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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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 number 0-16276
STERLING FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2449551
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 North Pointe Boulevard
Lancaster, Pennsylvania 17601-4133
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 581-6030
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $5.00 Per Share
(Title of class)
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or
any amendment to this Form 10-K. | |
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
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at February 27, 1998 was approximately $159,963,708.
The number of shares of Registrant's Common Stock outstanding on February 27,
1998 was 6,161,006.
Documents Incorporated by Reference
Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of
Shareholders are incorporated by reference into Part III of this report.
Sterling Financial Corporation
Table of Contents
Page
Part I
Item 1. Business............................................. 3
Item 2. Properties........................................... 9
Item 3. Legal Proceedings.................................... 9
Item 4. Submission of Matters to a Vote of Security Holders.. 9
Part II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters.......................... 10
Item 6. Selected Financial Data.............................. 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 11
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk.......................................... 28
Item 8. Financial Statements and Supplementary Data.......... 30
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. 54
Part III
Item 10. Directors and Executive Officers of the Registrant... 55
Item 11. Executive Compensation............................... 55
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 55
Item 13. Certain Relationships and Related Transactions....... 55
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.......................................... 56
Signatures...................................................... 57
PART I
Item 1 - Business
Sterling Financial Corporation
Sterling Financial Corporation (the "Corporation") is a registered bank
holding company and a Pennsylvania business corporation, headquartered in
Lancaster, Pennsylvania. The Corporation was organized on February 23, 1987 as a
bank holding company for The First National Bank of Lancaster County, now, by
change of name, Bank of Lancaster County, N.A. (the "Bank").
The Corporation provides a wide variety of commercial banking and trust
services through the Bank.
A major source of operating funds for the Corporation is dividends provided
by the Bank. The Corporation's expenses consist principally of operating
expenses. Dividends paid to stockholders are, in part, obtained by the
Corporation from dividends declared and paid to it by the Bank.
As a bank holding company, the Corporation is registered with the Federal
Reserve Board in accordance with the requirements of the Bank Holding Company
Act of 1956, as amended, and is subject to regulation by the Federal
Reserve Board and by the Pennsylvania Department of Banking.
In addition, the Corporation owns all of the outstanding stock of Sterling
Mortgage Services, Inc., a Pennsylvania corporation and a mortgage service
company formed by the Corporation as a wholly owned subsidiary and is presently
inactive.
Bank of Lancaster County
The Bank is a full service commercial bank operating under charter from the
Comptroller of the Currency. On July 29, 1863, the Comptroller of the Currency
authorized The First National Bank of Strasburg to commence the business of
banking. On September 1, 1980, the name was changed to The First National Bank
of Lancaster County. At the time of the holding company's organization, on June
30, 1987, the institution's name was changed to its present name, Bank of
Lancaster County, N.A. At December 31, 1997, the Bank had total assets of
$845,311,000 and total deposits of $720,480,000.
The main office of the Bank is located at 1 East Main Street, Strasburg,
Pennsylvania. In addition to its main office, the Bank had twenty-eight (28)
branches in Lancaster County and one (1) branch in Chester County, Pennsylvania
in operation at December 31, 1997.
The Bank provides a full range of banking services. These include demand,
savings and time deposit services, NOW (Negotiable Order of Withdrawal)
accounts, money market accounts, safe deposit boxes, a VISA credit card,
and a full spectrum of personal and commercial lending
activities. The Bank maintains correspondent relationships with major banks
in Philadelphia and Baltimore.
Through these correspondent relationships, the Bank can offer a variety of
collection and international services.
With the installation of three automated teller machines (ATMs) in April,
1983, the Bank was the first financial institution in Lancaster County to join
the MAC (Money Access Center) Network. The Bank now has 25 ATMs in Lancaster
County. The Bank became a participating member of the Plus System in the Fall
of 1984. This membership entitles the Bank's MAC/Plus cardholders to
have access to a nationwide network of over 150,000 ATMs.
The Bank introduced Discount Brokerage Service in July, 1983. This service
is offered in coordination with Fiserv Investor Services, Inc., an affiliate of
BHCM, Inc. and meets the needs of the commission-conscious investor. In 1992,
the Bank began offering mutual funds to customers. The Bank is in the process
of formalizing a product sales agreement with a third party marketer to sell
fixed annuities. As required, the Bank has obtained an insurance license
from the Commonwealth of Pennsylvania. The Bank expects to
begin making this product available during the first quarter of 1998.
Management believes these services are important additions to the Bank's
product line and that these products make a statement about the Bank's
progressive attitude towards the provision of the
Bank's financial services in the future.
The Bank was given permission to open a Trust Department by the Comptroller
of the Currency on May 10, 1971. The Trust Department provides personal and
corporate trust services. These include estate planning, administration of
estates and the management of living and testamentary trusts and investment
management services. Other services available are pension and profit sharing
trusts and self-employed retirement trusts. Trust Department assets were over
$379 million at December 31, 1997.
On January 31, 1983, the Bank purchased Town & Country, Inc., a
Pennsylvania corporation and a vehicle and equipment leasing company,
operating in Pennsylvania and other states. Its principal
office is located at 1097 Commercial Avenue, East Petersburg, PA.
Town & Country, Inc. employs forty-two (42) people.
The Bank's principal market area is Lancaster County, Pennsylvania.
Lancaster County is the sixth largest county in Pennsylvania, in terms of
population, behind Philadelphia, Allegheny, Montgomery, Delaware and Bucks.
Lancaster County, with an area of 949 square miles, has a population of
approximately 450,000 people. Lancaster's tradition of economic stability has
continued, with agriculture, industry and tourism all contributing to the
overall strength of the economy. Lancaster County has one of the
strongest and most stable economies in the state. No single sector
dominates the county's economy.
One of the best agricultural areas in the nation, Lancaster County
continues to be the top agricultural county in the state, leading
Pennsylvania in production of most crops and all livestocks, with
the exception of sheep. Lancaster County is also one of the leading
industrial areas in the state. The county is considered a
prime location for manufacturing, away from congested
areas, yet close to major east coast markets. Diversification of industry has
helped to maintain the economic stability of the county. The unemployment rate
of the county in December 1997 was 2.9%, which was lower than the statewide rate
(4.8%) and the national rate (4.7%). Lancaster County's December unemployment
rate of 2.9% was the best among Pennsylvania's 14 metropolitan areas. Lancaster
County, with its many historic sites, well-kept farmlands and the large Amish
community has become very attractive to tourists and is one of the top tourist
attractions in the United States.
The Bank has no significant foreign sources and makes no significant
foreign application of funds.
The Bank is subject to regulation and periodic examination by the
Comptroller of the Currency. The Bank's deposits are insured by the Federal
Deposit Insurance Corporation, as provided by law.
Competition
The financial services industry in the Corporation's service area is
extremely competitive. The Corporation's competitors within its service area
include multi-bank holding companies, with resources substantially greater than
those of the Corporation. Many competitor financial institutions have legal
lending limits substantially higher than the Bank's legal lending limit.
The Bank is subject to intense competition in all respects and areas of its
business from banks and other financial institutions, including savings
and loan associations, finance companies, credit unions and other
providers of financial services. There are 14 full-service commercial banks
with offices in Lancaster County. Some of these banks have branches located
throughout Lancaster County and beyond. The institutions range in asset
size from approximately $233 million to over $57 billion. Four (4) banks in the
trade area exceed $5 billion in assets. Several banks are part of bank
holding company systems. One bank is a subsidiary of a
bank holding company that has assets in excess of $73 billion while two other
banks are subsidiaries of bank holding companies with over $45 billion in
assets.
Due to the Bank's location, the Bank is in direct competition with the larger
banks, as well as, a number of smaller banks. The increased competition has
resulted from a changing legal and regulatory climate, as well as, from the
economic climate. As of December 31, 1997, the Bank ranked, as measured by
total deposits, as the third largest in market share within
Lancaster County of the banks doing business in Lancaster County.
The Bank is not, however, the third largest bank in Lancaster County.
As of December 31, 1997, the Bank had total assets of over $845 million and
ranked ninth on this basis among the commercial banks with offices
located in Lancaster County.
In September 1994, federal legislation was enacted that is expected to have
a significant effect in restructuring the banking industry in the United
States. See "Interstate Banking Legislation" herein. As a result,
the Corporation expects the operating environment for Pennsylvania-based
financial institutions to become increasingly competitive.
Additionally, the manner in which banking institutions conduct their
operations may change materially as the activities increase in which bank
holding companies and their banking and nonbanking subsidiaries are
permitted to engage, and funding and investment alternatives
continue to broaden, although the long-range effects of these changes
cannot be predicted, with reasonable certainty, at
this time. These changes most probably will further narrow the differences and
intensify competition between and among commercial banks, thrift institutions,
and other financial service companies. See "Proposed Legislation and
Regulations" herein.
Neither the Corporation nor the Bank rely on a single customer or a few
customers, including federal, state or local governments and agencies thereunder
the loss of which would have a material adverse effect on the business of the
Bank.
Supervision and Regulation
Bank Holding Company Regulation
The Corporation is registered as a bank holding company and is subject to
the regulations of the Board of Governors of the Federal Reserve System (the
"Federal Reserve") under the Bank Holding Company Act of 1956, as amended
("BHCA"). Bank holding companies are required to file periodic reports with and
are subject to examination by the Federal Reserve. The Federal Reserve has
issued regulations under the BHCA that require a bank holding company to serve
as a source of financial and managerial strength to its subsidiary banks. As a
result, the Federal Reserve, pursuant to such regulations, may require the
Corporation to stand ready to use its resources to provide adequate capital
funds to the Bank during periods of financial stress or adversity.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), a bank holding company is required to guarantee the compliance of
any insured depository institution subsidiary that may become
"undercapitalized" (as defined by regulations) with the terms of any
capital restoration plan filed by such subsidiary with its
appropriate federal banking agency, up to specified limits.
Under the BHCA, the Federal Reserve has the authority to require a bank
holding company to terminate any activity or relinquish control of a nonbank
subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious
risk to the financial soundness and stability of any bank
subsidiary of the bank holding company.
The BHCA prohibits the Corporation from acquiring direct or indirect
control of more than 5% of the outstanding shares of any class of voting stock
or substantially all of the assets of any bank or merging or
consolidating with another bank holding company without prior
approval of the Federal Reserve. Such a transaction would also
require approval of the Pennsylvania Department of Banking. Pennsylvania law
permits Pennsylvania bank holding companies to control an unlimited
number of banks.
Additionally, the BHCA prohibits the Corporation from engaging in or from
acquiring ownership or control of more than 5% of the outstanding shares of any
class of voting stock of any company engaged in a nonbanking business unless
such business is determined by the Federal Reserve to be so closely
related to banking as to be a proper incident thereto. The Federal
Reserve can differentiate between nonbanking activities that are
initiated by a bank holding company or subsidiary and activities
that are acquired as a going concern. The BHCA does not place territorial
restrictions on the activities of such nonbanking-related
activities. The Corporation and its subsidiaries are prohibited from
engaging in certain tie-in arrangements in connection with any
extension of credit, lease or sale of property, or
furnishing of services.
The activities that the Federal Reserve has determined by regulation to be
permissible are:
(1) making, acquiring, or servicing loans or other extensions of credit
for its own account or for the account of others;
(2) operating an industrial bank, Morris Plan bank, or industrial loan
company, in the manner authorized by state law, so long as the
institution is not a bank;
(3) operating as a trust company in the manner authorized by federal or
state law so long as the institution is not a bank and does not make
loans or investment or accept deposits, except as may be permitted
by the Federal Reserve;
(4) subject to limitations, acting as an investment or financial
advisor (i) to a mortgage or real estate investment trust,
(ii) to certain registered investment companies,
(iii) by providing portfolio investment advice
to other persons, (iv) by furnishing general
economic information and advice, general economic statistical
forecasting services, and industry studies, (v) by providing
financial advice to state and local governments, or (vi) by
providing financial and transaction advice to corporations,
institutions, and certain persons in connection with mergers,
acquisitions, and other financial transactions;
(5) subject to limitations, leasing real or personal property or acting
as agent, broker, or adviser in leasing such property in accordance
with prescribed conditions;
(6) investing in corporations or projects designed primarily to promote
community welfare;
(7) providing to others data processing services and data transmission
services, data bases, and facilities, within certain limitations;
(8) subject to limitations, engaging in certain agency and underwriting
activities with respect to credit insurance, and certain other
insurance activities as permitted by the Federal Reserve;
(9) owning, controlling, or operating a savings association, if the
savings association engages only in deposit-taking activities and
lending and other activities that are permissible for bank holding
companies under Federal Reserve regulations;
(10) providing courier services for certain financial documents;
(11) subject to limitations, providing management consulting advice to
nonaffiliated bank and nonbank depository institutions;
(12) retail selling of money orders and similar consumer-type payment
instruments having a face value of $1,000 or less, selling U.S.
Savings Bonds, and issuing and selling traveler's checks;
(13) performing appraisals of real estate and personal property;
(14) subject to limitations, acting as intermediary for the financing of
commercial or industrial income-producing real estate by arranging
for the transfer of the title, control, and risk of such a real
estate project to one or more investors;
(15) providing certain securities brokerage services;
(16) subject to limitations, underwriting and dealing in government
obligations and certain other instruments;
(17) subject to limitations, providing foreign exchange and transactional
services;
(18) subject to limitations, acting as a futures commission merchant for
nonaffiliated persons;
(19) subject to limitations, providing investment advice on financial
futures and options to futures;
(20) subject to limitations, providing consumer financial counseling;
(21) subject to limitations, tax planning and preparation;
(22) providing check guaranty services;
(23) subject to limitations, operating a collection agency; and
(24) operating a credit bureau.
Federal Reserve approval may be required before the Corporation or its
nonbank subsidiaries may begin to engage in any such activity and before any
such business may be acquired.
Dividend Restrictions
The Corporation is a legal entity separate and distinct from the Bank and
the Corporation's nonbank subsidiaries. The Corporation's revenues (on a parent
Company only basis) result almost entirely from dividends paid to the
Corporation by its subsidiaries. The right of the company, and consequently
the right of creditors and shareholders of the Corporation,
to participate in any distribution of the assets or earnings of any subsidiary
through the payment of such dividends or otherwise is necessarily
subject to the prior claims of creditors of the subsidiary (including
depositors, in the case of the Bank), except to the extent
that claims of the Corporation in its capacity as a creditor may be recognized.
Federal and state laws regulate the payment of dividends by the
Corporation's subsidiaries. See "Supervision and Regulation - Regulation of the
Bank" herein.
Further, it is the policy of the Federal Reserve that bank holding
companies should pay dividends only out of current earnings. Federal banking
regulators also have the authority to prohibit banks and bank holding companies
from paying a dividend if they should deem such payment to be an unsafe or
unsound practice.
Capital Adequacy
Bank holding companies are required to comply with the Federal Reserve's
risk-based capital guidelines. The required minimum ratio of total capital to
risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) is 8%. At least half (4%) of the total capital is
required to be "Tier 1 capital," consisting principally of common shareholders'
equity, noncumulative perpetual preferred stock, a limited amount of cumulative
perpetual preferred stock, and minority interests in the equity accounts of
consolidated subsidiaries, less certain intangible assets. The remainder
("Tier 2 capital") may consist of a limited amount of subordinated debt and
intermediate-term preferred stock, certain hybrid capital instruments and other
debt securities, perpetual preferred stock, and a limited amount of the general
loan loss allowance. In addition to the risk-based capital guidelines, the
Federal Reserve requires a bank holding company to maintain a minimum "leverage
ratio." This requires a minimum level of Tier 1 capital (as determined under
the risk-based capital rules) to average total consolidated assets of
3% for those bank holding companies that have the highest regulatory
examination ratings and are not contemplating or experiencing significant
growth or expansion. All other bank holding companies are
expected to maintain a ratio of at least 1% to 2%
above the stated minimum. Further, the Federal Reserve has indicated that it
will consider a "tangible Tier 1 capital leverage ratio" (deducting all
intangibles) and other indicia of capital strength in evaluating proposals for
expansion or new activities. The Federal Reserve has not advised the
Corporation of any specific minimum leverage ratio applicable to
the Corporation.
Pursuant to FDICIA, the federal banking agencies have specified, by
regulation, the levels at which an insured institution is considered "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," or "critically undercapitalized." Under these regulations,
an institution is considered "well capitalized" if it has a total
risk-based capital ratio of 10% or greater, a Tier 1 risk-based
capital ratio of 6% or greater, a leverage ratio of 5%
or greater, and is not subject to any order or written
directive to meet and maintain a specific capital level. The Corporation
and the Bank, at December 31, 1997, qualify as "well capitalized"
under these regulatory standards.
FDIC Insurance
The Bank is subject to Federal Deposit Insurance Corporation ("FDIC")
assessments. The FDIC has adopted a risk-related premium assessment system for
both the Bank Insurance Fund ("BIF") for banks and the Savings Association
Insurance Fund ("SAIF") for savings associations. Under this system, FDIC
insurance premiums are assessed based on capital and supervisory measures.
Under the risk-related premium assessment system, the FDIC, on a semiannual
basis, assigns each institution to one of three capital groups (well
capitalized, adequately capitalized, or undercapitalized) and further assigns
such institution to one of three subgroups within a capital
group corresponding to the FDIC's judgment of its strength
based on supervisory evaluations, including examination
reports, statistical analysis, and other information relevant to
gauging the risk posed by the institution. Only institutions with a total
risk-based capital to risk-adjusted assets ratio of 10% or
greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or
greater, and a Tier 1 leverage ratio of 5% or greater, are
assigned to the well-capitalized group.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 to recapitalize the Savings Association Insurance Fund
("SAIF") administered by the Federal Deposit Insurance Corporation
("FDIC") and to provide for repayment of the FICO
(Financial Institution Collateral Obligation) bonds
issued by the United States Treasury Department. The FDIC levied a one-time
special assessment on SAIF deposits equal to 65.7 cents per $100 of the
SAIF-accessible deposit base as of March 31, 1995. During 1997, 1998, and
1999, the Bank Insurance Fund ("BIF") will pay $322 million of FICO debt
service, and SAIF will pay $458 million. During 1997,
1998, and 1999, the average regular annual deposit insurance assessment
is estimated to be about 1.29 cents per $100 of deposits for BIF
deposits and 6.44 cents per $100 of deposits for SAIF deposits.
Individual institution's assessments will continue to vary according to their
capital and management ratings. As always, the FDIC will be able to raise the
assessments as necessary to maintain the funds at their target capital ratios
provided by law. After 1999, BIF and SAIF will share the FICO costs equally.
Under current estimates, BIF and SAIF assessment bases would each be assessed at
the rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will
mature in 2018-2019, ending the interest payment obligation.
Regulation of the Bank
The operations of the Bank are subject to federal and state statutes
applicable to banks chartered under the banking laws of the United States, to
members of the Federal Reserve System, and to banks whose deposits are
insured by the FDIC. The Bank's operations are also subject to regulations
to the OCC, the Federal Reserve, and the FDIC.
The OCC, which has primary supervisory authority over the Bank, regularly
examines banks in such areas as reserves, loans, investments, management
practices, and other aspects of operations. These examinations are designed for
the protection of the Bank's depositors rather than the Corporation's
shareholders. The Bank must furnish annual and quarterly reports to the OCC,
which has the authority under the Financial Institutions Supervisory Act to
prevent a national bank from engaging in an unsafe or unsound practice in
conducting its business.
Federal and state banking laws and regulations govern, among other things,
the scope of a bank's business, the investments a bank may take, the reserves
against deposits a bank must maintain, the types and terms of loans a bank may
make and the collateral it may take, the activities of a bank with respect to
mergers and consolidations, and the establishment of branches. Pennsylvania law
permits statewide branching.
Under the National Bank Act, as amended, the Bank is required to obtain the
prior approval of the OCC for the payment of dividends if the total of all
dividends declared by the Bank in one year would exceed the Bank's net profits
(as defined and interpreted by regulation) for the two preceding years, less any
required transfers to surplus. In addition, the Bank may only pay dividends to
the extent that its retained net profits (including the portion transferred to
surplus) exceed statutory bad debts (as defined by regulation). Under FDICIA,
any depository institution, including the Bank is prohibited from paying any
dividends, making other distributions or paying any management fees if, after
such payment, it would fail to satisfy its minimum capital requirements.
