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May 6, 2005
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FIRST CHESTER COUNTY CORPORATION
Commission File Number 0-12870
Gentlemen:
Pursuant to the reporting requirements of the Securities and Exchange Act of
1934, we are filing herewith the above listed Registrant's Quarterly Report on
Form 10-Q for the period ended March 31, 2005.
Very truly yours,
/s/ T. Benjamin Marsho
---------------------------------------
T. Benjamin Marsho, Assistant Treasurer
(Principal Accounting and Financial Officer)
TBJ/jd
Enclosures
cc: Patricia A. Gritzan, Esquire, Saul Ewing LLP, Philadelphia, PA
David Burns, CPA, Grant Thornton, Philadelphia, PA
Ward Johnson, VP, First Union Bank, Philadelphia, PA
James Shilling, VP, Kish Bank, Belleville, PA
1
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, 2005, 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. 0-12870.
FIRST CHESTER COUNTY CORPORATION
---------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2288763
------------ ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
9 North High Street, West Chester, Pennsylvania 19380
----------------------------------------------- -----
(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 X No ___ -
The number of shares outstanding of Common Stock of the Registrant as of May 2,
2005 was 5,044,367.
2
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
INDEX
PAGE
Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Statements of Condition
March 31, 2005 (unaudited) and December 31, 2004 4
Consolidated Statements of Income
Three-Months Ended March 31, 2005 and 2004 (unaudited) 5
Consolidated Statements of Cash Flows
Three-Months Ended March 31, 2005 and 2004 (unaudited) 6
Notes to Consolidated Financial Statements 7-9
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-26
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 27
Item 4 - Controls & Procedures 27
Part II. OTHER INFORMATION
Item 1 - Legal Proceedings 28
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 3 - Defaults Upon Senior Securities 28
Item 4 - Submission of Matters to a Vote of Security Holders 28-29
Item 5 - Other Information 30
Item 6 - Exhibits 30
Signatures 31
Index to Exhibits 32
Exhibits 33
3
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(Dollars in thousands) March 31,
2005 December 31,
(unaudited) 2004*
----------- ------------
ASSETS
Cash and due from banks $ 21,522 $ 24,656
Federal funds sold and other overnight investments - 6,500
Interest bearing deposits in banks 230 454
-------- --------
Total cash and cash equivalents 21,752 31,610
-------- --------
Investment securities held-to-maturity (fair value of $10
at March 31, 2005 and $11 at December 31, 2004, respectively) 10 10
Investment securities available-for-sale, at fair value 109,990 140,019
Loans and leases 640,841 618,005
Less: Allowance for loan and lease losses (7,449) (7,213)
-------- --------
Net loans and leases 633,392 610,792
Premises and equipment 13,848 14,137
Other assets 9,403 8,907
-------- --------
Total assets $ 788,395 $ 805,475
======== ========
LIABILITIES
Deposits
Noninterest-bearing $ 126,717 $ 125,452
Interest-bearing (including certificates of deposit over $100
of $29,503 and $33,048 - March 31, 2005 and
December 31, 2004 respectively) 515,853 537,566
-------- --------
Total deposits 642,570 663,018
Federal Home Loan Bank advances and other borrowings 70,799 66,464
Junior subordinated debentures 15,465 15,465
Other liabilities 4,777 5,126
-------- --------
Total liabilities $ 733,611 $ 750,073
-------- --------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00; authorized, 25,000,000 shares;
outstanding, 5,279,633 at March 31, 2005 and 4,799,666 December 31, 2004 5,280 4,800
Additional paid-in capital 1,633 2,052
Retained earnings 54,113 53,749
Accumulated other comprehensive loss (1,401) (78)
Treasury stock, at cost: 240,767 shares and 261,185 shares
at March 31, 2005 and December 31, 2004, respectively (4,841) (5,121)
-------- --------
Total stockholders' equity 54,784 55,402
-------- --------
Total liabilities and stockholders' equity $ 788,395 $ 805,475
======== ========
The accompanying notes are an integral part of these statements.
* Derived from our audited, consolidated financial statements included in our
Annual Report on Form 10-K for the fiscal year ended 12/31/04
4
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(Dollars in thousands - except per share) Three Months Ended
---------------------------
March 31,
---------------------------
2005 2004
------- -------
INTEREST INCOME
Loans and leases, including fees $ 8,918 $ 7,332
Investment securities 1,237 1,287
Federal funds sold and other overnight investments 27 19
Deposits in banks 2 1
--------- ---------
Total interest income 10,184 8,639
--------- ---------
INTEREST EXPENSE
Deposits 1,752 1,180
Junior subordinated debentures 220 165
Federal Home Loan Bank advances and other borrowings 594 324
--------- ---------
Total interest expense 2,566 1,669
--------- ---------
Net interest income 7,618 6,970
Provision for loan and lease losses 507 300
--------- ---------
Net interest income after provision for possible loan losses 7,111 6,670
--------- ---------
NON-INTEREST INCOME
Trust and Investment Services 869 947
Service charges on deposit accounts 473 524
Investment securities gains, net 67 53
Operating lease rental income 228 193
Gains on the sale of fixed assets and OREO 1 25
Gains and fees on the sale of residential mortgages 81 141
Other 565 503
--------- ---------
Total non-interest income 2,284 2,386
--------- ---------
NON-INTEREST EXPENSE
Salaries and employee benefits 4,092 3,875
Occupancy, equipment and data processing 1,383 1,330
Depreciation expense on operating leases 200 172
Bank shares tax 173 125
Professional services 796 334
Other 1,323 1,077
--------- ---------
Total non-interest expense 7,967 6,913
--------- ---------
Income before income taxes 1,428 2,143
INCOME TAXES 410 642
--------- ---------
NET INCOME $ 1,018 $ 1,501
========= =========
PER SHARE DATA
Basic earnings per common share $ 0.20 $ 0.30
========= =========
Diluted earnings per common share $ 0.19 $ 0.29
========= =========
Dividends declared $ 0.1283 $ 0.1238
========= =========
Basic weighted average shares outstanding 5,215,017 4,976,453
========= =========
Diluted weighted average shares outstanding 5,034,483 5,192,946
========= =========
The accompanying notes are an integral part of these statements.
