FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004, OR
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( ) 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. 0-12870.
FIRST CHESTER COUNTY CORPORATION
---------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2288763
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
9 North High Street, West Chester, Pennsylvania 19380
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(Address of principal executive office) (Zip code)
(484) 881-4000
(Registrant's telephone number, including area code)
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 -
The number of shares outstanding of Common Stock of the Registrant as of May 10,
2004 was 4,535,331.
1
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
INDEX
PAGE
Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Statements of Condition
March 31, 2004 (unaudited) and December 31, 2003 3
Consolidated Statements of Income
Three-Months Ended March 31, 2004 and 2003 (unaudited) 4
Consolidated Statements of Cash Flows
Three-Months Ended March 31, 2004 and 2003 (unaudited) 5
Notes to Consolidated Financial Statements 6-8
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-22
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 23
Item 4 - Controls & Procedures 23-24
Part II. OTHER INFORMATION
Item 1 - Legal Proceedings 25
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities 25
Item 3 - Defaults Upon Senior Securities 25
Item 4 - Submission of Matters to a Vote of Security Holders 25-26
Item 5 - Other Information 27
Item 6 - Exhibits and Reports on Form 8-K 27
Signatures 28
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(Dollars in thousands) March 31,
2004 December 31,
(unaudited) 2003*
----------- ------------
ASSETS
Cash and due from banks $ 28,509 $ 27,738
Federal funds sold and other overnight investments 13,700 2,500
Interest bearing deposits in banks 412 374
-------- --------
Total cash and cash equivalents 41,850 31,383
-------- --------
Investment securities held-to-maturity (fair value of $15
at March 31, 2004 and $20 at December 31, 2003, respectively) 14 19
Investment securities available-for-sale, at fair value 123,910 130,710
Loans and leases 525,160 511,249
Less: Allowance for loan and lease losses (6,000) (5,864)
-------- --------
Net loans and leases 519,160 505,385
Premises and equipment 12,836 13,168
Other assets 9,156 8,545
-------- --------
Total assets $ 706,926 $ 689,210
======== ========
LIABILITIES
Deposits
Noninterest-bearing $ 128,036 $ 114,307
Interest-bearing (including certificates of deposit over $100
of $21,591 and $21,346 - March 31, 2004 and
December 31, 2003 respectively) 463,261 463,007
-------- --------
Total deposits 591,297 577,314
Federal Home Loan Bank advances and other borrowings 42,237 40,543
Junior subordinated debentures 15,450 -
Guaranteed preferred beneficial interest in Corporation's subordinated debentures - 15,000
Other liabilities 4,585 4,603
-------- --------
Total liabilities $ 653,569 $ 637,460
======== ========
STOCKHOLDERS' EQUITY
Common stock, par value $1.00; authorized, 25,000,000 shares;
outstanding, 4,799,666 at March 31, 2004 and December 31, 2003 4,800 4,800
Additional paid-in capital 2,161 1,877
Retained earnings 51,617 50,116
Accumulated other comprehensive income 317 307
Treasury stock, at cost: 264,762 shares and 283,144 shares
at March 31, 2004 and December 31, 2003, respectively (5,538) (5,350)
-------- --------
Total stockholders' equity 53,357 51,750
-------- --------
Total liabilities and stockholders' equity $ 706,926 $ 689,210
======== ========
The accompanying notes are an integral part of these statements.
* Derived fromour audited, consolidated financial statements included in our
Annual Report on Form 10-K for the fiscal year ended 12/31/03.
3
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(Dollars in thousands - except per share) Three Months Ended
---------------------------
March 31,
---------
2004 2003
------- -------
INTEREST INCOME
Loans and leases, including fees $ 7,332 $ 7,007
Investment securities 1,287 1,222
Federal funds sold 19 93
Deposits in banks 1 1
-------- --------
Total interest income 8,639 8,323
-------- --------
INTEREST EXPENSE
Deposits 1,180 1,695
Securities sold under repurchase agreements - 3
Junior subordinated debentures 165 -
Guaranteed preferred beneficial interest in Corporation's
subordinated debentures - 63
Federal Home Loan Bank advances and other borrowings 324 180
-------- --------
Total interest expense 1,669 1,941
-------- --------
Net interest income 6,970 6,382
Provision for loan losses 300 394
-------- --------
Net interest income after provision for possible loan losses 6,670 5,988
-------- --------
NON-INTEREST INCOME
Trust and Investment Services 947 783
Service charges on deposit accounts 524 533
Investment securities gains, net 53 58
Operating lease rental income 193 251
Gain on the sale of premises and other real estate owned 25 -
Gains and fees on the sale of residential mortgages 141 411
Gains and fees on the sale of credit card portfolio - 306
Other 503 527
-------- --------
Total non-interest income 2,386 2,869
-------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 3,875 3,678
Net occupancy, equipment and data processing 1,330 1,343
Depreciation expense on operating leases 172 171
Bank shares tax 125 109
Professional services 334 257
Other 1,077 1,082
-------- --------
Total non-interest expense 6,913 6,640
-------- --------
Income before income taxes 2,143 2,217
INCOME TAXES 642 664
-------- --------
NET INCOME $ 1,501 $ 1,553
======== ========
PER SHARE DATA
Basic earnings per common share $ 0.33 $ 0.35
======== ========
Diluted earnings per common share $ 0.32 $ 0.34
======== ========
Dividends declared $ 0.1375 $ 0.1350
======== ========
Basic weighted average shares outstanding 4,524,048 4,437,965
========= =========
Diluted weighted average shares outstanding 4,720,860 4,514,025
========= =========
The accompanying notes are an integral part of these statements.
4
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
(Dollars in thousands) March 31,
------------------------------
2004 2003
---- -----
OPERATING ACTIVITIES
Net Income $ 1,501 $ 1,553
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 622 708
Provision for loan and lease losses 300 394
Amortization of investment security premiums
and accretion of discounts 179 492
Amortization of deferred fees on loans (38) (169)
Investment securities gains, net (53) (58)
Decrease in other assets 662 130
Decrease in other liabilities (18) (84)
-------- --------
Net cash provided by operating activities $ 3,155 $ 2,966
-------- --------
INVESTING ACTIVITIES
(Increase) decrease in loans (13,979) 9,950
Proceeds from sales of investment securities available-for-sale 12,195 1,140
Proceeds from maturities of investment securities available-for-sale 8,187 22,175
Proceeds from maturities of investment securities held to maturity 1 --
Purchases of investment securities available-for-sale (13,944) (23,827)
Purchase of premises and equipment, net (290) (383)
-------- --------
Net cash (used in) provided by investing activities $ 7,830 $ (9,055)
-------- --------
FINANCING ACTIVITIES
Proceeds (repayments) from FHLB advances and other
short term borrowings 1,114 (403)
Proceeds (repayments) from FHLB advances and other
long term borrowings 580 --
Increase in deposits 13,983 18,422
Cash dividends paid (631) (600)
Treasury stock transactions 96 240
-------- --------
Net cash provided by (used in) financing activities 15,142 17,659
-------- --------
NET INCREASE IN CASH AND CASH
EQUIVALENTS 10,467 29,680
Cash and cash equivalents at beginning of year 31,383 48,867
-------- --------
Cash and cash equivalents at end of period $ 41,850 $ 78,547
======= =========
The accompanying notes are an integral part of these statements.