A subsidiary bank of a bank holding company, such as the Bank, is subject
to certain restrictions imposed by the Federal Reserve Act on any extensions of
credit to the bank holding company or its subsidiaries, on investments in the
stock or other securities of the bank holding company or its subsidiaries, and
on taking such stock or securities as collateral for loans. The Federal
Reserve Act and Federal Reserve regulations also place certain limitations
and reporting requirements on extensions of credit by a bank to
the principal shareholders of its parent holding company, among others,
and to related interests of such principal shareholders. In addition,
such legislation and regulations may affect the terms upon which any
person becoming a principal shareholder of a holding company may obtain credit
from banks with which the subsidiary bank maintains a correspondent
relationship.
The Bank, and the banking industry in general, are affected by the monetary
and fiscal policies of government agencies, including the Federal Reserve.
Through open market securities transactions and changes in its discount rate and
reserve requirements, the Board of Governors of the Federal Reserve exerts
considerable influence over the cost and unavailability of funds for lending and
investment.
Interstate Banking Legislation
In September 1994, the Riegle-Neal Interstate Banking and Branching
Efficiency Act (the "Interstate Banking Act") was enacted. The Interstate
Banking Act facilitates the interstate expansion and consolidation of banking
organizations (i) by permitting bank holding companies that are adequately
capitalized and adequately managed, beginning September 29, 1995, to acquire
banks located in states outside their home states regardless of whether such
acquisitions are authorized under the law of the host state; (ii) by permitting
the interstate merger of banks after June 1, 1997, subject to the right of
individual states to "opt in" or "opt out" of this authority before that date;
(iii) by permitting banks to establish new branches on an interstate basis
provided that such action is specifically authorized by the law of the host
state; (iv) by permitting, beginning September 29, 1995, a bank to engage in
certain agency relationships (i.e., to receive deposits, renew time deposits,
close loans (but not including loan approvals or disbursements), service loans,
and receive payments on loans and other obligations) as agent for any bank or
thrift affiliate, whether the affiliate is located in the same state or a
different state than the agent bank; and (v) by permitting foreign banks to
establish, with approval of the regulators in the United States, branches
outside their "home" states to the same extent that national or state
banks located in the home state would be authorized to do so.
One effect of this legislation will be to permit the Corporation to acquire
banks and bank holding companies located in any state and to permit
qualified banking organizations located in any state to acquire banks and bank
holding companies located in Pennsylvania, irrespective of state law.
In July 1995, the Pennsylvania Banking Code was amended to authorize full
interstate banking and branching under Pennsylvania law. Specifically, the
legislation (i) eliminates the "reciprocity" requirement previously applicable
to interstate commercial bank acquisitions by bank holding companies,
(ii) authorizes interstate bank mergers and reciprocal interstate branching
into Pennsylvania by interstate banks, and (iii) permits Pennsylvania
institutions to branch into other states with the prior approval of the
Pennsylvania Department of Banking.
Overall, this federal and state legislation has, as was predicted, had the
effect of increasing consolidation and competition and promoting geographic
diversification in the banking industry.
Proposed Legislation and Regulations
From time to time, various federal and state legislation is proposed that
could result in additional regulation of, and restrictions on, the business of
the Corporation and the Bank, or otherwise change the business environment.
Management cannot predict whether any of this legislation, if enacted, will
have a material effect on the business of the Corporation.
Employees
As of December 31, 1997, there were 469 persons employed by the Bank, of
which 350 were full-time and 119 were part-time employees. These figures do not
include employees of Town & Country, Inc. which employed 42 persons.
Item 2 - Properties
The Bank, in addition to its main office, had, at December 31, 1997, a
branch network of 29 offices and 2 off-site electronic MAC/ATM installations.
All branches are located in Lancaster County with the exception of one office,
located in Chester County. Branches at nineteen (19) locations are occupied
under leases and at three branches, the Bank owns the building, but leases the
land. One off-site MAC/ATM installation is occupied under lease. All other
properties were owned in fee. All real estate and buildings owned by the Bank
are free and clear of encumbrances. The Corporation owns no real estate.
The leases expire intermittently over the years through 2022 and most are
subject to one or more renewal options. During 1997, aggregate annual rentals
for real estate did not exceed three percent of the Bank's operating expenses.
On December 4, 1996, the Bank purchased a property located at 1097
Commercial Avenue, East Petersburg, PA, situated on 12.7 acres with a building
containing approximately 123,000 square feet. The building is used to house the
Bank's Administrative Service Center as well as other departments of the Bank.
Town & Country, Inc., a wholly owned subsidiary of the Bank, also occupies this
building. The building is owned in fee by the Bank, free and clear of
encumbrances. The Bank sold the building which previously housed the
Administrative Service Center. Settlement took place on February 21, 1997.
Town & Country, Inc. sold the building it formerly occupied on April 1,
1997.
In 1995, the Bank completed construction of a new headquarters building
including a branch banking office. The building also serves as headquarters for
the Corporation. Occupancy took place in July of 1995. The three-story
building contains approximately 53,000 square feet. The Bank and the
Corporation occupy approximately 43,000 square feet. Nearly 10,000 square
feet has been leased to other tenants. The building is owned in
fee by the Bank, free and clear of encumbrances.
Item 3 - Legal Proceedings
As of December 31, 1997, there were no material pending legal proceedings,
other than ordinary routine litigation incidental to the business, to which the
Corporation or its subsidiaries are a party or by which any of their property is
the subject.
Item 4 - Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the
fourth quarter of 1997.
PART II
Item 5 - Market for the Registrant's Common Equity and Related Stockholder
Matters
As of January 29, 1998, the common stock of the Corporation began trading
on the NASDAQ National Market. The trading symbol for Sterling Financial
Corporation is SLFI. There are 35,000,000 shares of common stock
authorized and at February 27, 1998, 6,161,006 shares were outstanding.
As of February 27, 1998, the Corporation had approximately 3,081
stockholders of record. There is no other class of stock authorized
or outstanding. During 1997, the price range of the
common stock known by management to have traded was $25.00 to $32.00 per share.
A regular $.20 per share dividend, as well as a $.04 per share "Special
Dividend," was declared in the third quarter of 1997 and is reflected in the
table below. The Corporation is restricted as to the amount of dividends
that it can pay to stockholders by virtue of the
restrictions on the Bank's ability to pay dividends to the
Corporation. See Note 19 to the 1997 Consolidated Financial
Statements. The Corporation paid a 5% stock dividend in July 1996. The
following table reflects the bid and asked prices reported for the Corporation's
common stock at the end of the period indicated and the cash dividends declared
on the common stock for the periods indicated. All information has been
restated to give effect to the 5% stock dividend paid in 1996.
In the absence of an active market, these prices may not
reflect the actual market value of the
Corporation's stock for the periods reported.
1997 Bid Ask Dividend
First Quarter $25.25 $25.75 $.19
Second Quarter 25.375 25.625 .19
Third Quarter 25.75 26.125 .24
Fourth Quarter 30.50 32.00 .20
1996 Bid Ask Dividend
First Quarter $25.18 $26.13 $.18
Second Quarter 26.36 26.60 .18
Third Quarter 26.25 26.75 .19
Fourth Quarter 25.25 26.25 .19
The prices used in the previous table represent bid and asked prices
furnished by F.J. Morrissey & Company; Hopper Soliday & Co., Inc.; Legg Mason
Wood Walker, Inc.; Prudential Securities; Ryan, Beck & Company; or The National
Quotation Bureau. These quotations reflect inter-dealer prices, without retail
markup, markdown or commission.
The Corporation maintains a Dividend Reinvestment and Stock Purchase Plan
for eligible stockholders who elect to participate in the plan. A copy of the
Prospectus for this plan can be obtained by writing to: Bank of Lancaster
County, N.A. Dividend Reinvestment and Stock Purchase Plan, 101 North
Pointe Boulevard, Lancaster, Pennsylvania 17601-4133.
Item 6 - Selected Financial Data
The following selected financial data should be read in conjunction with
the Corporation's consolidated financial statements and the
accompanying notes presented elsewhere herein.
Summary of Operations
(Dollars in thousands, except per share data)
Years Ended 1997 1996 1995 1994 1993
Interest income.............. $ 56,499 $ 52,558 $ 48,850 $ 41,931 $ 40,092
Interest expense............. 25,326 22,823 21,153 14,926 15,042
------ ------ ------ ------ ------
Net interest income.......... 31,173 29,735 27,697 27,005 25,050
Provision for loan losses.... 1,129 580 534 1,081 2,430
------ ------ ------ ------ ------
Net interest income after
provision for loan losses... 30,044 29,155 27,163 25,924 22,620
Other income................. 11,930 9,442 7,397 6,222 8,107
Other expenses............... 28,082 25,639 22,527 21,232 20,176
------ ------ ------ ------ ------
Income before income taxes... 13,892 12,958 12,033 10,914 10,551
Applicable income taxes...... 3,491 3,147 3,039 2,637 2,749
------ ------ ------ ------ ------
NET INCOME................... $ 10,401 $ 9,811 $ 8,994 $ 8,277 $ 7,802
====== ====== ====== ====== ======
Per Common Share:*
Net income (basic and diluted)$ 1.68 $ 1.57 $ 1.45 $ 1.35 $ 1.30
Cash dividends declared**.... .82 .74 .89 .58 .54
Book value................... 12.03 11.12 10.79 9.76 8.58
Book value (excluding
SFAS 115)................. 11.56 10.86 10.51 9.69 8.58
Average shares outstanding 6,202,696 6,235,257 6,204,212 6,128,058 6,013,937
Ratios:
Return on average assets.... 1.32% 1.34% 1.36% 1.38% 1.41%
Return on average equity.... 14.89% 15.01% 15.02% 15.47% 16.90%
Financial Condition at
Year-End:
Assets...................... $ 845,488 $ 764,072 $ 711,154 $ 633,395 $ 587,883
Loans (net of unearned)..... 511,637 473,832 426,312 392,649 359,365
Deposits.................... 718,661 647,036 610,105 537,002 505,680
Stockholders' Equity........ 73,987 69,179 63,909 57,285 49,467
Average Assets.............. 789,314 732,226 659,335 600,263 555,216
*Figures prior to 1996 were restated for stock dividends of 5% paid in 1996 and 5%
paid in 1993, a two-for-one stock split paid on September 1, 1994 and for
comparative purposes.
**The 1997 dividend includes a $.04 per share "Special Dividend," declared in the
third quarter. The 1995 dividend includes a $.25 per share "Special Dividend"
declared in the second quarter.
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion provides management's analysis of the consolidated
financial condition and results of operations of the Corporation and its
subsidiaries, the Bank and its subsidiary, Town & Country, Inc.
and Sterling Mortgage Services, Inc. Management's discussion and
analysis should be read in conjunction with the audited financial statements
and footnotes appearing elsewhere in this report.
(All dollar amounts presented in the tables are in thousands, except per
share data.)
Results of Operations Summary
Net income for 1997 was $10,401,000, an increase of $590,000 or 6% over
the $9,811,000 earned in 1996. The results of 1996 were $817,000 or 9.1%
higher than the $8,994,000 reported in 1995. Basic earnings per share
and diluted earnings per share on net income amounted to $1.68, $1.57
and $1.45 for the years ended 1997, 1996 and 1995, respectively.
Basic earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding, which
were 6,202,696, 6,235,257 and 6,204,212 for 1997, 1996 and 1995,
respectively. The weighted number of common shares and dilutive
potential common stock used in calculating the diluted earnings per
share were 6,205,784, 6,235,330 and 6,204,212, respectively for 1997, 1996
and 1995. Figures prior to 1997 were restated to reflect a 5%
stock dividend paid in July, 1996.
Return on average total assets was 1.32% in 1997 compared to 1.34%
in 1996 and 1.36% in 1995. Return on average stockholders' equity was 14.89%,
in 1997 compared to 15.01% in 1996 and 15.02%, in 1995.
Growth in earning assets was the primary factor contributing to the
increased earnings in 1997 and 1996. As of December 31, 1997, earning assets
were approximately $747 million compared to $673 million at
December 31, 1996, and $629 million at December 31, 1995.
Average earning assets for 1997 increased nearly $51 million,
to approximately $699 million, up 7.9% from the prior year.
Similarly, in 1996, average earning assets increased
approximately $61 million, up 10.4% from 1995. The current year increase,
as well as the increse in 1996, was primarily due to increases
in both loans and investments.
Average interest bearing liabilities increased nearly $48
million or 8.3% in 1997, compared to an increase of nearly $59 million,
or 11.3% in 1996.
The increase in average earning assets exceeded the increase in average
interest-bearing liabilities in both 1997 and 1996.
Provision for loan losses increased to $1,129,000 in 1997 from $580,000
in 1996. The provision in 1995 was $534,000.
Non-interest income increased $2,488,000 in 1997, compared to an
increase of $2,045,000 in 1996. In 1997, all categories of non-interest
income increased over the previous year.
Non-interest expenses increased $2,443,000 or 9.5% in 1997 compared
to an increase of $3,112,000 or 13.8% in 1996 over 1995.
The majority of assets and liabilities of a financial institution are
monetary in nature and, therefore, differ greatly from most commercial and
industrial companies that have significant investments in fixed
assets or inventories. However, inflation does have an important impact on the
growth of total assets and on non-interest expenses, which tend to
rise during periods of general inflation. The level of inflation over the
last few years has been declining.
During 1997, 1998 and 1999, the Federal Deposit Insurance Corporation
(the "FDIC") estimates that the average regular annual deposit insurance
assessment will be about 1.29 cents per $100 of deposits for
BIF deposits and 6.44 cents per $100 of deposits for SAIF
deposits. Individual institution's assessments will continue to vary
according to their capital and management ratings. As always, the FDIC
will be able to raise the assessments as necessary to maintain
the funds at their target capital ratios provided by law.
Based on the above legislation, the Bank experienced an increase in the
FDIC assessment in 1997 over 1996.
The passage of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 and the Riegle Community Development and Regulatory
Improvement Act has not yet, but may have a significant impact upon
the Corporation. The key provisions pertain to interstate banking
and interstate branching as well as a reduction in the regulatory burden on
the banking industry. Since September 1995, bank holding companies may
acquire banks in other states without regard to state law. In addition,
banks could merge with other banks in another state beginning in June
1997. States may adopt laws preventing interstate branching but, if
so, no out-of-state bank can establish a branch in such state and no
bank in such state may branch outside the state. Pennsylvania recently
amended the provisions of its Banking Code to authorize full interstate banking
and branching under Pennsylvania law and to facilitate
the operations of interstate banks in Pennsylvania. As a result of legal
and industry changes, management predicts that consolidation will
continue as the financial services industry strives for
greater cost efficiencies and market share. Management believes that
such consolidation may enhance its competitive position as a community bank.
There are numerous proposals before Congress to modify the
financial services industry and the way commercial banks operate.
However, it is difficult to determine at this time what effect
such provisions may have until they are enacted into law. Except as
specifically described above, management believes that the effect
of the provisions of the aforementioned legislation on the
liquidity, capital resources and results of operations of the Corporation
will be immaterial. Management is not aware of any other current
specific recommendations by regulatory authorities or proposed legislation,
which if they were implemented, would have a material adverse effect
upon the liquidity, capital resources or results of operations,
although the general cost of compliance with numerous and multiple federal
and state laws and regulations does have and in the future may have a
negative impact on the Corporation's results of operations.
In addition to historical information, this Annual Report on Form 10-K
Annual Report contains forward-looking statements. The forward-looking
statements contained herein are subject to certain risks and
uncertainties that could cause actual results to differ
materially from those projected in the forward-looking statements.
Important factors that might cause such a difference include, but are
not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of
Operations." Readers are cautioned not to place undue reliance on
these forward-looking statements, which reflect management's analysis only as
of the date hereof. The Corporation undertakes no obligation
to publicly revise or update these forward-looking statements to
reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors described in other
documents the Corporation files from time to time with the Securities and
Exchange Commission, including the Quarterly Reports on Form 10-Q to
be filed by the Corporation, and any Current Reports on Form 8-K filed by the
Corporation.
Management has initiated an enterprise-wide program to prepare the
Corporation's computer systems and applications for the year 2000. In
January 1997, the Corporation began converting its
computer systems to be year 2000 compliant. On December 31, 1997,
approximately 59 percent of the Corporation's systems were compliant,
with all systems expected to be compliant by May of 1999. The Corporation
continues to evaluate appropriate courses of corrective action,
including replacement of certain systems whose associated costs
would be recorded as assets and amortized. The total cost of the project is
being funded through operating cash flows. Accordingly, the Corporation
does not expect the amounts required to be expensed over the
next two years to have a material effect on its financial
position or results of operations.
Aside from those matters described above, management does not believe that
there are any trends or uncertainties which would have a material
impact on future operating results, liquidity or capital resources
nor is it aware of any current recommendations by the regulatory authorities
which if they were to be implemented would have such an effect.
Net Interest Income
The primary component of the Corporation's net earnings is net
interest income, which is the difference between interest and
fees earned on interest-earning assets and interest paid
on deposits and borrowed funds. For presentation and analytical purposes,
net interest income is adjusted to a taxable equivalent basis. For purposes of
calculating yields on tax-exempt interest income, the taxable equivalent
adjustment equates tax-exempt interest rates to taxable interest rates as
noted in Table 1. Adjustments are made using a statutory
federal tax rate of 34% for 1997, 1996 and 1995.
Table 1 presents average balances, taxable equivalent interest income
and expense and the yields earned or paid on these assets and
liabilities. The increase in net interest income during
1997 and 1996 resulted from increased volumes in average earning assets.
Average earning assets increased 7.9% in 1997 and 10.4% in 1996.
These increases were primarily funded with interest-bearing
liabilities which increased 8.3% in 1997 and 11.3% in 1996.
Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity
Interest Rates and Interest Differential-Tax Equivalent Yields
(Unaudited)
Years ended December 31,
1997 1996 1995
Average Annual Average Annual Average Annual
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest bearing deposits
with banks..............$ 214 $ 13 5.90% $ 103 $ 6 5.72% $ 30 $ 2 6.78%
Federal Funds sold......... 13,110 730 5.57% 7,376 398 5.39% 7,583 449 5.92%
Investment securities:
U.S. Treasury securities. 28,330 1,679 5.93% 28,789 1,686 5.86% 28,696 1,675 5.84%
U.S. Government agencies. 33,508 2,100 6.27% 33,895 2,192 6.47% 27,999 1,761 6.29%
State and Municipal
securities.............. 60,324 4,702 7.79% 57,966 4,615 7.96% 48,884 4,083 8.35%
Other securities......... 66,207 4,131 6.24% 57,189 3,535 6.18% 66,990 4,294 6.41%
------- ------- ------ -------- ------- ------ -------- ------- -----
Total investment securities188,369 12,612 6.70% 177,839 12,028 6.76% 172,569 11,813 6.85%
Loans:
Commercial...............265,638 24,021 9.04% 245,018 22,276 9.09% 226,032 21,284 9.42%
Consumer.................133,125 11,927 8.96% 130,044 11,401 8.77% 106,171 9,766 9.20%
Mortgages................ 47,983 3,814 7.95% 41,046 3,330 8.11% 32,739 2,771 8.46%
Leases................... 50,811 5,221 10.28% 46,420 4,865 10.48% 41,974 4,350 10.36%
------- ------- ------ -------- ------- ------ -------- ------- -----
Total loans................497,557 44,983 9.04% 462,528 41,872 9.05% 406,916 38,171 9.38%
------- ------- ------ -------- ------- ------ -------- ------- -----
Total earning assets.......699,250 58,338 8.34% 647,846 54,304 8.38% 587,098 50,435 8.59%
Allowance for loan losses.. (7,863) (7,863) (7,155)
Cash and due from banks.... 32,409 30,238 27,763
Other nonearning assets.... 65,518 62,005 51,629
------- -------- --------
Total nonearning assets.... 90,064 84,380 72,237
------- ------- ------ -------- -------- ------ -------- -------- -----
Total assets..............$789,314 $ 58,338 7.39% $732,226 $ 54,304 7.42% 659,335 $ 50,435 7.65%
======== ======= ====== ======== ======== ====== ======== ======= ======
Liabilities and Stockholders' Equity
Deposits:
Demand deposits
Noninterest bearing....$ 74,332 $ 0 0.00% $ 72,052 $ 0 0.00% $66,133 $ 0 0.00%
Demand deposits
Interest bearing........267,987 6,931 2.59% 257,622 6,726 2.61% 239,036 7,181 3.00%
Savings deposits......... 58,149 1,188 2.04% 58,232 1,288 2.21% 54,982 1,333 2.42%
Time deposits............262,681 14,805 5.64% 229,835 12,695 5.52% 194,512 10,579 5.44%
------- -------- ------ -------- ------- ------ -------- ------- -----
Total deposits.............663,149 22,924 3.46% 617,741 20,709 3.35% 554,663 19,093 3.44%
Other borrowed funds....... 35,316 2,402 6.80% 30,578 2,114 6.91% 29,143 2,060 7.07%
Other liabilities.......... 18,894 17,122 14,856
Stockholders' equity....... 71,955 66,785 60,673
------- -------- ------ -------- ------- ------ -------- ------- -----
Total liabilities and
Stockholders' equity....$789,314 $ 25,326 3.21% $732,226 $ 22,823 3.12% $659,335 $ 21,153 3.21%
======== ======== ====== ======== ======== ====== ======== ======= =====
Net interest income/
Average total assets...... $ 33,012 4.18% $ 31,481 4.30% $ 29,282 4.44%
Net interest income/
Average earning assets.... $ 33,012 4.72% $ 31,481 4.86% $ 29,282 4.99%
Net interest income on a fully taxable equivalent basis increased by
$1,531,000 in 1997 compared to an increase of $2,199,000 in 1996. Table 2
indicates that of the increase in 1997, $1,788,000 was the result
of increased volumes. This figure was reduced by $257,000
due to changes in interest rates. The increase in 1996 resulted in
$2,910,000 from increased volumes while a reduction of $711,000 was
realized due to changes in interest rates.