5
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
(Dollars in thousands) March 31,
------------------------------
2005 2004
---- -----
OPERATING ACTIVITIES
Net Income $ 1,018 $ 1,501
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 713 622
Provision for loan and lease losses 507 300
Amortization of investment security premiums
and accretion of discounts 560 179
Amortization of deferred fees on loans 2 (38)
Investment securities (gains), net (67) (53)
(Increase) in other assets (1,818) 662
(Decrease) in other liabilities (349) (18)
------- -------
Net cash provided by operating activities $ 566 $ 3,155
------- -------
INVESTING ACTIVITIES
(Increase) in loans (23,109) (13,979)
Proceeds from sales of investment securities available-for-sale 26,099 12,195
Proceeds from maturities of investment securities available-for-sale 51,764 8,187
Proceeds from maturities of investment securities held to maturity -- 1
Purchases of investment securities available-for-sale (48,327) (13,944)
Purchase of premises and equipment, net (425) (290)
------- -------
Net cash provided by investing activities $ 6,002 $ (7,830)
------- -------
FINANCING ACTIVITIES
Increase in Federal Home Loan advances 4,335 1,694
(Decrease) increase in deposits (20,448) 13,983
(Decrease) increase in securities sold under repurchase agreements
Cash dividends paid (653) (631)
Purchase of Treasury stock 340 96
------- -------
Net cash provided by (used in) financing activities (16,426) 15,142
------- -------
NET DECREASE IN CASH AND CASH
EQUIVALENTS (9,858) 10,467
Cash and cash equivalents at beginning of year 31,610 31,383
------- -------
Cash and cash equivalents at end of period $ 21,752 $ 41,850
======= =======
The accompanying notes are an integral part of these statements.
6
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(UNAUDITED)
1. BASIS OF PRESENTATION
The foregoing 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, 2004.
The results of operations for the three-month period ended March
31, 2005 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, 2005.
2. EARNINGS PER SHARE
Three Months ended March 31, 2005
- ---------------------------------
Income Shares Per Share
(numerator) (denominator) Amount
----------- ------------- ---------
Basic earnings per share
Net income available to common stockholders $1,018 5,034,483 $ 0.20
Effect of Dilutive Securities
Options to purchase common stock -- 180,534 (0.01)
----- --------- -----
Diluted earnings per share
Net income available to common stockholders $1,018 5,215,017 $ 0.19
===== ========= =====
Three Months ended March 31, 2004
- ---------------------------------
Income Shares Per Share
(numerator) (denominator) Amount
----------- ------------- ---------
Basic earnings per share
Net income available to common stockholders $1,501 4,976,453 $ 0.30
Effect of Dilutive Securities
Options to purchase common stock -- 216,494 (.01)
----- --------- -----
Diluted earnings per share
Net income available to common stockholders $1,501 5,192,946 $ 0.29
===== ========= =====
7
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(UNAUDITED)
3. COMPREHENSIVE INCOME
Components of comprehensive income are presented in the following
chart:
Three Months Ended
March 31,
------------------------
2005 2004
------- -------
Unrealized gains on securities:
Unrealized gains (losses) arising in period $ 1,707 $ 806
Reclassification adjustment -- --
Net unrealized gains (losses) 67 53
------ -----
Other comprehensive income before taxes 1,774 859
Income tax expense (450) (218)
------ -----
Other comprehensive income 1,324 641
------ -----
Comprehensive income (losses) $ 2,342 $2,142
====== =====
4. JUNIOR SUBORDINATED DEBENTURES
Management has determined that First Chester County Capital Trust I
& II qualify as variable interest entities under FASB Interpretation
Number ("FIN") 46, as revised. First Chester County Capital Trust I &
II issued mandatorily redeemable preferred securities to investors and
loaned the proceeds to the Corporation. First Chester County Capital
Trust I & II are included in the Corporation'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 were required to
be applied to certain variable interest entities by March 31, 2004. The
Corporation adopted the provisions under the revised interpretation in
the first quarter of 2004. The deconsolidation resulted in the
Corporation's investment in the common securities of First Chester
County Capital Trust I & II being included in other assets and a
corresponding increase in outstanding debt of $465 thousand. In
addition, the income received on the Corporation's common securities
investment is included in other income. The adoption of FIN 46(R) did
not have a material impact on the Corporation's financial position or
results of operations. The Federal Reserve has issued proposed guidance
on the regulatory capital treatment for the trust-preferred securities
issued by the Corporation as a result of the adoption of FIN 46(R). On
March 1, 2005, the Federal Reserve Bank released its final rule on the
treatment of trust preferred securities. The final rule retains the
current bifurcated system that limits the percentage of total capital
that may be composed of trust preferred securities: 15% of core capital
elements limit for "internationally active banks"; 25% of core capital
elements for non-internationally active banks. The final ruling will
not affect the calculations of the Corporation's capital ratios.
