SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 E. LANCASTER AVENUE, DOWNINGTOWN, PA 19335
---------------------------------------- ----------
(Address Of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 269-9700
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): YES NO X
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
COMMON STOCK ($1.00 PAR VALUE) 4,536,009
------------------------------ -----------------------------
(Title of Each Class) (Number of Shares Outstanding
as of November 1, 2002)
<page>
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
INDEX
-----
PAGE
PART 1. FINANCIAL INFORMATION NUMBER
- ------------------------------ ------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 2002 and June 30, 2002 (Unaudited) 1
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended September 30, 2002 and 2001 (Unaudited) 2
STATEMENT OF OTHER COMPREHENSIVE INCOME
Three Months Ended September 30, 2002 and 2001 (Unaudited) 3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended September 30, 2002 and 2001 (Unaudited) 4
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 5 - 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11 - 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 21 - 23
ITEM 4. CONTROLS AND PROCEDURES 24
PART 2. OTHER INFORMATION
- --------------------------
ITEM 1. LEGAL PROCEEDINGS 24
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24 - 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25 - 26
SIGNATURES 27
- ----------
CERTIFICATIONS 28 - 31
- --------------
<page>
<table>
<caption>
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
SEPTEMBER 30, JUNE 30,
2002 2002
------------- ---------
(UNAUDITED)
<s> <c> <c>
ASSETS $ 4,021 $ 10,232
Cash and due from banks
Interest-bearing deposits 33,907 29,163
--------- ---------
TOTAL CASH AND CASH EQUIVALENTS 37,928 39,395
--------- ---------
Trading account securities 16 16
Investment securities available for sale 113,666 101,393
Investment securities held to maturity (fair value -
September 30, 2002, $36,934;
June 30, 2002, $41,439) 36,316 41,180
Loans held for sale 1,310 138
Loans receivable 382,088 369,685
Deferred fees (1,491) (1,533)
Allowance for loan losses (4,736) (4,588)
--------- ---------
Loans receivable, net 375,861 363,564
--------- ---------
Accrued interest receivable 2,767 2,543
Property and equipment - net 12,789 12,765
Other assets 4,480 5,038
--------- ---------
TOTAL ASSETS $ 585,133 $ 566,032
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 399,062 $ 385,980
Securities sold under agreements to repurchase 24,290 18,249
Advance payments by borrowers for taxes and insurance 1,056 2,831
Federal Home Loan Bank advances 102,143 102,454
Accrued interest payable 868 882
Trust preferred securities 10,000 10,000
Other liabilities 1,635 1,465
--------- ---------
TOTAL LIABILITIES 539,054 521,861
--------- ---------
Commitments and contingencies (Note 4)
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;
4,552,183 and 4,335,183 shares issued at September 30,
2002 and June 30, 2002, respectively 4,552 4,335
Additional paid-in capital 30,192 26,885
Retained earnings - partially restricted 11,631 14,115
Treasury stock (16,122 and 33,753 shares at September 30, 2002 and
June 30, 2002, respectively, at cost) (246) (515)
Accumulated other comprehensive loss, net of tax (50) (649)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 46,079 44,171
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 585,133 $ 566,032
========= =========
</table>
See accompanying notes to unaudited consolidated financial statements
1
<page>
<table>
<caption>
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except for Per Share Amounts)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2002 2001
----------- -----------
(Unaudited)
<s> <c> <c>
INTEREST INCOME:
Loans $ 6,612 $ 6,808
Mortgage-backed securities 387 220
Interest-bearing deposits 91 250
Investment securities:
Taxable 862 1,432
Non-taxable 468 495
----------- -----------
TOTAL INTEREST INCOME 8,420 9,205
----------- -----------
INTEREST EXPENSE:
Deposits 2,233 3,732
Securities sold under agreements to repurchase 59 31
Short-term borrowings 310 347
Long-term borrowings 1,175 809
----------- -----------
TOTAL INTEREST EXPENSE 3,777 4,919
----------- -----------
NET INTEREST INCOME 4,643 4,286
Provision for loan losses 141 131
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 4,502 4,155
----------- -----------
OTHER INCOME:
Investment services income 892 855
Service charges and fees 714 453
Gain on the sale of:
Loans 9 51
Available for sale securities 116 152
Other 42 44
----------- -----------
TOTAL OTHER INCOME 1,773 1,555
----------- -----------
OPERATING EXPENSES:
Salaries and employee benefits 2,480 2,200
Occupancy and equipment 706 578
Data processing 257 251
Advertising 35 17
Deposit insurance premiums 16 21
Other 827 701
----------- -----------
TOTAL OPERATING EXPENSES 4,321 3,768
----------- -----------
Income before income taxes 1,954 1,942
Income tax expense 489 480
----------- -----------
NET INCOME $ 1,465 $ 1,462
=========== ===========
EARNINGS PER SHARE (1)
Basic $ 0.32 $ 0.32
=========== ===========
Diluted $ 0.32 $ 0.32
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING (1)
Basic 4,528,730 4,545,552
=========== ===========
Diluted 4,584,769 4,569,152
=========== ===========
</table>
(1) Earnings per share and weighted average shares outstanding have been
restated to reflect the effects of the 5% stock dividends paid in September
2002 and 2001.
