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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, 1998
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. |X|
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 26, 1999 was approximately $175,748,981.
The number of shares of Registrant's Common Stock outstanding on February 26,
1999 was 6,447,136.
Documents Incorporated by Reference
Portions of the Proxy Statement for the Registrant's 1999 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............................................. 1
Item 2. Properties........................................... 3
Item 3. Legal Proceedings.................................... 4
Item 4. Submission of Matters to a Vote of Security Holders.. 4
Part II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters.......................... 4
Item 6. Selected Financial Data.............................. 5
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 6
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk.................................... 6
Item 8. Financial Statements and Supplementary Data.......... 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. 50
Part III
Item 10. Directors and Executive Officers of the Registrant... 51
Item 11. Executive Compensation............................... 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 51
Item 13. Certain Relationships and Related Transactions....... 51
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.......................................... 52
Signatures...................................................... 53
PART I
Item 1 - Business
Sterling Financial Corporation
Sterling Financial Corporation is a Pennsylvania business corporation,
based in Lancaster, Pennsylvania. The corporation was organized on
February 23, 1987 and became a bank holding company through the acquisition
on June 30, 1987 of all the outstanding stock of The First National Bank of
Lancaster County, now by change of name, Bank of Lancaster County, N.A.
The corporation provides a wide variety of commercial banking and trust
services through its wholly owned subsidiary, Bank of Lancaster County, N.A.
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 and is subject to regulation by the Federal Reserve Board
and by the Pennsylvania Department of Banking.
On July 21, 1998, Sterling Financial Corporation organized T & C Leasing,
Inc., a Pennsylvania corporation. T & C Leasing, Inc. is a nationwide vehicle
and equipment leasing company operating primarily in Pennsylvania. Its
principal office is located at 1097 Commercial Avenue, East Petersburg,
Pennsylvania.
In addition, the corporation also owns all of the outstanding stock of a
non-bank subsidiary, Sterling Mortgage Services, Inc., a mortgage service
company formed by the corporation as a wholly owned subsidiary that presently is
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, we changed the name to The First National Bank
of Lancaster County. At the time of the holding company reorganization,
on June 30, 1987, the name was changed to its present name,
Bank of Lancaster County, N.A. At December 31, 1998, the bank had total
assets of $918,688,000 and total deposits of $784,422,000.
The main office of the bank is located at 1 East Main Street, Strasburg,
Pennsylvania. In addition to its main office, the bank had 29 branches in
Lancaster County and 1 branch in Chester County, Pennsylvania in operation at
December 31, 1998.
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, and a full spectrum of
personal and commercial lending activities. The bank maintains
correspondent relationships with major banks in New York City and
Philadelphia. Through these correspondent relationships, the bank can
offer a variety of collection and international services.
With the installation of 3 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. In mid-year 1998, the Bank of
Lancaster County began offering fixed annuities in addition to mutual funds as
an alternative investment vehicle for appropriate customers.
The annuities are available from 3 insurance companies, AIG,
Jackson National and CIGNA, with BankMark Corporation, Morris Plains, New
Jersey, providing marketing support services. As required, the bank obtained
an insurance license from the Commonwealth of Pennsylvania.
Management believes these services are important
additions to our product line and make a statement about our progressive
attitude in providing financial services for the future.
The Comptroller of the Currency gave the bank permission to open a Trust
Department 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 nearly $531 million at December 31, 1998.
On January 31, 1983, the bank purchased Town & Country, Inc., which is 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 50 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 455,000 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 economy.
One of the best agricultural areas in the nation, Lancaster 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. Lancaster County
ended 1998 with the lowest unemployment rate in Pennsylvania.
The unemployment rate of the county in December 1998 was 2.7% which
was significantly lower than the statewide rate of 3.8% and national rate
of 4.0%. Lancaster County's December unemployment rate of
2.7% tied for the lowest in the state with State College. 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 applications 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. Several of the financial
institutions exceed $20 billion in assets while one is
in excess of $235 billion in assets. The increased competition has
resulted from a changing legal and regulatory climate, as well as, from
the economic climate. As of December 31, 1998, the bank ranked, as measured
by total deposits, as the second largest in market
share within Lancaster County of the banks doing
business in Lancaster County. The bank is not, however, the second largest bank
in Lancaster County. As of December 31, 1998, the bank had total assets of over
$918 million.
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 under
the Bank Holding Company Act. 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 Bank Holding Company Act 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, 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 Bank Holding Company Act, 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 Bank Holding Company Act 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 Bank Holding Company Act 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 Bank Holding Company
Act 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:
making, acquiring, or servicing loans or other extensions of
credit for its own account or for the account of others;
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;
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;
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;
subject to limitations, leasing real or personal property or acting
as agent, broker, or adviser in leasing such property in accordance
with prescribed conditions;
investing in corporations or projects designed primarily to promote
community welfare;
providing to others data processing services and data transmission
services, data bases, and facilities, within certain limitations;
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;
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;
providing courier services for certain financial documents;
subject to limitations, providing management consulting advice to
nonaffiliated bank and nonbank depository institutions;
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;
performing appraisals of real estate and personal property;
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;
providing certain securities brokerage services;
subject to limitations, underwriting and dealing in government
obligations and certain other instruments;
subject to limitations, providing foreign exchange and
transactional services;
subject to limitations, acting as a futures commission merchant
for nonaffiliated persons;
subject to limitations, providing investment advice on financial
futures and options to futures;
subject to limitations, providing consumer financial counseling;
subject to limitations, tax planning and preparation;
providing check guaranty services;
subject to limitations, operating a collection agency; and
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 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, 1998, qualify as "well capitalized" under these regulatory
standards.
FDIC Insurance
The bank is subject to Federal Deposit Insurance Corporation assessments.
The FDIC has adopted a risk-related premium assessment system for both the Bank
Insurance Fund for banks and the Savings Association Insurance Fund 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
administered by the Federal Deposit Insurance Corporation 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 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 1 year would exceed the bank's net profits,
as defined and interpreted by regulation, for the 2 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 availability of funds for lending and
investment.
Interstate Banking Legislation
In September 1994, the Riegle-Neal Interstate Banking and Branching
Efficiency Act was enacted. The Interstate Banking Act facilitates the
interstate expansion and consolidation of banking organizations:
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;
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;
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;
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
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:
eliminates the "reciprocity" requirement previously applicable to
interstate commercial bank acquisitions by bank holding companies,
authorizes interstate bank mergers and reciprocal interstate branching
into Pennsylvania by interstate banks, and
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, 1998, there were 468 persons employed by the bank, of
which 352 were full-time and 116 were part-time employees. These figures do not
include employees of Town & Country, Inc. which employed 50 persons.
Item 2 - Properties
The bank, in addition to its main office, had, at December 31, 1998, a
branch network of 30 offices and 2 off-site electronic MAC/ATM installations.
All branches are located in Lancaster County with the exception of 1 office
located in Chester County. Branches at 20 locations are occupied under leases
and at 3 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 1 or more renewal options. During 1998, aggregate annual rentals for
real estate paid did not exceed 3% 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. At December 31, 1998, approximately 24,000 square feet of this
building was leased to outside parties. 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 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 39,281 square feet while nearly 13,719
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, 1998, 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 1998.
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 26, 1999, 6,447,136 shares were outstanding.
As of February 26, 1999, the corporation had approximately
3,245 stockholders of record. There is no other
class of stock authorized or outstanding. 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. These dividends
are restated to give effect to the 5% stock dividend paid
in June, 1998. 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 1998 Consolidated Financial Statements.