8
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(UNAUDITED)
5. STOCK-BASED COMPENSATION
At March 31, 2005, the Corporation had one stock-based employee
compensation plan. The Corporation 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, "Accounting for Stock-Based Compensation"
to stock-based employee compensation.
Three Months Ended
March 31,
---------------------------
2005 2004
---- ----
Net income (in thousands) As reported $ 1,018 $ 1,501
Stock-based compensation costs determined
under fair value method for all awards --* $ 17
------ ------
Pro forma net income $ 1,018 $ 1,484
Earnings per share (Basic) As reported $ 0.20 $ 0.30
Pro forma $ 0.20 $ 0.30
Earnings per share (Diluted) As reported $ 0.19 $ 0.29
Pro forma $ 0.19 $ 0.29
* As of March 31, 2005, there was no remaining unamortized compensation expense
On March 31, 2004, the Financial Accounting Standards Board (FASB)
issued a proposed Statement, SFAS No 123(R) "Share-Based Payment, an
Amendment of FASB Statements No. 123 and APB No. 25," 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. On
October 13, 2004, FASB voted to delay the adoption of this proposed
standard by public companies until their first fiscal quarter beginning
after June 15, 2004. On March 29, 2005 the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin No. 107 "Share-Based
Payment" to provide guidance regarding the application of FASB
Statement No.123(R) and was issued to assist preparers by simplifying
some of the implementation challenges of SFAS 123(R) and to enhance the
information that investors receive. Additionally, on April 14, 2005,
the SEC approved the delay of the effective date of SFAS 123(R). Under
the new rule SFAS 123(R) will now be effective for public companies for
annual, rather than interim periods that begin after June 15, 2005. The
Corporation is currently evaluating this statement and its effects on
its results of operations.
9
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(UNAUDITED)
6. EARNINGS PER SHARE AND STOCKHOLDERS' EQUITY
Earnings per share are calculated using the weighted average shares
outstanding during the year. On April 19, 2005, the Board of Directors
declared a 10% stock dividend to stockholders of record on May 2, 2005,
payable May 19, 2005. Par value remained at $1.00 per share. The stock
split resulted in the issuance of 458,579 additional shares of common
stock from authorized but unissued shares. The issuance of authorized
but unissued shares resulted in the transfer of 458,579 from additional
paid-in capital to common stock, representing the par value of the
shares issued. Accordingly, earnings per share, cash dividends per
share, and weighted average shares of common stock outstanding have
been restated to reflect the stock split.
10
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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," "will," "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:
o 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;
o 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;
o costs of the Corporation's training initiatives, product
development, investment in building its Management team,
initiatives to improve efficiency and accessibility to customers,
branch expansion, new technology, new marketing initiatives, and
operating systems may exceed expectations;
o competition among financial and non-financial institutions in the
Corporation's market area that may result in customer turnover and
lower interest rate margins;
o changes in the regulatory environment, securities markets, general
business conditions and inflation may adversely affect loan
demand, credit quality, consumer spending and saving habits,
interest rate margins, and operating expenses;
o impact of changes in interest rates on customer behavior;
o the impact of changes in demographics on branch locations;
o technological changes;
o changes in the value of securities and investments managed
for others may affect the growth level of the Corporation's
non-interest income;
o changes in the credit of our borrowers, the collateral securing
assets or other aspects of credit quality; and
o our ability to manage the risks involved in the foregoing.
11
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - Continued
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 any 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.
12
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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, 2005 was $1.02 million, a
decrease of $483 thousand or 32.2% from $1.50 million for the same period in
2004. The decrease in net income for the three-month period ended March 31, 2005
was a result of increases in several non-interest expense categories as well as
an increase in the provision for loan and lease losses when compared to the same
quarter last year. The increased non-interest expenses can be attributed
primarily to increased costs of staffing and benefits, professional and
consulting fees, and costs related to the Corporation's new imaging and branding
rollout. The increased expenses were partially offset by an increase in net
interest income. Net interest income has benefited from both increases in volume
and increases in rates on the adjustable rate portion of the Corporation's loan
portfolio, partially offset by increased rates on interest-bearing liabilities.
The specific components of net interest income, non-interest income and
non-interest expenses are discussed on pages 14 and 18. Basic earnings per share
for the three months ending March 31, 2005 and 2004 were $0.20 and $0.30 per
share, respectively. Cash dividends declared during the three-month period ended
March 31, 2005 were $0.1283 an increase of 3.6% from $0.1238 per share for the
same period in 2004. Over the past ten years, the Corporation's practice has
been to pay a dividend of at least 35.0% of net income.
13
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
March December
-------------------------- --------
2005 2004 2004
---- ---- --------
SELECTED RATIOS
Return on average assets 0.51% 0.87% 0.88%
Return on average equity 7.28% 11.37% 11.59%
Earnings retained 35.95% 57.96% 58.95%
Dividend payout ratio 64.05% 42.04% 41.05%
Book value per share $10.87 $10.70 $12.14
The table of "Consolidated Average Balance Sheet and Taxable Equivalent
Income/Expense and Rates" on page 17 may assist the reader in the following
discussion.
