDITION JUNE 30,
------------------------------------------
2002 2001
---- -----
ASSETS
On deposit with subsidiaries $ 120 $ 606
Securities available for sale 1,966 1,656
Investment in subsidiaries 52,117 37,658
Other assets 353 178
--------- ---------
TOTAL ASSETS $ 54,556 $ 40,098
========= =========
LIABILITIES
Other liabilities $ 75 $ --
Subordinated debentures 10,310 --
--------- ---------
TOTAL LIABILITIES 10,385 --
STOCKHOLDERS' EQUITY 44,171 40,098
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 54,556 $ 40,098
========= =========
STATEMENTS OF OPERATIONS YEAR ENDED JUNE 30,
--------------------------------------
2002 2001 2000
--------------------------------------
INCOME
Dividends from subsidiaries $ 1,540 $ 1,200 $ 980
Equity in undistributed income
of subsidiaries 4,199 2,708 3,490
Interest and other income 69 103 103
--------- --------- --------
TOTAL INCOME 5,808 4,011 4,573
EXPENSE
Other expense 233 8 16
--------- --------- --------
NET INCOME $ 5,575 $ 4,003 $ 4,557
========= ========= ========
STATEMENTS OF CASH FLOWs YEAR ENDED JUNE 30,
--------------------------------------
2002 2001 2000
--------------------------------------
OPERATING ACTIVITIES:
Net income $ 5,575 $ 4,003 $ 4,557
Add (deduct) items not affecting
cash flows from operating
activities:
Equity in undistributed income
of subsidiaries (4,199) (2,708) (3,490)
Loss on sale of investment
securities 24 -- --
(Increase) decrease in other
assets, net (273) 3 (4)
Increase (decrease) in other
liabilities 75 -- --
Reduction of common stock
acquired by ESOP -- -- --
--------- --------- ----------
NET CASH FLOWS FROM OPERATING
ACTIVITIES 1,202 1,298 1,071
--------- --------- ----------
INVESTMENT ACTIVITIES:
Purchase of securities available
for sale -- -- (259)
Proceeds from sales and calls of
securities available for sale -- -- 259
--------- --------- ----------
Net cash flows used in investment
activities -- -- --
--------- --------- ----------
FINANCING ACTIVITIES:
Income tax benefit on exercise of
stock options (21) (26) (16)
Capital contribution to
subsidiaries (9,760) -- --
Proceeds from the issuance of
subordinated debentures 10,310 -- --
Cash dividends (1,709) (1,463) (1,383)
Payment for fractional shares (5) (7) (7)
Common stock repurchased (664) (219) (531)
Proceeds from exercise of stock
options 162 274 103
Proceeds from issuance of common
stock -- 116 613
--------- --------- ----------
Net cash flows used in financing
activities (1,687) (1,325) (1,221)
--------- --------- ----------
NET INCREASE (DECREASE) IN CASH (485) (27) (150)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 606 633 783
--------- --------- ----------
END OF PERIOD $ 121 $ 606 $ 633
========= ========= ==========
NON-CASH ITEMS:
Net unrealized loss on investment
securities available for sale,
net of taxes $ (649) $ (1,892) $ (1,703)
========= ========= ==========
Stock dividend issued $ 2,882 $ 3,344 $ 3,014
========= ========= ==========
72
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from pages 3
to 8 of the Company's Definitive Proxy Statement for the Annual meeting of
Stockholders to be held on October 22, 2002 which was filed with the SEC on
September 13, 2002 ("Definitive Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference on pages 9 to
16 of the Company's Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required herein is incorporated by reference from pages 3
to 8 of the Company's Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein is incorporated by reference to page 17 and
18 of the Definitive Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) The following consolidated financial statements and report of
Independent Auditors of Chester Valley Bancorp Inc. and Subsidiaries
are included in Item 8 of this Annual Report on Form 10-K:
(a) Consolidated Statements of Financial Condition at June 30, 2002
and 2001.
(b) Consolidated Statements of Operations for the Years Ended June
30, 2002, 2001, and 2000.
(c) Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the Years Ended June 30, 2002, 2001, and 2000.