The following table reflects the quarterly high and low prices of the
corporation's common stock for the periods 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 June, 1998.
Price Range Per Share Per Share
1998 High Low Dividend
First Quarter $34.76 $29.76 $.20
Second Quarter 57.00 33.81 .21
Third Quarter 49.88 35.00 .21
Fourth Quarter 44.00 39.63 .21
Price Range Per Share Per Share
1997 High Low Dividend
First Quarter $24.76 $24.29 $.18
Second Quarter 24.52 24.29 .18
Third Quarter 24.88 24.29 .23
Fourth Quarter 30.24 24.76 .19
The corporation maintains a Dividend Reinvestment and Stock Purchase Plan
for eligible shareholders who elect to participate in the plan. You may obtain
a copy of the prospectus for the plan by writing to: Bank of
Lancaster County, N.A.
Dividend Reinvestment and Stock Purchase Plan, 101 North Pointe Boulevard,
Lancaster, Pennsylvania 17601-4133.
As of December 31, 1998, the following firms made a market in the
corporation's common stock:
Hopper Soliday & Co.
F.J. Morrissey & Co., Inc.
Prudential Securities, Inc.
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 1998 1997 1996 1995 1994
Interest income............. $60,066 $ 56,499 $ 52,558 $ 48,850 $ 41,931
Interest expense............ 27,925 25,326 22,823 21,153 14,926
------ ------ ------ ------ ------
Net interest income......... 32,141 31,173 29,735 27,697 27,005
Provision for loan losses... 896 1,129 580 534 1,081
------ ------ ------ ------ ------
Net interest income after
provision for loan losses.. 31,245 30,044 29,155 27,163 25,924
Other income................ 14,187 11,930 9,442 7,397 6,222
Other expenses.............. 30,188 28,082 25,639 22,527 21,232
------ ------ ------ ------ ------
Income before income taxes.. 15,244 13,892 12,958 12,033 10,914
Applicable income taxes..... 3,643 3,491 3,147 3,039 2,637
------ ------ ------ ------ ------
NET INCOME..................$ 11,601 $ 10,401 $ 9,811 $ 8,994 $ 8,277
====== ====== ====== ====== ======
Per Common Share:*
Net income - basic..........$ 1.80 $ 1.60 $ 1.50 $ 1.38 $ 1.29
Net Income - diluted........ 1.79 1.60 1.50 1.38 1.29
Cash dividends declared**... .83 .78 .70 .85 .55
Book value.................. 12.63 11.46 10.59 10.28 9.30
Book value (excluding
SFAS 115)................. 11.90 11.01 10.34 10.01 9.23
Average shares outstanding -
basic.................... 6,456,896 6,511,742 6,545,925 6,513,333 6,433,385
Average shares outstanding -
diluted...................6,478,290 6,514,984 6,546,002 6,513,333 6,433,385
Ratios:
Return on average assets.. 1.33% 1.32% 1.34% 1.36% 1.38%
Return on average equity.. 15.63% 14.89% 15.01% 15.02% 15.47%
Financial Condition at
Year-End:
Assets.................... $ 919,264 $ 845,488 $ 764,072 $ 711,154 $ 633,395
Loans (net of unearned)... 534,209 511,637 473,832 426,312 392,649
Deposits.................. 781,383 718,661 647,036 610,105 537,002
Stockholders' Equity...... 81,313 73,987 69,179 63,909 57,285
Average Assets............ 874,640 789,314 732,226 659,335 600,263
*Figures prior to 1998 were restated for stock dividends of 5% paid in
1998 and 5% paid in 1996, 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. Both have been restated
to give effect to the 5% stock dividends paid in 1998 and 1996.
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., T & C Leasing,
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 1998 was $11,601,000, an increase of $1,200,000 or 11.5%
over the $10,401,000 earned in 1997. The results of 1997 were $590,000 or 6%
higher than the $9,811,000 reported in 1996. Basic earnings per share on
net income amounted to $1.80, $1.60 and $1.50 for the years ended
1998, 1997 and 1996.
Basic earnings per share were computed by dividing net income by the weighted
average number of shares of common stock outstanding, which were 6,456,896,
6,511,742 and 6,545,925 for 1998, 1997 and 1996. Diluted earnings per share on
net income amounted to $1.79, $1.60 and $1.50 for the years ending 1998, 1997
and 1996. The weighted number of common shares and dilutive potential
common stock
used in calculating the diluted earnings per share were 6,478,290, 6,514,984 and
6,546,002 for 1998, 1997 and 1996. Figures prior to 1998 were restated to
reflect a 5% stock dividend paid in June, 1998.
Return on average total assets was 1.33% in 1998 compared to 1.32% in 1997
and 1.34% in 1996. Return on average stockholders' equity was 15.63%, in 1998
compared to 14.89% in 1997 and 15.01% in 1996.
Growth in earning assets was the primary factor contributing to the
increased earnings in 1998 and 1997. As of December 31, 1998, earning assets
were approximately $810 million compared to $747 million at December 31, 1997,
and $673 million at December 31, 1996. Average earning assets for 1998
increased over $74 million, to approximately $773 million, up 10.6% from the
prior year. Similarly, in 1997, average earning assets
increased over $51 million, up 7.9% from 1996. The current year increase,
as well as the increase in 1997, was primarily due to increases
in both loans and investments.
Average interest bearing liabilities increased over $68 million or 10.9% in
1998, compared to an increase of nearly $48 million, or 8.3% in 1997.
The increase in average earning assets exceeded the increase in average
interest-bearing liabilities in both 1998 and 1997.
Provision for loan losses decreased to $896,000 in 1998 from $1,129,000 in
1997. The provision in 1996 was $580,000.
Non-interest income increased $2,257,000 in 1998, compared to an increase
of $2,488,000 in 1997.
Non-interest expenses increased $2,106,000 or 7.5% in 1998 compared to an
increase of $2,443,000 or 9.5% in 1997 over 1996.
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
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 1998 and 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 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
ready. On December 31, 1998, approximately 71% of the corporation's systems
were ready, with all systems expected to be ready by June 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 year to have a material
effect on its financial position or results of operations.
On February 10, 1999, the corporation entered into an agreement to acquire
Northeast Bancorp, Inc., the parent company of First National Bank of North
East, based in Maryland. Northeast Bancorp is an $82 million bank
holding company for First National Bank of North East,
with 4 branches located in Cecil County,
Maryland. Under the terms of the agreement, Northeast Bancorp shareholders will
receive 2 shares of Sterling Financial Corporation common stock for each
share of Northeast Bancorp's common stock in a tax-free exchange. The
purchase, which is subject to regulatory approval, will give Sterling
Financial its first banking presence outside of Pennsylvania.
The transaction is expected to be completed in
mid 1999 and the acquisition is expected to be accounted for as a pooling of
interests. First National Bank of North East will continue to operate as a
separate bank after the acquisition.
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 1998, 1997 and 1996.
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 1998 and 1997 resulted from increased
volumes in average earning assets. Average earning assets increased 10.6% in
1998 and 7.9% in 1997. These increases were primarily funded with interest
bearing liabilities which increased 10.9% in 1998 and 8.3% in 1997.
Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity
Interest Rates and Interest Differential-Tax Equivalent Yields
(Unaudited)
Years ended December 31,
1998 1997 1996
Average Annual Average Annual Average Annual
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest bearing deposits
with banks..............$ 170 $ 10 5.70% $ 214 $ 13 5.90% $ 103 $ 6 5.72%
Federal Funds sold......... 18,077 985 5.45% 13,110 730 5.57% 7,376 398 5.39%
Investment securities:
U.S. Treasury securities. 32,581 1,910 5.86% 28,330 1,679 5.93% 28,789 1,686 5.86%
U.S. Government agencies. 37,607 2,318 6.16% 33,508 2,100 6.27% 33,895 2,192 6.47%
State and Municipal
securities.............. 68,457 5,180 7.57% 60,324 4,702 7.79% 57,966 4,615 7.96%
Other securities......... 86,540 5,301 6.13% 66,207 4,131 6.24% 57,189 3,535 6.18%
------ ----- ----- ------- ------ ------ ------- ------ ------
Total investment securities225,185 14,709 6.53% 188,369 12,612 6.70% 177,839 12,028 6.76%
Loans:
Commercial...............292,666 25,750 8.80% 265,638 24,021 9.04% 245,018 22,276 9.09%
Consumer.................131,084 11,615 8.86% 133,125 11,927 8.96% 130,044 11,401 8.77%
Mortgages................ 51,278 4,012 7.82% 47,983 3,814 7.95% 41,046 3,330 8.11%
Leases................... 55,004 5,463 9.93% 50,811 5,221 10.28% 46,420 4,865 10.48%
------ ------ ----- ------- ------- ------- ------- ------- ------
Total loans................530,032 46,840 8.84% 497,557 44,983 9.04% 462,528 41,872 9.05%
------- ------ ----- ------- ------- ------ ------- ------- ------
Total earning assets.......773,464 62,544 8.09% 699,250 58,338 8.34% 647,846 54,304 8.38%
Allowance for loan losses.. (7,894) (7,863) (7,863)
Cash and due from banks.... 27,625 32,409 30,238
Other non-earning assets... 81,445 65,518 62,005
------- ------- -------
Total non-earning assets...101,176 90,064 84,380
------- ------- ------ ------- ------- ------ ------- ------- ------
Total assets..............$874,640 $62,544 7.15% $789,314 $ 58,338 7.39% $732,226 $54,304 7.42%
======== ======= ====== ======== ======= ====== ======= ====== =====
Liabilities and Stockholders' Equity
Deposits:
Demand deposits
Noninterest-bearing....$ 83,972 $ 0 0.00% $ 74,332 $ 0 0.00% $ 72,052 $ 0 0.00%
Demand deposits
Interest-bearing........289,062 7,289 2.52% 267,987 6,931 2.59% 257,622 6,726 2.61%
Savings deposits......... 57,615 1,131 1.96% 58,149 1,188 2.04% 58,232 1,288 2.21%
Time deposits............313,963 17,522 5.58% 262,681 14,805 5.64% 229,835 12,695 5.52%
------- ------ ----- ------- -------- ------ -------- ------- ------
Total deposits.............744,612 25,942 3.48% 663,149 22,924 3.46% 617,741 20,709 3.35%
Other borrowed funds....... 31,549 1,983 6.29% 35,316 2,402 6.80% 30,578 2,114 6.91%
Other liabilities.......... 20,684 18,894 17,122
Stockholders' equity....... 77,795 71,955 66,785
------ ------ ----- ------- ------- ------ -------- ------- ------
Total liabilities and
Stockholders' equity....$874,640 $ 27,925 3.19% $789,314 $ 25,326 3.21% $732,226 $22,823 3.12%
======== ======= ====== ======== ======== ====== ======== ======= ======
Net interest income/
Average total assets...... $ 34,619 3.96% $ 33,012 4.18% $31,481 4.30%
Net interest income/
Average earning assets.... $ 34,619 4.48% $ 33,012 4.72% $31,481 4.86%
Net interest income on a fully taxable equivalent basis increased by
$1,607,000 in 1998 compared to an increase of $1,531,000 in 1997. Table 2
indicates that of the increase in 1998, $2,507,000 was the result of increased
volumes. This figure was reduced by $900,000 due to changes in interest rates.
The increase in 1997 resulted in $1,788,000 from increased volumes and a
reduction of $257,000 due to changes in interest rates.
For the year 1998 compared to 1997, loan volumes, on average, increased
over $32 million and income earned on loans increased $1,857,000,
tax adjusted. This compares to a volume increase of over $35
million in 1997 over 1996 with an increase in income
earned on loans amounting to $3,111,000. As a result of
increased volumes in 1998, nearly $3 million contributed to the increase in
income on loans. Rates charged on loans decreased in 1998. The decrease in
rates reduced interest $1,079,000 in income earned on loans. Increased
volume in loans in 1997 contributed nearly $3.2 million to the increase
in income, while a decrease in interest rates reduced
income earned on loans by $60,000.
Total investment securities, on average, increased over $36.8 million in
1998 over 1997 compared to an increase of over $10.5 million in 1997 over 1996.
Increased volume in both periods was responsible for the increase in interest
income on securities. Table 2 indicates that, of the increase in interest
income in 1998, $2,465,000 was the result of increased volume while a
decrease in interest rates caused a $368,000 reduction.
Increased volume in securities in 1997 contributed nearly $712,000 to the
increase while a decrease in rates caused a $128,000 reduction.
Interest income on federal funds sold contributed $255,000 to the increase
in net income in 1998 over 1997. Increased volumes generated an increase of
$277,000 which was reduced by $22,000 due to a decrease in rates.
Interest bearing deposits, on average, grew over $71.8 million in 1998. The
major portion of the increase in interest expense on deposits was generated on
time deposits, as a result of increased volumes. Although there were increased
volumes on the other deposits, with the exception of savings deposits, the
decrease in rates paid on these deposits reduced the total interest expense by
$406,000. Interest expense on interest bearing deposits increased over $2.2
million in 1997 over 1996. Increased volumes generated an increase of
$2,083,000 while an increase in income of $132,000 resulted from
increased rates.
Interest expense on borrowed funds decreased $419,000 in 1998 over 1997
compared to an increase of $288,000 in 1997 over 1996. A decrease in volume as
well as a decrease in interest rates generated the decrease in 1997. The major
portion of the increase in 1997 over 1996 was a result of increased volume.
Table 2 - Analysis of Changes in Net Interest Income
The rate-volume variance analysis set forth in the table below, which is
computed on a tax equivalent basis, compares changes in net interest income for
the periods indicated by their rate and volume components.
1998 Versus 1997 1997 Versus 1996
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
Volume Rate Total Volume Rate Total
Interest Income
Interest on deposits
with banks...........$ (3) 0 $ (3) $ 6 $ 1 $ 7
Interest on federal
funds sold........... 277 (22) 255 309 23 332
Interest on investment
securities........... 2,465 (368) 2,097 712 (128) 584
Interest and fees on
loans................ 2,936 (1,079) 1,857 3,171 (60) 3,111
------- -------- ------ ------ ------- -------
Total interest income...$ 5,675 $ (1,469) $ 4,206 $ 4,198 $ (164) $ 4,034
------- -------- ------ ------ ------- -------
Interest Expense
Interest on
interest-bearing
demand deposits......$ 545 (187) 358 $ 271 $ (66) $ 205
Interest on
savings deposits...... (11) (46) (57) (2) (97) (99)
Interest on
time deposits......... 2,890 (173) 2,717 1,814 295 2,109
Interest on
borrowed funds........ (256) (163) (419) 327 (39) 288
------- -------- ------ ------- ------- -------
Total interest expense.. $ 3,168 $ (569) $ 2,599 $ 2,410 $ 93 $ 2,503
------- -------- ------ ------- ------- -------
Net interest income..... $ 2,507 $ (900) $ 1,607 $ 1,788 $ (257) $ 1,531
======= ======== ======= ======= ======= =======
Provision for Loan Losses
The provision for loan losses charged against earnings was $896,000 in 1998
compared to $1,129,000 in 1997 and $580,000 in 1996. 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 $1,008,000 in 1998, $1,199,000 in 1997 and
$560,000 in 1996. Gross charge-offs for 1998 were $1,269,000, a 15% decline
from the $1,502,000 reported in 1997. The decline in the provision for
loan losses, gross and net charge-offs was a result of
improvement in credit quality,
particularly in the consumer portfolio. Management instituted certain
underwriting criteria during 1997 and 1998 that had a positive effect on the
quality of the consumer portfolio. Personal bankruptcies continue to play a
significant role in the losses. Management expects further improvement in 1999
in the consumer portfolio. Loan quality remains high in the commercial loan
portfolio. The net losses to average loans and leases in 1998 were in line with
the bank's peers.