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, 2005 was $7.8 million, an increase of 9.2% from $7.1
million for the same period in 2004. The increase in tax equivalent net interest
income can be attributed to an increase in the average balance of
interest-earning assets and an increase in the average interest rates earned on
interest earning assets when compared to the same period last year, partially
offset by an increase in the yields paid on interest-bearing liabilities.
The average net yield on interest-earning assets, on a tax equivalent basis
was 4.08% for the three-month period ended March 31, 2005, compared to 4.34% for
the same period in 2004, a decrease of 6.0% or 26 basis points (one basis point
is equal to 1/100 of a percent). The average yield on interest-earning assets
increased 1.3% or 7 basis points to 5.43% in 2005 compared to 5.36% in 2004. The
average yield paid on interest-bearing liabilities increased 29.7% or 38 basis
points to 1.66% in 2005 from 1.28% in 2004. The increase is due to the
increasing of interest rates paid on deposit accounts. Interest rates and
pricing competition may also continue to put pressure on our net-interest margin
and may adversely impact net-interest income in future time periods.
Additionally, pressure to raise deposits to fund loan growth has caused the
Corporation to acquire funds through brokered deposits and offering overnight
deposit products to customers as an alternative to overnight sweep investments.
The higher cost of these funding sources will contribute to the increased yield
on interest-bearing liabilities and impact net-interest income.
Average interest-earning assets increased approximately $105.1 million or
16.1% to $759.5 million during the three-month period ending March 31, 2005,
compared to $654.4 million during the same period last year. The increase in
average interest-earning assets can be attributed to a $107.7 million or 20.8%
increase in average total loans, partially offset by a $2.6 million or 34.6%
decrease in average federal funds sold and other overnight investments.
Average interest-bearing liabilities increased approximately $97.1 million
or 18.6% to $618.6 million during the three-month period ending March 31, 2005,
compared to $521.5 million during the same period last year. The increase in
average interest-bearing liabilities was the result of a $67.8 million or 14.6%
increase in interest-bearing deposits and a $29.2 million or 71.3% increase in
Federal Home Loan Bank advances and other borrowings.
14
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
NET YIELD ON INTEREST EARNING ASSETS
Three-Months
----------------------
Ended March 31,
----------------------
2005 2004
---- ----
Yield on Interest-Earning Assets 5.43% 5.36%
Yield on Interest Bearing Liabilities 1.66% 1.28%
---- ----
Net Interest Spread 3.77% 4.08%
Contribution of Interest-Free Funds 0.31% 0.26%
---- ----
Net Yield on Interest-Earning Assets 4.08% 4.34%
==== ====
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, 2005 increased $8 thousand or 42.1% to
$27 thousand when compared to the same period in 2004. This increase is
primarily the result of a 118% or 118 basis point increase on rates earned on
Federal funds, partially offset by a $2.6 million or 34.6% decrease in the
average balance of federal funds sold and other overnight investments from $7.6
million in 2004 to $5.0 million in 2005.
INTEREST INCOME ON INVESTMENT SECURITIES
On a tax equivalent basis, interest income on investment securities
decreased 4.1% for the three-month period ended March 31, 2005 to approximately
$1.3 million compared to $1.4 million during the same period in 2004. The
decrease was primarily the result of a 4.0% or 17 basis point decrease on the
rates earned on such investments as well as a 0.2% or $215 thousand decrease in
the average balance of investment securities to $128.8 million on a tax
equivalent basis.
INTEREST INCOME ON LOANS AND LEASES
Interest income on loans, on a tax equivalent basis, generated by the
Corporation's loan portfolio increased 21.7% to $9.0 million for the three-month
period ended March 31, 2005 compared to $7.4 million at March 31, 2004. The
increase in interest income for the three-month period ended March 31, 2005 is
the direct result of a $107.7 million or 20.8% increase in the average balance
of loans and leases outstanding compared to the same period in 2004. Although
loan yields in the first quarter of 2005 have increased, yields have been
declining over the last several quarters. Over the last several quarters loans
were repriced to current market rates due to both contractual terms and
negotiation or refinancing. Even though the interest rate environment has
started to increase the relatively low rates will continue to have an impact on
yields. Increasing rates should positively impact loan and lease interest income
as the adjustable rate loans in the portfolio increase.
INTEREST EXPENSE ON DEPOSIT ACCOUNTS
Interest expense on deposit accounts increased 48.5% for the three-month
period ended March 31, 2005 to approximately $1.8 million compared to $1.2
million for the same period in 2004. This increase was due to a 30.7% or 31
basis point increase on rates paid on interest-bearing deposits and a 14.6% or
$67.8 million increase in average interest-bearing deposits to $532.9 million
when compared to the same period in 2004.
15
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
In 2004 there were five interest rate increases during the second half of
the year, bringing the Federal Funds rate up from 1.00% to 2.25%. During the
first quarter of 2005 there have been two more increases of 25 basis points
bringing the Federal Funds rate up to 2.75% as of March 31, 2005. These rate
increases have put pressure on the pricing of the Corporation's deposit base and
on the cost of raising new deposits. Competition for deposits from other banks
and non-banking institutions such as credit unions and mutual fund companies
continues to be strong. As the Corporation competes for deposit dollars, or
acquires funds from higher cost sources, to fund its growth in a raising rate
environment, this component of net interest income will continue to rise.