See accompanying notes to unaudited consolidated financial statements
2
<page>
<table>
<caption>
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
STATEMENT OF OTHER COMPREHENSIVE INCOME
(Dollars in Thousands)
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
2002 2001
------- -------
(Unaudited)
<s> <c> <c>
NET INCOME $ 1,465 $ 1,462
Other comprehensive income, net of tax:
Net unrealized holding gains on securities available for sale
during the period 676 500
Reclassification adjustment for gains
included in net income (77) (34)
------- -------
COMPREHENSIVE INCOME $ 2,064 $ 1,928
======= =======
</table>
See accompanying notes to unaudited consolidated financial statements.
3
<page>
<table>
<caption>
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------
2002 2001
- ----------------------------------------------------------------------------------------------------------------
(Unaudited)
<s> <c> <c>
Net income $ 1,465 $ 1,462
Add (deduct) items not affecting cash flows provided by (used in) operating activities:
Depreciation 267 257
Provision for loan losses 141 131
Gain on sale of securities available for sale (116) (152)
Originations of loans held for sale (4,823) (1,067)
Proceeds from sale of loans held for sale 3,660 2,431
Gain on sale of loans held for sale (9) (51)
Amortization of deferred loan fees, discounts and premiums (100) (258)
Decrease in trading account securities -- (5)
(Increase) decrease in accrued interest receivable (224) 389
Decrease (increase) in other assets 151 (2,733)
Decrease in accrued interest payable (14) (619)
Increase (decrease) in other liabilities 170 (2,416)
- ----------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) operating activities 568 (2,631)
- ----------------------------------------------------------------------------------------------------------------
Cash flows (used in) provided by investment activities:
Capital expenditures (291) (473)
Net increase in loans (12,277) (5,520)
Purchase of investment securities held to maturity (1,822) (15,410)
Proceeds from maturities, payments and calls of investment securities held to maturity 6,719 14,830
Purchase of securities available for sale (21,253) (20,680)
Proceeds from sales and calls of securities available for sale 10,008 47,757
- ----------------------------------------------------------------------------------------------------------------
Net cash flows (used in) provided by investment activities (18,916) 20,504
- ----------------------------------------------------------------------------------------------------------------
Cash flows provided by (used in) financing activities
Net increase (decrease) in deposits before interest credited 11,049 (8,842)
Interest credited to deposits 2,033 3,646
Increase in securities sold under agreements to repurchase 6,041 4,961
Repayments of FHLB advances (311) (4)
Net increase in other borrowings -- 4
Decrease in advance payments by borrowers for taxes and insurance (1,775) (1,716)
Cash dividends on common stock (431) (411)
Treasury stock issued 275 --
Payment for fractional shares -- (5)
Stock options exercised -- 12
- ----------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities 16,881 (2,355)
- ----------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (1,467) 15,518
CASH AND CASH EQUIVALENTS:
Beginning of period 39,395 23,912
--------------------
End of period $ 37,928 $ 39,430
====================
SUPPLEMENTAL DISCLOSURES:
Cash payments during the year for:
Taxes $ 150 $ 115
Interest $ 3,791 $ 5,538
NON-CASH ITEMS:
Stock dividend issued $ 3,518 $ 2,882
Net unrealized gain on investment securities available for sale, net of tax $ 599 $ 466
</table>
See accompanying notes to unaudited consolidated financial statements.
4
<page>
CHESTER VALLEY BANCORP INC.
AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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. 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 Pennsylvania-chartered 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 under the same
corporate title. As a consequence of such charter conversion and with the
approval by the Federal Reserve Bank of Philadelphia under delegated authority
from the Board of Governors of the Federal Reserve System ("FRB"), the Holding
Company became a bank holding company that has also been designated by the FRB
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 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 Securities and Exchange Commission
("SEC"). 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.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, the Bank and PCIS. The accounts of
the Bank include its wholly-owned subsidiaries, First Financial Investments Inc.
and D & S Service Corp., which owns D & F Projects and Wildman Projects, Inc.,
both of which are wholly-owned subsidiaries thereof. All material inter-company
balances and transactions have been eliminated in consolidation. Prior period
amounts are reclassified when necessary to conform with the current period's
presentation.
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States of America ("GAAP") for complete financial
statements. However, such information reflects all adjustments, which are, in
the opinion of management, necessary for a fair presentation of results for the
three-month unaudited interim periods.
5
<page>
The results of operations for the three-month period ended September 30, 2002,
are not necessarily indicative of the results to be expected for the entire
fiscal year ending June 30, 2003. The consolidated financial statements
presented herein should be read in conjunction with the audited consolidated
financial statements and the notes thereto included in the Company's Annual
Report to Stockholders for the fiscal year ended June 30, 2002.