For the year 1997 compared to 1996, loan volumes, on average, increased
over $35 million and income earned on loans increased $3,111,000,
tax adjusted. This compares to a volume increase of nearly $56 million in
1996 over 1995 with an increase in income earned on loans amounting
to $3,701,000. As a result of increased volumes in 1997,
nearly $3.2 million contributed to the increase in income on loans.
Rates charged on loans decreased in 1997. The decrease in rates
reduced interest $60,000 in income earned on loans.
Increased volume in loans in 1996 contributed over $5.2 million to
the increase in income, while a decrease in interest rates reduced
income earned on loans by $1.5 million.
Total investment securities, on average, increased over $10.5 million in
1997 over 1996 compared to an increase of over $5.2 million in 1996 over
1995. Increased volume in both periods was primarily responsible
for the increase in interest income on securities. Table 2 indicates
that, of the increase in interest income in 1997, $712,000 was the result
of increased volume while a decrease in interest rates caused a
$128,000 reduction. Increased volume in securities in 1996 contributed
nearly $361,000 to the increase while a decrease in rates
caused a $146,000 reduction.
Interest income on federal funds sold contributed $332,000 to the
increase in net income in 1997 over 1996. Increased volume, as well
as increased rates, combined to produce this increase.
Interest bearing deposits, on average, grew over $43 million in 1997.
The major portion of the increase in interest expense on deposits was
generated on time deposits, as a result of increased volume
and rates paid for these deposits. Although there were
increased volumes on the other deposits, the decrease in rates
paid on these deposits reduced the total interest expense by $163,000.
Interest expense on interest bearing deposits increased over
$1.6 million in 1996 over 1995. Increased volumes generated an
increase of $2,558,000 while a reduction in income of $942,000 resulted
from decreased rates.
Interest expense on borrowed funds increased $288,000 in 1997 over 1996
compared to an increase of $54,000 in 1996 over 1995. The major portion
of the increase in these periods was a result of increased volume.
Table 2 - Analysis of Changes in Net Interest Income
The rate-volume variance analysis set forth in the table below, which is
computed on a tax equivalent basis, compares changes in net interest
income for the periods indicated by their rate and volume components.
,caption>
1997 Versus 1996 1996 Versus 1995
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
Volume Rate Total Volume Rate Total
Interest Income
Interest on deposits
with banks...........$ 6 $ 1 $ 7 $ 5 $ (1) $ 4
Interest on federal
funds sold........... 309 23 332 (12) (39) (51)
Interest on investment
securities........... 712 (128) 584 361 (146) 215
Interest and fees on
loans................ 3,171 (60) 3,111 5,216 (1,515) 3,701
------- -------- --------- -------- -------- -------
Total interest income...$ 4,198 $ (164) $ 4,034 $ 5,570 $ (1,701) $ 3,869
------- -------- --------- -------- -------- -------
Interest Expense
Interest on
interest-bearing
demand deposits......$ 271 $ (66) $ 205 $ 558 $ (1,013) $ (455)
Interest on
savings deposits...... (2) (97) (99) 79 (124) (45)
Interest on
time deposits......... 1,814 295 2,109 1,921 195 2,116
Interest on
borrowed funds........ 327 (39) 288 102 (48) 54
------- -------- -------- -------- -------- --------
Total interest expense..$ 2,410 $ 93 $ 2,503 $ 2,660 $ (990) $ 1,670
------- -------- -------- -------- -------- --------
Net interest income.....$ 1,788 $ (257) $ 1,531 $ 2,910 $ (711) $ 2,199
======= ======== ======== ======== ======== ========
Provision for Loan Losses
The provision for loan losses charged against earnings was $1,129,000
in 1997 compared to $580,000 in 1996 and $534,000 in 1995. The provision
reflects the amount deemed appropriate by management to produce
an adequate reserve to meet the present and foreseeable risk
characteristics of the loan portfolio. Management's judgement is
based on the evaluation of individual loans and their overall risk
characteristics, past loan loss experience, and other relevant factors. Net
charge-offs amounted to $1,199,000 in 1997, $560,000 in 1996 and
$394,000 in 1995. Gross charge-offs for 1997 were $1,502,000, an
increase over the $703,000 reported in 1996. The increases in the
provision for loan losses, gross and net charge-offs were a result of a
reduction in asset quality in the consumer loan portfolio,
particularly the installment and credit card portfolios.
Personal bankruptcies played a significant role in the losses.
Management has instituted certain changes in underwriting criteria in an
effort to reduce the risk of similar increases in the future.
Management does not expect to experience a similar
increase in losses in 1998 in the consumer portfolio. Management
believes that despite the increase in the losses in 1997, the percentage of
net losses to average loans and leases is
comparable to the Bank's peers.
The allowance for loan losses as a percent of loans at December 31, 1996
was 1.65%, while at December 31, 1997 it was 1.51%.
Non-Interest Income
Table 3 - Non-Interest Income
1997/1996 1996/1995
Increase Increase
(Decrease) (Decrease)
1997 Amount % 1996 Amount % 1995
Income from fiduciary activities.$ 1,513 $ 374 32.8% $1,139 $ 283 33.1% $ 856
Service charges on deposit
accounts....................... 2,909 424 17.1% 2,485 475 23.6% 2,010
Other service charges, commissions
and fees....................... 1,456 512 54.2% 944 124 15.1% 820
Mortgage banking income........... 1,305 113 9.5% 1,192 667 127.0% 525
Other operating income............ 4,539 1,015 28.8% 3,524 338 10.6% 3,186
Investment securities gains or
(losses)....................... 208 50 31.7% 158 158 .0% 0
------ ------ ------ ------ ------- ------ ------
Total............................$11,930 $ 2,488 26.4% $9,442 $ 2,045 27.7% $7,397
======= ======= ====== ====== ======= ====== ======
Non-interest income, recorded as other operating income, consists of
income from fiduciary activities, service charges on deposit accounts,
other service charges, commissions and fees, mortgage banking
income and other income such as safe deposit box rents and income
from operating leases.
Income from fiduciary activities in the amount of $1,513,000 in 1997
was $374,000 or 32.8% greater than the $1,139,000 recorded in 1996.
Income in 1996 was $283,000 or 33.1% greater than the $856,000
recorded in 1995. Fees increased primarily due to increased transaction
volumes.
Service charges on deposit accounts increased to $2,909,000, an increase of
$424,000 or 17.1% over the $2,485,000 reported for 1996. Service charges on
deposit accounts in 1996 were $475,000 more than the $2,010,000 reported
for 1995. General increases in service charges on various accounts,
as well as, transaction volume produced the increases for
the periods reported. Management continuously monitors fee
structure and makes changes where they believe appropriate.
Other service charges, commissions and fees were $1,456,000 in 1997
compared to $944,000 in 1996 and $820,000 in 1995. The increase in 1997
over 1996 was $512,000 or 54.2%. The significant increase in 1997 is
attributable to the introduction of ATM charges. Other contributors
to the increase were fees received on mutual fund transactions and
fees on the Bank's debit card.
Income from mortgage banking activities increased to $1,305,000 in 1997
from $1,192,000 in 1996. Mortgages sold in the secondary market in
1997 increased to approximately $40.9 million from $33.2 million
in 1996. All mortgages sold were originated by the Bank's
mortgage department or the branch network. No mortgages were
acquired from third parties, nor have servicing rights been purchased
from third parties. A low interest rate environment in 1997, as well
as an expansion in mortgage products and services
resulted in the increase in volume in 1997. The Bank retains
mortgage servicing rights on the majority of mortgages originated and
sold on the secondary market. The Bank's mortgage servicing
portfolio was $175 million as of December 31, 1997 compared
to $155 million on December 31, 1996.
Another component of the mortgage banking increase in profit was caused
by implementation of FASB 122 (subsequently replaced by FASB 125)
which required that mortgage servicing rights be
recognized for their economic value, as of January 1,
1996. Mortgage servicing has a value because of the value of the
future servicing income to be recieved over the life of a mortgage.
The value of servicing rights is available through third
party purchasers in private transactions. The Bank has
developed business relationships with a third party mortgage company,
which sets the values of mortgage servicing rights based upon the mortgage
company's price offerings. The Bank recognized $470,805 in
mortgage servicing values in 1996 for its originated
servicing portfolio, when in previous years no value was recognized.
In 1997, the amount recognized was $549,756. Mortgage servicing rights are
recorded as an asset and recognized directly to income as if
the servicing had been sold. The asset is amortized as a charge to
earnings over the estimated servicing life of the associated
mortgage. Mortgage servicing assets, as of December 31, 1997, and 1996
were $892,000 and $442,000, respectively. Actual pay-off of mortgages
serviced with a recorded asset value are immediately charged against earnings.
Other operating income increased $1,015,000 to $4,539,000 in 1997 from
$3,524,000 in 1996. Other income was $3,186,000 in 1995. Income generated
from operating leases was a major contributor to this increase.
Income on operating leases increased approximately $400,000 in
1997 over 1996. Gains realized on the sale of real estate
and equipment, which amounted to $456,000, also added to the increase.
Investment securities transactions reflect a gain of $208,000 in 1997
compared to a gain of $158,000 in 1996 on securities sold from
the available-for-sale securities. There were no securities sold in 1995.
The Bank does not engage in trading activities. Therefore, the adoption
of SFAS 115 did not impact current year earnings.
As a result of these changes in the components of non-interest income,
total other operating income increased $2,488,000 in 1997 over 1996
compared to an increase of $2,045,000 in 1996 over 1995.
Non-Interest Expense
Table 4 - Non-Interest Expense
1997/1996 1996/1995
Increase Increase
(Decrease) (Decrease)
1997 Amount % 1996 Amount % 1995
Salaries and employee benefits...$16,398 $ 1,371 9.1% $15,027 $1,987 15.2% $13,040
Net occupancy expense............. 2,290 181 8.6% 2,109 388 22.5% 1,721
Furniture & equipment expense..... 2,480 436 21.3% 2,044 439 27.4% 1,605
FDIC insurance assessment......... 81 79 --- 2 (620) (99.7%) 622
Other operating expense........... 6,833 376 5.8% 6,457 918 16.6% 5,539
----- ------ ----- ------ ----- ----- -------
Total............................$28,082 $ 2,443 9.5% $25,639 $3,112 13.8% $22,527
======= ======= ===== ====== ====== ===== =======
Non-interest expense consists of salaries and employee benefits,
net occupancy expense, furniture and equipment expense and other operating
expenses.
Total operating expenses for 1997 were $28,082,000 compared to
$25,639,000 in 1996. This represents an increase of $2,443,000 or 9.5%. This
compares to an increase of $3,112,000 of 13.8% in 1996.
The largest component of the Corporation's other operating expense is
salaries and employee benefits, which increased to $16,398,000 in 1997
or $1,371,000 (9.1%) over the $15,027,000 reported
in 1996. In 1996, expenses increased $1,987,000 (15.2%)
over the $13,040,000 reported in 1995. The increases in 1997 and 1996
were primarily due to increases in staff as well as increases in wages
and the increased cost of employee benefits. During 1996,
four branch offices were opened. In December 1995,
two branch offices were acquired from another financial institution.
Each of these acquisitions contributed to the increase in 1996.
Three of the branches opened in 1996 were opened in the last quarter of 1996.
Occupancy expense increased $181,000 or 8.6% to $2,290,000 in 1997 from
$2,109,000 in 1996. By comparison, during 1996, there was an increase of
$388,000 or 22.5%. Three new branch offices were opened in the last
quarter of 1996. In addition, on December 4, 1996, the Bank
purchased property located at 1097 Commercial Avenue,
East Petersburg, Pennsylvania situated on 12.7 acres with a building
containing approximately 123,000 square feet. The building now
houses the Bank's Administrative Service Center, as well as other
departments of the Bank. Town & Country, Inc., a
wholly owned subsidiary of the Bank, also occupies this building.
These additions contributed to the increase in occupancy expense in 1997.
As noted, the Bank added four branch facilities to its
network in 1996. In addition, the Bank completed
construction of a new headquarters building in 1995 that also includes
branch banking facilities and two branch offices were acquired from
another financial institution in December 1995. These additions and expenses
relating to occupancy such as real estate taxes, insurance, utilities,
maintenance and janitor services contributed to the increase in occupancy
expense.
Furniture and equipment expenses were $2,480,000 in 1997 and $2,044,000
in 1996. This represents an increase of $436,000 or 21.3%. The increase
in 1996 over 1995 was $439,000 or 27.4%. Reflected in this increase is a
$244,000 increase in depreciation expense in 1997. Service contracts on
equipment also contributed to the increase in 1997.
The FDIC insurance assessment reflects an increase of $79,000 in 1997
over 1996. On September 30, 1996, the President signed into law the
Deposit Insurance Funds Act of 1996 to recapitalize the Savings
Association Insurance Fund ("SAIF") administered by
the Federal Deposit Insurance Corporation ("FDIC") and to provide
for repayment of the FICO (Financial Institution Collateral Obligation)
bonds issued by the United States Treasury Department. The FDIC levied a
one-time special assessment on SAIF deposits equal to 65.7 cents per $100
of the SAIF-assessable deposit base as of March 31, 1995.
During 1997, 1998 and 1999, the Bank Insurance Fund ("BIF")
will pay $322 million of FICO debt service, and SAIF will pay $458
million. During 1997, 1998 and 1999, the average regular annual
deposit insurance assessment is estimated to be about 1.29 cents
per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits
for SAIF deposits. Individual institution's assessments will
continue to vary according to their capital and management ratings.
As always, the FDIC will be able to raise the assessments as necessary to
maintain the funds at their target capital ratios provided
by law. After 1999, BIF and SAIF will share the FICO costs equally.
Under current estimates, BIF and SAIF assessment bases would each
be assessed at the rate of approximately 2.43
cents per $100 of deposits. The FICO bonds will mature in 2018-2019, ending
the interest payment obligation. The legislation caused the Bank to
experience an increase in the 1997 FDIC assessment over the 1996 assessment.
Other operating expense increased $376,000 or 5.8% in 1997 compared to an
increase of $918,000 in 1996. The 1997 increase is consistent with rising costs
associated with the acquisition of services in this category of expense.
Expenses in this category include postage, Pennsylvania Shares Tax,
advertising and marketing, professional services, telephone,
stationery and forms, ATM fees, insurance premiums, expense of other real
estate owned and other expense categories not specifically
identified on the income statement. Contributing to the increase in
1997 were increases in Pennsylvania Shares Tax, professional
services, postage, MAC fees and telephone expense.
Income Taxes
Income tax expense was $3,491,000 in 1997 compared to $3,147,000 in
1996 and $3,039,000 in 1995. These increases were a result of higher
levels of taxable income and increased earnings each year. The Corporation's
effective tax rate was 25.1%, in 1997, compared with 24.3%,
in 1996, and 25.3%, in 1995. Use of tax credits in 1997 and
1996 resulted in a lower effective tax rate than 1995 even though income
before taxes increased. Additional information relating to income
taxation is presented in the Notes to Consolidated Financial Statements.
Financial Condition
Investment Portfolio
Table 5 - Investment Securities at Cost
The following table shows the amortized cost of the held-to-maturity
securities owned by the Corporation as of the dates indicated. Investment
securities are stated at cost adjusted for amortization of
premiums and accretion of discounts.
December 31,
1997 1996 1995
U.S. Treasury securities................$ 6,537 $ 12,888 $ 18,837
Obligations of other U.S. Government
agencies and corporations............. 9,696 11,607 18,473
Obligations of states and political
subdivisions.......................... 45,816 37,584 40,212
Mortgage-backed securities.............. 1,575 2,076 3,854
Other bonds, notes and debentures....... 18,574 27,269 38,944
--------- --------- ---------
Subtotal................................ 82,198 91,424 120,320
Non-marketable securities............... 2,957 2,798 2,565
--------- --------- ---------
Total...................................$ 85,155 $ 94,222 $ 122,885
========= ========= =========
The following table shows the amortized cost and fair value of the
available-for-sale securities owned as of the dates indicated.
December 31,
1997 1996 1995
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- -------- -------- ----------- --------
U.S. Treasury securities............$ 24,435 $ 24,625 $ 13,611 $ 13,598 $ 11,046 $ 11,155
Obligations of other U.S. Government
agencies and corporations.......... 26,821 27,008 18,800 18,718 15,489 15,632
Obligations of states and political
subdivisions....................... 21,840 22,571 20,488 20,819 19,622 19,945
Mortgage-backed securities........... 832 829 1,125 1,117 1,249 1,242
Other bonds, notes and debentures.... 42,955 43,178 22,752 22,771 19,013 19,247
-------- --------- -------- -------- --------- --------
Subtotal............................. 116,883 118,211 76,776 77,023 66,419 67,221
Equity securities.................... 174 3,263 171 2,352 88 1,746
-------- --------- -------- -------- --------- --------
Total................................$117,057 $ 121,474 $ 76,947 $ 79,375 $ 66,507 $ 68,967
======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields)
The following table shows the maturities of held-to-maturity debt
securities at amortized cost as of December 31, 1997 and approximate weighted
average yields of such securities. Yields are shown on a tax
equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 3,999 5.71% $ 2,538 5.99% $ --- ---% $ --- ---% $ 6,537 5.82%
Obligations of
other U.S.
Government
agencies and
corporations.. 5,452 5.79% 3,256 6.06% 988 6.48% --- ---% 9,696 5.95%
Obligations of
states and
political sub-
divisions..... 3,966 5.96% 11,264 7.40% 21,463 7.62% 9,123 7.58% 45,816 7.41%
Mortgage-backed
securities.... 60 8.62% 1,102 8.68% 226 8.55% 187 7.61% 1,575 8.53%
Other bonds,
notes and
debentures.... 9,476 6.15% 9,098 6.53% --- ---% --- ---% 18,574 6.34%
------- ----- -------- ------ -------- ------ ------- ------ -------- -----
$22,953 5.96% $27,258 6.87% $ 22,677 7.58% $ 9,310 7.58% $82,198 6.89%
======= ===== ======= ====== ======== ===== ======= ====== ======== =====
The following table shows the maturities of available-for-sale debt
securities at amortized cost as of December 31, 1997 and approximate
weighted average yields of such securities. Yields are shown on a
tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 4,500 4.17% $ 19,622 6.13%$ 313 6.21% $ --- ---% $ 24,435 5.77%
Obligations of
other U.S.
Government
agencies and
corporations.. 1,299 5.98% 19,876 6.26% 5,646 6.66% --- ---% 26,821 6.33%
Obligations of
states and
political sub-
divisions..... 603 7.93% 4,119 7.14% 15,308 7.91% 1,810 7.91% 21,840 7.77%
Mortgage-backed
securities.... 278 5.85% 554 5.91% --- ---% --- ---% 832 5.89%
Other bonds,
notes and
debentures.... 4,952 6.13% 38,003 6.49% --- ---% --- ---% 42,955 6.45%
------- ------ ------- ------ ------- ----- ------- ----- -------- ------
$11,632 5.44% $82,174 6.38% $21,267 7.55% $ 1,810 7.91% $116,883 6.52%
======= ====== ======= ====== ======= ===== ======= ===== ======== ======
Loans
Table 7 - Loan Portfolio
The following table sets forth the composition of the Corporation's loan
portfolio as of the dates indicated:
December 31,
1997 1996 1995 1994 1993
Commercial, financial and
agricultural..............$ 271,605 $ 239,701 $ 228,058 $ 208,918 $ 191,431
Real estate-construction... 6,045 5,608 6,378 8,542 10,265
Real estate-mortgage....... 49,438 45,373 33,124 30,505 22,335
Consumer................... 132,778 136,989 116,210 106,921 101,256
Lease financing (net of
unearned income)......... 52,207 47,346 43,904 38,771 35,443
---------- ---------- ---------- ---------- ---------
Total loans.................$ 512,073 $ 475,017 $ 427,674 $ 393,657 $ 360,730
========== ========== ========== ========== =========
Table 8 - Loan Maturity and Interest Sensitivity
The following table sets forth the maturity and interest sensitivity of
the loan portfolio as of December 31, 1997:
After one
Within but within After
one year five years five years Total
Commercial, financial and agricultural..$ 121,240 $ 129,905 $ 20,460 $ 271,605
Real estate-construction................ 1,009 5,036 none 6,045
--------- --------- -------- --------
$ 122,249 $ 134,941 $ 20,460 $ 277,650
========= ========= ========= =========
Loans due after one year totaling $94,632,000 have variable interest rates.