INTEREST EXPENSE ON FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
Interest expense on Federal Home Loan Bank ("FHLB") and other borrowings
increased $897 thousand or 83.3% to $594 thousand for the three-month period
ended March 31, 2005 from $270 thousand and a 22 basis point or 7.0% increase in
the average rates paid on FHLB borrowings when compared to the same period in
2004. The need for borrowing has increased over the last several quarters to
support loan growth. FHLB borrowing has been a low cost alternative to deposits
to support loan growth. Average FHLB and other borrowings increased to $70.2
million as of March 31, 2005 compared to $41.0 million during the same period in
2004. 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 2005, the Corporation recorded a $507 thousand
provision for loan and lease losses compared to $300 thousand for the same
period in 2004, an increase of 69.0%. The increase in the provision for loan and
lease losses is primarily attributed to loan growth during the quarter and is
consistent with Management's allowance for loan and lease loss methodology. The
allowance for loan losses as a percentage of total loans was 1.16% as of March
31, 2005, 1.14% as of March 31, 2004, and 1.17% as of December 31, 2004.
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 4.27% to $2.3 million for the three
months ended March 31, 2005, compared to $2.4 million in the same period of
2004. The various components of non-interest income are discussed below.
The largest component of non-interest income is Trust and Investment
Services revenue, which decreased $78 thousand or 8.24% to $869 thousand for the
three-months ended March 31, 2005 compared with the same period in 2004. Trust
and Investment Services income is based primarily on the market value of assets
under management. The decrease in Trust and Investment Services revenue can be
attributed to a 3.65% decrease in the market value of assets under management,
from $555.7 million at March 31, 2004 to $535.4 million at March 31, 2005. In
the third quarter of 2004 the Corporation announced that its Trust Division had
16
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
formed a strategic alliance with Haverford Financial Services (HFS). HFS will
provide investment management services on a subadvisory basis to trust clients
for which they will be paid a portion of the investment management fees.
Service charges on deposit accounts decreased $51 thousand for the
three-month period ended March 31, 2005 to $473 thousand as compared to $524
thousand in the same period in 2004. The decline in service charges is a result
of a reduced amount of overdraft charges on retail and commercial demand deposit
accounts and a decrease in the service charges for these accounts. The
introduction of a "Free Checking" product during the first quarter of this year
contributed to the decrease in service charges and will impact this component of
non-interest income as some current accounts may move to this new product.
Gains on the sale of investment securities increased $14 thousand for the
three-month period ended March 31, 2005 to $67 thousand as compared to $53
thousand in the same period in 2004. These gains were realized as a result of
normal portfolio management.
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, 2005
increased $35 thousand from $193 thousand to $228 thousand when compared to the
same period in 2004.
Gains on the sale of premises and other real estate owned ("OREO") were $1
thousand for the three-months ended March 31, 2005 as compared to $25 thousand
for the same period in 2004. OREO balances decreased $775 thousand from March
31, 2004 to $689 thousand at March 31, 2005 as our Credit Administration
Department continues to reduce non-performing loans. Subsequent to quarter-end
on April 4, 2005, the single OREO property reported as of quarter end was sold
resulting in a nominal loss. There currently are no OREO properties on the
Corporation's balance sheet.
Gains and fee income generated on the sale of residential mortgages for the
three-month period ended March 31, 2005 decreased $60 thousand from $141
thousand to $81 thousand compared to the same period in 2004. The decrease is
primarily due to a lower volume of originations and sales of residential
mortgages during the three-months ended March 31, 2005 to $565 thousand as
compared to the same period in 2004.
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 increased $62 thousand for the three-month period
ended March 31, 2005 when compared to the same period in 2004.
NON-INTEREST EXPENSE
Total non-interest expense for the first quarter of 2005 increased 15.3% to
$8.0 million compared to the same period in 2004. The various components of
non-interest expense are discussed below.
17
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
First quarter 2005 salaries and employee benefits increased 5.6% to $4.1
million for the three-month period ended March 31, 2005 compared to the same
period in 2004. The salaries and benefit expense increase is reflective of costs
associated with the building of our management team and our repositioning
initiatives.
Net occupancy, equipment and data processing expense increased 4.0% to $1.4
million for the three-month period ended March 31, 2005 compared to the same
period last year. The increase can be attributed to expense for the new
Corporate branding initiative, including signage and displays, as well as
increased infrastructure needed for our new branch sites.
Depreciation on operating leases increased 16.3% to $200 thousand for the
three-month period ended March 31, 2005 from $172 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 $ 462 thousand or 138.3% to
$796 thousand for the three-month period ended March 31, 2005 compared to the
same period in 2004. The increase is largely the result of increased consultant,
accounting, and legal fees associated with the Corporation's efforts to comply
with the Sarbanes-Oxley legislation that became effective in 2004. Direct
expenses incurred during the first quarter of 2005 related to audit and
attestation services for our 2004 financial statements were approximately $235
thousand. The remaining portion of the increase from quarter to quarter
represents other consulting fees for real estate management, benefit plans, and
management planning.
Total other non-interest expense increased 23.0% to $1.3 million for the
three months ended March 31, 2005 compared to the same period in 2004. Other
non-interest expense includes marketing expenses, annual meeting and reports,
trust processing, postage, directors' costs, telephone, travel and entertainment
and operating supplies. Increases in marketing expenses from the introduction of
our new corporate marketing line as well as advertising were a large part of the
increase. As the Corporation promotes its products and services this expense
component is expected to increase. Also during the first quarter of 2004, the
Corporation received an additional benefit in the amount of approximately $50
thousand on its director and officer's life insurance policy related to the
death of the Corporations' former President and CEO.