EARNINGS PER SHARE
The dilutive effect of stock options is excluded from the computation of basic
earnings per share but included in the computation of diluted earnings per
share. Earnings per share and weighted average shares outstanding for the
periods presented herein have been adjusted to reflect the effects of the 5%
stock dividends paid in September 2002 and 2001.
The following table sets forth the computation of basic and diluted earnings per
share:
THREE MONTHS ENDED SEPTEMBER 30
2002 2001
------------- -------------
Numerator:
Net income $ 1,465 $ 1,462
============= =============
Denominator:
Denominator for basic per share-
weighted average shares 4,528,730 4,545,552
Effect of dilutive securities:
Stock options 56,039 23,600
------------- -------------
Denominator for diluted earnings
per share-adjusted weighted
average shares and assumed
exercise 4,584,769 4,569,152
============= =============
Basic earnings per share $ 0.32 $ 0.32
============= =============
Diluted earnings per share $ 0.32 $ 0.32
============= =============
The number of antidilutive stock options excluded was 114,212 and 386,293 for
the three-month periods ended September 30, 2002 and 2001, respectively.
6
<page>
NOTE 2 - LOANS RECEIVABLE
Loans receivable, excluding loans held for sale, are summarized as follows:
SEPTEMBER 30, JUNE 30,
2002 2002
------------ ---------
(In thousands)
First mortgage loans:
Residential $129,618 $133,751
Construction-residential 20,500 19,190
Land acquisition and development 15,629 16,707
Commercial 108,834 103,985
Construction-commercial 17,283 12,573
Commercial business 38,576 36,774
Consumer 73,697 69,538
----------- -----------
TOTAL LOANS 404,137 392,518
----------- -----------
Less:
Undisbursed loan proceeds:
Construction-residential (16,889) (17,277)
Construction-commercial (5,160) (5,556)
Deferred loan fees - net (1,491) (1,533)
Allowance for loan losses (4,736) (4,588)
----------- -----------
NET LOANS $375,861 $363,564
=========== ===========
NOTE 3 - 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. Loss factors are
applied to homogeneous and graded loans based upon prior loss experience of the
portfolio, delinquency trends, the volume of non-performing loans and micro and
macro economic conditions. 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.
7
<page>
For purposes of applying the measurement criteria for impaired loans, the
Company includes large loans and 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
September 30, 2002 and June 30, 2002, the recorded investment in impaired loans
was $1.01 million and $944 thousand. The Company's policy for the recognition of
interest income on impaired loans is to put them on non-accrual status. 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 in the impaired loan. At September 30, 2002 and June 30,
2002 there was no valuation allowance against these impaired loans.
NOTE 4 - COMMITMENTS AND CONTINGENCIES
Commitments to potential mortgagors of the Bank amounted to $2.99 million as of
September 30, 2002. These fixed rate loans (primarily consisting of
single-family residential mortgages) bearing interest rates of between 5.50% and
7.50%. At September 30, 2002, the Company had $22.05 million of undisbursed
construction loan funds as well as $48.06 million of undisbursed remaining
consumer and commercial line balances.
NOTE 5 - 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 adjusts and pays interest quarterly
based on three month Libor plus 360 basis points, to investors and 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 can be
redeemed 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.
8
<page>
NOTE 6 - REGULATORY CAPITAL
The Holding Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. 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 Holding Company's and the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Holding Company and the Bank must meet specific
capital guidelines that involve quantitative measures of the Holding Company's
and the Bank's assets, liabilities, and certain off balance sheet items as
calculated under regulatory accounting practices. The Holding Company and 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 Holding Company and 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 adjusted total assets (as defined). At September 30, 2002 and June
30, 2002 the Holding Company and the Bank were in compliance with all such
requirements are deemed "well-capitalized" for regulatory purposes. There are no
conditions or events since September 30, 2002 that management believes have
changed such characterization.
The Holding Company's and the Bank's regulatory capital amounts and ratios are
presented in the table as follows (dollars in thousands):
<table>
<caption>
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------- ------------------------ -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ---------- ----------- --------- ----------- ----------
<s> <c> <c> <c> <c> <c> <c>
AS OF SEPTEMBER 30, 2002:
HOLDING COMPANY
Total Capital
(to Risk-Weighted Assets) $60,666 15.47% $31,372 8.00% $39,215 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $55,930 14.26% $15,686 4.00% $23,529 6.00%
Tier 1 Capital
(to Average Assets) $55,930 9.83% $22,765 4.00% $28,457 5.00%
BANK
Total Capital
(to Risk-Weighted Assets) $56,654 14.53% $31,198 8.00% $38,998 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $51,918 13.31% $15,599 4.00% $23,399 6.00%
Tier 1 Capital
(to Average Assets) $51,918 9.19% $22,600 4.00% $28,249 5.00%
AS OF JUNE 30, 2002:
HOLDING COMPANY
Total Capital
(to Risk-Weighted Assets) $59,353 15.99% $29,697 8.00% $37,121 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $54,765 14.75% $14,848 4.00% $22,272 6.00%
Tier 1 Capital
(to Average Assets) $54,765 9.97% $21,966 4.00% $27,457 5.00%
BANK
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%
</table>
9
<page>
NOTE 7 - SEGMENT REPORTING
The Company has two reportable segments: First Financial and PCIS. First
Financial operates a branch bank network with nine full-service banking offices
and provides primarily deposit 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 in southeastern Pennsylvania.