The allowance for loan losses as a percent of loans at December 31, 1997
was 1.51%, while at December 31, 1998 it was 1.43%.
Non-Interest Income
Table 3 - Non-Interest Income
1998/1997 1997/1996
Increase Increase
(Decrease) (Decrease)
1998 Amount % 1997 Amount % 1996
Income from fiduciary activities.$ 1,879 $ 366 24.2% $ 1,513 $ 374 32.8% $1,139
Service charges on deposit
accounts....................... 2,908 (1) ---- 2,909 424 17.1% 2,485
Other service charges, commissions
and fees....................... 1,729 273 18.8% 1,456 512 54.2% 944
Mortgage banking income........... 1,811 506 38.8% 1,305 113 9.5% 1,192
Income from sale of assets........ 1,338 1,338 ---- none none ---- none
Other operating income............ 4,522 (17) (.4%) 4,539 1,015 28.8% 3,524
Investment securities gains or
(losses)....................... none (208)(100.0%) 208 50 31.7% 158
------ ------ ------ ------ ------ ------ ------
Total............................$14,187 $2,257 18.9% $11,930 $ 2,488 26.4% $9,442
======= ======= ====== ====== ====== ====== ======
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. Reflected in
non-interest income is the sale of the bank's credit card portfolio.
Income from fiduciary activities in the amount of $1,879,000 in 1998 was
$366,000 or 24.2% greater than the $1,513,000 recorded in 1997. Income in 1997
was $374,000 or 32.8% greater than the $1,139,000 recorded in 1996. Fees
increased primarily due to increased transaction volumes.
Service charges on deposit accounts decreased to $2,908,000, a decrease of
$1,000 over the $2,909,000 reported for 1997. Service charges on deposit
accounts in 1997 was $424,000 more than the $2,485,000 reported for 1996.
General increases in service charges on various accounts, as well as,
transaction volume produced the increase in 1997 over 1996. Management
continuously monitors the fee structure and makes
changes where appropriate.
Other service charges, commissions and fees were $1,729,000 in 1998
compared to $1,456,000 in 1997 and $944,000 in 1996. The increase in 1998 over
1997 was $273,000 or 18.8%. The significant increase in 1997 is attributable to
the introduction of ATM charges. Other contributors to the increase in 1998 as
well as 1997 were the fees received on mutual funds transactions and fees on the
bank's debit card.
Income from mortgage banking activities increased to $1,811,000 in 1998
from $1,305,000 in 1997. Mortgages sold in the secondary market in 1998
increased to approximately $88.9 million from $40.9 million in 1997. All
mortgages sold were originated by the bank's mortgage operation and branch
network. No mortgages were acquired from third parties, nor have servicing
rights been purchased from third parties. A low interest rate environment in
1998 and 1997, as well as an expansion in mortgage products and services
resulted in the increase in volume in 1998 and 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
totaled $221 million as of December 31, 1998 compared to $175
million on December 31, 1997.
Another component of the mortgage banking increase in income was a result
of the implementation of FASB 122, subsequently replaced by FASB 125, which
required that mortgage servicing rights be recognized for their economic value,
beginning January 1, 1996. Mortgage servicing has an economic value because of
future servicing income to be received over the life of the mortgage. The value
of servicing rights is available through third party purchasers in private
transactions. The bank has developed a business relationship with an
independent consultant to determine the values of mortgage servicing rights.
In 1998, the amount recognized to income was $839,880. 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, 1998
and 1997 amounted to $1,382,000 and $892,000. The market value of all mortgage
servicing assets is also determined by the independent consultant. The market
valuation, or impairment, of all the mortgage assets was $41,000 as of December
31, 1998. This impairment was charged against earnings and is carried as a
valuaion allowance for mortgage servicing assets.
Other operating income decreased $17,000 to $4,522,000 in 1998 from
$4,539,000 in 1997. Other income was $3,524,000 in 1996. Income generated from
operating leases was a major contributor to the increase in 1997. 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 in 1997. Income on operating leases increased nearly
$415,000 in 1998 over 1997.
The major contributor to the increase in total other operating income
was a one-time earnings gain of $1,338,507 as a result of the sale of the
bank's credit card portfolio in the second quarter of 1998.
Investment securities transaction reflect a gain of $208,000 in 1997
compared to $158,000 in 1996 on securities sold from the available-for-sale
securities. There were no securities sold in 1998.
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 $2,257,000 in 1998 over 1997 compared to
an increase of $2,448,000 in 1997 over 1996.
Non-Interest Expense
Table 4 - Non-Interest Expense
1998/1997 1997/1996
Increase Increase
(Decrease) (Decrease)
1998 Amount % 1997 Amount % 1996
Salaries and employee benefits...$17,638 $ 1,240 7.6% $16,398 $ 1,371 9.1% $15,027
Net occupancy expense............. 2,088 (202) (8.8%) 2,290 181 8.6% 2,109
Furniture & equipment expense..... 2,755 275 11.1% 2,480 436 21.3% 2,044
FDIC insurance assessment......... 87 6 7.4% 81 79 --- 2
Other operating expense........... 7,620 787 11.5% 6,833 376 5.8% 6,457
----- ------ ----- ------ ------ ----- -------
Total............................$30,188 $ 2,106 7.5% $28,082 $2,443 9.5% $25,639
======= ======= ===== ======= ====== ===== =======
Non-interest expense consists of salaries and employee benefits, net
occupancy expense, furniture and equipment expense and other operating expenses.
Total operating expenses for 1998 were $30,188,000 compared to $28,082,000
in 1997. This represents an increase of $2,106,000 or 7.5%. This compares to
an increase of $2,443,000 or 9.5% in 1997.
The largest component of the corporation's other operating expense is
salaries and employee benefits which increased to $17,638,000 in 1998 or
$1,240,000 or 7.6% over the $16,398,000 reported in 1997. In 1997, expenses
increased $1,371,000 or 9.1% over the $15,027,000 reported in 1996. The increase
in 1997 was primarily due to increases in staff as well as increases in wages
and the increased cost of employee benefits. The increase in 1998 was
related more to increases in wages and the increased cost of employee
benefits. The full-time equivalent employees in 1998 rose to 436
from 431 in 1997. The full-time equivalent in 1996 was 400.
Occupancy expenses decreased $202,000 or 8.8% to $2,088,000 in 1998 from
$2,290,000 in 1997. By comparison, during 1997, there was an increase of
$181,000 or 8.6%. 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, PA 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 along with expenses relating to
occupancy such as real estate taxes, insurance, utilities,
maintenance and janitor services contributed to the increase in
occupancy expense in 1997. One new branch facility was opened in
1997 as well as 1998. At December 31, 1998, approximately
24,000 square feet of the building at 1097 Commercial Avenue was leased to
outside parties.