5
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial
information. In the opinion of Management, all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation
of the financial position and the results of operations for the interim
period presented have been included. These interim financial statements
should be read in conjunction with the consolidated financial
statements and footnotes thereto included in our Annual Report on Form
10-K for the fiscal year ended December 31, 2003.
2. The results of operations for the three-month period ended March 31,
2004 are not necessarily indicative of the results to be expected for
the full year. Information regarding risks and uncertainties that could
cause actual results to vary materially from our prior performance may
be found in Management's Discussion and Analysis of Financial Condition
and Results of Operations in Part I, Item 2 of our Quarterly Report on
Form 10-Q for the period ending March 31, 2004.
3. Earnings per share are based on the weighted average number of shares
of common stock outstanding during the period. Diluted net income per
share includes the effect of options granted.
4. The Corporation follows the provisions of FASB issued SFAS No. 130,
Reporting of Comprehensive Income on January 1, 2002. SFAS No. 130
establishes standards for reporting and display of comprehensive income
and its components. Other comprehensive income (loss) net of taxes for
the three-month period ended March 31, 2004 was $641 thousand compared
to ($213) thousand in the same period last year. Total comprehensive
income (which is the sum of net income and other comprehensive income
mentioned above), for the three-month ended March 31, 2004 and 2003 was
$2.142 million and $1.340 million, respectively.
5. The Corporation adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," on January 1, 2002. SFAS 142 requires that, upon its adoption,
amortization of goodwill will cease and instead, the carrying value of
goodwill will be evaluated for impairment on an annual basis. The
Corporation has no goodwill or intangible assets that are affected by
this provision; therefore, the adoption of SFAS No. 142 did not have an
impact on the Corporation's financial condition, results of operations
or cash flows.
6
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(UNAUDITED)
6. Management has determined that First Chester County Capital Trust I &
II qualify as a variable interest entity under FASB Interpretation
Number ("FIN") 46, as revised. First Chester County Capital Trust I &
II issued mandatory redeemable preferred stock to investors and loaned
the proceeds to the Company. First Chester County Capital Trust I & II
is included in the Company's consolidated balance sheet and statements
of income as of and for the year ended December 31, 2003. Subsequent to
the issuance of FIN 46 in January 2003, the FASB issued a revised
interpretation, FIN 46(R) "Consolidation of Variable Interest
Entities," the provisions of which must be applied to certain variable
interest entities by March 31, 2004. The Company adopted the provisions
under the revised interpretation in the first quarter of 2004.
Accordingly, as of March 31, 2004, the Company no longer consolidates
First Chester County Capital Trust I & II. The deconsolidation results
in the investment in the common stock of First Chester County Capital
Trust I & II entity to being included in other assets as of March 31,
2004 and a corresponding increase in outstanding debt of $450 thousand.
In addition, the income received on the Company's common stock
investment is included in other income. The adoption of FIN 46R did not
have a material impact on the financial position or results of
operations. The banking regulatory agencies have not issued any
guidance that would change the regulatory capital treatment for the
trust-preferred securities issued by First Chester County Capital Trust
I & II based on the adoption of FIN 46(R). However, as additional
interpretations from the available, management will reevaluate its
potential impact to its Tier I capital calculation under such
interpretations.
7. Stock-based Compensation
At March 31, 2004, the Bank had one stock-based employee compensation
plan. The Bank accounts for that plan under the recognition and
measurement principles of APB 25, "Accounting for Stock Issued to
Employees" and related interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted
under the plan had an exercise price equal to the market value of the
underlying common stock on the date of grant.
The following table provides the disclosures required by SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure" and
illustrates the effect on net income and earnings per share if the
Corporation had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation.
3/31/04 3/31/03
------- -------
Net income (in thousands) As reported $ 1,501 $ 1,553
Stock-based compensation costs determined
under fair value method for all awards 17 35
------- --------
Pro forma net income $ 1,484 $ 1,518
Earnings per share (Basic) As reported $ 0.33 $ 0.35
Pro forma $ 0.33 $ 0.34
Earnings per share (Diluted) As reported $ 0.32 $ 0.34
Pro forma $ 0.32 $ 0.33
There were no options granted in the first quarter of 2004 or 2003.
7
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(UNAUDITED)
8. On March 31, 2004, the Financial Accounting Standards Board (FASB)
issued a proposed Statement, "Share-Based Payment," an Amendment of
FASB Statements No. 123 and APB No. 95, that addresses the accounting
for share-based payment transactions in which an enterprise receives
employee services in exchange for (a) equity instruments of the
enterprise or (b) liabilities that are based on the fair value of the
enterprise's equity instruments or that may be settled by the issuance
of such equity instruments. Under the FASB's proposal, all forms of
share-based payments to employees, including employee stock options,
would be treated the same as other forms of compensation by recognizing
the related cost in the income statement. The expense of the award
would generally be measured at fair value at the grant date. Current
accounting guidance requires that the expense relating to so-called
fixed plan employee stock options only be disclosed in the footnotes to
the financial statements. The proposed Statement, which would be
effective for fiscal years beginning after December 15, 2004, would
eliminate the ability to account for share-based compensation
transactions using APB Opinion No. 25, "Accounting for Stock Issued to
Employees." The Corporation is currently evaluating this proposed
statement and its effects on its results of operations.
9. In October 2003, the AICPA issued SOP 03-3, "Accounting for Loans or
Certain Debt Securities Acquired in a Transfer." SOP 03-3 applies to a
loan with evidence of deterioration in credit quality subsequent to its
origination that is acquired by completion of a transfer (as defined in
SOP 03-3), for which it is probable at acquisition of such loan, that
the acquirer will be unable to collect all contractually required
payments receivable. SOP 03-3 requires that the acquirer recognize the
excess of all cash flows expected at acquisition over the investor's
initial investment in the loan as interest income on a level-yield
basis over the life of the loan as the accretable yield. The loan's
contractual required payments receivable in excess of the amount of its
cash flows expected at acquisition (non-accretable difference) should
not be recognized as an adjustment to yield, a loss accrual or a
valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early
adoption is permitted. Management is currently evaluating the
provisions of SOP-03-3.
10. The SEC recently released Staff Accounting Bulletin No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105
provides guidance about the measurement of loan commitments recognized
at fair value under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. SAB 105 also requires companies to
disclose their accounting policy for those loan commitments including
methods and assumptions used to estimate fair value and associated
hedging strategies. SAB 105 is effective for all loan commitments
accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 is not expected to have a material effect
on our consolidated financial statements.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion is intended to further your understanding of the
consolidated financial condition and results of operations of First Chester
County Corporation and its direct and indirect wholly-owned subsidiaries, First
National Bank of Chester County (the "Bank"), FNB Property Management, LLC,
First National Insurance Services, LLC, Turks Head Properties, Inc., Turks Head
II, LLC, First Chester County Capital Trust I, and First Chester County Capital
Trust II, (collectively, the "Corporation"). It should be read in conjunction
with the consolidated financial statements included in this report.