The remaining $60,769,000 in loans have fixed rates.
Table 9 - Nonaccrual, Past Due and Restructured Loans
The following table presents information concerning the aggregate amount of
nonaccrual, past due and restructured loans:
December 31,
1997 1996 1995 1994 1993
Nonaccrual loans...........$ 1,314 $ 1,193 $ 1,010 $ 2,127 $ 2,960
Accruing loans, past due
90 days or more......... 787 737 330 1,127 522
Restructured loans........ 2,105 none none none none
-------- -------- -------- -------- --------
Total nonperforming loans.. 4,206 1,930 1,340 3,254 3,482
Other real estate owned.... 341 81 252 759 251
-------- -------- -------- -------- --------
Total nonperforming assets.$ 4,547 $ 2,011 $ 1,592 $ 4,013 $ 3,733
======== ======== ======= ======== ========
Ratios:
Non-performing loans to
total loans.......... .82% .41% .31% .83% .97%
Non-performing assets to
total loans and other
real estate owned.... .89% .42% .37% 1.02% 1.04%
Non-performing assets to
total assets.......... .54% .26% .22% .63% .63%
Allowance for loan losses to
non-performing loans.. 183.8% 404.1% 580.6% 234.8% 206.2%
The economic conditions within the Corporation's market area remained
healthy in 1997. The unemployment rate for Lancaster County, which is the
Bank's primary market area was 2.9%. The jobless rate during 1997 hovered
close to 3%, which was the lowest or second lowest in the state.
Lancaster County's unemployment rate has historically been and
continues to be one of the lowest among Pennsylvania's 14
metropolitan regions. It also remains well below the state unemployment
rate of 4.80%, as reported for December 1997. Management believes
that the unemployment rate for 1998 is expected to mirror that of
1997 with little movement in either direction. Management believes that
Lancaster's labor market is expected to remain one of the
tightest in the state.
Lancaster County also was strong compared to the national unemployment
levels. The U.S. unemployment rate was at 4.70% in December 1997
compared to 5.3% in December 1996. The average for the year of 4.9%
was the best since 1973. Unemployment hasn't been lower since 1969.
Economists do not anticipate much change this year in the
health of labor markets and believe the unemployment rate will
drift toward 4.5% or a shade lower before rising late in the
year toward 5%.
The Bank's loan delinquency, as a percent of loans outstanding,
declined during 1997. At December 31, 1997, the rate was at .83%
compared to .96% and .58% for December 31, 1996 and December 31,
1995, respectively. The average delinquency rate
of .99% for 1997 did increase compared to .77% in 1996. The
increase in the average delinquency rate is primarily attributable to increases
in the retail portfolio, particularly in the
installment and credit card portfolios. The Bank is not immune to
the continued rise in the number of bankruptcies that occurred in 1997 and
1996 nationwide. While management believes delinquency rates could
continue an upward trend during 1998, management does not
expect that they will approach the national delinquency rates. The .83%
remains well below the accepted level established by
management and below that of the Bank's peers. During the year,
total nonaccrual loans and other real estate owned increased to $1,655,000
from $1,274,000 at December 31, 1996. Total non-performing assets
increased to $4,547,000 compared to $2,011,000 for
December 31, 1996, representing a 126.1% increase. The increase in the
total non-performing assets is primarily attributed to the restructure of
a series of loans to one borrower involving $2,105,000. There are no
commitments to lend additional funds to this borrower in
relation to the restructured loans. A loan is categorized as
restructured if the original interest rate on the loan, repayment terms
or both are restructured due to a deterioration in the
financial condition of the borrower. In the case of the above referenced
loans, the Bank is secured by real estate. The loans are
current and have performed in accordance with the contractural terms,
both prior to and after the restructure. Accrual of interest on
these loans continues.
The Bank's reserve coverage declined during the year. Reserves, as a
percent of non-performing loans, declined to 184% compared with 404% for
December 31, 1996, and 581% for December 31, 1995.
This decline in reserve coverage is a result of the
restructured loans in 1997 which were not present in 1996 and 1995.
A portion of the Bank's loan portfolio consists of loans to
agricultural-related borrowers. These loans are made for a variety of
purposes within the industry. Lancaster County continues to be the
top agricultural county in the state, leading Pennsylvania in production
of most crops and all livestock with the exception of sheep.
Dairy production remains Lancaster County's number one agricultural industry.
The Lancaster County dairy industry suffered in 1997 due to a steep drop
in milk prices. During the later part of 1997, milk prices
edged up slightly. Management hopes that this portion of the loan
portfolio will continue to show growth, but notes that
agricultural loans are susceptible to a variety of external factors
such as adverse climate, economic conditions, etc., in addition to factors
common to other industries.
In 1997, Lancaster County's residental real estate market enjoyed a
strong year. Through November 1997, houses sold countywide were up 5.4%
during the same 11-month period in 1996. Residential construction
contracts, however, dropped 6% between 1996 and 1997,. Reasonably
low interest rates, a continuing strong economy and minimal
inflation accounted for the sales performance. Strong home sales are
predicted through at least the first half of 1998. Non-residential
contracts increased by 25% over 1996.
The year 1998 is expected to be equivalent to 1997.
Most of the Bank's business activity is with customers located within
the Bank's defined market area. The majority of the Bank's real estate
loans are located within this area, therefore both a debtor's
ability to honor his obligations and increases and decreases in the market
value of the real estate collateralizing loans are affected by
the level of economic activity in Lancaster County.
The Bank's general policy is to cease accruing interest on loans when
management determines that a reasonable doubt exists as to the
collectibility of additional interest. Interest income on these
loans is only recognized to the extent payments are
received. Loans on a nonaccrual status were $1,314,000 at
December 31, 1997, compared to $1,193,000 at December 31, 1996. If interest
income had been recorded on all such loans for the years indicated, such
interest income would have been increased by approximately $152,755 and
$116,567 for 1997 and 1996 respectively. Interest income
recorded on nonaccrual loans was $20,020 and $27,532 for 1997 and 1996,
respectively. Potential problem loans are included as performing loans,
and are loans with respect to which possible
credit problems of the borrower cause management to doubt the ability of
the borrower to comply with present repayment terms. These loans
may eventually result in disclosure as non-performing loans. At
December 31, 1997, the Bank had no loans to disclose as potential problem
loans.
The Corporation implemented SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosures," an
amendment of SFAS No. 114, at the beginning of 1995.
The Bank defined impaired loans as all loans on nonaccrual status
and restructured, except those specifically excluded from the
scope of SFAS No. 114, regardless of the credit grade assigned by loan
review committee. All impaired loans are measured using the
fair value of the collateral for each loan. When an impaired
loan is measured as less than the recorded investment in the loan,
the Bank compares the impairment measured to the existing
allowance assigned to the loan. If the impairment is greater
than the allowance, the Bank adjusts the existing allowance to
reflect the greater amount or takes a charge to the provision for
loan losses in that amount. If the impairment is less than the existing
allowance for a particular loan, no adjustment to the
allowance or to the provision for loan and lease losses is made.
The Bank was not required to adjust for impaired loans for the periods
indicated.
The following table presents information concerning impaired loans
at December 31:
1997 1996
Gross impaired loans which have allowances..........$3,419 $1,193
Less: Related allowances for loan losses......... (410) (179)
------ ------
Net impaired loans..................................$3,009 $1,014
====== ======
The increase in impaired loans is primarily attributable to the
restructure of a series of loans to one borrower involving $2,105,000.
A loan is categorized as restructured if the original interest
rate on the loan, repayment terms or both are restructured due to a
deterioration in the financial condition of the borrower that
otherwise would not have been granted. In the case of the above
referenced loans, the Bank is fully secured with real estate.
The loans are current and have performed in accordance with the
contractural terms, both prior to and after the restructure.
Accrual of interest on these loans continue.
At December 31, 1997, there were no concentrations exceeding 10% of
total loans. A concentration is defined as amounts loaned to a
multiple number of borrowers engaged in similar activities which
would cause them to be similarly affected by changes in
economic or other conditions. There were no foreign loans outstanding at
December 31, 1997.
Allowance for Loan Losses
Table 10 - Summary of Loan Loss Experience
Years ended December 31,
1997 1996 1995 1994 1993
Allowance for Loan Losses:
Beginning balance.............$ 7,800 $ 7,780 $ 7,640 $ 7,180 $ 5,400
Loans charged off during year:
Commercial, financial and
agricultural.............. 43 37 50 157 194
Real estate mortgage........ 419 184 252 235 392
Consumer.................... 919 458 360 360 290
Lease financing............. 121 24 14 10 14
------- ------- ------- ------- -------
Total charge-offs........... 1,502 703 676 762 890
------- ------- ------- ------- -------
Recoveries:
Commercial, financial and
agricultural.............. 4 5 117 61 157
Real estate mortgage........ 112 42 72 2 8
Consumer.................... 122 88 91 77 63
Lease financing............. 65 8 2 1 12
------- ------- ------- ------- -------
Total recoveries............ 303 143 282 141 240
------- ------- ------- ------- -------
Net loans charged off......... 1,199 560 394 621 650
Additions charged to
operations.................. 1,129 580 534 1,081 2,430
------- ------- ------- ------- -------
Balance at end of year........$ 7,730 $ 7,800 $ 7,780 $ 7,640 $ 7,180
======= ======= ======= ======= =======
Ratio of net loans charged
off to average loans
outstanding................. .24% .12% .10% .17% .18%
Ratio of net loans charged
off to loans at end of year. .23% .12% .09% .16% .18%
Net loans charged off to
allowance for loan losses.. 15.51% 7.18% 5.06% 8.13% 9.05%
Net loans charged off to
provision for loan losses.. 106.20% 96.55% 73.78% 57.45% 26.75%
Allowance for loan losses as a
percent of average loans... 1.55% 1.69% 1.91% 2.04% 2.01%
Allowance for loan losses
as a percent of loans at
end of year................ 1.51% 1.65% 1.82% 1.95% 2.00%
Allowance for loan losses
as a percent of
nonperforming loans........ 183.8% 404.1% 580.6% 234.8% 206.2%
The Corporation experienced a 113.7% increase in gross charge-offs
in 1997. Net charge-offs increased 114.1% in 1997. The increase
in charge offs was a result of a reduction in asset quality
in the consumer loan portfolios, particularly the
installment and credit card portfolios. Personal bankruptcies played a
significant role in the losses. Management has instituted certain changes
in underwriting criteria in an effort to reduce the risk of
increases in the future. For the year, the Corporation recorded
net charge-offs of $1,199,000 or .24% of average loans
outstanding, compared to $560,000 or .12% of average loans in
1996 and $394,000 or .10% of average loans in 1995.
The provision for loan losses charged to operating expense
reflects the amount deemed appropriate by management to produce an
adequate reserve to meet the present risk and inherent risk
in the loan portfolio. Management performs a quarterly
assessment of the loan portfolio to determine the appropriate level of
the allowance. The factors considered in this evaluation include,
but are not limited to, estimated loan losses identified
through a loan review process, general economic conditions,
deterioration in pledged collateral, past loan experience and
trends in delinquencies and nonaccruals. Management uses available
information to determine the appropriate level of the allowance for
possible loan losses. However, the allowance may be affected in the future
based upon changes in the economic conditions and other factors.
While there can be no assurance that material amounts of additional loan loss
provisions will not be required in the future, management believes that,
based upon information presently available, the amount of the allowance
for possible loan losses is adequate.
Management has not targeted any specific coverage ratio of
non-performing loans by the allowance for loan losses and the coverage
ratio may fluctuate based on loans placed into or removed
from non-performing status.
Table 11 - Allocation of Allowance for Loan Losses
December 31,
1997 1996
Commercial, financial and agricultural..........$ 3,529 $ 3,471
Real estate - mortgage.......................... 25 5
Consumer........................................ 910 590
Leases.......................................... 599 620
Unallocated..................................... 2,667 3,114
------- -------
Total...........................................$ 7,730 $ 7,800
======= =======
Deposits
Table 12 - Average Deposit Balances and Rates Paid
The average amounts of deposits and rates paid for the years indicated are
summarized below:
1997 1996 1995
Amount Rate Amount Rate Amount Rate
Demand deposits.....................$ 74,332 --- $ 72,052 --- $ 66,133 ---
Interest-bearing demand deposits.... 267,987 2.59% 257,622 2.61% 239,036 3.00%
Savings deposits.................... 58,149 2.04% 58,232 2.21% 54,982 2.42%
Time deposits....................... 262,681 5.64% 229,835 5.52% 194,512 5.44%
-------- ----- -------- ----- -------- -----
$663,149 3.46% $617,741 3.35% $554,663 3.44%
======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity
The maturities of time deposits of $100,000 or more are summarized below:
December 31,
1997 1996
Three months or less..........................$ 11,058 $ 6,095
Over three thru six months.................... 6,541 6,112
Over six thru twelve months................... 9,209 9,026
Over twelve months............................ 10,357 5,963
------- -------
Total.........................................$ 37,165 $ 27,196
======= =======
Capital
Total stockholders' equity increased over $4.8 million or 7% in 1997 to
$73,987,000. Total stockholders' equity at December 31, 1996 of $69,179,000
represented an increase of nearly $5.3 million or 8.3% over the $63,909,000
reported at December 31, 1995. The increase for 1997 was the difference
between net income of $10.4 million less dividends declared of approximately
$5.1 million. Adding to the increase in stockholders' equity was an
increase in net unrealized gains on available-for-sale securities in the
amount of $1.3 million. These increases were to some
degree offset by the repurchase of outstanding common stock
throughout the year. Treasury stock purchased during the period was $3.3
million. The Corporation issued $1.5 million in treasury shares.
The major portion of the increase in 1996 was due to
net income of $9.8 million less dividends declared $4.5 million.
During 1997, the Corporation announced that the Board of Directors
authorized the repurchase of up to 140,000 shares of the
outstanding common stock. During 1997, the Corporation
repurchased 127,751 shares for $3.3 million. The Corporation used,
during 1997, 55,868 shares of treasury stock for the Dividend
Reinvestment Plan and 1,600 shares for the Director's Compensation Plan.
Federal regulatory authorities promulgate risk-based capital guidelines
that are applicable to banks and bank holding companies in an
effort to make regulatory capital more responsive to the risk
exposure related to various categories of assets and off-balance sheet items.
These guidelines require that banking organizations meet a
minimum risk-based capital, define the components of capital,
categorize assets into different risk classes and include certain
off-balance sheet items in the calculation of capital requirements. The
components of total capital are called Tier 1 and Tier 2
capital. In the case of the Bank, Tier 1 capital is the shareholders'
equity and Tier 2 capital is the allowance for loan losses. The risk-based
capital ratios are computed by dividing the components of capital by
risk-weighted assets. Risk-weighted assets are determined by
assigning various levels of risk to different categories of assets
and off-balance sheet items. Regulatory authorities have decided to exclude
the net unrealized holding gains and losses on
available-for-sale securities from the definition of common
stockholders' equity for regulatory capital purposes. However,
national banks will continue to deduct unrealized losses on equity
securities in their computation of Tier 1 capital. Therefore, national
banks will continue to report the net unrealized gains
and loses on available-for-sale securities in the reports of
condition and income submitted to federal regulators as required by
SFAS 115 and the financial reports prepared in accordance with generally
accepted accounting principles, but will exclude these amounts
from calculations of Tier 1 capital. In addition, national banks should use
the amortized cost of available-for-sale debt securities (as
opposed to fair value) to determine the average total assets as well as
the risk-weighted assets used in the calculations of the leverage and
risk-based capital ratios. The ratios below and in Table 14
reflect the above definition of common stockholders'
equity which includes common stock, capital surplus and retained earnings,
less net unrealized holding losses on available-for-sale
equity securities with readily determinable fair values.
The Bank's ratios at December 31, 1997, 1996 and 1995 were
above the final risk-based capital standards that require Tier 1
capital of at least 4% and total risk-based capital of 8% of
risk-weighted assets. The Tier 1 capital ratio
at December 31, 1997 was 10.23% and the total risk-based capital
ratio was 11.38%, which exceeds the minimum capital guidelines.
Tier 1 capital ratio was 10.68% and the total risk-based capital
ratio was 11.93% at December 31, 1996 while Tier 1 capital
ratio was 10.95% and the total risk-based capital ratio was
12.21% at December 31, 1995. At December 31, 1997, the Corporation
and the Bank, exceeded all capital
requirements and are considered to be "well capitalized."
Table 14 - Capital and Performance Ratios
The following are selected ratios for the years ended December 31:
1997 1996 1995
Return on average assets...................... 1.32% 1.34% 1.36%
Return on average equity...................... 14.89% 15.01% 15.02%
Dividend payout ratio......................... 48.79% 45.95% 58.48%
Average total equity to average assets........ 8.89% 8.95% 9.10%
Total equity to assets at year end............ 8.45% 8.87% 8.79%
Primary capital ratio......................... 9.28% 9.80% 9.78%
Tier 1 risk-based capital ratio............... 10.23% 10.68% 10.95%
Total risk-based capital ratio................ 11.38% 11.93% 12.21%
Liquidity
Liquidity is the ability to meet the requirements of customers for
loans and deposit withdrawals in the most economical manner. Some
liquidity is ensured by maintaining assets which may be immediately converted
into cash at minimal cost. Liquidity from asset categories
is provided through cash, noninterest-bearing and interest-bearing
deposits with banks, federal funds sold and marketable investment
securities maturing within one year. Investment securities maturing
within one year were $34,585,000 at December 31, 1997
compared to $27,169,000 at December 31, 1996.
Interest-bearing deposits with banks were $643,498 at December 31, 1996
compared to $14,565 at December 31, 1997. Federal funds sold
totaled $28,150,000 at December 31, 1997 compared to $24,150,000
at December 31, 1996. Securities available-for-sale as of
December 31, 1997 were $121,474,497 compared to $79,374,627
as of December 31, 1996.
The loan portfolio also provides an additional source of liquidity due
to the Bank's participation in the secondary mortgage market. Sales of
residential mortgages in the secondary market were approximately
$40.9 million in 1997 and $33.2 million in 1996, which allowed
the Bank to meet the needs of customers for new mortgage financing.
The loan portfolio also provides significant liquidity through repayment of
loans by maturity or scheduled amortization payments.
On the liability side, liquidity is available through customer deposit
growth and short term borrowings. Federal Home Loan Bank
available borrowing capacity as of December 31, 1997 was $16,800,000
with existing capital stock ownership. Federal funds
purchased lines are also in place.
Management monitors liquidity daily because customer deposit levels
fluctuate daily and loan fundings, maturities and investment
purchases occur with irregularity.
The amount of liquidity needed is determined by the changes in levels of
deposits and in the demand for loans. Management believes that these
mentioned sources of funds provide sufficient liquidity.
New Financial Accounting Standard
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125 - "Accounting for
Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." This Statement
amends and extends to all servicing assets and libilities
the accounting standards for mortgage servicing rights now in FASB Statement
No. 65, "Accounting for Certain Mortgage Banking Activities,"
and supercedes FASB Statement No. 122, "Accounting for
Mortgage Servicing Rights." SFAS No. 125 establishes accounting
and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on the
consistent application of the financial-components approach.
This approach requires the recognition of financial assets and
servicing assets that are controlled by the reporting entity,
the derecognition of financial assets when control is surrendered
and the derecognition of liabilities when they are extinguished.
Specific criteria are established for determining when control has
been surrendered in the transfer of financial assets. Liabilities
incurred and deriviatives obtained by transferors in connection
with the transfer of financial assets are measured at fair
value, if practicable. Servicing assets and other retained
interests in transferred assets are measured by allocating any prior
carrying amount between the assets sold, if any, and the interest
retained, if any, based on the relative fair values of the assets
at the date of transfer. Servicing assets retained are then subject
to amortization and assessment for impairment. As issued, this
Statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after
December 31, 1996, and is to be applied prospectively.