Furniture and equipment expenses were $2,755,000 in 1998 and $2,480,000 in
1997. This represents an increase of $275.000 or 11.1%. The increase in 1997
over 1996 was $436,000 or 21.3%. Reflected in this increase is a $159,000
increase in depreciation expense in 1998. Service contracts on equipment also
contributed to the increase in 1998.
The FDIC insurance assessment reflects an increase of $6,000 in 1998 over
1997. On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 to recapitalize the Savings Association
Insurance Fund
administered by the Federal Deposit Insurance Corporation 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 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 of $79,000 in the 1997 FDIC assessment over the
1996 assessment.
Other operating expenses increased $787,000 or 11.5% in 1998 compared to
an increase of $376,000 in 1997. The 1998 increase is consistent with rising
costs associated with acquiring services covered 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 1998 were increases in Pennsylvania Shares Tax, professional
services, MAC fees, telephone expense, stationery and supplies, other real
estate expenses and losses associated with a limited partnership.
Income Taxes
Income tax expense was $3,643,000 in 1998 compared to $3,491,000 in 1997
and $3,147,000 in 1996. These increases were a result of higher
levels of taxable income and increased earnings each year. The corporation's
effective tax rate was 23.9% in 1998 compared with 25.1% in 1997
and 24.3% in 1996. Use of tax credits in 1998 and an
increase in tax exempt interest resulted in a lower
effective tax rate than 1997 even though income taxes increased. Additional
information related to income taxation is presented in the Notes to Consolidated
Financial Statements.
Financial Condition
Investment Portfolio
Table 5 - Investment Securities at Cost
The following table shows the amortized cost of the held-to-maturity
securities owned by the corporation as of the dates indicated. Investment
securities are stated at cost adjusted for amortization of premiums and
accretion of discounts.
December 31,
1998 1997 1996
U.S. Treasury securities................$ 2,508 $ 6,537 $ 12,888
Obligations of other U.S. Government
agencies and corporations............. 2,208 9,696 11,607
Obligations of states and political
subdivisions.......................... 44,465 45,816 37,584
Mortgage-backed securities.............. 1,219 1,575 2,076
Other bonds, notes and debentures....... 10,808 18,574 27,269
--------- --------- ---------
Subtotal................................ 61,208 82,198 91,424
Non-marketable securities............... 3,201 2,957 2,798
--------- --------- ---------
Total...................................$ 64,409 $ 85,155 $ 94,222
========= ========= =========
The following table shows the amortized cost and fair value of the
available-for-sale securities owned as of the dates indicated.
December 31,
1998 1997 1996
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- -------- -------- ----------- --------
U.S. Treasury securities............$ 29,265 $ 29,930 $ 24,435 $ 24,625 $ 13,611 $ 13,598
Obligations of other U.S. Government
agencies and corporations.......... 37,713 38,285 26,821 27,008 18,800 18,718
Obligations of states and political
subdivisions....................... 36,938 37,986 21,840 22,571 20,488 20,819
Mortgage-backed securities........... 461 461 832 829 1,125 1,117
Other bonds, notes and debentures.... 66,215 67,312 42,955 43,178 22,752 22,771
-------- --------- -------- -------- --------- --------
Subtotal............................. 170,592 173,974 116,883 118,211 76,776 77,023
Equity securities.................... 174 3,904 174 3,263 171 2,352
-------- --------- -------- -------- --------- --------
Total................................$170,766 $ 177,878 $117,057 $121,474 $ 76,947 $ 79,375
======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields)
The following table shows the maturities of held-to-maturity debt
securities at amortized cost as of December 31, 1998 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....$ 2,005 6.03% $ 503 5.84% $ --- ---% $ --- ---% $ 2,508 5.99%
Obligations of
other U.S.
Government
agencies and
corporations.. 252 6.69% 1,956 6.08% --- ---% --- ---% 2,208 6.15%
Obligations of
states and
political sub-
divisions..... 2,499 5.41% 11,738 5.23% 22,943 5.12% 7,285 4.90% 44,465 5.13%
Mortgage-backed
securities.... 260 8.54% 646 8.52% 200 8.33% 113 7.41% 1,219 8.39%
Other bonds,
notes and
debentures.... 5,047 6.61% 5,761 5.82% --- ---% --- ---% 10,808 6.19%
------- ----- ------- ------ -------- ----- ------- ----- ------- -----
$10,063 6.25% $20,604 5.59% $ 23,143 5.15% $ 7,398 4.94% $61,208 5.45%
======= ===== ======= ====== ======== ===== ======= ===== ======= =====
The following table shows the maturities of available-for-sale debt
securities at amortized cost as of December 31, 1998 and approximate weighted
average yields of such securities. Yields are shown on a tax equivalent basis,
assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru
1 Year and less 5 Years 10 Years Over 10 Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
securities....$ 7,568 4.91% $ 21,697 5.82%$ --- ---% $ --- ---% $ 29,265 5.58%
Obligations of
other U.S.
Government
agencies and
corporations.. 3,424 6.37% 23,325 6.05% 10,964 6.17% --- ---% 37,713 6.11%
Obligations of
states and
political sub-
divisions..... 1,142 5.70% 9,127 5.30% 15,134 5.12% 11,535 4.57% 36,938 5.01%
Mortgage-backed
securities.... 189 5.65% 272 5.65% --- ---% --- ---% 461 5.65%
Other bonds,
notes and
debentures.... 11,885 6.48% 54,330 6.15% --- ---% --- ---% 66,215 6.21%
------- ------ ------- ------ ------- ----- ------- ----- -------- ------
$24,208 5.93% $108,751 5.99% $26,098 5.56% $11,535 4.57% $170,592 5.82%
======= ====== ======= ====== ======= ===== ======= ===== ======== ======
Loans
Table 7 - Loan Portfolio
The following table sets forth the composition of the corporation's loan
portfolio as of the dates indicated:
December 31,
1998 1997 1996 1995 1994
Commercial, financial and
agricultural..............$ 290,619 $ 271,605 $ 239,701 $ 228,058 $ 208,918
Real estate-construction... 6,053 6,045 5,608 6,378 8,542
Real estate-mortgage....... 48,381 49,438 45,373 33,124 30,505
Consumer................... 131,939 132,778 136,989 116,210 106,921
Lease financing (net of
unearned income)......... 57,327 52,207 47,346 43,904 38,771
---------- ---------- ---------- ---------- ---------
Total loans.................$ 534,319 $ 512,073 $ 475,017 $ 427,674 $ 393,657
========== ========== ========== ========== =========
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, 1998:
After one
Within but within After
one year five years five years Total
Commercial, financial and
agricultural....................$ 104,041 $ 146,505 $ 40,073 $ 290,619
Real estate-construction........ 5,111 289 653 6,053
--------- --------- -------- ---------
$ 109,152 $ 146,794 $ 40,726 $ 296,672
========= ========= ======== =========
Loans due after one year totaling $107,980,000 have variable interest
rates. The remaining $79,540,000 in loans have fixed rates.