18
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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) 2005 2004
------------------------------ ---------------------------
Daily Daily
Average Average
Balance Interest Rate Balance Interest Rate
ASSETS ------- -------- ---- ------- -------- ----
Federal funds sold $ 4,953 $ 27 2.18% $ 7,577 $ 19 1.00%
Interest-bearing deposits in banks 647 2 1.24% 372 1 1.08%
Investment securities
Taxable 104,999 1,061 4.04% 104,196 1,103 4.23%
Tax-exempt(1) 23,808 256 4.31% 24,826 271 4.36%
------- ------ ------- -----
Total investment securities 128,807 1,317 4.09% 129,022 1,374 4.26%
------- ------ ------- -----
Loans and leases (2)
Taxable 613,710 8,804 5.74% 508,487 7,247 5.70%
Tax-exempt(1) 11,402 168 5.89% 8,935 124 5.57%
------- ------ ------- -----
Total loans and leases 625,112 8,972 5.74% 517,422 7,371 5.70%
------- ------ ------- -----
Total interest-earning assets 759,519 10,318 5.43% 654,393 8,765 5.36%
Non-interest earning assets
Allowance for possible loan losses (7,334) (5,959)
Cash and due from banks 24,382 21,949
Other assets 23,266 22,546
------- -------
Total assets $799,833 $692,929
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings, NOWS & money market deposits 419,925 $ 1,054 1.00% $354,632 $ 497 0.56%
Certificates of deposits and other time 112,996 698 2.47% 110,470 683 2.47%
------- ------ ------- -----
Total interest bearing deposits 532,921 1,752 1.32% 465,102 1,180 1.01%
Junior subordinated debentures 15,465 220 5.69% 15,450 165 4.27%
Federal Home Loan Bank advances and
other borrowings 70,217 594 3.38% 40,985 324 3.16%
------- ------ ------- -----
Total interest bearing liabilities 618,603 2,566 1.66% 521,538 1,669 1.28%
------- ------ ------- -----
Non-interest bearing liabilities
Non-interest bearing demand deposits 120,188 113,347
Other liabilities 5,128 5,244
------- -------
Total liabilities 743,919 640,128
Stockholders' equity 55,914 52,801
------- -------
Total liabilities and stockholders' equity $799,833 $692,929
======= =======
Net interest income $ 7,752 $7,096
====== =====
Net yield on interest earning assets 4.08% 4.34%
==== ====
(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 2005 and 2004.
(2) Non-accruing loans are included in the average balance.
19
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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, 2005 was $410
thousand, compared to $642 thousand in the same period last year. This
represents an effective tax rate of 28.7% for the first quarter of 2005 and
2004.
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, 2005 December 31, 2004 Average Balance
----------------------- ---------------------- -------- ----------
Average Effective Average Effective Dollar Percentage
Deposit Type Balance Yield Balance Yield Variance Variance
- ------------ ------- --------- --------- --------- -------- ----------
NOW Accounts $173,908 1.00% $129,569 0.51% $ 44,339 34.22%
Money Market 23,165 0.64% 26,255 0.51% (3,090) (11.77%)
Statement Savings 65,903 0.64% 65,682 0.56% 221 0.34%
Other Savings 1,231 0.65% 1,370 0.51% (139) (10.15%)
CD's Less than $100,000 84,379 2.41% 85,873 2.46% (1,494) (1.74%)
------- ------- -------
Total Core Deposits 348,586 1.25% 308,749 1.06% 39,837 12.90%
Non-Interest Bearing
Demand Deposit Accounts 120,188 - 125,074 - (4,886) (3.91%)
------- ------- -------
Total Core and Non-Interest
Bearing Deposits 468,774 0.93% 433,823 0.75% 34,951 8.06%
------- ------- -------
Tiered Savings 155,718 1.22% 168,180 0.86% (12,462) (7.41%)
CD's Greater than $100,000 28,617 2.66% 25,966 2.28% 2,631 10.21%
------- ------- -------
Total Deposits $653,109 1.07% $627,969 1.84% $ 25,140 4.00%
======= ======= =======
20
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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 2005, average FHLB advances were approximately $70.8
million and consisted of term advances with a variety of maturities. The average
interest rate on these advances was approximately 3.4%. The Bank currently has a
maximum borrowing capacity with the FHLB of approximately $147.4 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.
To supplement the Corporation's sources of liquidity, the Corporation has
acquired funds through brokered deposits and offering overnight deposit products
to customers as an alternative to overnight sweep investments. Management will
continue to research and acquire funds from alternative sources consistent with
the Corporation's needs and safety and soundness considerations.
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 $231 million or
29.4% of total assets at March 31, 2005 compared with a negative $213.4 million
or 26.5% of total assets at December 31, 2004. 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.