The FASB became aware that the volume and variety of certain
transactions and the related changes to information
systems and accounting processes necessary to comply
with the requirements of SFAS No. 125 would make it extremely
difficult, if not impossible, for some affected companies to
comply by January 1, 1997. As a result, in December 1996, the
FASB issued FASB No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125" that defers, for one year,
the effective date of certain provisions, as well as accounting for
transfers and servicing for repurchase agreements, dollar-roll,
securities lending and similar transactions. Therefore, this
Statement shall be effective for such transfers of financial assets
after December 31, 1997. Management does not expect the adoption of
SFAS No. 127 to have a material effect on the financial
position or results of operations of the Corporation.
In February 1997, the FASB issued SFAS No. 128 - "Earnings per Share,"
effective for periods ending after December 15, 1997. SFAS
No. 128 is designed to simplify the computation of
earnings per share and requires disclosure of "basic earnings per share"
and, if applicable, "diluted earnings per share." Earlier application is not
permitted. The Statement requires restatement of all prior period earnings
per share data when adopted. Management does not expect SFAS No. 129
to material impact on the Corporation's reported earnings per share.
In February 1997, SFAS No. 129 - "Disclosure of Information about Capital
Structure" was issued by the FASB, which establishes standards for disclosing
information about an entity's capital structure. It consolidates the disclosure
requirements that were previously covered in APB-10, APB-15 and FAS-47.
The Statement is effective for periods ending after December 15, 1997.
Managemnt does not expect SFAS No. 129 to have a material impact
on the Corporation.
In June 1997, the FASB issued Statement No. 130 - "Reporting Comprehensive
Income," which establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Statement No. 130 requires that all items
that are required to be recognized as components of comprehensive
income be reported in a financial statement that is displayed with the
same prominence as other financial statements. Statement No. 130 is
effective for fiscal years beginning after December 15, 1997. This
Statement will require the Corporation to set forth
additional disclosures in the Corporation's financial statements.
In June 1997, the FASB issued SFAS No. 131 - "Disclosures about
Segments of an Enterprise and Related Information." This Statement
establishes standards for the way that public business enterprises
report information about operating segments in annual financial
statements and requires that those enterprises report selected information
about operating segments in interim financial reports issued to shareholders.
The Statement also establishes standards for related disclosures
about products and services, geographic areas and major
customers. This Statement supersedes FASB No. 14,
- - "Financial Reporting for Segments of a Business Enterprise," but retains
the requirement to report information about major customers.
It amends FASB Statement No. 94 - "Consolidation
of All Majority-Owned Subsidiaries," to remove the special
disclosure requirements for previously unconsolidated subsidiaries.
The Statement is effective for fiscal years beginning after December 15, 1997.
This Statement will require the Corporation to set forth additional
disclosures in the Corporation's financial statements.
Item 7A - Quantitative and Qualitative Disclosures About Market Risk
Discussion of Market Risk and Interest Rate Sensitivity
As a financial institution, the primary component of the Bank's market risk
is interest rate volatility. Changes in interest rates will
ultimately impact the Bank's interest income from earning assets and the
interest expense from funding sources (deposits and debt).
Based upon the Bank's nature of operations, the Bank is not subject to
foreign currency exchange or commodity price risk. The Bank's market
area for loans and deposits is concentrated in Lancaster County,
Pennsylvania and as such is subject to risks associated with the
local economy. The Bank does not own any trading assets.
The Bank does not have any hedging transactions in place such as
interest rate swaps and caps.
Management endeavors to control the exposure of earnings to changes in
interest rates. The Bank's asset/liability committee manages interest rate
risk by various means including '"Gap" management and internally developed
models and reports. In 1997, the Bank also utilized Sheshunoff Interest
Rate Risk management services and IBAA investment portfolio
valuation services to enhance risk exposure review. Interest
repricing of assets and liabilities is measured over future time
periods (interest rate sensitivity gaps). While all time gaps are measured,
management's primary focus is the cumulative gap through six months,
as this time frame directly impacts net interest income in the near
term time horizon and is most difficult to make reactive adjustment
to actual rate movements.
The Bank has various investments structured to change investment yield with
current market conditions. Assets subject to repricing include federal funds
sold (repricing daily), loans floating to "treasury bill" indexes
(repricing monthly) and loans tied to "prime" or other indexes subject
to immediate change. Other factors effecting income are
maturing and contracted repayments and\ prepayments of existing loans
and investments. These cash flows will be re-invested at
current market yields.
The Bank's funding liabilities (customer deposits and borrowed funds) have
more complex repricing characteristics, since interest bearing deposits are
subject to rate change but are not specifically indexed to
"prime" or "treasury" indexes. Time certificates and borrowed money
are subject to interest rate change at maturity. The Bank's deposit
funding is essentially comprised of "core" deposits that have been
historically loyal and stable, and these deposits, with the exception of
certificates of deposit, have not been rate sensitive. All interest
rates do not move in full and equal amounts for loans and
deposits. Deposit rates historically lag loans in rate
movement, and rate movement occurs to a smaller degree for deposits than
loans. Modeling is used to forecast projected impact to the net interest
margin as a result of rate movements, either increasing or decreasing.
Historic pricing correlations are calculated for all
interest-bearing deposit products for rate change repricing impact
as - immediate, monthly, and annually over a five year time period.
As illustrated in Table 15, management's view of interest rate sensitivity
reflects a calculated interpretation of net interest margin
exposure to rate changes. Pricing correlations
are constantly refined by management. There is no guarantee that past
history will accurately reflect future changes.
Table 15 - Interest Rate Sensitivity Gaps
0-30 31-90 91-180 181-365 Over 1 Over 2 Over 3 Over 4 Over
Days Days Days Days to 2 Yrs to 3 Yrs to 4 Yrs to 5 Yrs 5 Yrs
Assets
Fed Funds sold......$ 28,150 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
Investment securities-
Maturities.......... 5,252 8,325 11,735 19,150 34,185 27,889 21,376 18,017 61,507
Loans-Variable Rate.. 101,135
Loans-Fixed Rate..... 2,241 13,973 19,927 35,098 59,621 54,961 46,254 38,029 88,191
Leases-Finance....... 2,287 4,568 4,868 8,942 15,905 9,273 5,888 473 3
Allowance for loan
losses.............. 0 0 0 0 0 0 0 0 (7,730)
Non-earning assets... 0 0 0 0 0 0 0 0 105,995
-------- -------- -------- -------- -------- -------- -------- -------- -------
Total...............$ 139,065 $ 26,866 $ 36,530 $ 63,190 $ 109,711 $ 92,123 $ 73,518 $ 56,519 $247,966
Cumulative..........$ 139,065 165,931 202,461 265,651 375,362 467,485 541,003 597,522 845,488
Liabilities & Capital
Interest Deposits-NOW,
Super NOW, Savings &
Money Market.......$ 63,752 $ 14,420 $ 5,620 $ 11,240 $ 19,089 $ 19,089 $ 19,089 $ 19,089 $170,662
C/D - Maturities.... 12,608 34,328 41,464 69,022 99,392 29,818 5,916 1,498 0
Borrowings-
Banking activity... 3,001 2 3 6 12 962 681 12 320
Borrowings-
Leasing activity... 1,255 2,510 5,020 7,157 7,080 7,291 0 0 0
Non Interest Bearing
Deposits........... 0 0 0 0 0 0 0 0 82,565
Non Interest Bearing
Liabilities........ 0 0 0 0 0 0 0 0 17,528
Stockholders'Equity. 0 0 0 0 0 0 0 0 73,987
-------- -------- -------- -------- -------- -------- -------- -------- -------
Total...............$ 80,616 $ 51,260 $ 52,107 $ 87,425 $ 125,573 $ 57,160 $ 25,686 $ 20,599 $345,062
Cumulative..........$ 80,616 $ 131,876 $ 183,983 $ 271,408 $ 396,981 454,141 479,827 500,426 845,488
Period GAP (Dollars)$ 58,449 $ (24,394)$ (15,577)$ (24,235)$ (15,862)$ 34,963 $ 47,832 $ 35,920 $(97,096)
as % of Total Assets 7% -3% -2% -3% -2% 4% 6% 4% -11%
Cumulative GAP
(Dollars)..........$ 58,449 $ 34,055 $ 18,478$ (5,757)$ (21,619)$ 13,344 $ 61,176 $ 97,096 $ 0
as % of Total Assets 7% 4% 2% -1% -3% 1% 7% 11% 0%
During 1997, the net interest income tax-equivalent yield margin on average
earning assets dropped to 4.72% from 4.86% in 1996. Prime rate in 1997
started at 8.25%, increased in March to 8.50% and stayed
at that level for the remainder of the year. The average
tax-equivalent yield on earning assets decreased
in 1997 to 8.34%, down from 8.38% in 1996. Average earning assets
increased by $51,400,000 in 1997. Average deposit funding increased
$45,400,000 in 1997. Total deposit funding cost increased
to 3.46% from 3.35% in 1996. Compression of the net
interest margin was primarily a result of growth in certificates
of deposit funding as a percentage of total funding mix, local
competitive cost for these certificates of deposits, and a very competitive
local market for loans.
Future change in net income as a result of interest rate change is
presented in the graph (Table 15a). This analysis, completed by Sheshunoff,
depicts the projected change to income resulting from interest
rate movements. The Bank's risk to interest rate movement
illustrates that the future income of the Bank will increase with
increasing market rates. Future income would increase by 6.01% and
11.84% with market rate increases of 1.00% and 2.00% respectively. Future
income would decrease by 2.21% and 6.13% with market rate decreases
of 1.00% and 2.00% respectively. These projections assume that
management does not actively manage the balance sheet during
changing market environments.
Present value of equity as a result of interest rate change is presented
in the graph (Table 15b). This analysis, completed by Sheshunoff,
depicts the projected change in the market value of equity as result
of interest rate movements. Future market value of equity
would decrease by 2.55% and 5.15% with market rate increases of
1.00% and 2.00% respectively. Future market value of equity would increase
by 2.49% and 4.09% with market rate decreases of 1.00% and
2.00% respectively.
Table 15a Table 15b
1998 Net Income Projections Present Value Equity
Changes in Changes in
Basis Points Net Income % Change Basis Points Market Value % Change
-200 $ 8,542 -6.13% -200 $117,135 4.09%
-150 8,721 -4.16% -150 116,229 3.29%
-100 8,898 -2.21% -100 115,334 2.49%
-50 9,078 -0.24% -50 114,459 1.72%
0 9,099 0.00% 0 112,528 0.00%
50 9,378 3.06% 50 111,137 -1.24%
100 9,646 6.01% 100 109,660 -2.55%
150 9,910 8.91% 150 108,179 -3.87%
200 10,177 11.84% 200 106,738 -5.15%
Item 8 - Financial Statements and Supplementary Data
(a) The following audited consolidated financial statements and related
documents are set forth in this Annual Report on Form 10-K on the following
pages:
Page
Report of Independent Auditors 31
Consolidated Balance Sheets 32
Consolidated Statements of Income 33
Consolidated Statements of Changes in Stockholders' Equity 34
Consolidated Statements of Cash Flows 35
Notes to Consolidated Financial Statements 36
(b) The following supplementary data is set forth in this Annual Report on
Form 10-K on the following pages:
Summary of Quarterly Financial Data (Unaudited) 54
Trout, Ebersole & Groff, LLP
Certified Public Accountants
1705 Oregon Pike
Lancaster, Pennsylvania 17601
(717)569-2900
FAX (717) 569-0141
Independent Auditors' Report
Board of Directors and Shareholders
Sterling Financial Corporation and Subsidiaries
Lancaster, Pennsylvania
We have audited the accompanying consolidated balance sheets of Sterling
Financial Corporation and Subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of
management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Sterling Financial Corporation and Subsidiaries at December 31,
1997 and 1996 and the consolidated results of their operations and
their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted
accounting principles.
As discussed in Note 2, the Corporation changed its method of
accounting for mortgage servicing rights to adopt the provisions
of the Financial Accounting Standards Board's SFAS No. 122, "Accounting
for Mortgage Servicing Rights," at January 1, 1996.
Trout, Ebersole & Groff, LLP
Trout, Ebersole & Groff, LLP
Certified Public Accountants
January 22, 1998
Lancaster, Pennsylvania
Consolidated Balance Sheets
Sterling Financial Corporation and Subsidiaries
As of December 31,
(Dollars in thousands)
1997 1996
Assets
Cash and due from banks...........................................$ 34,292 $ 31,339
Interest-bearing deposits in other banks.......................... 15 644
Federal funds sold................................................ 28,150 24,150
Mortgage loans held for sale...................................... 792 1,016
Investment Securities: (Note 4)
Securities held-to-maturity
(market value - $86,465 - 1997 and $94,778 - 1996)............. 85,155 94,222
Securities available-for-sale.................................... 121,474 79,375
Loans (Note 5).................................................... 512,073 475,017
Less: Unearned income........................................... (436) (1,185)
Allowance for loan losses (Note 6)......................... (7,730) (7,800)
-------- -------
Loans, net........................................................ 503,907 466,032
-------- -------
Premises and equipment (Note 7)................................... 21,938 22,658
Other real estate owned........................................... 341 81
Accrued interest receivable and prepaid expenses.................. 12,243 11,262
Other assets (Note 8)............................................. 37,181 33,293
-------- -------
Total Assets..................................................... $845,488 $764,072
======== ========
Liabilities
Deposits:
Noninterest bearing.............................................$ 82,565 $ 82,175
Interest bearing (Note 9)....................................... 636,096 564,861
-------- --------
Total Deposits.................................................... 718,661 647,036
-------- --------
Interest-bearing demand notes issued to U.S. Treasury (Note 10)... 3,000 2,741
Other liabilities for borrowed money (Note 10).................... 32,312 30,434
Accrued interest payable and accrued expenses..................... 10,165 8,705
Other liabilities................................................. 7,363 5,977
-------- --------
Total Liabilities................................................. 771,501 694,893
Stockholders' Equity -------- --------
Common Stock -(par value:$5.00)
No. shares authorized: 1997 and 1996 - 35,000,000
No. shares issued: 1997 - 6,237,009; 1996 - 6,237,009
No. shares outstanding: 1997 - 6,149,795; 1996 - 6,220,078...... 31,185 31,185
Capital surplus................................................... 16,321 16,325
Retained earnings................................................. 25,828 20,502
Net unrealized gain on securities available-for-sale, net of taxes 2,916 1,603
Less: Treasury Stock (87,214 shares in 1997 and
16,931 shares in 1996) - at cost........................... (2,263) (436)
-------- --------
Total Stockholders' Equity........................................ 73,987 69,179
-------- --------
Total Liabilities and Stockholders' Equity........................$845,488 $764,072
======== ========
See accompanying notes to financial statements
Consolidated Statements of Income
Sterling Financial Corporation and Subsidiaries
For the years ended December 31,
(Dollars in thousands, except per share data) 1997 1996 1995
Interest Income
Interest and fees on loans...........................$ 44,744 $ 41,611 $ 37,975
Interest on deposits in other banks.................. 13 6 2
Interest on federal funds sold....................... 730 398 449
Interest and dividends on investment securities:
Taxable............................................ 7,681 7,442 7,526
Tax-exempt......................................... 3,103 2,882 2,695
Dividends on stock................................. 228 219 203
--------- --------- ---------
Total Interest Income................................ 56,499 52,558 48,850
--------- --------- ---------
Interest Expense
Interest on time certificates of deposit of
$100,000 or more................................... 1,710 934 893
Interest on all other deposits....................... 21,214 19,775 18,200
Interest on demand notes issued to the U.S. Treasury. 113 95 114
Interest on federal funds purchased.................. 1 89 66
Interest on other borrowed money..................... 2,288 1,930 1,880
--------- --------- ---------
Total Interest Expense............................... 25,326 22,823 21,153
--------- --------- ---------
Net Interest Income.................................. 31,173 29,735 27,697
Provision for loan losses (Note 6)................... 1,129 580 534
--------- --------- ---------
Net Interest Income after Provision for Loan Losses.. 30,044 29,155 27,163
--------- --------- ---------
Other Operating Income
Income from fiduciary activities..................... 1,513 1,139 856
Service charges on deposit accounts.................. 2,909 2,485 2,010
Other service charges, commissions and fees.......... 1,456 944 820
Mortgage banking..................................... 1,305 1,192 525
Other operating income (Note 8)...................... 4,539 3,524 3,186
Investment securities gains or (losses).............. 208 158 none
--------- --------- ---------
Total Other Operating Income......................... 11,930 9,442 7,397
--------- --------- ---------
Other Operating Expenses
Salaries and employee benefits (Note 11)............. 16,398 15,027 13,040
Net occupancy expense................................ 2,290 2,109 1,721
Furniture and equipment expense (including depreciation
of $1,500 in 1997, $1,256 in 1996 and $917 in 1995). 2,480 2,044 1,605
FDIC insurance assessment............................ 81 2 622
Other operating expenses............................. 6,833 6,457 5,539
--------- --------- ---------
Total Other Operating Expenses....................... 28,082 25,639 22,527
--------- --------- ---------
Income Before Income Taxes........................... 13,892 12,958 12,033
Applicable income taxes (Note 15).................... 3,491 3,147 3,039
--------- --------- ---------
Net Income...........................................$ 10,401 $ 9,811 $ 8,994
========= ========= =========
Earnings per common share:
Net Income (Basic earnings per share)..............$ 1.68 $ 1.57 $ 1.45
Net Income (Diluted earnings per share)............$ 1.68 $ 1.57 $ 1.45
Cash dividends declared per common share.............$ .82 $ .74 $ .89
See accompanying notes to financial statements
Consolidated Statements of Changes in Stockholders' Equity
Sterling Financial Corporation and Subsidiaries
Net
Unrealized
Gain on
Available-
Shares for-Sale
Common Common Capital Retained Securities, Treasury
Stock Stock Surplus Earnings Net of Taxes Stock Total
(Dollars in thousands)
Balance, January 1, 1995.......5,874,417 $ 29,372 $ 8,544 $ 19,114 $ 420 $ (165)$ 57,285
Net income.................... 8,994 8,994
Common stock issued
Dividend Reinvestment Plan... 45,121 225 1,115 1,340
Employee Stock Plan.......... 13,148 66 325 391
Cash dividends declared -
Common stock................. (5,260) (5,260)
Purchase of Treasury Stock
(41,880 shares).............. (1,252) (1,252)
Issuance of Treasury Stock
Dividend Reinvestment Plan
(40,528 shares).............. 3 1,204 1,207
Change in net unrealized gain on
available-for-sale securities,
net of taxes................. 1,204 1,204
--------- -------- -------- -------- ---------- ------- --------
Balance, December 31, 1995....5,932,686 29,663 9,987 22,848 1,624 (213) 63,909
Net income.................... 9,811 9,811
Common stock issued
Dividend Reinvestment Plan... 2,517 13 58 71
Employee Stock Plan.......... 5,690 28 140 168
Stock dividend issued -
Common stock - 5%, including
cash paid in lieu of
fractional shares........... 296,116 1,481 6,144 (7,649) (24)
Cash dividends declared -
Common stock................. (4,508) (4,508)
Purchase of Treasury Stock
(21,026 shares).............. (547) (547)
Issuance of Treasury Stock
Dividend Reinvestment Plan
(8,435 shares)............... (3) 247 244
Employee Stock Plan
(2,819 shares)............... (1) 77 76
Change in net unrealized gain
on available-for-sale
securities, net of taxes...... (21) (21)
--------- -------- -------- -------- ---------- ------- -------
Balance, December 31, 1996....6,237,009 31,185 16,325 20,502 1,603 (436) 69,179
Net Income.................... 10,401 10,401
Cash dividends declared -
Common stock................. (5,075) (5,075)
Purchase of Treasury Stock
(127,751 shares)............. (3,302) (3,302)
Issuance of Treasury Stock
Dividend Reinvestment Plan
(55,868 shares).............. (4) 1,434 1,430
Director's Compensation Plan
(1,600 shares)............... 41 41
Change in net unrealized gain
on available-for-sale
securities, net of taxes...... 1,313 1,313
--------- -------- -------- -------- ---------- ------- -------
Balance, December 31, 1997... 6,237,009 $ 31,185 $ 16,321 $ 25,828 $ 2,916 $(2,263) $73,987
========= ======== ======== ======== ========== ======= =======
See accompanying notes to financial statements
Consolidated Statements of Cash Flows
Sterling Financial Corporation and Subsidiaries
For the years ended December 31,
(Dollars in thousands) 1997 1996 1995
Cash Flows from Operating Activities
Net Income...........................................$ 10,401 $ 9,811 $ 8,994
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation...................................... 1,948 1,625 1,198
Accretion & amortization of investment securities. 266 356 367
Provision for possible loan losses................ 1,129 580 534
Provision for deferred income taxes............... 638 824 579
(Gain) on sale of property and equipment.......... (456) (2) (1)
(Gain) on sales of investment securities.......... (208) (158) none
(Gain) on sale of mortgage loans.................. (319) (262) (163)
Proceeds from sales of mortgage loans............. 41,188 33,480 16,283
Originations of mortgage loans held for sale...... (40,645) (33,272) (16,558)
Change in operating assets and liabilities:
(Increase) decrease in accrued interest receivable
and prepaid expenses............................ (981) 517 (2,825)
(Increase) in other assets....................... (4,148) (6,583) (2,469)
Increase (decrease) in accrued interest payable
and accrued expenses........................... 822 (350) 1,915
Increase (decrease) in other liabilities........ 711 836 (753)
--------- --------- ---------
Net cash provided by/(used in) operating activities.. 10,346 7,402 7,101
Cash Flows from Investing Activities
Proceeds from interest bearing deposits
in other banks..................................... 968 1,023 1,052
Purchase of interest bearing deposits in other banks. (339) (1,643) (1,052)
Proceeds from sales of investment securities
available-for-sale.................................. 214 670 none
Proceeds from maturities or calls of investment
securities held-to-maturity.... .................... 30,541 37,508 30,095
Proceeds from maturities or calls of investment
securities available-for-sale....................... 10,007 8,948 2,921
Purchases of investment securities held-to-maturity.. (22,185) (9,791) (46,273)
Purchases of investment securities available-for-sale (49,678) (19,310) (6,926)
Federal funds sold, net.............................. (4,000) (14,800) (9,350)
Net loans and leases made to customers............... (39,004) (48,080) (34,057)
Purchases of premises and equipment.................. (2,562) (7,880) (5,681)
Proceeds from sale of premises and equipment......... 1,790 49 11
--------- --------- ---------
Net cash provided by/(used in) investing activities.. (74,248) (53,306) (69,260)
Cash Flows from Financing Activities
Net increase in demand deposits, NOW and
savings accounts................................... 18,429 12,013 32,041
Net increase in time deposits........................ 53,195 24,918 41,062
Net increrase (decrease) in interest bearing demand
notes issued to the U.S. Treasury................... 259 507 (680)
Proceeds from borrowings............................. 25,652 58,474 39,180
Repayments of borrowings............................. (23,774) (49,563) (36,830)
Federal funds purchased, net......................... none none (6,000)
Proceeds from issuance of common stock............... none 239 1,731
Cash dividends paid.................................. (5,075) (4,508) (5,260)
Cash paid in lieu of fractional shares............... none (24) none
Acquisition of treasury stock........................ (3,302) (547) (1,252)
Proceeds from issuance of treasury stock............. 1,471 320 1,207
--------- --------- ---------
Net cash provided by/(used in) financing activities.. 66,855 41,829 65,199
--------- --------- ---------
Increase (decrease) in cash and due from banks....... 2,953 (4,075) 3,040
Cash and due from banks:
Beginning............................................ 31,339 35,414 32,374
--------- --------- ---------
Ending...............................................$ 34,292 $ 31,339 $ 35,414
========= ========= =========
Supplemental Disclosure of Cash Flow Information:
Cash payments for:
Interest paid to depositors and on borrowed money..$ 24,702 $ 22,637 $ 19,937
Income taxes....................................... 2,600 2,230 2,526
Supplemental Schedule of Noncash Investing and
Financing Activities:
Other real estate acquired in settlement of loans....$ 630 $ 119 $ 293
See accompanying notes to financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Sterling Financial Corporation and Subsidiaries
(All dollar amounts presented in the tables are in thousands, except per share
data)
Note 1 - Formation of Sterling Financial Corporation
As a result of a plan of reorganization, The First National Bank of
Lancaster County, now by name change, Bank of Lancaster County, N.A. (Bank),
became the wholly owned subsidiary of Sterling Financial Corporation (Parent
Company), a new bank holding company, at the close of business June 30, 1987.