Table 9 - Nonaccrual, Past Due and Restructured Loans
The following table presents information concerning the aggregate amount of
nonaccrual, past due and restructured loans:
December 31,
1998 1997 1996 1995 1994
Nonaccrual loans...........$ 812 $ 1,314 $ 1,193 $ 1,010 $ 2,127
Accruing loans, past due
90 days or more......... 613 787 737 330 1,127
Restructured loans........ 1,993 2,105 none none none
------- -------- -------- -------- --------
Total non-performing loans. 3,418 4,206 1,930 1,340 3,254
Other real estate owned.... 180 341 81 252 759
------- -------- -------- -------- --------
Total non-performing assets $ 3,598 $ 4,547 $ 2,011 $ 1,592 $ 4,013
======= ======== ======= ======== ========
Ratios:
Non-performing loans to
total loans.......... .64% .82% .41% .31% .83%
Non-performing assets to
total loans and other
real estate owned.... .67% .89% .42% .37% 1.02%
Non-performing assets to
total assets.......... .39% .54% .26% .22% .63%
Allowance for loan losses to
non-performing loans.. 222.9% 183.8% 404.1% 580.6% 234.8%
The economic conditions within the corporation's market area remained
healthy in 1998. This is reflected in the unemployment rate for Lancaster
County, which is the bank's primary market area. The jobless rate during 1998
hovered close to 3%, staying the lowest or second lowest in the state. The
county's unemployment rate has not exceeded 3% since November of 1997.
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 average national and state
average unemployment figures of 4.4% and 4.6% respectively. The
unemployment rate for 1999 is expected to mirror that of 1998
with little movement in either direction. Lancaster's labor market is expected
to remain one of the tightest in the state.
The strength in the employment sector in Lancaster County was also seen at
the national level. The U.S. unemployment rate stood at 4.5% in December 1998
compared to 4.7% in December 1997. Economists aren't looking for much change
this year in the health of labor markets. Indications are that the job market
remains robust.
The bank's loan delinquency as a percent of loans outstanding declined
during 1998. At December 31, 1998, this rate stood at .44% compared to .83% and
.96% for December 31, 1997 and December 31, 1996. The average delinquency rate
for 1998 of .56% declined from .99% in 1997. The decline in the average
delinquency rate was primarily attributed to improvement in the consumer
portfolio. The bank, however, is not immune to the significant role that
bankruptcies have on losses. During 1998, the bank's credit card portfolio was
sold, which, is believed, will have a positive effect on delinquencies and
losses. While management believes delinquency rates could rise during 1999,
expectations are that they will not approach the national delinquency rates.
The .44% remains well below the accepted level established by management
and that of its peers. During the year, total nonaccrual
loans and other real estate owned declined to $992,000 from $1,655,000
at December 31, 1997. Total non-performing
assets declined to $3,598,000 compared to $4,547,000 for December 31, 1997
representing a 21% decrease. The restructured loans are a series of loans to
one borrower involving $1,993,000. 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 such 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 continues.
The bank's reserve coverage increased during the year as reserves as a
percent of non-performing loans increased to 223% compared to 184% for December
31, 1997.
A portion of the bank's loan portfolio consists of loans to
agricultural-related borrowers. These loans consist of loans 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 latter part of 1998, milk prices
increased significantly. While the bank continues to pursue quality loans to
the dairy industry and the agricultural community in general, it
should be noted that these loans are susceptible to a variety of
external factors such as adverse climate, economic conditions, etc.,
in addition to factors common to other industries.
The residential real estate market in 1998 for Lancaster County enjoyed a
strong year. The county recorded a record year for sales of existing homes.
Residential construction contracts, however, increased at a much slower pace,
suggesting that the building boom in recent years may be over. Reasonably low
interest rates, a continuing strong economy, and minimal inflation accounted for
the sales performance. Non-residential contracts broke even with 1997,
which had experienced a significant increase over 1996.
Most of the bank's business activity is with customers located within the
bank's defined market area. Since the majority of the bank's real estate loans
are located within this area, a substantial portion of the debtor's ability to
honor their obligations and increases and decreases in the market value of the
real estate collateralizing such loans may be affected by the level of economic
activity in the market area.
The bank recognizes that the potential Year 2000 problems, relating to
computers, hardware, microchips, software and additional software applications
utilized by the bank's borrowers in their businesses, or by their suppliers,
vendors and their customers, may result in unexpected and material adverse
changes in borrowers' businesses or financial condition. In order to reduce the
potential risk to the bank from its borrowers, the bank has substantially
completed an assessment of the Year 2000 risk posed by its borrowers. Based on
this assessment, management does not believe that the Year 2000 risks from its
borrowers pose a material risk or threat to the safety and soundness of the
bank. Management believes that the provision for loan losses is adequate
to meet the present and forseeable risk characteristics
of the loan portfolio including the potential Year 2000
risks posed by its borrowers.
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. Loans on a nonaccrual status amounted to $812,000 at
December 31, 1998 compared to $1,314,000 at December 31, 1997. If interest
income had been recorded on all such loans for the years indicated, such
interest income would been been increased by approximately $85,667 and
$152,755 for 1998 and 1997. Interest income recorded on
nonaccrual loans amounted to $561 and $20,020 for 1998 and 1997.
Potential problem loans are loans which are included
as performing loans, but for which possible credit problems of the borrower
causes management to have doubts as to the ability of such borrower to comply
with present repayment terms and which may eventually result in disclosure as a
non-performing loan. At December 31, 1998, there were no such loans that had to
be disclosed 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 impairement 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:
1998 1997
Gross impaired loans which have allowances..........$2,805 $3,419
Less: Related allowances for loan losses......... (140) (410)
------ ------
Net impaired loans..................................$2,665 $3,009
====== ======
The decline in impaired loans is primarily attributed to a reduction in
non-accrual loans. A large portion of the impaired loans is attributed to the
restructure of a series of loans to one borrower. A loan is categorized as
restructured if the original interest rate on such loan, repayment terms, or
both are restructured due to a deterioration in the financial
condition of the borrower that otherwise would not have been
granted. In the case of the above referenced loans,
the bank is fully secured with real estate. The loans are
current and have performed in accordance with the contractural term, both prior
to and after the restructure. Accrual of interest on these loans continues.
At December 31, 1998, there were no concentrations exceeding 10% of loans.
A concentration is defined as amounts loaned to a multiple number of borrowers
engaged in similar activities which would cause them to be similarly affected by
changes in economic or other conditions. There were no foreign loans
outstanding at December 31, 1998.
Allowance for Loan Losses
Table 10 - Summary of Loan Loss Experience
Years ended December 31,
1998 1997 1996 1995 1994
Allowance for Loan Losses:
Beginning balance.............$ 7,730 $ 7,800 $ 7,780 $ 7,640 $ 7,180
Loans charged off during year:
Commercial, financial and
agricultural.............. 447 43 37 50 157
Real estate mortgage........ 268 419 184 252 235
Consumer.................... 500 919 458 360 360
Lease financing............. 54 121 24 14 10
------- ------- ------- ------- -------
Total charge-offs........... 1,269 1,502 703 676 762
------- ------- ------- ------- -------
Recoveries:
Commercial, financial and
agricultural.............. 34 4 5 117 61
Real estate mortgage........ 72 112 42 72 2
Consumer.................... 127 122 88 91 77
Lease financing............. 28 65 8 2 1
------- ------- ------- ------- -------
Total recoveries............ 261 303 143 282 141
------- ------- ------- ------- -------
Net loans charged off......... 1,008 1,199 560 394 621
Additions charged to
operations.................. 896 1,129 580 534 1,081
------- ------- ------- ------- -------
Balance at end of year........$ 7,618 $ 7,730 $ 7,800 $ 7,780 $ 7,640
======= ======= ======= ======= =======
Ratio of net loans charged
off to average loans
outstanding................. .19% .24% .12% .10% .17%
Ratio of net loans charged
off to loans at end of year. .19% .23% .12% .09% .16%
Net loans charged off to
allowance for loan losses.. 13.23% 15.51% 7.18% 5.06% 8.13%
Net loans charged off to
provision for loan losses.. 112.50% 106.20% 96.55% 73.78% 57.45%
Allowance for loan losses as a
percent of average loans... 1.44% 1.55% 1.69% 1.91% 2.04%
Allowance for loan losses
as a percent of loans at
end of year................ 1.43% 1.51% 1.65% 1.82% 1.95%
Allowance for loan losses
as a percent of
non-performing loans....... 222.9% 183.8% 404.1% 580.6% 234.8%
The corporation experienced a 15% decline in gross charge-offs, while net
charge-offs declined 16%. The decline in charge offs was a result of
improvement in the consumer loan portfolios. During 1998, the bank sold
its credit card portfolio, which had a positive
effect on losses. Personal bankruptcies continue
to play a significant role in the losses. Management instituted certain
underwriting criteria in 1997 and 1998 which is believed to also have had a
positive effect on losses. For the year, the corporation recorded net
charge-offs of $1,008,000 or .19% of average loans outstanding compared to
$1,199,000 or .24% of average loans in 1997 and $560,000 or .12% of
average loans in 1996.