The Company evaluates performance based on profit or loss from operations before
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. PCIS was acquired by the Company on May 29,
1998. The two segments are managed separately. All senior officers from PCIS
prior to the acquisition have been retained to manage PCIS.
The following table highlights income statement and balance sheet information
for each of the segments at or for September 30, 2002 and 2001:
<table>
<caption>
AT AND DURING THE THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------- ------------------------------------------
2002 2001
------------------------------------------- ------------------------------------------
BANK PCIS TOTAL BANK PCIS TOTAL
------------ ----------- ------------ ----------- ------------ -----------
(In thousands)
<s> <c> <c> <c> <c> <c> <c>
Net interest
income $ 4,639 $ 4 $ 4,643 $ 4,268 $ 18 $ 4,286
Other income 982 791 1,773 721 834 1,555
Total net income 1,377 88 1,465 1,374 88 1,462
Total assets 583,323 1,810 585,133 539,701 1,542 541,243
Total interest-
bearing deposits 32,370 1,537 33,907 33,142 1,189 34,331
Total trading
securities -- 16 16 -- 21 21
</table>
NOTE 8 - RECENT ACCOUNTING PRONOUNCEMENTS
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS
In October 2002, the FASB issued Statement No. 147, Acquisitions of Certain
Financial Institutions, which amends SFAS No. 72, Accounting for Certain
Acquisitions of Banking or Thrift Institutions, SFAS No.144, Accounting for the
Impairment or Disposal of Long-Lived Assets, and FASB Interpretation No. 9.
Except for transactions between two or more mutual enterprises, this Statement
removes acquisitions of financial institutions from the scope of both Statement
No. 72 and Interpretation 9 and requires that those transactions be accounted
for in accordance with FASB Statements No. 141, Business Combinations, and No.
142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5
of Statement No. 72 to recognize any excess of the fair value of liabilities
assumed over the fair value of tangible and identifiable intangible assets
acquired as an unidentifiable intangible asset of business no longer applies to
acquisitions within the scope of this Statement. In addition, this Statement
amends Statement No. 144 to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
Consequently, those intangible assets are subject to the same undiscounted cash
flow recoverability test and impairment loss recognition and measurement
provisions that Statement No. 144 requires for other long-lived assets that are
held and used.
10
<page>
With some exceptions, the requirements of Statement No. 147 are effective
October 1, 2002. The Company does not expect the adoption of this statement to
have an impact on the Company's consolidated earnings, financial condition, or
equity.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD-LOOKING STATEMENTS
In this Form 10-Q, the Company may have 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-Q. 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, many
of 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, changes in monetary policy, the general economic climate in
Chester County, the mid-Atlantic region and the country as a whole, loan
delinquency rates, changes in federal and state regulation, and other
uncertainties described in the Company's filings with the Securities and
Exchange Commission (the "Commission"), including this Form 10-Q. 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.
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 Company. The preparation
of these financial statements requires the Company 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
Company 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
Company bases its estimates on historical experience and various other 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.
11
<page>
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements: allowance for loan losses, income taxes, and
other-than-temporary investment security impairment.
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 of loss 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. Loss factors are
applied to homogeneous and graded loans based upon prior loss experience of the
portfolio, delinquency trends, the volume of non-performing loans and micro and
macro economic conditions. 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 management's best estimate of known and inherent
losses, 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 includes large loans and groups of smaller balance homogeneous loans,
primarily consisting of residential real estate loans and consumer loans as well
as commercial business loans with principal 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 September 30, 2002 and June 30, 2002, the recorded investment in
impaired loans was $1.01 million and $944 thousand, respectively. The Company's
policy for the recognition of interest income on impaired loans is to put them
on non-accrual status. 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 in the impaired loan.
12
<page>
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.
GENERAL
The Company's results of operations depend primarily on the Bank's 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 primarily 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.
13
<page>
The Company's results of operations also are affected by the provision for loan
losses resulting from management's assessment 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 expanding its commercial and construction lending activities,
increasing its commercial deposits and treasury management, consumer deposits
and loans as well as expanding its trust and investment management services.
BUSINESS STRATEGY
GROWTH. The Company seeks to increase its assets primarily through internal
growth and by expanding its operations. During fiscal 2003, the Company plans on
opening it's tenth branch office, which is scheduled to open in January 2003.