In addition to historical information, this discussion and analysis
contains statements relating to future results of the Corporation that are
considered "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements can often be
identified by the use of forward-looking terminology such as "believes,"
"expects," "intends," "may," "should" or "anticipates" or similar terminology.
These statements involve risks and uncertainties and are based on various
assumptions. Although the Corporation believes that its expectations are based
on reasonable assumptions, investors and prospective investors are cautioned
that such statements are only projections. The risks and uncertainties noted
below, among others, could cause the Corporation's actual future results to
differ materially from our historic results or the results described in
forward-looking statements made in this report or presented elsewhere by
Management from time to time.
These risks and uncertainties include, but are not limited to, the
following: (a) loan growth and/or loan margins may be less than expected due to
competitive pressures in the banking industry and/or changes in the interest
rate environment; (b) general economic conditions in the Corporation's market
area may be less favorable than expected resulting in, among other things, a
deterioration in credit quality causing increased loan losses; (c) costs of the
Corporation's planned training initiatives, product development, branch
expansion, new technology and operating systems may exceed expectations; (d)
competition among financial and non-financial institutions in the Corporation's
market area that may result in customer turnover and lower interest rate
margins; (e) changes in the regulatory environment (including changes in banking
law and accounting rules), securities markets, general business conditions and
inflation may adversely affect loan demand, credit quality, consumer spending
and saving habits, and interest rate margins; (f) impact of changes in interest
rates on customer behavior; (g) the impact of changes in demographics on branch
locations; (h) technological changes; (i) changes in the value of securities and
investments managed for others may affect the growth level of the Corporation's
non-interest income; (j) changes in the credit of our borrowers, the collateral
securing assets or other aspects of credit quality; and (k) our ability to
manage the risks involved in the foregoing. These risks and uncertainties are
all difficult to predict and most are beyond the control of the Corporation's
Management.
The Corporation undertakes no obligation to publicly release any revisions
to the forward-looking statements to reflect events or circumstances after the
date of this report.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The accounting and reporting policies of the Corporation conform with the
accounting principals generally accepted in the United States of America and
general practices within the financial services industry. The preparation of the
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
ALLOWANCE FOR CREDIT LOSSES The Corporation considers that the
determination of the allowance for loan losses involves a higher degree of
judgment and complexity than its other significant accounting policies. The
balance in the allowance for loan losses is determined based on Management's
review and evaluation of the loan portfolio in relation to past loss experience,
the size and composition of the portfolio, current economic events and
conditions, and other pertinent factors, including Management's assumptions as
to future delinquencies, recoveries and losses. All of these factors may be
susceptible to significant change. To the extent actual outcomes differ from
Management's estimates, additional provisions for loan losses may be required
that would adversely impact earnings in future periods.
INCOME TAXES
Under the liability method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities. Deferred tax assets are subject to Management's
judgment based upon available evidence that future realization is more likely
than not. If Management determines that the Corporation may be unable to realize
all or part of the net deferred tax assets in the future, a direct charge to
income tax expense may be required to reduce the recorded value of the net
deferred tax asset to the expected realizable amount.
EARNINGS AND DIVIDEND SUMMARY
Net income for the three months ended March 31, 2004 was $1.50 million, a
decrease of $52 thousand or 3.4 % from $1.55 million for the same period in
2003. The decrease in net income is the direct result of an after tax gain of
$214 thousand from the sale of the Bank's credit card portfolio in 2003 which
was not present in 2004. The decrease in net income for the three-month period
ended March 31, 2004 was impacted by a decrease in non-interest income due to
lower gains and fees on the sale of residential mortgages and an increase in
non-interest expense partially offset by increases in net-interest income. The
specific components of non-interest income and expense are discussed on pages 14
and 15. Basic earnings per share for the three months ending March 31, 2004 and
2003 were $0.33 and $0.35 per share, respectively. Cash dividends declared
during the three-month period ended March 31, 2004 were $0.1375 an increase of
1.85% from $0.135 per share for the same period in 2003. Over the past ten
years, the Corporation's practice has been to pay a dividend of at least 35.0%
of net income.
March December
------------------------- ---------
2004 2003 2003
---- ---- ----
SELECTED RATIOS
Return on average assets 0.87% 0.98% 0.88%
Return on average equity 11.37% 12.53% 11.48%
Earnings retained 57.96% 61.37% 58.07%
Dividend payout ratio 42.04% 38.63% 41.93%
Book value per share $11.77 $11.16 $11.46
The table of "Consolidated Average Balance Sheet and Taxable Equivalent
Income/Expense and Rates" on page 15 may assist the reader in the following
discussion.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
NET INTEREST INCOME
Net interest income is the difference between interest income earned on
interest-earning assets and interest expense paid on interest-bearing
liabilities. Net interest income on a tax equivalent basis for the three-month
periods ended March 31, 2004 was $7.1 million, an increase of 10.6% from $6.4
million for the same period in 2003. The increase in tax equivalent net interest
income can be attributed to an increase in the average balance of
interest-earning assets when compared to the same period last year, partially
offset by decreases in the average interest rate earned on interest-earning
asset and a decrease in the yields paid on interest-bearing liability.
The average net yield on interest-earning assets, on a tax equivalent basis
was 4.34% for the three-month period ended March 31, 2004, compared to 4.31% for
the same period in 2003, an increase of 0.70% or 3 basis points (one basis point
is equal to 1/100 of a percent). The average yield on interest-earning assets
decreased 4.5% or 25 basis points to 5.36% in 2004 compared to 5.61% in 2003.
The decrease is primarily due to a 71 basis point or 11.1% decrease in yield on
loans and leases partially offset by a 40 basis point or 10.4% increase in yield
on the investment securities. The average yield paid on interest-bearing
liabilities decreased 21.0% or 34 basis points to 1.28% in 2004 from 1.62% in
2003. The decrease is due to the lowering of interest rates paid on deposit
accounts. Interest rates and pricing competition may continue to put pressure on
our net-interest margin and may adversely impact net-interest income in future
time periods.
Average interest-earning assets increased approximately $58.9 million or
9.9% to $654.4 million during the three-month period ending March 31, 2004,
compared to $595.4 million during the same period last year. The increase in
average interest-earning assets was the result of a $1.9 million or 1.5%
increase in investment securities and a $78.5 million or 17.9% increase in
average total loans, partially offset by a $21.5 million or 74.0% decrease in
average federal funds sold and other overnight investments.
Average interest-bearing liabilities increased approximately $41.3 million
or 8.6% to $521.5 million during the three-month period ending March 31, 2004,
compared to $480.2 million during the same period last year. The increase in
average interest-bearing liabilities was the result of a $12.9 million or 2.8%
increase in interest-bearing deposits and an $18.5 million or 82.5% increase in
Federal Home Loan Bank advances and other borrowings, partially offset by a
11.1% or $13.8 million decrease in certificates of deposits and other time
deposits.