The provision for loan losses charged to operating expense reflects the
amount deemed appropriate by management to produce an adequate reserve to meet
the present risk and inherent risk in the loan portfolio, including the
potential Year 2000 risks posed by its borrowers. Management
performs a quarterly assessment of the loan portfolio to
determine the appropriate level of the
allowance. The factors considered in this evaluation include, but are not
limited to, estimated loan losses identified through a loan review process,
general economic conditions, deterioration in pledged collateral, past loan
experiences and trends in delinquencies and non-accruals. Managment uses
available information to determine the appropriate level of the allowance for
possible loan losses. However, the allowance may be affected in the future
based upon changes in the economic conditions and other factors.
While there can be no assurance that material amounts of additional
loan loss provisions will not be required in the future,
management believes that, based upon information
presently available, the amount of the allowance for possible loan losses is
adequate.
Management has not targeted any specific coverage ratio of nonperforming
loans by the allowance for loan losses and the coverage ratio may fluctuate
based on loans placed into or removed from nonperforming status.
Table 11 - Allocation of Allowance for Loan Losses
December 31,
1998 1997
Commercial, financial and agricultural..........$ 4,705 $ 3,529
Real estate - mortgage.......................... 107 25
Consumer........................................ 660 910
Leases.......................................... 527 599
Unallocated..................................... 1,619 2,667
------- -------
Total...........................................$ 7,618 $ 7,730
======= =======
Deposits
Table 12 - Average Deposit Balances and Rates Paid
The average amounts of deposits and rates paid for the years indicated are
summarized below:
1998 1997 1996
Amount Rate Amount Rate Amount Rate
Demand deposits.....................$ 83,972 --- $ 74,332 --- $ 72,052 ---
Interest bearing demand deposits.... 289,062 2.52% 267,987 2.59% 257,622 2.61%
Savings deposits.................... 57,615 1.96% 58,149 2.04% 58,232 2.21%
Time deposits....................... 313,963 5.58% 262,681 5.64% 229,835 5.52%
-------- ----- -------- ----- -------- -----
$744,612 3.48% $663,149 3.46% $617,741 3.35%
======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity
The maturities of time deposits of $100,000 or more are summarized below:
December 31,
1998 1997
Three months or less..........................$ 7,352 $ 11,058
Over three thru six months.................... 7,262 6,541
Over six thru twelve months................... 9,676 9,209
Over twelve months............................ 8,469 10,357
------- -------
Total.........................................$ 32,759 $ 37,165
======= =======
Capital
Total stockholders' equity increased over $7.3 million or 9.9% in 1998 to
$81,313,000. Total stockholders' equity at December 31, 1997 in the amount of
$73,987,000 represented an increase of over $4.8 million or 7% over the
$69,179,000 reported at December 31, 1996. A major portion of the increase for
1998 was the difference between net income of $11.6 million less dividends
declared of approximately $5.4 million. Adding to the increase in stockholders'
equity was an increase in net unrealized gains on available-for-sale securities,
accumulated other comprehensive income, in the amount of $1.8 million. Treasury
stock purchased during the period was $2.5 million. The corporation issued $1.8
million in treasury shares. The major portion of the increase in 1997 was due
to net income of $10.4 million less dividends declared of approximately $5.1
million. Adding to the increase in 1997 was an increase in accumulated other
comprehensive income in the amount of $1.3 million. These increases were offset
by the repurchase of outstanding stock throughout the year. 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.
During 1998, the Board of Directors
authorized the repurchase of up to 250,000 shares of the outstanding common
stock. During 1998, the Corporation repurchased 70,266 shares for $2.5
million. The Corporation used, during 1998, 79,332 shares for a
portion of the common stock issued for a 5% stock dividend, 36,448 shares
for the Dividend Reinvestment
Plan, 7,414 shares for the Employee Stock Plan, 2,000 shares for the Directors'
Compensation Plan and 1,400 shares for stock options exercised. Effective
December 1998, the Board of Directors of the corporation terminated the common
stock repurchase program that was approved in 1998.
Federal regulatory authorities promulgate risk-based capital guidelines
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 holding gains and losses 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, 1998, 1997
and 1996 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, 1998 was 9.73% and the total
risk-based capital ratio was 10.94%, which exceeds the minimum capital
guidelines. Tier 1 capital ratio was 10.23% and the total risk-based capital
ratio was 11.38% at December 31, 1997 while Tier 1 capital ratio was 10.68% and
the total risk-based capital ratio was 11.93% at December 31, 1996. At December
31, 1998, 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:
1998 1997 1996
Return on average assets...................... 1.33% 1.32% 1.34%
Return on average equity...................... 15.63% 14.89% 15.01%
Dividend payout ratio......................... 46.17% 48.79% 45.95%
Average total equity to average assets........ 8.54% 8.89% 8.95%
Total equity to assets at year end............ 8.40% 8.45% 8.87%
Primary capital ratio......................... 9.16% 9.28% 9.80%
Tier 1 risk-based capital ratio............... 9.73% 10.23% 10.68%
Total risk-based capital ratio................ 10.94% 11.38% 11.93%
Liquidity and Interest Rate Sensitivity
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 amounted to $34,221,000 at December 31, 1998 compared to
$34,585,000 at December 31, 1997. Interest bearing deposits with banks were
$557,000 at December 31, 1998 compared to $15,000 at December 31, 1997. Federal
funds sold totaled $26,850,000 at December 31, 1998 compared to $28,150,000 at
December 31, 1997. Securities available-for-sale as of December 31, 1998 were
$177,878,000 compared to $121,474,000 as of December 31, 1997.
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 $88.9 million in 1998 and
$40.9 million in 1997, 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 of $87
million during the next 12 months.
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, 1998 was $17,300,000 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 changes in levels of
deposits and in the demand for loans. Management believes that these mentioned
sources of funds provide sufficient liquidity.
YEAR 2000
The following section contains forward-looking statements which involve
risks and uncertainties. The actual impact on the corporation of the Year 2000
issue could materially differ from that which is anticipated in the
forward-looking statements as a result of certain factors identified below.
The Year 2000 issue ("Y2K") is the result of computer programs being
written using two digits rather than four to define the applicable year.
It is anticipated that most systems may recognize a date using "00"
as the year "1900" rather than "2000". This could result in system
failures, miscalculations, and
disruptions of normal business operations including, among other things, a
temporary inability to process transactions, send statements, or engage in
similar day to day business activities. At Sterling Financial Corporation, we
recognize the Year 2000 problem is more than just a systems issue. It is a
business issue, and we are dealing with it in that manner.