Each outstanding share of the Bank's common stock (par value $10.00) was
converted into two shares of common stock (par value $5.00) of the Parent
Company. The authorized capital of the Parent Company is 35,000,000 shares of
common stock.
Note 2 - Summary of Significant Accounting Policies
Business - Sterling Financial Corporation, through its subsidiary bank,
Bank of Lancaster County, N.A., and its subsidiary, Town & Country, Inc.,
provides a full range of banking services to individual and
corporate customers. The principal market area is Lancaster County,
Pennsylvania. Sterling Financial Corporation and the Bank of Lancaster
County, N.A. are subject to competition from other financial institutions.
Both are subject to regulations of certain federal agencies and, accordingly,
they are periodically examined by those regulatory authorities.
Basis of Financial Statement Presentation - The accounting and reporting
policies of Sterling Financial Corporation and its subsidiaries (the
Corporation) conform to generally accepted accounting principles and
to general practices within the banking industry. In preparing
the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and revenues and
expenses for the period. Actual results could differ significantly from these
estimates.
Principles of Consolidation - The accompanying consolidated financial
statements include the accounts of Sterling Financial Corporation and its wholly
owned subsidiaries, Bank of Lancaster County, N.A. and its subsidiary Town &
Country, Inc., and Sterling Mortgage Services, Inc. (presently inactive). All
significant intercompany transactions have been eliminated in the consolidation.
Investment Securities - Investment securities include both debt securities and
equity securities. Sterling adopted Statement of Financial Accounting Standards
Board Statement No. 115 (SFAS 115), "Accounting for Certain Investments in Debt
and Equity Securities" as of January 1, 1994. SFAS 115 addresses the accounting
and reporting for investments in equity securities that have readily
determinable fair values and for all investments in debt securities. These
investments are to be classified in one of three categories and
accounted for as follows: 1) debt securities that a company
has the positive intent and ability to hold to maturity
are classified as held-to-maturity securities and reported at amortized cost; 2)
debt and equity securities that are bought and held principally for the purpose
of selling them in the near term are classified as trading securities and
reported at fair value with unrealized gains and losses included in earnings;
and 3) debt and equity securities not classified as either
held-to-maturity or trading securities are classified
as available-for-sale securities and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of stockholders' equity. Sterling has
segregated its investment securities into two categories: those held-to-maturity
and those available-for-sale.
Investment securities in the held-to-maturity category are carried at cost
adjusted for amortization of premiums and accretion of discounts, both computed
on the constant yield method. It is management's intent to hold investment
account securities until maturity. However, the investment portfolio does serve
as an ultimate source of liquidity. In order to acknowledge this function,
Sterling has designated certain specific debt securities as being available-
for-sale. Premiums and discounts are recognized in interest income computed
on the constant yield method. All marketable equity securities
are classified as available-for-sale. Realized gains and
losses on securities are computed using the specific identification
method and are included in Other Operating Income in
the Consolidated Statements of Income.
Future purchases of securities will be evaluated on an individual basis for
classification among the three permissible categories based on management's
intent and the ability to hold each security to maturity, on the relative sizes
of the security categories in relation to future liquidity needs, on current
asset/liability management strategies and other criteria as appropriate.
Premises and Equipment - Premises, furniture and equipment, leasehold
improvements, and capitalized leases are stated at cost, less accumulated
depreciation and amortization. For book purposes, depreciation is computed
primarily by using the straight-line method over the estimated useful life of
the asset. Charges for maintenance and repairs are expensed as incurred.
Gains and losses on dispositions are reflected in current operations.
Other Real Estate Owned - Other real estate owned is carried at the lower of
cost or an amount not in excess of estimated fair value.
Allowance for Loan Losses - The provision for loan losses charged to operating
expense reflects the amount deemed appropriate by management to produce an
adequate reserve to meet the present and foreseeable risk characteristics of the
loan portfolio. Management's judgement is based on the evaluation of individual
loans and their overall risk characteristics, past loan loss experience, and
other relevant factors. Loan losses are charged directly against the allowance
and recoveries on previously charged-off loans are added to the allowance.
Interest Income - Interest on installment loans is recognized primarily on the
simple interest, actuarial and the rule of seventy-eights methods. Interest on
other loans is recognized based upon the principal amount outstanding. The
general policy has been to cease accruing interest on loans when it is
determined that a reasonable doubt exists as to the collectibility of
additional interest. Interest income on these loans is only
recognized to the extent payments are received.
Loan Origination Fees and Costs - Loan fees, net of loan origination costs,
are deferred and amortized to interest income over the life of the loan. The
amortization of net deferred fees is discontinued on non-accrual loans.
Federal Income Taxes - Applicable income taxes are based on income as reported
in the consolidated financial statements. Deferred income taxes are provided
for those elements of income and expense which are recognized in
different periods for financial reporting and income tax purposes.
Trust Department Assets and Income - Trust assets held by the Bank in a
fiduciary or agency capacity for customers of the Trust Department are not
included in the financial statements since such items are not assets of the
Bank. Trust income has been recognized on the cash basis
which is not significantly different from amounts that would have been
recognized on the accrual basis.
Presentation of Cash Flows - For purposes of reporting cash flows, cash and
due from banks includes cash on hand and amounts due from banks
(including cash items in process of clearing).
Reclassifications - Certain income items for prior years have been
reclassified in order to conform with the current year presentation with
no effect to net income.
Accounting for Mortgage Servicing Rights - FASB Statement No. 122,
"Accounting for Mortgage Servicing Rights - an amendment of FASB Statement
No. 65," effective for fiscal years beginning after
December 15, 1995, establishes accounting standards for recognizing
servicing rights on mortgage loans. The Corporation
has historically originated mortgage loans as a normal business activity,
selling the mortgages on the secondary market to Federal Home Loan
Mortgage Corporation and Federal National Mortgage Association and
retaining all mortgage servicing. Mortgage sale income has
been recorded on a "net" gain/loss basis. FASB No. 122
requires recognition of servicing "value" as an asset and immediate income as
though mortgage servicing has been sold rather than retained. The servicing
asset valuation must be amortized over the expected servicing life of the
mortgage portfolio. In addition, the mortgage servicing asset must be valued
periodically for impairment, based upon review of expected servicing life in
relation to current market rates. The implementation of FASB No. 122 results in
a greater recognition of income from mortgage origination and sales activity and
a corresponding decrease of servicing income over the serviced mortgage
portfolio life.
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125 - "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities." This Statement amends
and extends to all servicing assets and liabilities the accounting standards for
mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain
Mortgage Banking Activities," and supercedes FASB Statement No. 122, "Accounting
for Mortgage Servicing Rights." This Statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
December 31, 1996, and is to be applied prospectively. The application of this
Standard did not have a material effect on earnings. The FASB also subsequently
issued FASB No. 127 that delayed until January 1, 1998, the effective date of
certain provisions of FASB 125. Transactions subject to the later effective
date include securities lending, repurchase agreements, dollar-rolls
and similar secured financing arrangements.
Application of the new rules is not expected to
have a material impact on Sterling's consolidated financial statements.
Mortgage Loans Held for Sale - Mortgage loans held for sale are recorded at
the lesser of current secondary market value or the actual book value of loans.
Note 3 - Restrictions on Cash and Due From Banks
The Bank is required to maintain reserves, in the form of cash and balances
with the Federal Reserve Bank, against their deposit liabilities. The average
amount of these reserve balances for the year ended December 31, 1997 was
approximately $3,389,000. Balances maintained at the Federal Reserve Bank are
included in cash and due from banks.
Note 4 - Investment Securities
Securities pledged to secure government and other public deposits, trust
deposits, short-term borrowings, and other balances as required or permitted by
law were carried at $49,320,182 in 1997 and $47,763,546 in 1996.
The amortized cost and fair values of investment securities held-to-
maturity are as follows:
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities............$ 6,537 $ 16 $ 3 $ 6,550
Obligations of other U.S. Government
agencies and corporations......... 9,696 26 10 9,712
Obligations of states and political
subdivisions...................... 45,816 1,129 14 46,931
Mortgage-backed securities.......... 1,575 84 1 1,658
Other bonds, notes and debentures... 18,574 95 12 18,657
---------- --------- --------- --------
Subtotal............................ 82,198 1,350 40 83,508
Nonmarketable equity securities..... 2,957 none none 2,957
---------- --------- --------- --------
Total...............................$ 85,155 $ 1,350 $ 40 $ 86,465
========== ========= ========= ========
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities............$ 12,888 $ 42 $ 32 $ 12,898
Obligations of other U.S. Government
agencies and corporations......... 11,607 35 77 11,565
Obligations of states and political
subdivisions...................... 37,584 560 169 37,975
Mortgage-backed securities.......... 2,076 108 1 2,183
Other bonds, notes and debentures... 27,269 154 64 27,359
---------- --------- -------- --------
Subtotal............................ 91,424 899 343 91,980
Nonmarketable equity securities..... 2,798 none none 2,798
---------- ---------- --------- --------
Total...............................$ 94,222 $ 899 $ 343 $ 94,778
=========== ========== ========= ========
Included in nonmarketable equity securities is Federal Reserve stock,
Federal Home Loan Bank of Pittsburgh stock and Atlantic Central Bankers Bank
stock.
The amortized cost and fair values of held-to-maturity debt securities at
December 31, 1997, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or
without call or prepayment penalties.
December 31, 1997
Amortized Fair
Cost Value
Due in one year or less................$ 22,893 $ 22,929
Due after one year through five years.. 26,321 26,553
Due after five years through ten years. 22,286 23,018
Due after ten years.................... 9,123 9,350
----------- -----------
80,623 81,850
Mortgage-backed securities............. 1,575 1,658
----------- -----------
$ 82,198 $ 83,508
=========== ===========
The amortized cost and fair values of investment securities
available-for-sale are as follows:
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities..............$ 24,435 $ 211 $ 21 $ 24,625
Obligations of other U.S. Government
agencies and Corporations............ 26,821 208 21 27,008
Obligations of states and political
subdivisions......................... 21,840 750 19 22,571
Mortgage-backed securities............ 832 none 3 829
Other bonds, notes and debentures..... 42,955 281 58 43,178
-------- ------- ------ --------
Subtotal.............................. 116,883 1,450 122 118,211
Equity securities and corporate
stock............................... 174 3,089 none 3,263
-------- ------- ------ --------
Total.................................$117,057 $ 4,539 $ 122 $121,474
======== ======= ====== ========
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities............$ 13,611 $ 60 $ 73 $ 13,598
Obligations of other U.S. Government
agencies and corporations......... 18,800 63 145 18,718
Obligations of states and political
subdivisions...................... 20,488 400 69 20,819
Mortgage-backed securities.......... 1,125 1 9 1,117
Other bonds, notes and debentures... 22,752 129 110 22,771
---------- --------- -------- --------
Subtotal............................ 76,776 653 406 77,023
Equity securities and corporate
stock............................. 171 2,181 none 2,352
---------- ---------- --------- --------
Total...............................$ 76,947 $ 2,834 $ 406 $ 79,375
=========== ========== ========= ========
The amortized cost and fair values of available-for-sale debt securities at
December 31, 1997 by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call
or prepayment penalties.
December 31, 1997
Amortized Fair
Cost Value
Due in one year or less...................$ 11,354 $ 11,356
Due after one year through five years..... 81,619 82,224
Due after five years through ten years.... 21,268 21,941
Due after ten years....................... 1,810 1,861
-------- --------
116,051 117,382
Mortgage-backed securities................ 832 829
-------- --------
$116,883 $118,211
======== ========
Proceeds from sales of investment securities available-for-sale during
1997 and 1996 were $214,000 and $670,095 respectively. Gains of $208,457 in
1997 and $158,373 in 1996 were realized on these sales. There were no
sales of investment securities in 1995.
Note 5 - Loans
Loans outstanding at December 31, are as follows:
1997 1996
Commercial, financial and agricultural.....................$ 271,605 $ 239,701
Real estate - construction................................. 6,045 5,608
Real estate - mortgage..................................... 49,438 45,373
Consumer................................................... 132,778 136,989
Lease financing receivables (net of unearned income)....... 52,207 47,346
------------ ------------
Total loans, gross.........................................$ 512,073 $ 475,017
============ ============
Loans on a nonaccrual status amounted to $1,314,000 at December 31, 1997,
compared to $1,193,000 at December 31, 1996. If interest income had been
recorded on all such loans for the years indicated, such interest income would
have increased by approximately $152,755 and $116,567 for 1997 and 1996
respectively. Restructured loans at December 31, 1997 amounted to $2,105,000.
There were no restructured loans at December 31, 1996.
SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures," an amendment of SFAS No. 114, was implemented at
the beginning of 1995. The Bank has defined impaired loans as all loans on
nonaccrual status and troubled debt restructured loans, except those
specifically excluded from the scope of SFAS No. 114, regardless of the
credit grade assigned by loan review. All impaired loans were
measured by utilizing the fair value of the collateral for each loan.
When the measure of an impaired loan is less than the recorded investment in
the loan, the Bank will compare the impairment to the existing allowance
assigned to the loan. If the impairment is greater than the
allowance, the Bank will adjust the existing allowance to reflect the greater
amount or take a corresponding charge to the provision for loan losses. If the
impairment is less than the existing allowance for a particular loan, no
adjustments to the allowance or the provision for loan and lease losses will be
made. There was no adjustment necessary for the impaired loans for the periods
indicated.
The average amount of impaired loans for the fourth quarter of 1997 was
$3,586,053 compared to $1,171,599 for the fourth quarter 1996, while the
average for the year 1997 was $2,203,003 compared to $1,119,305 for 1996.
The following table presents information concerning impaired loans at
December 31:
1997 1996
Gross impaired loans which have allowances..........$ 3,419 $1,193
Less: Related allowances for loan losses......... (410) (179)
------- ------
Net impaired loans..................................$ 3,009 $1,014
======= ======
Note 6 - Allowance for Loan Losses
Changes in the Allowance for Loan Losses were as follows:
1997 1996 1995
Balance at January 1..................................$ 7,800 $ 7,780 $ 7,640
Recoveries credited to allowance...................... 303 143 282
Provisions for loan losses charged to income.......... 1,129 580 534
-------- -------- --------
Total................................................. 9,232 8,503 8,456
Losses charged to allowance........................... 1,502 703 676
-------- -------- --------
Balance at December 31................................$ 7,730 $ 7,800 $ 7,780
========= ======== ========
Ratio of Allowance to loans, net of unearned income
at end of year..................................... 1.51% 1.65% 1.82%
Note 7 - Premises and Equipment
Premises and equipment at December 31, 1997 and 1996 is summarized as follows:
1997 1996
Land.............................................$ 3,539 $ 3,756
Buildings........................................ 15,977 16,603
Buildings under capitalized lease................ 104 104
Leasehold improvements........................... 796 813
Equipment, furniture and fixtures................ 12,604 11,553
Construction in progress......................... none 430
---------- ----------
33,020 33,259
Less: Accumulated depreciation................... (11,082) (10,601)
---------- ----------
$ 21,938 $ 22,658
========== ==========
Depreciation expense amounted to $1,947,904 in 1997, $1,625,184 in 1996 and
$1,197,980 in 1995.
Note 8 - Other Assets
Included in other assets for 1997 and 1996 is $30,650,237 and $26,533,442
respectively which represents operating leases generated by Town & Country,
Inc. The income generated from the leases for 1997 and 1996 amounted to
$3,050,664 and $2,647,810 respectively and is reflected in other
operating income.
The following schedule provides an analysis of Town & Country's investment
in property on operating leases and property held for lease by major classes as
of December 31, 1997 and 1996:
1997 1996
Construction equipment...........$ 932 $ 400
Transportation equipment......... 17,108 14,604
Automobiles...................... 18,855 17,218
Manufacturing equipment.......... 1,044 961
Trucks........................... 17,889 14,956
Other............................ 5,107 4,028
---------- -----------
Total............................ 60,935 52,167
Less: Accumulated depreciation... (30,285) (25,634)
---------- -----------
$ 30,650 $ 26,533
========== ===========
The following is a schedule by years of minimum future rentals on
noncancelable operating leases as of December 31, 1997:
Year ending December 31:
1998...............................$ 14,740
1999................................ 2,441
2000................................ 611
2001................................ 320
2002................................ 122
-------
Total minimum future rentals.......$ 18,234
=======
Also included in other assets is mortgage servicing rights activity. The
activity for the years ended December 31, 1997 and 1996 is as follows:
1997 1996
Balance beginning of year.............$ 442 $ none
Capitalized mortgage servicing rights. 563 471
Amortization.......................... (113) (29)
------- ------
Balance at end of year................$ 892 $ 442
======= ======
The Corporation adopted, effective January 1, 1996, Statement of Financial
Accounting Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights,"
an ammendment of FASB Statement No. 65. In June 1996, the Financial Accounting
Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." The
Statement amends and extends to all servicing assets and liabilities the
accounting standards for mortgage servicing rights now in FASB
Statement No. 65, "Accounting for Certain Mortgage Banking Activities,"
and supercedes SFAS No. 122. This Statement requires that servicing
assets and liabilities be subsequently measured by (a) amortization in
proporation to and over the period of estimated net
servicing income or loss and (b) assessment for asset impairment or increased
obligation based on their fair values. A valuation allowance will be
recorded if the unamortized mortgage servicing rights exceed their fair value.