NET YIELD ON INTEREST EARNING ASSETS
Three-Months
Ended March 31,
----------------------
2004 2003
---- ----
Yield on Interest-Earning Assets 5.36% 5.61%
Yield on Interest Bearing Liabilities 1.28% 1.62%
----- -----
Net Interest Spread 4.08% 3.99%
Contribution of Interest-Free Funds 0.26% 0.32%
----- -----
Net Yield on Interest-Earning Assets 4.34% 4.31%
===== =====
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
INTEREST INCOME ON FEDERAL FUNDS SOLD AND OTHER OVERNIGHT INVESTMENTS
Interest income on federal funds sold and other overnight investments for
the three-month period ended March 31, 2004 decreased $74.0 thousand or 79.6% to
$19 thousand when compared to the same period in 2003. This decrease is
primarily the result of a $21.5 million or 74.0% decrease in the average balance
of federal funds sold and other overnight investments from $29.1 million in 2003
to $7.6 million in 2004 and a 21.9% or 28 basis point decrease on rates earned.
The decrease in the average balance of federal funds sold and overnight
investments can be attributed to strong loan growth in the first quarter of
2004.
INTEREST INCOME ON INVESTMENT SECURITIES
On a tax equivalent basis, interest income on investment securities
increased 11.8% for the three-month period ended March 31, 2004 to approximately
$1.4 million compared to $1.2 million during the same period in 2003. The
increase was primarily the result of a 10.4% or 40 basis point increase on the
rates earned on such investments as well as a 1.5% or $ 1.8 million increase in
the average balance of investment securities to $129.0 million on a tax
equivalent basis. The increase in average investment securities was the result
of the Corporation's increased cash position due to increased deposits generated
by our new and existing branch locations and Management's decision to invest
excess liquidity in investment securities.
INTEREST INCOME ON LOANS AND LEASES
Interest income on loans, on a tax equivalent basis, generated by the
Corporation's loan portfolio increased 4.8% to $7.4 million for the three-month
period ended March 31, 2004 compared to $7.0 million at March 31, 2003. The
increase in interest income for the three-month period ended March 31, 2004 is
the direct result of a $78.5 million or 17.9% increase in the average balance of
loans and leases outstanding compared to the same period in 2003, partially
offset by a 11.1% or 71 basis point decrease on rates earned on the portfolio.
The low interest rate environment has resulted in substantial decreases in
interest rates earned on loans and leases as loans have been repriced to current
market rates due both to contractual terms and negotiation or refinancing.
Interest rate competition may result in the continuation of lowering yields.
INTEREST EXPENSE ON DEPOSIT ACCOUNTS
Interest expense on deposit accounts decreased 30.4% for the three-month
period ended March 31, 2004 to approximately $1.2 million compared to $1.7
million for the same period in 2003. The decrease is primarily the result of a
32.7% or 49 basis point decrease on rates paid on interest-bearing deposits.
This decrease was partially offset by a 2.8% or $12.9 million increase in
average interest-bearing deposits to $465.1 million when compared to the same
period in 2003.
Competition for deposits from non-banking institutions such as credit
unions and mutual fund companies continues to be strong. Despite the
competition, the Corporation's deposit base continues to grow and is expected to
continue to grow as we open new branches and attract new customers with new
services at existing branches. The Corporation continually explores for new
branch sites to expand its core deposit base.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
INTEREST EXPENSE ON FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
Interest expense on Federal Home Loan Bank ("FHLB") and other borrowings
increased $144 thousand or 80.0% to $324 thousand for the three-month period
ended March 31, 2004 from $180 thousand when compared to the same period in
2003. The need for borrowing has increased over the last several quarters to
support loan growth. FHLB borrowing has been a good low cost alternative to
deposits to support loan growth. Average FHLB and other borrowings increased to
$41.0 million as of March 31, 2004 compared to $22.5 million during the same
period in 2003. Borrowings at any time may consist of one or more of the
following: FHLB Overnight or Term Advances and advances under agreements with
our correspondent banks.
PROVISION FOR LOAN AND LEASE LOSSES
During the first quarter of 2004, the Corporation recorded a $300 thousand
provision for loan and lease losses compared to $394 thousand for the same
period in 2003, a decrease of 23.9%. The allowance for loan losses as a
percentage of total loans was 1.14% as of March 31, 2004, 1.46% as of March 31,
2003, and 1.15% as of December 31, 2003. Management believes that the allowance
for loan losses is adequate based on its current assessment of probable and
estimated losses. See the section titled "Allowance For Loan and Lease Losses"
for additional discussion.
NON-INTEREST INCOME
Total non-interest income decreased 16.8% to $2.4 million for the three
months ended March 31, 2004, compared to $2.9 million in the same period of
2003. The various components of non-interest income are discussed below.
The primary reason for the decrease in total non-interest income is that in
2003, the Corporation sold its Credit Card portfolio to Elan Financial Services
and recognized a gain of $306 thousand. This was a one-time transaction and
there was no comparable transaction in 2004. Also, gains and fee income
generated on the sale of residential mortgages for the three-month period ended
March 31, 2004 decreased $270 thousand from $411 thousand to $141 thousand
compared to the same period in 2003. The decrease is primarily due to a lower
volume of originations of residential mortgages during the three-months ended
March 31, 2004 as compared to the same period in 2003.
The largest component of non-interest income is Trust and Investment
Services revenue, which increased $164 thousand or 21.0% to $ 947 thousand for
the three-months ended March 31, 2004 compared with the same period in 2003.
Trust and Investment Services income is based primarily on the market value of
assets under management. The increase in Trust and Investment Services revenue
is the result of a 12.4 % increase in the market value of assets under
management, from $494.3 million at March 31, 2003 to $555.7 million at March 31,
2004. Trust and Investment Services revenue also increased due to an increase in
estate revenue recognized during the quarter.
Gains on the sale of investment securities decreased $5 thousand for the
three-month period ended March 31, 2004 to $53 thousand as compared to $58
thousand in the same period in 2003. These gains were realized as a result of
normal portfolio management.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
The Corporation has operating lease agreements with several customers; the
income on these leases is classified as "Rental Income". Rental Income on
operating lease agreements for the three-month period ended March 31, 2004
decreased $58 thousand from $251 thousand to $193 thousand when compared to the
same period in 2003. The Corporation did not add any significant volume of these
types of leases in 2003 or for the three-month period ended March 31, 2004. See
related depreciation expense in the non-interest expense section.
Gains on the sale of premises and other real estate owned ("OREO") were $25
thousand for the three-months ended March 31, 2004. There were no gains on sale
of premises and OREO for the three-month period ended March 31, 2003. OREO
balances increased $1.1 million from March 31, 2003 to $1.5 million at March 31,
2004 as our Credit Administration Department continues to reduce non-performing
loans.
Other non-interest income includes ATM surcharge revenue, STAR / Visa
Check Card revenue, safe deposit box income, merchant services income, loan fee
income, miscellaneous loan income, rental income and other miscellaneous income.
Other non-interest income decreased $24 thousand for the three-month period
ended March 31, 2004 when compared to the same period in 2003.