The primary objectives of the fiscal 2003 strategic plan are to increase loans,
in particular commercial real estate, construction and consumer loans, increase
core deposits (consisting of all deposits other than certificates of deposits)
and increase trust and investment services income. The Company's net loans
increased by $12.30 million, or 3.38% from $363.56 million at June 30, 2002 to
$375.86 million at September 30, 2002. The growth of core deposits was $8.83
million or 4.60% from $192.02 million at June 30, 2002 to $200.85 million at
September 30, 2002.
EMPHASIS ON COMMERCIAL LENDING. The Company has been and will continue to seek
to increase its higher yielding portfolios of commercial real estate and
commercial business loans. The Company's commercial real estate, commercial
business and construction and land acquisition loans comprised in the aggregate
49.69% of its total loan portfolio at September 30, 2002 compared to 48.21% at
June 30, 2002. Single-family and multi-family residential loans comprised 32.07%
of the Company's loan portfolio at September 30, 2002 as compared to 34.08% at
June 30, 2002.
MAINTAIN LOAN QUALITY. Management believes that maintaining high loan quality is
essential to achieving and sustaining long-term financial success. Accordingly,
the Company has sought to maintain a high level of loan quality and moderate
credit risk by using underwriting standards which management believes are
conservative and by generally limiting its lending activity to the origination
of loans secured by property located in its market area. The Company's
non-accrual loans increased slightly by $66 thousand to $1.01 million at
September 30, 2002. The Company's ratio of non-performing loans to total loans
was 0.17% and its allowance for loan losses to non-performing loans was 486.02%
at June 30, 2002, while at September 30, 2002 the percentages were 0.17% and
468.91%, respectively.
14
<page>
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, $150.00 million at September 30, 2002
compared to $142.59 million at June 30, 2002. In addition, the Company had
short-term interest-bearing deposits of $33.91 million at September 30, 2002
compared to $29.16 million at June 30, 2002.
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 core deposits totaled $200.85 million or 57.32% of the Company's
total deposits at September 30, 2002, as compared to $192.02 million or 56.35%
at June 30, 2002, an $8.83 million or 4.60% increase. This increase in lower
costing core deposits is primarily attributable to the continuing effort to grow
such deposits. Pursuant to the Company's strategy, one of the major focuses in
2003 is on increasing commercial and consumer core deposits and relying less on
higher rate municipal deposits. 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 the Board of
Directors. 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.
15
<page>
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 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 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. The interest rate
sensitivity analysis at September 30, 2002 is on page 23.
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 on page 23
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 to the same degree or at 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.
FINANCIAL CONDITION
The Company's total assets increased $19.1 million to $585.13 million at
September 30, 2002 from $566.03 million at June 30, 2002, principally due to a
$12.30 million increase in loans receivable, net, to $375.86 million from
$363.56 million at June 30, 2002 combined with a $4.74 million increase in
interest-earning deposits from $29.16 million at June 30, 2002 to $33.91 million
at September 30, 2002 and an increase in investments of $7.41 million. These
increases were partially offset by a $6.21 million decrease in cash in banks
from $10.23 million at June 30, 2002 to $4.02 million at September 30, 2002.
Liabilities increased $17.19 million. This increase is primarily attributable to
an increase in deposits of $13.08 million from $385.98 million at June 30, 2002
to $399.06 million at September 30, 2002 as well as an increase in securities
sold under agreements to repurchase of $6.04 million.
Stockholders' equity increased $1.91 million to $46.08 million at September 30,
2002 from $44.17 million at June 30, 2002, primarily as a result of net income
of $1.47 million, a decrease in net unrealized losses on securities available
for sale, net of tax, of $599 thousand and a decrease in treasury stock of $269
thousand. These increases in stockholders' equity were partially offset by,
among other things, cash dividends of $431 thousand. The increase in common
stock and additional paid in capital was primarily due to a 5% stock dividend
paid in September 2002.
16
<page>
RESULTS OF OPERATIONS
The most significant element in the determination of results of operation is net
interest income which is the difference between interest income on loans and
investments and interest expense on deposits and borrowings. Each element is
affected by both rates and volumes.
NET INTEREST INCOME AND INTEREST SPREAD ANALYSIS
- ------------------------------------------------
The following table sets forth, for the periods indicated, information on a tax
equivalent basis 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) the interest rate spread;
and (5) net interest-earning assets and their net yield. Average balances are
determined on a daily basis.