There was no valuation allowance for servicing rights for
the year ended December 31, 1997. Mortgage servicing rights
are a result of originated mortgages. There have been
no mortgage servicing rights purchased.
Note 9 - Time Certificates of Deposit
At December 31, 1997 and 1996, time certificates of deposit of $100,000 or
more aggregated $36,164,467 and $26,196,721 respectively.
Note 10 - Short-Term Borrowings and Other Liabilities for Borrowed Money
The Bank maintains lines of credit with various correspondent banks to use
as sources of short-term funds. Federal funds purchased, borrowings from the
Federal Reserve Bank and interest bearing demand notes issued to the U.S.
Treasury would be considered short-term borrowings. There were no federal funds
purchased or borrowings from the Federal Reserve Bank at December 31, 1997 or
1996. Interest-bearing demand notes issued to U.S. Treasury were $3,000,000 and
$2,741,000 for 1997 and 1996 respectively. In addition, the Bank maintains a
line of credit with the Federal Home Loan Bank of Pittsburgh. Based on the
amount of the Federal Home Loan Bank stock owned by the Bank, the maximum
borrowing capacity at December 31, 1997 was $16,800,000. There were no advances
from the Federal Home Loan Bank considered as short-term borrowings at December
31, 1997 or 1996.
The average balance outstanding for any category of short-term borrowings
during the periods reported was less than 30 per cent of stockholders' equity at
the end of each period reported.
The following represents other liabilities for borrowed money at December 31:
1997 1996
Notes payable-Town & Country, Inc.(Subsidiary of Bank)
borrowings from various lenders for leasing operations......$30,313 $28,423
Federal Home Loan Bank advances............................... 1,999 2,011
------ ------
Total.........................................................$32,312 $30,434
====== ======
Liabilities in connection with Town & Country, Inc. leasing operations are
payable to various lenders at various terms. The estimated current portion of
this debt is $15,941,971 at December 31, 1997. The borrowings from the Federal
Home Loan Bank of Pittsburgh, which total $1,999,395, consist of three advances.
An advance in 1993 in the amount of $950,000 carries an interest rate of 5.39%
per year and matures September 13, 2000. In 1995 an advance was obtained in the
amount of $668,700, at a rate of 6.41% per year and matures September 28, 2001.
In 1996, $400,000 was advanced at the rate of 3% per year and matures March 7,
2011. The balance on this obligation at December 31, 1997 was $380,695.
Note 11 - Pension and Employee Stock Bonus Plan
The Bank of Lancaster County, N.A. and its subsidiary, Town & Country, Inc.
maintains a qualified non-contributory pension plan for their employees. The
Plan specifies fixed benefits to provide a monthly pension benefit at age 65 for
life equal to one and one-half percent of each participant's final average
salary (highest five consecutive years' base compensation preceding
retirement) for each year of credited service. Salary in excess of
$160,000 (effective in the year 1997) is disregarded in determining a
participant's retirement benefit pursuant to IRS regulations. All employees
with one year of service who work at least 1,000 hours per year and
who are at least age 21 are eligible to participate. A participant becomes
100% vested upon completion of five years with a vesting credit.
Net periodic pension cost for 1997, 1996 and 1995 included the following:
1997 1996 1995
Service cost.......................$ 583 $ 614 $ 579
Interest cost...................... 608 567 504
Return on Plan assets..............(2,208) (1,049) (950)
Net amortization and deferral...... 1,351 368 417
------ ------ ------
Net periodic pension cost..........$ 334 $ 500 $ 550
====== ====== ======
The following table sets forth the Plan's funded status at December 31, 1997,
1996 and 1995:
Actuarial present value of benefit obligations:
1997 1996 1995
Accumulated benefit obligation, including vested
benefits of $6,389,173 for 1997, $5,499,101 for 1996
and $5,238,774 for 1995..................................$ 6,580 $ 5,551 $ 5,275
======= ======= =======
Projected benefit obligation for service rendered to
date......................................................$(9,670) $(8,451) $(8,143)
Plan assets at fair value.. ............................... 10,554 8,265 6,728
------- ------- -------
Projected plan assets in excess of or (less than)
benefit obligation........................................$ 884 $ (186) $(1,415)
Unrecognized net (gain) or loss from past experience
different from that assumed and effects of changes
in assumptions............................................ (694) 449 1,495
Unrecognized net (asset) or obligation..................... (138) (207) (276)
Unrecognized prior service cost............................ (111) (120) (128)
------- ------- -------
Prepaid (accrued) pension cost included
in other assets (liabilities).............................$ (59) $ (64) $ (324)
======= ======= =======
The weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation were 7% and 4.50%, respectively, at December 31,
1997. The expected long-term rate of return on plan assets in 1997 was 9%.
The Bank of Lancaster County maintained during 1997, an Employee Stock Plan
(the "Plan") which was approved by the shareholders in 1982. All employees of
the Bank who have attained the age of 18, have completed one year of service and
worked at least 1,000 hours per year are eligible to participate in the Plan.
Outside directors are not eligible to participate in the Plan. Employees of
Town & Country, Inc., a wholly-owned subsidiary of the Bank participate
only in the salary deferral feature of the Plan.
The Plan has two components, a salary deferral feature and a performance
incentive feature. Under the salary deferral feature of the Plan, a participant
may make voluntary contributions to the Plan each year of between 2% and 10% of
compensation. The Bank will make a matching contribution equal to 25% of each
participant's voluntary contributions, up to the first 6%. Under the
performance incentive feature of the Plan, the Bank contributes to
the Plan each year an amount determined by the Board of Directors
on the basis of the achievement by the Bank of certain
performance objectives. Contributions made by the Bank to
the Plan pursuant to the performance incentive feature are allocated to
participants in the same proportion that each participant's compensation
bears to the aggregate compensation of all participants.
During 1997, the Plan was amended to allow participants to defer their
contributions to five different investment alternatives. Previously, all
contributions to the Plan were invested in Sterling Financial Corporation
stock. The matching contributions and the performance incentive
feature continue to be invested in Sterling Financial Corporation stock.
The number of shares owned by the Employees Stock Plan at
December 31, 1997 was 527,566 with an approximate
market value of $16,486,000.
Bank contributions to the Plan vest in each participant's account at the
rate of 20% for each year of service. Normally, benefits may be paid from the
Plan on retirement, termination, disability or death. Participants in the Plan
may withdraw their own contribution earlier under several restricted conditions
of hardship with approval of the Plan Committee. The Plan provides that each
participant may vote the shares in his or her account through the Plan Trustee
at any shareholder meeting. The Bank of Lancaster County Trust
Department serves as Trustee for the Plan. All dividends received
on Sterling Financial Corporation stock are reinvested
in additional shares of Sterling Financial Corporation
stock. The amount of dividends received during 1997 amounted to $423,093.
The contribution to the performance incentive portion of the Plan was
$245,000, $235,000 and $216,000 for 1997, 1996 and 1995 respectively. The
contribution to the salary deferral portion of the Plan was $100,682 in 1997,
$75,619 in 1996 and $65,946 in 1995.
Effective January 1, 1993, Sterling adopted Statement of Financial
Accounting Standards No. 106 - "Employers' Accounting for Postretirement
Benefits Other Than Pensions." Under SFAS No. 106, the cost of
postretirement benefits other than pensions must be recognized
on an accrual basis as employees perform services to earn the benefits.
This is a significant change from the previous generally accepted
practice of accounting for these benefits which was on a cash
basis. The accumulated postretirement benefit obligation at the date of
adoption (the "transition obligation") could have been recognized in
operations as the cumulative effect of an accounting change in the
period of adoption, which would have resulted in an actuarially
determined pre-tax charge to earnings of $1,026,457, or its recognition
could be delayed by amortizing the obligation over
future periods as a component of the postretirement benefit cost. Sterling
adopted SFAS No. 106 by recognizing the transition on a delayed basis. The
transition obligation in the amount of $1,026,457 is being amortized on a
straight-line basis over a 20 year period which is the average remaining service
period of active plan participants.
The cost for postretirement benefits other than pensions consisted of the
following components at December 31, 1997, 1996 and 1995:
1997 1996 1995
Service cost......................$ 77 $ 96 $ 93
Interest cost..................... 86 100 99
Amortization of unrecognized
transition obligation........... 51 51 51
Amortization of unrecognized
prior service cost.............. (19) none none
Amortization of unrecognized
net (gain) or loss.............. (4) none none
----- ----- -----
Net periodic postretirement
benefit cost.................... $191 $247 $243
==== ==== ====
Sterling's postretirement benefits other than pensions are currently not
funded. The status of the plans at December 31, 1997, 1996 and 1995 is as
follows:
Actuarial valuation of accumulated postretirement benefit obligation:
1997 1996 1995
Retirees..................................$ 295 $ 319 $ 324
Fully eligible active plan participants... 314 290 323
Other active plan participants............ 610 601 787
----- ----- -----
$1,219 $1,210 $1,434
Unrecognized transition obligation........ (770) (821) (872)
Unrecognized prior service cost........... 232 251 none
Unrecognized net gain (loss).............. 315 195 56
----- ----- -----
Accrued postretirement benefit cost....... $ 996 $ 835 $ 618
===== ===== =====
The assumed postretirement health care cost trend rate used in measuring
the accumulated postretirement benefit was 7% in 1997, decreasing by .5% per
year to an ultimate rate of 5% in 2001 and remains at that level thereafter.
The discount rate used to measure the accumulated postretirement benefit
obligation was 7% in 1997.
The health care cost trend rate assumption has a significant effect on the
amounts reported. To illustrate, increasing the assumed health care cost trend
rates by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of December 31, 1997 by $241,275 and the
aggregate of the service and interest cost components of net periodic
postretirement benefit cost for the year ended December 31, 1997 by $40,761.
The Board of Directors of the Bank adopted a Retirement Restoration Plan
during 1996 for any officer whose compensation exceeded $160,000. The Plan was
designed to "restore" the level of benefits which is lost to these employees
under the organization's qualified retirement plans because of Internal Revenue
Code restrictions.
The Plan is designed to mirror the provisions set forth in the qualified
retirement plans available to all Bank of Lancaster County employees -- the
defined benefit pension plan, and the employee stock or 401(k) plan. The Plan
allows for the calculation of benefits on the officer's salary in excess of
$160,000. The effective date of the Plan was May 1, 1996.
The net periodic pension cost for the Retirement Restoration Plan for 1997
and 1996 included the following:
1997 1996
---- ----
Service cost.....................................$ 13 $ 8
Interest cost.................................... 15 9
Amortization of unrecognized prior service cost.. 20 13
------- ------
Net periodic pension cost........................$ 48 $ 30
======= ======
Actuarial valuation of benefit obligation:
1997 1996
---- ----
Projected benefit obligation...................$ (216)$ (205)
Fair value of plan assets...................... 0 0
-------- -------
Funded status..................................$ (216)$ (205)
Unrecognized prior service cost................ 146 167
Unrecognized net (gain) or loss................ (8) 8
-------- -------
Accrued retirement restoration plan liability..$ (78)$ (30)
======== =======
Note 12 - Advertising
The Corporation expenses advertising costs as incurred. The expenses for
1997, 1996 and 1995 were $569,484, $552,451 and $474,030 respectively.
Note 13 - Stock Options
On November 19, 1996, the Board of Directors of the Corporation adopted the
Sterling Financial Corporation 1996 Stock Incentive Plan (the "Stock Incentive
Plan") which was approved by the shareholders of this Corporation at the 1997
Annual Meeting of Shareholders. The stated purpose of the Stock Incentive Plan
is to advance the development, growth and financial condition of the
Corporation. The Stock Incentive Plan provides for the issuance of shares
of the Corporation's Common Stock to the Corporation's employees.
The shares of Common Stock that may be issued under the
Stock Incentive Plan shall not exceed in the aggregate
500,000 shares of Common Stock.
The Stock Incentive Plan is administered by a disinterested committee of
the Corporation's Board of Directors. Incentive awards can be
made in the form of incentive stock options, nonqualified
stock options, stock appreciation rights or
restricted stock as the disinterested committee deems appropriate.
Sterling has elected to follow Accounting Principles Board Opinion No. 25,
"Acccounting for Stock Issued to Employees" (APB 25) and related interpretations
in accounting for its employee stock options. Accordingly, no compensation cost
has been recognized. Had compensation cost been determined on the basis for
fair value pursuant to FASB Statement No. 123, net income and earnings
per share would have been reduced as follows:
1997 1996 1995
Net Income: ---- ---- ----
As reported..................... $10,401 $ 9,811 $ 8,994
Proforma - Granted.............. 10,090 9,594 8,994
Proforma - Exercisable.......... 10,332 9,811 8,994
Earnings Per Share:
As reported - basic and diluted. $ 1.68 $ 1.57 1.45
Proforma - Granted.............. 1.62 1.54 1.45
Proforma - Exercisable.......... 1.67 1.57 1.45
Proforma disclosure of net income recognized compensation expense are not likely
to be representative of the effects on net income for future years.
The following is a summary of the status of the Plan:
1997 1996 1995
Weighted Weighted Weighted
Average Average Average
Exercised Exercised Exercised
Shares Price Shares Price Shares Price
------ ------- ------ ------- ------ -------
Outstanding at January 1....32,850 $ 24.30 0 $ -- 0 $ --
Granted...................36,750 29.06 32,850 24.30 0 --
Exercised................. 0 -- 0 -- 0 --
Forfeited.................(1,500) 24.30 0 -- 0 --
Outstanding at December 31..68,100 26.87 32,850 24.30 0 --
Options Exercisable at
December 31................10,450 24.30 0 -- 0 --
Weighted Average Fair Value
of Options granted during
the year................... $8.45 $6.62 0
The fair value of each option granted is estimated on the grant date using
the Black-Scholes model. The following assumptions were made in estimating the
fair value.
Assumption 1997 1996
Dividend Yield.......... 2.53% 2.91%
Risk-Free Interest Rate. 5.78% 6.39%
Expected Life........... 10 years 10 years
Expected Volatility..... 12.103% 10.617%
Note 14 - Operating Leases
The Bank leases certain banking facilities under operating leases which
expire on various dates to 2022. Renewal options are available on these leases.
Minimum future rental payments as of December 31, 1997 are as follows:
Operating
Leases
1998.........................$ 574
1999......................... 509
2000......................... 333
2001......................... 275
2002......................... 189
Later years.................. 1,784
-------
Total minimum future rental
payments...................$ 3,664
=======
Total rent expense charged to operations amounted to $587,126 in 1997,
$562,547 in 1996 and $479,809 in 1995.
Note 15 - Applicable Income Taxes
The effective income tax rates for financial reporting purposes are less
than the Federal statutory rate of 34% for 1997, 1996 and 1995 for reasons shown
as follows:
For the years ended December 31,
Statutory Statutory Statutory
1997 Rate 1996 Rate 1995 Rate
Federal income tax expense
at statutory rate............$ 4,723 34.0% $ 4,406 34.0% $ 4,091 34.0%
Reduction resulting from:
Nontaxable interest income... (1,213) (8.7%) (1,153) (8.9%) (1,046) (8.7%)
Other, net.................... (112) (.9%) (186) (1.4%) (71) (.6%)
------- ------ ------ ------ ------- ------
Applicable Federal income taxes.$ 3,398 24.4% $ 3,067 23.7% $ 2,974 24.7%
State income taxes.............. 93 .7% 80 .6% 65 .6%
-------- ------- ------- ------ ------- ------
Applicable income taxes.........$ 3,491 25.1% $ 3,147 24.3% $ 3,039 25.3%
======= ====== ======= ====== ======= ======
Taxes currently payable.........$ $ 2,323 $ 2,460
Deferred income taxes........... 824 579
------- ------- -------
Applicable income taxes.........$ 3,491 $ 3,147 $ 3,039
======= ======= =======
The Corporation had net deferred tax credits of $5,639,000, $4,326,000 and
$3,512,000 at December 31, 1997, 1996 and 1995 respectively. The tax effect of
temporary differences that gave use to significant portions of the deferred tax
liabilities at December 31, 1997 and 1996, are as follows:
December 31,
1997 1996
---- ----
Deferred tax assets:
Allowance for loan losses.....................$ 2,628 $ 2,763
Deferred loan fees and costs.................. 29 43
Postretirement benefits other than pensions... 339 292
Foreclosed assets............................. 7 7
Pension....................................... 49 47
Other......................................... 79 38
------- -------
Total deferred tax assets...................$ 3,131 $ 3,190
======= =======
Deferred tax liabilities:
Leasing....................................... (6,930) (6,375)
Depreciation.................................. (271) (294)
Unrealized gains on investments............... (1,501) (826)
Other......................................... (68) (21)
------- -------
Total deferred tax liabilities..............$(8,770) $(7,516)
======= =======
Net deferred tax liability..................$(5,639) $(4,326)
======= =======
Amounts for the current year are based upon estimates and assumptions as of
the date of this report and could vary from amounts shown on the tax return when
filed. Accordingly, amounts previously reported for 1996 may change as a result
of adjustments to conform to tax returns filed.
The Financial Accounting Standards Board has issued Statement No. 109,
"Accounting for Income Taxes," which significantly changes the recognition and
measurement of deferred income tax assets and liabilities. Statement 109
requires that deferred income taxes be recorded on an asset/liability method and
adjusted when new tax rates are enacted. The corporation adopted Statement No.
109 beginning with its year ending December 31, 1993. The Statement provides
that the effect of its adoption may be recorded entirely in the year of adoption
or retroactively by restating one or more prior years. The statement was
retroactively applied to 1990.
Note 16 - Disclosures about Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value.
Cash and Short-Term Investments - For those short-term instruments, the
carrying amount is a reasonable estimate of fair value.
Investment Securities - For investment securities, fair value equals quoted
market price, if available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.
Loans - For certain homogenous categories of loans, such as some
residential mortgages, fair value is estimated using the quoted market prices
for securities backed by similar loans, adjusted for differences
in loan characteristics. The fair value of other types of loans
is estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same remaining maturities. Lease
contracts as defined in FASB Statement No. 13, "Accounting for Leases," are
not included in this disclosure statement.
Deposit Liabilities - The fair value of demand deposits, savings accounts
and certain money market deposits is the amount payable on demand at the
reporting date. The fair value of fixed-maturity certificates of deposits is
estimated using the rates currently offered for deposits of similar remaining
maturities.
Federal Funds Purchased - The carrying amount of federal funds purchased
approximates its fair value due to the overnight maturities of these financial
instruments.
U.S. Treasury Demand Notes - For U.S. Treasury demand notes, the carrying
amount is a reasonable estimate of fair value.
Other Borrowings - Rates currently available to the Corporation for debt
with similar terms and remaining maturities are used to estimate fair value of
existing debt.
Commitments to Extend Credit and Standby Letters of Credit - The fair value
of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present creditworthiness of the counterparties. For fixed-rate loan
commitments, fair value also considers the difference between current levels of
interest rates and committed rates. The fair value of guarantees and letters of
credit is based on fees currently charged for similar agreements or on the
estimated cost to terminate them or otherwise settle the obligations with the
counterparties at the reporting date.
The estimated fair values of the Corporation's financial instruments are as
follows:
1997 1996
--------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- ---------
Financial Assets:
Cash and short-term investments.....$ 34,307 $ 34,307 $ 31,983 $ 31,983
Investment securities
held-to-maturity................. 85,155 86,465 94,222 94,778
Investment securities
available-for-sale............... 121,474 121,474 79,375 79,375
Loans............................... 460,658 428,687
Less: Allowance for loan losses.... (7,131) (7,180)
--------- --------- --------- ---------
Net loans...........................$ 453,527 $ 454,042 $ 421,507 $ 421,936
Financial Liabilities:
Deposits..........................$ 718,661 $ 680,629 $ 647,036 $ 649,315
U.S. Treasury demand notes........ 3,000 3,000 2,741 2,741
Other borrowings.................. 32,312 32,183 30,434 30,189
Unrecognized financial instruments:*
Interest rate swaps:
In a net receivable position.....$ none $ none $ none $ none
In a net payable position........ (none) (none) (none) (none)
Commitments to extend credit...... (50) (50) (82) (82)
Standby letters of credit......... (50) (50) (48) (48)
Financial guarantees written...... (none) (none) (none) (none)
* The amounts shown under "Carrying Amount" represent accruals or deferred income
(fees) arising from those unrecognized financial instruments.