NON-INTEREST EXPENSE
Total non-interest expense for the first quarter of 2004 increased 4.1% to
$6.9 million compared to the same period in 2003. The various components of
non-interest expense are discussed below.
First quarter 2004 salaries and employee benefits increased 5.4% to $3.9
million for the three-month period ended March 31, 2004 compared to the same
period in 2003. Higher employment and annual employee salary increases and a
proportional increase in employee benefits are primarily responsible for the
increase. At March 31, 2004, the Corporation employed 270 full time and 26 part
time employees compared to 238 full time and 44 part time employees at March 31,
2003. The additional employees were needed for our new branches and other
departments.
Net occupancy, equipment and data processing expense decreased 0.97% to
$1.3 million for the three-month period ended March 31, 2004 compared to the
same period last year. The decrease is the result of decreases in depreciation
on core systems and hardware expense.
Depreciation on operating leases increased 0.6% to $172 thousand for the
three-month period ended March 31, 2004 from $171 thousand when compared at the
same period last year. This depreciation expense is the result of operating
lease agreements the Corporation has with several of our customers. The income
associated with these operating leases is classified as Rental Income.
Expenses for professional services increased $77 thousand or 30.0% to $334
thousand for the three-month period ended March 31, 2004 compared to the same
period in 2003. The increase is the result of increased consultant, accounting,
and legal fees.
Other non-interest expense includes marketing expenses to promote our full
array of products and services and our corporate image. Total other non-interest
expense decreased 0.4% to $1.0 million for the three months ended March 31, 2004
compared to the same period in 2003.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
CONSOLIDATED AVERAGE BALANCE SHEET
AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES FOR THE
THREE MONTHS ENDED MARCH 31,
(Dollars in thousands) 2004 2003
------------------------------ ----------------------------
Daily Daily
Average Average
ASSETS Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Federal funds sold $ 7,577 $ 19 1.00% $ 29,107 $ 93 1.28%
Interest-bearing deposits in banks 372 1 1.08% 242 1 1.65%
Investment securities
Taxable 104,196 1,103 4.23% 125,979 1,208 3.84%
Tax-exempt(1) 24,826 271 4.36% 1,194 21 6.94%
------- ----- ------- -----
Total investment securities 129,022 1,374 4.26% 127,173 1,229 3.86%
------- ----- ------- -----
Loans and leases (2)
Taxable 508,487 7,247 5.70% 434,304 6,949 6.40%
Tax-exempt(1) 8,935 124 5.57% 4,619 86 7.44%
------- ----- ------- -----
Total loans and leases 517,422 7,371 5.70% 438,923 7,035 6.41%
------- ----- ------- -----
Total interest-earning assets 654,393 8,765 5.36% 595,445 8,358 5.61%
Non-interest earning assets
Allowance for possible loan losses (5,959) (6,230)
Cash and due from banks 21,949 24,325
Other assets 22,546 21,024
------- -------
Total assets $692,929 $634,564
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings, NOWS & money market deposits $354,632 $ 497 0.56% $327,980 $ 727 0.89%
Certificates of deposits and other time 110,470 683 2.47% 124,525 968 3.12%
------- ----- ------- -----
Total interest bearing deposits 465,102 1,180 1.01% 452,232 1,695 1.50%
Securities sold under repurchase agreements - - - 540 3 2.22%
Junior subordinated debentures 15,450 165 4.27% - - -
Guaranteed Preferred beneficial interest in
Corporation's subordinated debentures - - - 5,000 63 5.04%
Federal Home Loan Bank advances and
other borrowings 40,985 324 3.16% 22,461 180 3.21%
------- ----- ------- -----
Total interest bearing liabilities 521,538 1,669 1.28% 480,233 1,941 1.62%
------- ----- ------- -----
Non-interest bearing liabilities
Non-interest bearing demand deposits 113,347 99,417
Other liabilities 5,244 5,346
-------- -------
Total liabilities 640,128 584,996
Stockholders' equity 52,801 49,568
-------- -------
Total liabilities and stockholders' equity $692,929 $634,564
======= =======
Net interest income $7,096 $6,417
===== =====
Net yield on interest earning assets 4.34% 4.31%
===== =====
(1) The indicated income and annual rate are presented on a taxable equivalent
basis using the federal marginal rate of 34% adjusted for the TEFRA 20%
interest expense disallowance for 2004 and 2003.
(2) Non-accruing loans are included in the average balance.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
INCOME TAXES
Income tax expense for the three-month period ended March 31, 2004 was $642
thousand, compared to $664 thousand in the same period last year. This
represents an effective tax rate of 30.0% for the first quarter of 2004 and
2003.
LIQUIDITY MANAGEMENT AND INTEREST RATE SENSITIVITY
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for business expansion. Liquidity management addresses the
Corporation's ability to meet deposit withdrawals either on demand or at
contractual maturity, to repay borrowings as they mature and to make new loans
and investments as opportunities arise. Liquidity is managed on a daily basis
enabling Management to monitor changes in liquidity and to react accordingly to
fluctuations in market conditions. The primary sources of liquidity for the
Corporation is funding available from, deposit growth, FHLB Borrowings and cash
flow from the investment and loan portfolios. Deposits consist of NOW,
money-market, savings, tiered savings, large and small dollar certificates of
deposit and non-interest bearing demand deposit accounts. The Corporation
considers funds from NOW, money market, savings and certificates less than $100
thousand as "core" deposit because of the historical stability of such sources
of funds. Details of core deposits, non-interest bearing demand deposit accounts
and other deposit sources are highlighted in the following table:
DEPOSIT ANALYSIS
(Dollars in thousands) March 31, 2004 December 31, 2003 Average Balance
--------------------------- -------------------------- ------- -------------
Average Effective Average Effective Dollar Percentage
Deposit Type Balance Yield Balance Yield Variance Variance
- ------------ ------- ----------- -------- ------------ -------- -------------
NOW Accounts $ 93,834 0.13% $ 88,518 0.19% $ 5,316 6.01%
Money Market 27,345 0.48% 26,051 0.70% 1,294 4.97%
Statement Savings 65,011 0.54% 63,032 0.77% 1,979 3.14%
Other Savings 1,343 0.60% 1,522 0.79% (179) (11.76%)
CD's Less than $100,000 88,978 2.31% 96,773 2.93% (7,795) (8.05%)
------- ------- ------
Total Core Deposits 276,511 0.96% 275,896 1.33% 615 0.22%
Non-Interest Bearing
Demand Deposit Accounts 113,347 107,334 - 6,013 5.60%
------- ------- ------
Total Core and Non-Interest
Bearing Deposits 389,858 0.68% 383,230 0.96% 6,628 1.73%
------- ------- ------
Tiered Savings 167,099 0.82% 159,220 1.04% 7,879 4.95%
CD's Greater than $100,000 21,492 3.16% 22,365 2.48% (873) (3.90%)
------- ------- ------
Total Deposits $578,449 0.82% $564,815 1.04% $13,634 2.41%
======= ======= ======
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
The Bank, as a member of the FHLB, maintains several credit facilities.