<table>
<caption>
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------
2002 2001
-------------------------------- --------------------------------
(Dollars in Thousands)
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
-------------------------------- --------------------------------
<s> <c> <c> <c> <c> <c> <c>
ASSETS:
Loans and loans held for sale $ 372,994 $ 6,631 7.11% $ 350,338 $ 6,838 7.81%
Securities and other investments 174,157 1,982 4.55% 172,404 2,582 5.99%
---------------------- ----------------------
Total interest-earning assets 547,151 8,613 6.30% 522,742 9,420 7.21%
------------------ ------------------
Non-interest earning assets 36,566 25,182
---------- ----------
TOTAL ASSETS $ 583,717 $ 547,924
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits and repurchase agreements $ 392,137 2,233 2.26% $ 413,359 3,732 3.58%
FHLB advances and other borrowings 130,208 1,544 4.70% 80,476 1,187 5.85%
---------------------- ----------------------
TOTAL INTEREST-BEARING LIABILITIES 522,345 3,777 2.87% 493,835 4,919 3.95%
-------------------------------- --------------------------------
Non-interest-bearing liabilities 16,174 12,971
Stockholders' equity 45,198 41,118
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 583,717 $ 547,924
========== ==========
NET INTEREST INCOME/INTEREST RATE SPREAD $ 4,836 3.43% $ 4,501 3.26%
================== ==================
NET INTEREST INCOME/AVERAGE
INTEREST-EARNING ASSETS 3.51% 3.42%
======= =======
RATIO OF AVERAGE INTEREST-EARNING ASSETS TO
INTEREST-BEARING LIABILITIES 105% 106%
======= =======
</table>
Net interest income, on a fully tax equivalent basis, increased 7.44% to $4.84
million for the three-month period ended September 30, 2002, compared to $4.50
million for the same period in 2001 as the Company's interest expense decreased
at a more rapid rate than its interest income.
Total interest income, on a fully tax equivalent basis, decreased $807 thousand
or 8.6% to $8.61 million for the three-month period ended September 30, 2002,
from $9.42 million for the same period in 2001, primarily as a result of the
effect of the weighted average yield on interest-earning assets decreasing .91%
or 12.6% due primarily to declines in market rates of interest during 2001. This
decrease was offset, in part, by the increase of the average balance of interest
earning assets.
The average balance of interest-earning assets increased $24.41 million to
$547.15 million for the three-month period ended September 30, 2002 from $522.74
million for the same period in 2001. The increase in the three-month period was
primarily due to a $22.66 million increase in the average balance of loans
during the three-month period at September 30, 2002 reflecting the continued
implementation of the Company's business plan to increase its loan portfolio.
17
<page>
Total interest expense decreased $1.14 million or 23.17% to $3.78 million for
the three-month period ended September 30, 2002 from $4.92 million for the same
period in 2001. Such decline reflected, in large part, the decrease in the
weighted average rate paid of 1.08% or 27.34% on such liabilities to 2.87% for
the three-month period ended September 30, 2002 from 3.95% for the same period
in the prior year, resulting primarily from the continued decline in market
rates of interest experienced throughout all of 2001. Also contributing to the
decrease during 2002 period was the decrease in the average balance of deposits
of $21.22 million to $392.14 million offset in part by an increase in the
average balance of FHLB advances and other borrowings of $49.73 million to
$130.21 million.
The tax equivalent interest rate spread increased to 3.43% from 3.26% and the
average tax equivalent net yield on interest-earning assets increased to 3.51%
from 3.42% for the three-month periods ended September 30, 2002 and 2001,
respectively, due to the reasons discussed above.
PROVISION FOR LOAN LOSSES
The Company provided $141,000 and $131,000 for loan losses during the
three-month periods ended September 30, 2002 and 2001. These provisions have
been added to the Company's allowance for loan losses because of the increase in
classified loans and the Company's focus on building a larger loan portfolio of
commercial real estate and business loans, which typically have a greater risk
of loss than the Company's traditional loan portfolios, such as single-family
residential mortgages and real estate loans. This change in the character of the
loan portfolio, the current 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
September 30, 2002, the allowance for loan losses totaled $4.74 million or 1.24%
of net loans (before allowance), compared to $4.59 million or 1.26% of net loans
at June 30, 2002. As a percentage of non-performing assets, the allowance for
loan losses was 469% at September 30, 2002, compared to 486% at June 30, 2002,
and further compared to 323% at September 30, 2001.
OTHER INCOME
Total other income increased $218 thousand to $1.77 million during the
three-month period ended September 30, 2002, as compared to $1.56 million during
the same period in 2001. For the three- month period, service charges and fees
increased $261,000 because of both an introduction of the overdraft shield
program which charges customers a fee for overdraft protection, as well as
increases in the number of accounts and activity, while investment services
income increased $37,000. These increases were offset, in part, by decreases of
$42,000 and $36,000 on the sale of loans and available for sale securities,
respectively.
18
<page>
OPERATING EXPENSES
Total operating expenses increased by $553,000 to $4.32 million for the
three-month period ended September 30, 2002 as compared to the same period in
2001. The primary reasons for the increases in operating expenses for the
three-month period in fiscal 2002 are as follows: (i) salaries and employee
benefits increased $280,000 or 12.73% resulting from normal salary adjustments
effective July 1, 2002, additional officer level staff, anticipated year end
incentive payments and increased employee benefit costs; (ii) occupancy and
equipment expense increased $128,000 or 22.15% resulting from the expansion of
the Company's corporate headquarters; (iii) data processing costs increased
$6,000; (iv) advertising expense increased $18,000 or 105.88% resulting
primarily from advertising new customer programs; (v) other costs and expenses
increased $126,000 or 17.97% primarily from increases in consulting, printing,
legal and office supplies.