Note 17 - Commitments and Contingent Liabilities
In the normal course of business, there are various commitments and
contingent liabilities which are not reflected in the financial statements.
These include lawsuits and commitments to extend credit, guarantees and letters
of credit. In the opinion of management, there are no material commitments
which represent unusual risks.
A summary of the more significant commitments as of December 31, 1997 and
1996 are as follows:
Financial instruments whose contract amounts
represent credit risk:
1997 1996
Standby letters of credit ....................$ 3,932 $ 7,594
Commitments to extend credit..................$103,357 $ 80,259
Standby letters of credit are obligations to make payments under certain
conditions to meet contingencies related to customers' contractual agreements
and are subject to the same risk, credit review and approval process as loans.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require the payment of a fee. Since many of
the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily
represent future cash requirements. Each customer's creditworthiness is
evaluated on a case-by-case basis. Excluded from these amounts are commitments
to extend credit in the form of retail credit cards, check credit or related
plans.
Sterling's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. Sterling uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
Most of Sterling's business activity is with customers located within
Sterling's defined market area. Sterling grants commercial, residential and
consumer loans throughout the market area. The loan portfolio is well
diversified and Sterling does not have any significant concentrations of credit
risk.
In 1994, SFAS No. 119 - "Disclosure about Derivative Financial Instruments
and Fair Value of Financial Instruments" was issued effective for financial
statements issued after December 15, 1994. The Corporation has not entered into
any derivatives defined as a future, forward, swap, option, caps, floors, etc.
However, the financial instruments listed above as standby letters of credit and
commitments to extend credit have characteristics similar to derivatives. The
following is a schedule that represents the estimated risk of current interest
rates versus committed rates. Due to the uncertainty of when and how much a
commitment to extend credit will be exercised, estimates were used.
Fixed Rate Commitments
1997 1996
Carrying value at December 31,..............$ 0 $ 0
Commitment available not yet exercised......$ 24,992 $ 17,932
Commitment revalued at existing rates with
estimated activity........................$ 24,992 $ 17,932
Management has initiated an enterprise-wide program to prepare the
Corporation's computer systems and applications for the year 2000. In January
1997, the Corporation began converting its computer systems to be year 2000
compliant. On December 31, 1997, approximately 59 percent of the Corporation's
systems were compliant, with all systems expected to be compliant by May of
1999. The Corporation continues to evaluate appropriate courses of
corrective action, including replacement of certain systems whose associated
costs would be recorded as assets and amortized. The total
cost of the project is being funded through operating cash flows.
Accordingly, the Corporation does not expect the amounts
required to be expensed over the next two years to have a material effect
on its financial position or results of operations.
Note 18 - Related Party Transactions
Certain directors and officers of Sterling Financial Corporation and its
subsidiaries, their immediate families and companies in which they are principal
owners (more than 10%), were indebted to the Bank during 1997 and 1996. All
loans were made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons and, in the opinion of the management of the Bank, do not involve
more than a normal risk of collectibility or present other unfavorable
features. Total loans to these persons at December 31, 1997 and 1996
amounted to $3,039,888 and $5,435,443 respectively. During 1997, $1,947,765
of new loans were made and repayments totaled $4,343,320.
Note 19 - Dividend and Loan Restrictions
Dividends are paid by Sterling Financial Corporation from its assets which
are provided in part by dividends from Bank of Lancaster County, N.A. However,
certain restrictions exist regarding the ability of the Bank to transfer funds
to Sterling Financial Corporation in the form of dividends. The
approval of the Comptroller of the Currency shall be required if
the total of all dividends declared by the Bank in any calendar
year shall exceed the total of its net profits of that year
combined with its retained net profits of the preceding two
years. Under these restrictions, the Bank can declare dividends in 1998 without
approval of the Comptroller of the Currency of approximately $7,722,000 plus an
additional amount equal to the Bank's net profits for 1998 up to the date of any
such dividend declaration.
Under current Federal Reserve regulations, the Bank is limited in the
amount it may loan to Sterling Financial Corporation. Loans to
Sterling Financial Corporation may not exceed 10% of the Bank's
capital stock and surplus.
Note 20 - Earnings per Share Computations
In 1997, the Financial Accounting Standards Board issued Statement No.
128 - "Earnings per Share." The Statement is effective for
periods ending after December 15, 1997. The Statement is
designed to simplify the computation of earnings per share and
requires disclosure of "basic earnings per share" and if
applicable, "diluted earnings per share." Basic earnings per share is
simply the per share allocation of income available to common
stockholders based only on the weighted average number of common shares
actually outstanding during the period. Diluted earnings per
share represents the per share allocation of income
attributable to common stockholders based on the weighted average number of
common shares actually outstanding plus all dilutive potential common shares
outstanding during the period. The Statement requires restatement of all
prior period earnings per share date when adopted.
Basic earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding which were
6,202,696, 6,235,257 and 6,204,212 for 1997, 1996 and 1995 respectively, after
giving retroactive effect to a 5% stock dividend paid in July 1996. Diluted
earnings per share were computed by dividing net income by the weighted average
number of shares of common stock outstanding plus all dilutive potential common
shares outstanding during the period which were 6,205,784, 6,235,330 and
6,204,212 at 1997, 1996 and 1995, respectively, after giving retroactive effect
to a 5% stock dividend paid in July 1996.
The following data show the amounts used in computing earnings per share
and the effect of income and the weighted average number of shares of dilutive
potential common stock.
1997 1996 1995
Net Income...................................... $ 10,401 $ 9,811 $ 8,994
-------- ------- -------
Income available to common stockholders
used in basic and diluted earnings per share... $ 10,401 $ 9,811 $ 8,994
======== ======= =======
Weighted average number of common shares used
in basic earnings per share................... 6,202,696 6,235,257 6,204,212
Effect of dilutive securities
Stock Options................................. 3,088 73 0
--------- --------- ---------
Weighted number of common shares and dilutive
potential common stock used in diluted
earnings per share............................ 6,205,784 6,235,330 6,204,212
========= ========= =========
Note 21 - Sterling Financial Corporation (Parent Company Only) Financial
Information
Condensed Balance Sheets
As of December 31,
1997 1996
Assets
Cash.......................................................$ 1,760 $ 1,109
Securities available-for-sale.............................. 216 185
Investment in subsidiaries at equity....................... 72,980 69,026
Other assets............................................... 68 51
-------- -------
Total Assets.................................................$ 75,024 $ 70,371
======== ========
Liabilities
Other liabilities..........................................$ 1,037 $ 1,192
Stockholders' Equity
Common Stock...............................................$ 31,185 $ 31,185
Capital Surplus............................................ 16,321 16,325
Retained Earnings.......................................... 25,828 20,502
Net Unrealized Gain on securities available-for-sale,
net of taxes........................................... 2,916 1,603
Less: Treasury Stock at cost............................... (2,263) (436)
-------- --------
Total Stockholders' Equity...................................$ 73,987 $ 69,179
-------- --------
Total Liabilities and Stockholders' Equity...................$ 75,024 $ 70,371
======== ========
Condensed Statements of Income
Years Ended December 31,
1997 1996 1995
Income
Dividends from subsidiaries...............$ 7,876 $ 4,847 $ 3,837
Dividends on investment securities........ 4 3 2
Other income.............................. 1 1 1
Investment securities gains............... 4 none none
-------- -------- --------
Total Income............................ 7,885 4,851 3,840
-------- -------- --------
Expenses
Other expense............................. 210 155 141
-------- -------- --------
Total Expenses.......................... 210 155 141
-------- -------- --------
Income before income taxes and equity
in undistributed net income
of subsidiaries........................... 7,675 4,696 3,699
Income taxes (credits)...................... (68) (51) (47)
-------- -------- --------
7,743 4,747 3,746
Equity in undistributed income of
subsidiaries.............................. 2,658 5,064 5,248
-------- -------- --------
Net Income..................................$ 10,401 $ 9,811 $ 8,994
======== ======== ========
Statements of Cash Flows
Years Ended December 31,
1997 1996 1995
Cash flows from operating activities
Net income........................................$ 10,401 $ 9,811 $ 8,994
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Undistributed (earnings) loss of subsidiaries..... (2,658) (5,064) (5,248)
(Gain) on sales of investment securities.......... (4) none none
Changes in operating assets and liabilities:
(Increase) decrease in other assets............. (17) 796 (519)
(Decrease) increase in other liabilities........ (165) 164 142
-------- -------- --------
Net cash provided by/(used in)
operating activities............................ 7,557 5,707 3,369
-------- -------- --------
Cash flows from investing activities
Proceeds from sales of investment securities
avaiable-for sale............................... 9 none none
Purchase of investment securities
available-for-sale.............................. (9) (83) (81)
-------- -------- --------
Net cash provided by/(used in) investing
activities...................................... none (83) (81)
-------- -------- --------
Cash flows from financing activities
Proceeds from issuance of common stock........... none 239 1,731
Cash dividends paid.............................. (5,075) (4,508) (5,260)
Cash dividends paid in lieu of
fractional shares............................... none (24) none
Acquisition of treasury stock.................... (3,302) (547) (1,252)
Proceeds from issuance of treasury stock......... 1,471 320 1,207
-------- -------- --------
Net cash provided by/(used in) financing
activities...................................... (6,906) (4,520) (3,574)
-------- -------- --------
Increase (decrease) in cash....................... 651 1,104 (286)
Cash
Beginning....................................... 1,109 5 291
-------- -------- -------
Ending.........................................$ 1,760 $ 1,109 $ 5
========= ======== =======
Summary of Quarterly Financial Data (Unaudited)
Sterling Financial Corporation and Subsidiaries
The following is a summary of the quarterly results of operations for the
years ended December 31, 1997 and 1996. Net income per share of common stock
has been restated to retroactively reflect a 5% stock dividend
paid in July 1996.
1997
Quarter Ended
March June September December
31 30 30 31
Interest income..................$ 13,396 $ 13,950 $ 14,434 $ 14,719
Interest expense................. 5,735 6,173 6,574 6,844
--------- ------- -------- --------
Net interest income.............. 7,661 7,777 7,860 7,875
Provision for loan losses........ 198 453 335 143
--------- ------- -------- --------
Net interest income after
provision for loan losses...... 7,463 7,324 7,525 7,732
Other income..................... 2,739 3,284 2,949 2,958
Other expenses................... 6,763 7,121 6,932 7,266
--------- -------- -------- --------
Income before income taxes....... 3,439 3,487 3,542 3,424
Applicable income taxes.......... 851 910 893 837
--------- -------- -------- --------
Net income.......................$ 2,588 $ 2,577 $ 2,649 $ 2,587
========= ======== ======== ========
Net income per share of common
stock (basic and diluted)......$ .42 $ .41 $ .43 $ .42
1996
Quarter Ended
March June September December
31 30 30 31
Interest income..................$ 12,798 $ 13,013 $ 13,227 $ 13,520
Interest expense................. 5,465 5,635 5,832 5,891
--------- ------- -------- --------
Net interest income.............. 7,333 7,378 7,395 7,629
Provision for loan losses........ 159 102 50 269
--------- ------- -------- --------
Net interest income after
provision for loan losses...... 7,174 7,276 7,345 7,360
Other income..................... 2,286 2,275 2,269 2,612
Other expenses................... 6,256 6,247 6,349 6,787
--------- -------- -------- --------
Income before income taxes....... 3,204 3,304 3,265 3,185
Applicable income taxes.......... 768 818 802 759
--------- -------- -------- --------
Net income.......................$ 2,436 $ 2,486 $ 2,463 $ 2,426
========= ======== ======== ========
Net income per share of common
stock (basic and diluted)......$ .39 $ .40 $ .39 $ .39
Item 9 - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
PART III
Item 10 - Directors and Executive Officers of the Registrant
Incorporated by reference is the information appearing under the headings
"Information about Nominees and Continuing Directors" and "Officers and
Executive Officers" of the 1998 Annual Meeting Proxy Statement.
Item 11 - Executive Compensation
Incorporated by reference is the information under the headings
"Compensation of Directors" and "Executive Compensation" of the 1998 Annual
Meeting Proxy Statement.
Item 12 - Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference is the information appearing under the headings
"Principal Holders" and "Beneficial Ownership of Executive Officers, Directors
and Nominees" of the 1998 Annual Meeting Proxy Statement.
Item 13 - Certain Relationships and Related Transactions
Incorporated by reference is the information appearing under the heading
"Transactions with Directors and Executive Officers" of the 1998 Annual Meeting
Proxy Statement and under "Notes to Consolidated Financial Statements - Note 18
- -Related Party Transactions" on page 51 of this Form 10-K.
PART IV
Item 14 - Exhibits, Financial Statement Schedules and Reports of Form 8-K
(a) The following documents are filed as part of this report:
1. The financial statements listed on the index set forth in Item 8 of
this Annual Report on Form 10-K are filed as part of
this Annual Report.
2. Financial Statement Schedules
All schedules are omitted because they are not either applicable, the
data are not significant or the required information is shown in the
financial statements or the notes thereto or elsewhere herein.
3. Exhibits
The following is a list of the Exhibits required by Item 601 of
Regulation S-K and are incorporated by reference herein or annexed
to this Annual Report.
3(i) Amended Articles of Incorporation of Sterling Financial
Corporation. (Incorporated by reference to Exhibit 3(i) of
the Current Report on Form 8-K, filed with the Securities and
Exchange Commission, on June 14, 1996.)
3(ii) Amended Bylaws of Sterling Financial Corporation. (Incorporated
by reference to Exhibit 3(ii) of the Current Report on Form 8-K,
filed with the Securities and Exchange Commission, on March 7,
1996.)
10a Employment Agreement, dated as of April 30, 1983, between The
First National Bank of Lancaster County and John E. Stefan.
(Incorporated by reference to Exhibit 10a of the Current Report
on Form 8-K, filed with the Securities and Exchange Commission,
on March 19, 1997.)
10b Assumption and Modification Agreeement, dated July 14, 1987, by
and among John E. Stefan, Bank of Lancaster County, N.A. and
Sterling Financial Corporation. (Incorporated by reference
to Exhibit 10b of the Current Report on Form 8-K, filed with
the Securities and Exchange Commission, on March 19, 1997.)
10c Sterling Financial Corporation 1996 Stock Incentive Plan.
(Incorporated by refernce to Exhibit 99 of the Current Report
on Form 8-K, filed with the Securities and Exchange Commission,
on February 5, 1997.)
10d The Sterling Financial Corporation Dividend Reinvestment and
Stock Purchase Plan. (Incorporated by reference to Exhibit A to
the Prospectus included in the Registration Statement No. 33-
55131 on Form S-3, filed with the Securities and Exchange
Commission on August 18, 1994.)
10e Letter Agreement between Sterling Financial Corporation and
Howard E. Groff, Sr., dated June 30, 1994. (Incorporated
by reference to Exhibit 10b on Form 10Q, filed with the
Securities and Exchange Commission, on November 14, 1994.)
10f The Corporation's 1997 Directors Stock Compensation Plan and
Policy. (Incorporated by reference to Exhibit 4.3 to the
Corporation's Registration Statement No. 333-28101 on Form S-8,
filed with the Securities and Exchange Commission on May 30,
1997.)
11 Statement re: Computations of Earnings Per Share (included
herein at Item 8 at Notes to Consolidated Financial
Statements, Note 20.)
21 Subsidiaries of the Registrant
23 Consent of Auditors
27 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the three months
ended December 31, 1997.
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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.
STERLING FINANCIAL CORPORATION
By: /s/ John E. Stefan
John E. Stefan
Chairman of the Board,
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated.
Signature Title Date
Chairman of the Board,
/s/ John E. Stefan President and Chief February 24, 1998
(John E. Stefan) Executive Officer; Director
/s/ J. Roger Moyer, Jr. Executive Vice President, February 24, 1998
(J. Roger Moyer, Jr.) Director
/s/ Jere L. Obetz Senior Vice President/Treasurer, February 24, 1998
(Jere L. Obetz) Chief Financial Officer
/s/ Ronald L. Bowman Vice President/Secretary, February 24, 1998
(Ronald L. Bowman) Principal Accounting Officer
Director February 24, 1998
(Richard H. Albright, Jr.)
Director February 24, 1998
(Robert H. Caldwell)
/s/ Howard E. Groff, Jr. Director February 24, 1998
(Howard E. Groff, Jr.)
/s/ Joan R. Henderson Director February 24, 1998
(Joan R. Henderson)
/s/ J. Robert Hess Director February 24, 1998
(J. Robert Hess)
/s/ Calvin G. High Director February 24, 1998
(Calvin G. High)
/s/ E. Glenn Nauman Director February 24, 1998
(E. Glenn Nauman)
/s/ Glenn R. Walz Vice Chairman of the Board, February 24, 1998
(Glenn R. Walz) Director
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
The following are the subsidiaries of Sterling Financial Corporation:
Subsidiary State of Incorporation or Organization
Bank of Lancaster County, N.A. Pennsylvania
1 East Main Street (National Banking Association)
P.O. Box 0300
Strasburg, PA 17579
Town & Country, Inc. (Wholly owned Pennsylvania
Subsidiary of Bank of Lancaster
County, N.A.)
1097 Commercial Avenue
East Petersburg, PA 17520
Sterling Mortgage Services, Inc. Pennsylvania
(Presently inactive)
101 North Pointe Boulevard
Lancaster, PA 17601-4133
Trout, Ebersole & Groff, LLP
Certified Public Accountants
1705 Oregon Pike
Lancaster, Pennsylvania 17061
Exhibit 23
Consent of Independent Certified Public Accountants
We hereby consent to the incorporation by reference in Registration
Statement No. 33-55131 on Form S-3 filed August 19, 1994 of our opinion dated
January 24, 1998, on the consolidated financial statements of Sterling Financial
Corporation for the year ended December 31, 1997 as set forth in this form 10-K.
/s/ Trout, Ebersole & Groff, LLP
Trout, Ebersole & Groff, LLP
Certified Public Accountants
Lancaster, Pennsylvania
March 6, 1998
Exhibit Index
Page
Exhibits Required Pursuant to (in accordance with
Item 601 of Regulation S-K sequential numbering system)
3(i). Articles of Incorporation of
Sterling Financial Corporation incorporated
by reference to Exhibit 3 of Registration
Statement on Form S-4 (No. 33-12635)
filed with the Securities and Exchange
Commission on March 13, 1987.
3(ii). Amended Bylaws of Sterling Financial Corporation
incorporated by reference to Exhibit 3(ii) on
Form 8-K filed with the Securities and Exchange
Commission on March 7, 1996.
10a Employment Agreement, dated as of April 30, 1983, between The
First National Bank of Lancaster County and John E. Stefan.
(Incorporated by reference to Exhibit 10a of the Current Report
on Form 8-K, filed with the Securities and Exchange Commission,
on March 18, 1997.)
10b Assumption an Modification Agreeement, dated July 14, 1987, by
and among John E. Stefan, Bank of Lancaster County, N.A. and
Sterling Financial Corporation. (Incorporated by reference
to Exhibit 10b of the Current Report on Form 8-K, filed with
the Securities and Exchange Commission, on March 18, 1997.)
10c Sterling Financial Corporation 1996 Stock Incentive Plan.
(Incorporated by refernce to Exhibit 99 of the Current Report
on Form 8-K, filed with the Securities and Exchange Commission,
on February 5, 1997.)
10d The Sterling Financial Corporation Dividend Reinvestment and
Stock Purchase Plan (Incorporated by reference to Exhibit A to
the Prospectus included in the Registration Statement No. 33-
55131 on Form S-3, filed with the Securities and Exchange
Commission on August 18, 1994.)
10e Letter Agreement between Sterling Financial Corporation and Howard
E. Groff, Sr., dated June 30, 1994. (Incorporated by reference
to Exhibit 10b on Form 10Q, filed with the Securities and Exchange
Commission, on November 14, 1994.)
10f The Corporation's 1997 Directors Stock Compensation Plan and
Policy. (Incorporated by reference to Exhibit 4.3 to the
Corporation's Registration Statement No. 333-28101 on Form S-8,
filed with the Securities and Exchange Commission on May 30,
1997.)
11 Statement re: Computations of Earnings Per Share (included
herein at Item 8 at Notes to Consolidated Financial
Statements, Note 20.)
21 List of Subsidiaries 54
23 Consent of Auditors 55
27 Financial Data Schedule