During the first quarter of 2004, average FHLB advances were approximately $41.0
million and consisted of term advances with a variety of maturities. The average
interest rate on these advances was approximately 3.13%. The Bank currently has
a maximum borrowing capacity with the FHLB of approximately $139.6 million. FHLB
advances are collateralized by a pledge on the Bank's portfolio of unencumbered
investment securities, certain mortgage loans and a lien on the Bank's FHLB
stock.
The goal of interest rate sensitivity management is to avoid fluctuating
net interest margins, and to enhance consistent growth of net interest income
through periods of changing interest rates. Such sensitivity is measured as the
difference in the volume of assets and liabilities in the existing portfolio
that are subject to repricing in a future time period. The Corporation's net
interest rate sensitivity gap within one year is a negative $213.2 million or
(30.2%) of total assets at March 31, 2004 compared with a negative $134.2
million or 20.4% of total assets at December 31, 2003. The Corporation's gap
position is one tool used to evaluate interest rate risk and the stability of
net interest margins. Another tool that management uses to evaluate interest
rate risk is a computer simulation model that assesses the impact of changes in
interest rates on net interest income, net-income under various interest rate
forecasts and scenarios. Management has set acceptable limits of risk within its
Asset Liability Committee ("ALCO") policy and monitors the results of the
simulations against these limits quarterly. As of the most recent quarter end
all results are within policy limits and indicate an acceptable level of
interest rate risk. Management monitors interest rate risk as a regular part of
corporate operations with the intention of maintaining a stable net interest
margin.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
INTEREST SENSITIVITY ANALYSIS
AS OF MARCH 31, 2004
One Over
(Dollars in thousands) Within through five Non-rate
one year five years years sensitive Total
------------ ---------- ------------ --------- ----------
ASSETS
Federal funds sold $ 13,700 $ -- $ -- $ -- $ 13,700
Investment securities 22,807 51,614 49,503 -- 123,924
Interest bearing deposits in banks 412 -- -- -- 412
Loans and leases 195,249 235,824 94,087 (6,000) 519,160
Cash and due from banks -- -- -- 27,738 27,738
Premises and equipment -- -- -- 12,836 12,836
Other assets -- -- -- 9,156 9,156
--------- -------- -------- --------- --------
Total assets $ 232,168 $ 287,438 $ 143,590 $ 43,730 $ 706,926
========= ======== ======== ========= ========
LIABILITIES AND CAPITAL
Non-interest bearing deposits $ -- $ -- $ -- $ 128,036 $ 128,036
Interest bearing deposits 426,934 27,456 8,871 -- 463,261
FHLB term advance 2,858 36,677 2,702 -- 42,237
Junior subordinated debentures 450 -- -- -- 450
Guaranteed preferred beneficial
Interest in Corporation's
Subordinated debentures 15,000 -- -- -- 15,000
Other liabilities 138 -- 4,447 -- 4,585
Capital -- -- -- 53,357 53,357
-------- -------- -------- --------- --------
Total liabilities & capital $ 445,380 $ 64,133 $ 16,020 $ 181,393 $ 706,926
======== ======== ======== ========= ========
Net interest rate
sensitivity gap $(213,212) $ 223,305 $ 127,570 $ (137,663)
======== ======== ======== =========
Cumulative interest rate
sensitivity gap $(213,212) $ 10,093 $ 137,663 $ --
======== ======= ======== ==========
Cumulative interest rate
sensitivity gap divided
by total assets (30.2%) 1.4% 19.5%
========= ========== =========
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is an amount that Management
believes will be adequate to absorb possible loan losses on existing loans that
may become uncollectible and is established based on Management's evaluations of
the collectibility of loans. The evaluations take into consideration such
factors as changes in the nature and volume of the loan portfolio, overall
portfolio quality, adequacy of collateral, review of specific problem loans, and
current economic conditions that may affect our borrower's ability to pay.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
ANALYSIS OF CHANGES IN THE ALLOWANCE FOR LOAN AND LEASE LOSSES AND
COMPARISON OF LOANS OUTSTANDING
(Dollars in thousands) March 31, December 31,
------------------------- ----------------------
2004 2003 2003
----------- ----------- ----------------------
Balance at beginning of period $ 5,864 $ 6,230 $ 6,230
--------- --------- ---------
Provision for loan and lease losses 300 394 2,519
--------- --------- ---------
Recoveries of loans previously charged-off 41 120 214
Loans charged-off (205) (355) (3,099)
--------- --------- ---------
Net loans charged-off (164) (235) (2,885)
--------- --------- ---------
Balance at end of period $ 6,000 $ 6,389 $ 5,864
========= ========= =========
Period-end loans outstanding $ 525,160 $ 436,348 $ 511,249
Average loans outstanding $ 517,422 $ 438,923 $ 470,413
Allowance for loan and lease losses as a
percentage of period-end loans outstanding 1.14% 1.46% 1.15%
Ratio of net charge-offs to average loans
outstanding (annualized) 0.13% 0.21% 0.61%
Non-performing loans include loans on non-accrual status and loans past due
90 days or more and still accruing. The Corporation's policy is to write down
all non-performing loans to net realizable value based on current assessments of
the value of collateral securing such loans and leases. Non-performing loans are
primarily collateralized by real estate and are in the process of collection. As
of March 31, 2004, the level of non-performing loans has decreased $3.6 million
from March 31, 2003, and non-performing loans decreased $1.3 million from
December 31, 2003. Management is not aware of any loans other than those
included in the following table that would be considered potential problem loans
and cause Management to have doubts as to the borrower's ability to comply with
loan repayment terms. Non-performing loans and leases reduce the Corporation's
earnings because interest income is not earned on such assets. Management has
taken aggressive steps to control current and future credit quality issues. The
following chart represents detailed information regarding non-performing loans
and leases.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
NON-PERFORMING LOANS AND ASSETS
(Dollars in thousands) March 31, December 31,
------------------------- -------------
2004 2003 2003
----------- ----------- -------
Past due over 90 days and still accruing $ 79 $ 72 $ 597
Non-accrual loans and leases 2,339 5,965 3,093
-------- ------- -------
Total non-performing loans and leases 2,418 6,037 3,690
Other real estate owned 1,464 368 965
-------- ------- -------
Total non-performing assets $ 3,882 $ 6,405 $ 4,655
======== ======= =======
Non-performing loans and leases as a percentage
of total loans and leases 0.46% 1.38% 0.72%
Allowance for loan and lease losses as a percentage
of non-performing loans and leases 248.06% 105.83% 158.92%
Non-performing assets as a percentage of
total loans and other real estate owned 0.74% 1.47% 0.91%
Allowance for loan and lease losses as a
percentage of non-performing assets 154.51% 99.75% 125.97%
Other real estate owned ("OREO") represents residential and commercial real
estate that had secured non-performing loans that the Bank acquired through
foreclosure or other collection efforts and that is held for sale. The value of
OREO has been written down to realizable value (net of estimated disposal costs)
based on professional appraisals. The increase in OREO in the first quarter was
due to the addition of one property. The Corporation is actively marketing all
OREO property.