INCOME TAX EXPENSE
The Company recorded a $489,000 income tax expense for the three-month period
ended September 30, 2002, as compared to $480,000 for the same period in 2001.
For the three-month period ended September 30, 2002 the effective tax rate
increased to 25.03% from 24.72% when compared to the same period in the prior
year.
ASSET QUALITY
Classified loans include non-performing loans, which are non-accruing, totaling
$1.01 million and $944 thousand at September 30, 2002 and June 30, 2002,
respectively. 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 is not accrued until the financial condition and payment record
of the borrower clearly demonstrates the borrower's ability to service the debt.
At September 30, 2002, the Company did not have any loans greater than 90 days
delinquent, which were accruing interest. Non-performing loans to total assets
were .17% at September 30, 2002 compared to .17% at June 30, 2002, and .25% at
September 30, 2001. Non-performing loans, which totaled $1.01 million at
September 30, 2002, consisted of 12 single-family residential mortgage loans
aggregating $916 thousand and non-performing consumer and commercial business
loans totaling $94 thousand.
At September 30, 2002 and June 30, 2002, the Company's classified loans, which
consisted of loans classified as special mention, substandard, doubtful and
loss, totaled $11.20 million and $6.24 million, respectively. Included in the
assets classified substandard at September 30, 2002 and 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, as well as a well-defined weakness that may jeopardize the
liquidation of the debt. Included, as classified loans at September 30, 2002 are
loans totaling approximately $10.17 million, which are current but have been
listed as either special mention or substandard and are being closely monitored.
19
<page>
In addition to non-performing loans, classified assets include three Municipal
Authority Revenue Bond investments that had an aggregate balance of $6.4 million
at September 30, 2002, after a write-down on two of the bonds totaling $955,000
at June 30, 2002. After the write-down, two of the Bonds have a carrying value
of $4.9 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 $4.9
million, $200 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, may reduce the losses incurred on the bonds.
These classified investments are closely monitored and fairly stated at
September 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 Federal Home Loan Bank of Pittsburgh ("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 September 30, 2002, there was no outstanding balance on
this line of credit.
20
<page>
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 September 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 September 30, 2002, the Company had $2.99 million in
commitments to fund loan originations. In addition, as of September 30, 2002,
the Company had undisbursed loans in process for construction loans of $22.05
million and $48.06 million in undisbursed lines of credit. The Company has also
issued $2.74 million in commercial letters of credit fully secured by deposit
accounts or real estate at September 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 September 30, 2002, liquidity for the Bank as
defined under these guidelines was 28.66%.
The Company's current dividend policy is to declare a regular quarterly dividend
with the intent that the level of the dividend per share be reviewed and
determined by the Board of Directors on a quarterly basis. Dividends will be in
the form of cash and/or stock after giving consideration to all aspects of the
Company's performance for the current and prior quarter and other relevant
aspects. During the quarter, the Board of Directors declared a 5% stock dividend
and a quarterly cash dividend of $.10 per share, both of which were paid in
September 2002. Cash dividends from the Holding Company are primarily dependent
upon dividends paid to it by First Financial, which, in turn, are subject to
certain restrictions established by federal regulators and Pennsylvania law.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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, investments and deposit taking activities. To that end,
management actively monitors and manages its interest rate risk exposure. At
September 30, 2002, the Company's management believes that the interest rate
exposure has not significantly changed from that disclosed as of June 30, 2002.
The primary asset/liability management goal of the Company is to manage and
control its interest rate risk, 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 Company'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.
21
<page>
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.
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 money
market, NOW and savings deposits are partially sensitive to interest rate
changes. Accordingly, some of the interest sensitive portions of such
liabilities are classified in the less than one-year categories with the
remainder placed in the other categories. Deposit products with interest rates
based on a particular index 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 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 to the same degree, at 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 throughout the year. Although interest rate sensitivity gap
is a useful measurement and contributes towards effective asset/liability
management, it is difficult to predict the effect of changing interest rates
solely on that measure. An alternative methodology is to estimate the changes in
the Company's portfolio equity over a range of interest rate scenarios.
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.
The following is an interest rate sensitivity analysis for the Bank at September
30, 2002.