(d) Consolidated Statements of Cash Flows for the Years Ended June
30, 2002, 2001 and 2000.
(e) Notes to Consolidated Financial Statements.
(f) Report of Independent Auditors.
73
(2) Financial statement schedules for which provision is made in the
applicable accounting regulations of the SEC are omitted because of
the absence of the conditions under which they are required or because
the required information is set forth in the Consolidated Financial
Statements or Notes thereto.
(b) Reports on Form 8-K
None
(c) The following exhibits are filed as a part of this Form 10-K.
INDEX TO EXHIBITS
Number Description of Documents
- ------
3a Restated Articles of Incorporation**
3b Bylaws, as amended
4 Specimen Stock Certificate*
10a Key Employee Stock Compensation Program, as amended**
10b Employee Stock Ownership Plan**
10c Employment Agreement By and Between the Holding Company, the
Bank and Donna M. Coughey
10e Employment Agreement By and Between the Holding Company, the
Bank and Colin N. Maropis**
10h Employment Agreement By and Between the Holding Company, the
Bank and Albert S. Randa
10j Amendment No. 1 to the Employment Agreement By and Between
the Holding Company, the Bank and Colin N. Maropis ***
10l 1997 Stock Option Plan as amended ****
10m 1993 Stock Option Plan as amended
11 Statement re: computation of per share earnings - reference is
made to Item 8 hereof
21 Subsidiaries of the Registrant - Reference is made to
Item, 1, Business - Subsidiaries," for the required information
23 Consent of Independent Auditors
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 dated September 13, 2002
(*) Incorporated herein by reference from the Company's Registration
Statement on Form S-4 (33-30433) dated August 10, 1989
(**) Incorporated herein by reference from the Company's Annual
Report on Form 10-KSB for the year ended June 30, 1990
(***) Incorporated herein by reference from the Company's Annual
Report on Form 10-KSB for the year ended June 30, 1992
(****) Incorporated herein by reference from the Company's Annual
Report on Form 10-KSB for the year ended June 30, 1997
(d) Not Applicable
74
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amended report to be
signed on its behalf by the undersigned, thereunto duly authorized.
CHESTER VALLEY BANCORP INC.
Dated: September 13, 2001 By: /s/ Donna M. Coughey
------------------------------
Donna M. Coughey
Director, President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Name Title Date
/s/ Robert J. Brabury Secretary September 13, 2002
- ------------------------------
Robert J. Bradbury
/s/ Edward T. Borer Director September 13, 2002
- ------------------------------
Edward T. Borer
/s/ Donna M. Coughey Director, President September 13, 2002
- ------------------------------ and Chief Executive
Donna M. Coughey Officer
/s/ John J. Cunningham, III Director September 13, 2002
- ------------------------------
John J. Cunningham, III
/s/ Gerard F. Griesser Director September 13, 2002
- ------------------------------
Gerard F. Griesser
/s/ James E. McErlane Director and Chairman September 13, 2002
- ------------------------------ of the Board
James E. McErlane
/s/ Richard L. Radcliff Director September 13, 2002
- ------------------------------
Richard L. Radcliff
/s/ Emory S. Todd Director September 13, 2002
- ------------------------------
Emory S. Todd
/s/ William M. Wright Director September 13, 2002
- ------------------------------
William M. Wright
/s/ Albert S. Randa Chief Financial Officer September 13, 2002
- ------------------------------
Albert S. Randa
75
CERTIFICATION PURSUANT TO RULE 13a-14
OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Donna M Coughey, the President and Chief Executive Officer of Chester Valley
Bancorp Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Chester Valley Bancorp
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
Date: September 13, 2002 /s/ Donna M. Coughey
-----------------------------------
Donna M. Coughey
President & Chief Executive Officer
CERTIFICATION PURSUANT TO RULE 13a-14
OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Albert S. Randa, the Chief Financial Officer and Treasurer of Chester Valley
Bancorp Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Chester Valley Bancorp
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
Date: September 13, 2002 /s/ Albert S. Randa
-------------------------------------
Albert S. Randa
Chief Financial Officer and Treasurer
76