21
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
INTEREST SENSITIVITY ANALYSIS
AS OF MARCH 31, 2005
One Over
(Dollars in thousands) Within through five Non-rate
one year five years years sensitive Total
--------- ---------- ---------- --------- ---------
ASSETS
Investment securities $ 13,494 $ 57,819 $ 38,687 $ -- $ 110,000
Interest bearing deposits in banks 230 -- -- -- 230
Loans and leases 249,026 277,153 114,662 (7,449) 633,392
Cash and due from banks -- -- -- 21,522 21,522
Premises and equipment -- -- -- 13,848 13,848
Other assets -- -- -- 9,403 9,403
-------- -------- --------- -------- --------
Total assets $ 262,750 $ 334,972 $ 153,349 $ 37,324 $ 788,395
======== ======== ========= ======== ========
LIABILITIES AND CAPITAL
Non-interest bearing deposits $ -- $ -- $ -- $ 126,717 $ 126,717
Interest bearing deposits 465,118 36,694 14,041 -- 515,853
FHLB term advance 13,351 49,338 8,110 -- 70,799
Junior subordinated debentures 15,465 -- -- -- 15,465
Other liabilities 227 -- 4,550 -- 4,777
Capital -- -- -- 54,784 54,784
--------- --------- -------- --------
Total liabilities & capital $ 494,161 $ 86,032 $ 26,701 $ 181,501 $ 788,395
========= ========= ======== ========
Net interest rate
sensitivity gap $(231,411) $ 248,940 $ 126,648 $(144,177)
======== ======== ======== ========
Cumulative interest rate
sensitivity gap $(231,411) $ 17,529 $ 144,177 $ --
======== ======== ======== ========
Cumulative interest rate
sensitivity gap divided
by total assets (29.4%) 2.2% 18.3%
======== ======== ========
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.
22
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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,
------------------------- ------------
2005 2004 2004
----------- ----------- ------------
Balance at beginning of period $ 7,213 $ 5,864 $ 5,864
--------- --------- ---------
Provision charged to operating expense 507 300 1,164
---------- ---------- ---------
Recoveries of loans previously charged-off 73 41 1,095
Loans charged-off (344) (205) ( 910)
---------- ---------- ----------
Net recoveries (loans charged-off) (271) (164) 185
---------- ---------- ----------
Balance at end of period $ 7,449 $ 6,000 $ 7,213
========= ========= =========
Period-end loans outstanding $ 640,841 $ 525,160 $ 618,005
Average loans outstanding $ 625,112 $ 517,422 $ 567,755
Allowance for loan and lease losses as a
percentage of period-end loans outstanding 1.16% 1.14% 1.17%
Net charge-offs (recoveries) to average loans
outstanding 0.04% 0.03% (0.03)%
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, 2005, the level of non-performing assets has increased $5.4 million
from March 31, 2004, and non-performing assets increased $641 thousand from
December 31, 2004. The increase in the level of non-performing loans from March
31, 2004 to March 31, 2005 is due to two real estate secured loans. One loan is
for approximately $5.9 million and was classified as non-accrual during the
fourth quarter of 2004. The other is a $1.9 million loan that was classified as
non-accrual at the end of the first quarter 2005. Management is actively working
to collect these loans and does not anticipate a loss of principal. 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.
23
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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,
------------------------- ------------
2005 2004 2004
----------- ----------- ------------
Past due over 90 days and still accruing $ 213 $ 79 $ --
Non-accrual loans and leases 8,373 2,339 7,877
-------- ------ ------
Total non-performing loans and leases 8,586 2,418 7,877
Other real estate owned 689 1,464 757
-------- ------ ------
Total non-performing assets $ 9,275 $ 3,882 $ 8,634
======== ====== ======
Non-performing loans and leases as a percentage
of total loans and leases 1.34% 0.46% 1.27%
Allowance for loan and lease losses as a percentage
of non-performing loans and leases 86.76% 248.06% 91.57%
Non-performing assets as a percentage of
total loans and other real estate owned 1.45% 0.74% 1.40%
Allowance for loan and lease losses as a
percentage of non-performing assets 80.31% 154.51% 83.54%
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. Subsequent to March 31, 2004, the property
that represents the OREO portion of non-performing assets was sold. The
Corporation holds no other OREO at this time.
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 $8.3
million, $7.9 million, and $2.3 million at March 31, 2005, December 31, 2004,
and March 31, 2004, respectively. The associated allowance for impaired loans
was $932 thousand, $882 thousand and $231 thousand at March 31, 2005, December
31, 2004, and March 31, 2004, respectively.
24
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
For the three months ended March 31, 2005, activity in the allowance for
impaired loan losses included a provision of $204 thousand, principal payments
of $41 thousand, charge offs of $113 thousand and recoveries of $0. Contractual
interest amounted to $148 thousand. Total cash collected on loans for the
three-month period ended March 31, 2005 was $412 thousand, $412 thousand was
applied to principal and $0 thousand was applied to interest.
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.
BRANCHING AND TECHNOLOGY PROJECTS
The Corporation intends to open a series of new branches throughout Chester
County over the next five years. A new customer focused branch design will be
introduced when construction is finished on the permanent branch building in
Oxford, Pennsylvania. The new "signature look" will be rolled out to new and
certain current locations over the next 5 years. Technological improvements
expected over the next 18 months, include secure electronic delivery of customer
checking and savings statements and an improvement of customer service issues as
the Bank utilizes the power of its new customer relationship management system
("CRM"). Management hopes to utilize the CRM along with the Answer Center to
identify service issues and customer trends on a proactive basis resulting in a
higher degree of customer satisfaction.
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, 2005, 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, 2004 due to lower than expected earnings in
2004 and first quarter 2005, have been computed in accordance with regulatory
accounting policies.
25
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Continued
March 31, December 31,
RISK-BASED -------------------------- ------------ "Well Capitalized"
CAPITAL RATIOS 2005 2004 2004 Requirements
- -------------- ------- ------ ---- ------------------
Corporation
Leverage Ratio 8.89% 9.73% 8.62% N/A
Tier I Capital Ratio 10.55% 11.87% 10.80% N/A
Total Risk-Based Capital Ratio 11.65% 12.93% 11.91% N/A
Bank
Leverage Ratio 8.07% 8.68% 8.11%
Tier I Capital Ratio 9.55% 10.74% 10.16% 6.00%
Total Risk-Based Capital Ratio 10.66% 11.80% 11.26% 10.00%
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.