22
<page>
<table>
<caption>
INTEREST RATE SENSITIVITY ANALYSIS AT SEPTEMBER 30, 2002
(Dollars in thousands)
MORE THAN MORE THAN MORE THAN MORE THAN
THREE MONTHS SIX MONTHS ONE YEAR THREE YEARS
THREE MONTHS THROUGH THROUGH THROUGH THROUGH MORE THAN
OR LESS SIX MONTHS ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS TOTAL
----------------------------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c> <c> <c>
INTEREST-EARNING ASSETS:
Loans: (1)
Real estate (2) $ 87,078 $ 36,691 $ 57,872 $ 66,148 $ 16,993 $ 4,853 $ 269,635
Commercial business 26,370 1,625 2,804 6,699 1,078 -- 38,576
Consumer 34,337 3,982 6,939 14,590 6,895 6,954 73,697
Securities and interest-bearing
deposits (3) 92,830 11,297 17,705 9,394 8,143 40,989 180,358
----------------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS $ 240,615 $ 53,595 $ 85,320 $ 96,831 $ 33,109 $ 52,796 $ 562,266
----------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 714 $ 716 $ 1,438 $ 5,825 $ 5,946 $ 15,411 $ 30,050
NOW accounts 1,341 1,343 2,692 10,853 10,993 28,132 55,354
Money market accounts 70,037 -- -- -- -- -- 70,037
Certificate accounts 41,177 20,327 57,964 57,311 9,683 6,390 192,852
Securities sold under agreements to
repurchase 24,289 -- -- -- -- -- 24,289
Borrowings 649 7,602 1,212 6,568 3,977 82,135 102,143
----------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES $ 138,207 $ 29,988 $ 63,306 $ 80,557 $ 30,599 $ 132,068 $ 474,725
----------------------------------------------------------------------------------------
Cumulative (deficit) excess of
interest-earning assets to
interest-bearing liabilities $ 102,408 $ 126,015 $ 148,029 $ 164,303 $ 166,813 $ 87,541 $ 87,541
============= ============ ============ ============ ============ =========== ==========
Cumulative ratio of interest
rate-sensitive assets to interest
rate-sensitive liabilities 174.1% 174.9% 163.9% 152.7% 148.7% 118.4% 118.4%
============= ============ ============ ============ ============ =========== ==========
CUMULATIVE DIFFERENCE AS A PERCENTAGE OF
TOTAL ASSETS 17.6% 21.7% 25.5% 28.3% 28.7% 15.1% 15.1%
============= ============ ============ ============ ============ =========== ==========
</table>
(1) Net of undisbursed loan proceeds.
(2) Includes commercial mortgage loans.
(3) Excludes SFAS 115 available for sale adjustment.
Certain shortcomings are inherent in the method of analysis presented in the
table above. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features, which restrict changes in interest rates both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table. Finally, the ability of many
borrowers to service their adjustable-rate loans may decrease in the event of an
interest rate increase.
23
<page>
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Within ninety days prior to the filing date of this Quarterly Report on Form
10-Q, the Company, under the supervision and with the participation of its
management, including its Chief Executive Officer and Chief Financial Officer,
performed an evaluation of the Company's disclosure controls and procedures, in
accordance with Rules 13a-14 and 13a-15 of the Securities Exchange Act of 1934
("Exchange Act"). Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that such disclosure controls and procedures
are effective to ensure that material information relating to the Company,
including its consolidated subsidiaries, is made known to them, particularly
during the period for which the periodic reports are being prepared.
Disclosure controls and procedures are the Company's controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the SEC's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files under the
Exchange Act is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROLS
No significant changes were made in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
the evaluation performed pursuant to Rule 13a-15 of the Exchange Act, referred
to above.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of stockholders was held
on October 22, 2002. The following matters were
presented for stockholder action at such meeting:
24
<page>
(1) To elect two directors for a term of three years or
until their successors have been elected and qualified:
Name Votes For Votes Withheld
----------------------- --------- --------------
Gerard F. Griesser 3,309,490 198,562
Emory S. Todd, Jr. 3,325,641 182,411
(2) To ratify the appointment of KPMG LLP as the Company's
independent auditors for the fiscal year ending June
30, 2003:
Votes For Votes Against Votes Abstained
--------- ------------- ---------------
3,325,700 181,226 1,125
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as a part of this Form-10Q
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 ***
101 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
November 14, 2002
25
<page>
NUMBER DESCRIPTION OF DOCUMENTS
- --------------------------------------------------------------------------------
(*) 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
(b) Reports on Form 8-K
Date Item and Description
---------------- ---------------------------------------------
October 25, 2002 9 - The Company announced the Company's
participation in the Mid-Atlantic 2002 Super-
Community Bank Conference which was held
in Baltimore Maryland on October 28-29, 2002
Included as an exhibit thereto was a copy of
the slide presentation that was used by the
Company at the conference.
26
<page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Chester Valley Bancorp Inc.
Date 11/14/02 /s/ Donna M. Coughey
-------------------- ------------------------------------------
Donna M. Coughey
President and Chief Executive Officer
Date 11/14/02 /s/ Albert S. Randa
-------------------- ------------------------------------------
Albert S. Randa, CPA
Chief Financial Officer and Treasurer
27
<page>
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 of Chester Valley Bancorp Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chester Valley Bancorp
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
28
<page>
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: 11/14/02 /s/ Albert S. Randa
------------------ --------------------------------------------
Albert S. Randa
Chief Financial Officer and Treasurer
29
<page>
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 quarterly report on Form 10-Q of Chester Valley Bancorp
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
30
<page>
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: 11/14/02 /s/ Donna M. Coughey
------------------ --------------------------------------------
Donna M. Coughey
President and Chief Executive Officer
31