LOAN IMPAIRMENT
The Corporation identifies a loan as impaired when it is probable that
interest and principal will not be collected according to the contractual terms
of the loan agreement. The accrual of interest is discontinued on impaired loans
and no income is recognized until all recorded amounts of interest and principal
are recovered in full.
FASB 114 "Accounting by Creditors for Impairment of Loans" requires the
Corporation to examine commercial and non-residential mortgage loans on
non-accrual status for impairment. The balance of impaired loans was $2.3
million, $3.1 million, and $5.8 million at March 31, 2004, December 31, 2003,
and March 31, 2003, respectively. The associated allowance for impaired loans
was $231 thousand, $309 thousand and $938 thousand at March 31, 2004, December
31, 2003, and March 31, 2003, respectively.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
For the three months ended March 31, 2004, activity in the allowance for
impaired loan losses included a provision of $19 thousand, principal payments of
$45 thousand, charge offs of $8 thousand and recoveries of $0. There was $23
thousand applied towards accrued but not paid interest for the three-month
period ended March 31, 2004 while contractual interest amounted to $52 thousand.
Total cash collected on loans for the three-month period ended March 31, 2004
was $449 thousand, $426 thousand was applied to principal and $23 thousand was
applied to interest.
For the three months ended March 31, 2003, activity in the allowance for
impaired loan losses included a provision of $203 thousand, charge offs of $30
thousand and recoveries of $10 thousand. There was no interest income recorded
for the three-month period ended March 31, 2003 while contractual interest
amounted to $104 thousand. Total cash collected on loans for the three-month
period ended March 31, 2003 was $756 thousand, $655 thousand was applied to
principal and $101 thousand was applied to recovery.
CAPITAL ADEQUACY
The Corporation is subject to Risk-Based Capital Guidelines adopted by the
Federal Reserve Board ("FRB") for bank holding companies. The Corporation is
also subject to similar capital requirements adopted by the Office of the
Comptroller of the Currency. Under these requirements, the regulatory agencies
have set minimum thresholds for Tier I Capital, Total Capital, and Leverage
ratios. At March 31, 2004, both the Corporation's and the Bank's capital
exceeded all minimum regulatory requirements, and were considered "well
capitalized" as defined in the regulations issued pursuant to the FDIC
Improvement Act of 1992. The Corporation's Risk-Based Capital Ratios, shown
below, have decreased from March 31, 2003 due to lower than expected earnings in
2003, have been computed in accordance with regulatory accounting policies.
March 31, December 31,
RISK-BASED -------------------------- ----------------- "Well Capitalized"
CAPITAL RATIOS 2004 2003 2003 Requirements
- -------------- ---------- ---------- ---- ----------------------
Corporation
Leverage Ratio 9.73% 8.42% 9.71% 5.00%
Tier I Capital Ratio 11.87% 11.14% 12.01% 6.00%
Total Risk-Based Capital Ratio 12.93% 12.39% 13.07% 10.00%
Bank
Leverage Ratio 8.82% 8.16% 8.68% 5.00%
Tier I Capital Ratio 10.74% 10.80% 10.72% 6.00%
Total Risk-Based Capital Ratio 11.80% 12.05% 11.79% 10.00%
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
The Bank is not under any agreement with the regulatory authorities nor is
it aware of any current recommendations by the regulatory authorities that, if
they were to be implemented, would have a material affect on liquidity, capital
resources or operations of the Corporation.
The Corporation and the Bank's risk-based capital ratios were positively
impacted by the July 11, 2002 ($5.0 million) and November 13, 2003 ($10.0
million) issuance of guaranteed preferred beneficial interest in the
Corporation's subordinated debentures. The banking regulatory agencies have not
issued any guidance that would change the regulatory capital treatment for the
trust-preferred securities issued by First Chester County Capital Trust I & II
based on the adoption of FIN 46(R). However, as additional interpretations from
the available, management will reevaluate its potential impact to its Tier I
capital calculation under such interpretations.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Corporation's assessment of its
sensitivity to market risk since its presentation in the 2003 Annual Report,
filed with the SEC via EDGAR as an exhibit to its Form 10-K for the fiscal year
ended December 31, 2003. Please refer to the "Management's Discussion and
Analysis" section on pages 18-30 of the Corporation's Annual Report for more
information.
ITEM 4. CONTROLS AND PROCEDURES
Certifications. Included with this Quarterly Report as Exhibits 31.1, 31.2, 31.3
and 31.4 are four certifications (the "Section 302 Certifications"), one by each
of our principal executive and financial officers (the "Principal Officers") and
our President and our Controller (our principal accounting officer). This
section of the Quarterly Report contains information concerning the evaluations
of our disclosure controls and procedures and internal control over financial
reporting that are referred to in the Section 302 Certifications. This
information should be read in conjunction with the Section 302 Certifications
for a more complete understanding of the topics presented.
Evaluation of Our Disclosure Controls and Procedures. The Securities and
Exchange Commission (the "SEC") requires that as of the end of the quarter
covered by this Report, the Principal Officers evaluate the effectiveness of the
design and operation of our disclosure controls and procedures and report on the
effectiveness of the design and operation of our disclosure controls and
procedures.
"Disclosure controls and procedures" mean the controls and other procedures that
are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934 (the
"Exchange Act"), such as this Quarterly Report, is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
promulgated by the SEC. Disclosure controls and procedures are also designed
with the objective of ensuring that such information is accumulated and
communicated to our management, including the Principal Officers, as
appropriate, to allow timely decisions regarding required disclosure.
Evaluation of Our Internal Control Over Financial Reporting. The SEC also
requires that the Principal Officers certify certain matters regarding our
internal control over financial reporting.
"Internal control over financial reporting" means the process designed by, or
under the supervision of, our Principal Officers, and effected by our board of
directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles and includes those policies and procedures that: (i)
pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of the assets of the issuer;
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the issuer are
being made only in accordance with authorizations of management and directors of
the issuer; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the issuer's
assets that could have a material effect on the financial statements.
23
ITEM 4. CONTROLS AND PROCEDURES - Continued
Among the matters our Principal Officers certify in the Section 302
Certifications are whether all "significant deficiencies" or "material weakness"
in the design or operation of our internal control over financial reporting that
are likely to adversely affect our ability to record, process, summarize and
report financial information have been disclosed to our auditors and the Audit
Committee of our Board of Directors. "Significant deficiencies" has the same
meaning as the term "reportable conditions" in auditing literature. Both terms
represent deficiencies in the design or operation of internal control over
financial reporting that could adversely affect a company's ability to record,
process, summarize and report financial data consistent with the assertions of
management in a company's financial statements. A "material weakness" is defined
in the auditing literature as a particularly serious reportable condition where
the design or operation of one or more internal control over financial reporting
components does not reduce to a relatively low level the risk that misstatements
caused by error or fraud may occur in amounts that would be material in relation
to the financial statements and not be detected within a timely period by
employees in the normal course of performing their assigned functions. A
"material weakness" constitutes a greater deficiency than a "significant
deficiency, but an aggregation of significant deficiencies may constitute a
material weakness in a company's internal control over financial reporting.