26
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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 2004 Annual Report,
filed with the SEC via EDGAR as an exhibit to its Form 10-K for the fiscal year
ended December 31, 2004. Please refer to the "Management's Discussion and
Analysis" section on pages 23-37 of the Corporation's Annual Report for more
information.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Included with this Quarterly Report as
Exhibits 31.1, 31.2, and 31.3 are three certifications (the "Section 302
Certifications"), one by each of our Chief Executive Officer, President and our
Assistant Treasurer, our principal executive, and financial officers (the
"Principal Officers"). 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.
The Securities and Exchange Commission (the "SEC") requires that as of the end
of the quarter covered by this Report, our CEO and Assistant Treasurer 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.
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
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, the only changes during the quarter covered by this
report were the post year-end remediation of material weaknesses, implemented as
follows:
o Access control issues relative to deposits, loans, central information
files, and ACH have been remediated through adjustment of menu options and
/ or access rights. These additional control procedures and related
documentation requirements are now in place.
o Additional detective control procedures and related documentation
requirements have been implemented relative to general ledger access.
27
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number Average Total Number of Shares Maximum Number (or Approximate
Period of Shares Price Paid (or Units) Purchased as Dollar Value) of Shares (or Units)
(or units) per Share Part of Publicly Announced that May Yet Be Purchased
Purchased (or Unit) Plans or Programs Under the Plans or Programs
------------ --------- -------------------------- ----------------------------------
January 1 to January 31, 2005 0 0 0 $6,715,573
February 1 to February 29, 2005 0 0 0 $6,715,573
March 1 to March 31, 2005 0 0 0 $6,715,573
Total 0 0 0 $6,715,573*
*The balance remaining under the Corporation's program to repurchase up to $10.0
million of the Corporation's common stock that was publicly announced on October
16, 2004.
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 19, 2005 (the "Meeting"). Notice of the Meeting was mailed to
shareholders of record on or about March 17, 2005, 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.
28
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION - CONTINUED
The matters submitted to a vote of shareholders at the meeting were
the following:
1. The election of four Class III directors, with each director to
serve until the 2008 Annual Meeting of Shareholders and until the
election and qualification of his or her respective successor;
2. The approval of the Corporation's Restricted Stock Plan;
3. The ratification of the appointment of Grant Thornton, LLP as the
Corporation's independent public accountants for the year ending
December 31, 2005; 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
------- --- --------
John A. Featherman, III 3,393,764 198,661
John Halsted 3,334,114 258,311
J. Carol Hanson 3,387,833 204,592
Edward A. Leo 3,394,995 197,430
The names of the other directors whose terms of office as directors
continued after the Meeting are as follows: John J. Ciccarone, M.
Robert Clarke, Clifford E. DeBaptiste, David L. Peirce, Kevin C.
Quinn and John B. Waldron.
The proposal to ratify the Corporation's Restricted Stock Plan 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
--- ------- ----------- ----------------
3,443,585 93,829 55,011 0
The proposal to ratify the appointment of Grant Thornton, LLP as the
Corporation's independent public accountants for the year ending
December 31, 2005 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
--- ------- ----------- ----------------
3,571,315 3,140 17,970 0
There was no other business that came before the Meeting or matters
incident to the conduct of the Meeting.
29
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION - CONTINUED
Item 5. Other Information
None
Item 6. Exhibits
(a) Exhibits
Exhibits marked as "(cp)" are management contracts or compensatory
plans, contracts or arrangements in which a director or executive
officer participates or may participate.
3(i). Certificate of Incorporation. Copy of the Corporation's
Articles of Incorporation, as amended, is incorporated herein by
reference to Exhibit 3 (i) to the Corporation's Quarterly Report On
Form 10-Q for the quarter ended March 31, 2004.
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.
10.1 2005 Restricted Stock Plan, is incorporated by
reference to Appendix A to the Corporation's 2005
Proxy Statement filed March 17, 2005. (cp)
10.2 Letter of Employment to Deborah Pierce (cp)
10.3 Change of Control Agreement between the Bank and
Deborah Pierce dated February 18, 2005 (cp)
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 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 Assistant Treasurer
30
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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
-----------------------
May 6, 2005 John A. Featherman
Chief Executive Officer
/s/ T. Benjamin Marsho
-----------------------
May 6, 2005 T. Benjamin Marsho
Assistant Treasurer
(Principal Accounting and
Financial Officer)
31
FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES
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 and those marked "(cp)" are management contracts or compensatory plans,
contracts or arrangements in which a director or executive officer participates
or may participate):
3(i). Certificate of Incorporation. Copy of the Corporation's Articles of
Incorporation, as amended, is incorporated herein by reference to Exhibit 3 (i)
to the Corporation's Quarterly Report On Form 10-Q for the quarter ended March
31, 2004.
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.
10.1 2005 Restricted Stock Plan, is incorporated by reference to
Appendix A to the Corporation's 2005 Proxy Statement filed
March 17, 2005. (cp)
10.2 Letter of Employment to Deborah Pierce (cp)
10.3 Change of Control Agreement between the Bank and Deborah Pierce
dated February 18, 2005 (cp)
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 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 Assistant Treasurer
32