Limitations on the Effectiveness of Controls. Our management, including the
Principal Officers, does not expect that our disclosure controls and procedures
or our internal control over financial reporting will prevent all errors and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, as opposed to absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within an entity have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, a system of controls may
become inadequate because of changes in conditions, or the degree of compliance
with the policies or procedures may deteriorate. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
Conclusions about the Effectiveness of the Disclosure Controls and Procedures.
As required by Rule 13a-15(b), the Corporation's management, including our
Principal Officers, conducted an evaluation as of the end of the period covered
by this report, of the effectiveness of the Corporation's disclosure controls
and procedures. Based on that evaluation, the Principal Officers concluded that,
subject to the limitations noted above, our disclosure controls and procedures
are effective to provide reasonable assurance that the disclosure controls and
procedures will meet their objectives.
Changes in Internal Control over Financial Reporting. As required by Rule
13a-15(d), the Corporation's management, including the Principal Officers
conducted an evaluation of the Corporation's internal control over financial
reporting to determine whether any changes occurred during the period covered by
this report that have materially affected, or are reasonably likely to
materially affect, the Corporation's internal control over financial reporting.
Based on that evaluation, there has been no such change during the quarter
covered by this report.
24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
Various actions and proceedings are presently pending to which
the Corporation is a party. These actions and proceedings
arise out of routine operations and, in Management's opinion,
will not, either individually or in the aggregate, have a
material adverse effect on the consolidated financial position
of the Corporation and its subsidiaries.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
-------------------------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES
(a) (b) (c) (d)
Total Average Total Number of Shares Maximum Number (or
Number Price Paid (or Units) Purchased Approximate Dollar Value) of
Period of Shares per Share as Part of Publicly Shares (or Units) that may be
Purchased (or unit) Announced Plans or Programs may Yet Be Purchased
--------- ---------- --------------------------- -----------------------------
January 1 to January 31, 2004
3,000 $26.24 3,000 $8,713,470
February 1 to February 29, 2004
12,180 $26.17 12,180 $8,394,706
March 1 to March 31, 2004 -- -- -- $8,394,706
Total 15,180 $26.21 15,180 $8,394,706
*All of the foregoing shares were purchased pursuant to the Corporation's
program to repurchase up to $10.0 million of the Corporation's common stock that
was publicly announced on October 16, 2003.
Item 3. Defaults upon Senior Securities
-------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Annual Meeting of Shareholders of the Corporation was held
on April 27, 2004 (the "Meeting"). Notice of the Meeting was
mailed to shareholders of record on or about March 24, 2004,
together with proxy solicitation materials prepared in
accordance with Section 14(a) of the Securities Exchange Act
of 1934, as amended, and the regulations promulgated there
under.
25
PART II - OTHER INFORMATION - CONTINUED
The matters submitted to a vote of shareholders at the meeting were the
following:
1. The election of three Class II directors, with each director
to serve until the 2007 Annual Meeting of Shareholders and
until the election and qualification of his or her respective
success; and
2. The approval of an amendment to the Corporation's Articles of
Incorporation to increase the number of authorized shares of
the Corporation's common stock, par value $1.00, from
10,000,000 to 25,000,000; and
3. The ratification of the appointment of Grant Thornton, LLP as
the Corporation's independent public accountants for the year
ending December 31, 2004; and
4. The transaction of such other business as may properly come
before the Annual Meeting and any adjournment thereof, and
matters incident to the conduct of the Annual Meeting.
There was no solicitation in opposition to the nominees of the
Board of Directors for election to the Board of Directors. All
three of the nominees were elected. The number of votes cast
for or withheld as well as the number of abstentions and
broker non-votes for each of the nominees for election to the
Board of Directors were as follows:
Nominee For Withheld
------- --- --------
David L. Peirce 3,482,794 265,344
M. Robert Clarke 3,497,633 250,505
Kevin C. Quinn 3,499,743 248,395
The names of the other directors whose terms of office as
directors continued after the Meeting are as follows: John A.
Featerman III, John S. Halsted, J. Carol Hanson, John J.
Ciccarone, Clifford E. DeBaptiste and John B. Waldron.
The proposal of an amendment to the Corporation's Articles of
Incorporation to increase the number of authorized shares of
the Corporation's common stock, par value of $1.00, from
10,000,000 to 25,000,000.
For Against Abstentions Broker Non-votes
--- ------- ----------- ----------------
3,490,236 219,501 38,401 0
The proposal to ratify the appointment of Grant Thornton, LLP
as the Corporation's independent public accountants for the
year ending December 31, 2004 was ratified. The numbers of
votes cast for or against as well as the number of abstentions
and broker non-votes for the ratification were as follows:
For Against Abstentions Broker Non-votes
--- ------- ----------- ----------------
3,719,019 17,871 11,248 0
There was no other business that came before the Meeting or
matters incident to the conduct of the Meeting.
26
PART II - OTHER INFORMATION - CONTINUED
Item 5. Other Information
-----------------
None
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
3(i). Certificate of Incorporation. Copy of the Corporation's Articles
of Incorporation, as amended.
3(ii). Bylaws of the Corporation, as amended. Copy of the Corporation's
Bylaws, as amended, is incorporated herein by reference to Exhibit 3(ii) to the
Corporation's Annual Report on Form 10-K for the year ended December 31, 2000.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of President
31.3 Rule 13a-14(a) Certification of Treasurer
31.4 Rule 13a-14(a) Certification of Assistant Treasurer
32.1 Section 906 Certification of the Chief Executive Officer
32.2 Section 906 Certification of the President
32.3 Section 906 Certification of the Treasurer
32.4 Section 906 Certification of the Assistant Treasurer
(b) Reports on Form 8-K
-------------------
A Form 8-K was filed with the SEC on January 26, 2004
furnished information related to the earnings for the
year ended December 31, 2003.
27
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.
FIRST CHESTER COUNTY CORPORATION
/s/ John A Featherman III
--------------------------
May 14, 2004 John A. Featherman
Chief Executive Officer
May 14, 2004 /s/ J. Duncan Smith
-------------------
J. Duncan Smith
Treasurer
(Principal Accounting
and Financial Officer)
28
INDEX TO EXHIBITS
The following is a list of the exhibits filed with, or incorporated by
reference into, this Report (those exhibits marked with an asterisk are filed
herewith):
* 3(i). Certificate of Incorporation. Copy of the Corporation's
Articles of Incorporation, as amended.
3(ii). Bylaws of the Corporation, as amended. Copy of the Corporation's
Bylaws, as amended, is incorporated herein by reference to Exhibit 3(ii) to the
Corporation's Annual Report on Form 10-K for the year ended December 31, 2000.
* 31.1 Rule 13a-14(a) Certification of Chief Executive Officer
* 31.2 Rule 13a-14(a) Certification of President
* 31.3 Rule 13a-14(a) Certification of Treasurer
* 31.4 Rule 13a-14(a) Certification of Assistant Treasurer
* 32.1 Section 906 Certification of the Chief Executive Officer
* 32.2 Section 906 Certification of the President
* 32.3 Section 906 Certification of the Treasurer
* 32.4 Section 906 Certification of the Assistant Treasurer
29