Corporation's State of Readiness
Sterling Financial Corporation is committed to ensuring that the
corporation's daily operations suffer little or no impact from the century date
change. The corporation has applied due diligence throughout the Y2K process,
following the guidelines contained in the series of Federal Financial
Institutions Examination Council's Interagency Guidelines. These guidelines
include the following five phases:
awareness,
assessment,
renovation or remediation,
testing or validation and
implementation.
Management has initiated an enterprise-wide program to prepare the
corporation's computer systems and applications for the Year 2000. The
corporation has developed a comprehensive inventory of all mainframe and PC
based applications, third-party relationships, environmental (bank
vaults, VCRs, security systems, etc.) and proprietary programs.
This assessment identified 224
systems or processes and 448 proprietary programs, which could be
impacted by the century date change.
The 448 proprietary programs consist of management reporting, interface
programs, and bridge programs. As of December 31, 1998, the corporation has
remediated 324 or 72% of these programs.
In January of 1997, the corporation began converting its computer systems
to be Year 2000 ready. As of December 31, 1998, approximately
71% of the corporation's systems were ready, with all systems
expected to be ready by June 1999.
Vendor Type Total# # Y2K Ready % Y2K Ready
PC Based Applications 125 81 65%
Mainframe Applications 49 36 73%
Third-Party Relationships 25 12 48%
Environmental 25 24 96%
Proprietary Programs 448 324 72%
Total 672 477 71%
The corporation has acquired its core mission-critical systems from a
highly regarded third-party vendor. Thus, even though the corporation
does not have direct control over the renovation process, it is
monitoring the progress of its third-party vendors to assess the status
of their Y2K readiness efforts. However, because most computer
systems are, by their very nature, independent, it
is possible that noncompliant third-party computers could impact the
corporation's computer systems. The corporation could be adversely affected by
the Y2K problem if it or unrelated parties fail to successfully address the
problem. Steps have been taken to communicate with the unrelated parties with
whom it deals to coordinate Year 2000 readiness. Additionally, we are dependent
on external suppliers, such as, wire transfer systems, telephone systems,
electric companies, and other utility companies for continuation of service. The
corporation is also assessing the impact, if any, the century date change may
have on its credit risk. The corporation is contacting its large commercial
loan customers concerning their level of readiness for Year 2000.
Formal communications have been initiated with all of its
vendors and large commercial customers to determine the extent to which the
corporation is vulnerable to those third-parties' failure to remedy
their own Year 2000 issues. The Y2K Project
Manager has available each vendors' Y2K readiness efforts which includes their
remediation plan, renovation approach, testing methodologies and target dates.
A comprehensive testing plan has been developed. The corporation has
prioritized all mainframe and PC based applications, third-party relationships,
environmental and proprietary programs to be tested. Separate environments for
testing have been defined and established. Beginning in the fourth quarter of
1998, the corporation performed a variety of testing to include limited unit
testing (aging dates forward on files), system testing (advancing the computer
system date forward) and combined system integration (running applications
dependent on each other together with the data files aged and computer system
date advanced forward) and acceptance testing (user review and validation). Test
scripts have been written which define the type of testing to be performed, the
resources necessary to perform the test, the transactions or files to be
processed, and expected results for each type of testing performed.
Additionally, a testing validation, certification and reporting process has been
established.
Costs of Year 2000
As of December 31, 1998, $245,532 has been expended as Year 2000 costs.
Management expects to spend a total of $329,927 for the entire project. The
estimated Year 2000 project costs include the costs and time associated with the
impact of third-parties' Year 2000 issues, and are based on presently available
information. The total cost of the project is being funded through operating
cash flows. 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. Accordingly, the corporation
does not expect the amounts required to be expensed over the next 12 months to
have a material effect on the financial position or results of operations.
However, if readiness is not achieved in a timely manner by the corporation or
any of its significant related third-parties, be it a supplier of services or
customer, the Y2K issue could possibly have a material effect on the
corporation's operations and financial position.
The cost of the projects and the date on which the corporation plans to
complete both Year 2000 modifications and systems conversions are based on
management's best estimates, which were derived utilizing numerous assumptions
of
future events including the continued availability of certain resources,
third-party modification plans and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could
differ materially from those plans. Specific factors that might cause such
material differences include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and
correct all relevant computer codes, and similar uncertainties.
Risks of Year 2000
At present, management believes its progress in remediating the proprietary
programs and installing Y2K upgrades to the third-party vendor mainframe and PC
based computer applications is on target. The Year 2000 computer problem
creates risk for the corporation from unforseen problems in its own
computer systems and from third-party vendors who provide the majority of
the corporation's mainframe and PC based computer applications.
Failures of third-party systems relative to
the Y2K issue could have a material impact on the corporation's ability to
conduct business.
Continency Plans
A contingency plan has been developed for mission-critical and required
mainframe and PC based applications, third-party relationships, environmental
and proprietary programs. The corporation's contingency plans involve the
use of manual labor and replacement or update of computer systems to
compensate for the loss or inconveniences caused by the disruption of
certain automated computer systems. The contingency plans define scheduled
completion dates, test dates and trigger dates. The trigger date being the
date the corporation would implement the continency plan.
A detailed business resumption contingency plan is currently under
development with a target completion date of March 31, 1999. This detailed
business resumption contingency plan will calculate a risk factor for each core
business line and/or product. Based on the calculated risk factor, a specific
business resumption contingency plan will be written and tested.
New Financial Accounting Standards
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 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 was effective for
such transfers of financial assets after December 31, 1997. Adoption of SFAS
No. 127 did not 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 was not permitted. The Statement requires restatement of all
prior period earnings per share data when adopted. Adoption of SFAS No. 128 did
not have a 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. There was no
material financial statement impact as a result of adopting SFAS No. 129.
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 was effective for fiscal years
beginning after December 15, 1997. Sterling adopted SFAS
No. 130, effective March 31, 1998. The adoption of this Statement
requires the corporation to provide additonal
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. The adoption of this Statement
requires the corporation to set forth additional disclosures in the
corporation's financial statements.
In February 1998, the FASB issued SFAS 132 - "Employers' Disclosures about
Pensions and Other Postretirement Benefits - an ammendment of FASB Statements
87, 88 and 106." This Statement revises employers' disclosures about
pension and other postretirement benefit plans. It does not change the
measurement or recognition of those plans. It standardizes
the disclosure requirements for pensions and other postretirement
benefits to the extent practicable, requires
additional information on changes in the benefit obligation and fair values of
plan assets that will facilitate analysis and eliminates certain disclosures
that are no longer useful as they were when FASB Statements
No. 87, No. 88 and No. 106 were issued. The Statement suggests combined
formats for presentation of pension and other postretirement benefit
disclosures. This Statement is effective for fiscal years beginning after
December 15, 1997. Restatement of disclosures for
earlier periods provided for comparative purposes is required unless the
information is not readily available, in which case the notes to the financial
statements should include all available information and a description of the
information not available. The adoption of this Statement required the
corporation to set forth additional disclosures in the corporation's financial
statements.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
Statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in
the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a
derivative may be specifically designated as:
a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm
commitment,
a hedge of the exposure to variable cash flows of a forecasted
transaction, or
a hedge of the foreign currency exposure of a net investment
in a foreign operation and unrecognized firm commitment,
an available-for-sale security, or a foreign-currency-denominated
forecaster transaction.
This Statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Sterling has not completed the analysis required to
estimate the impact of this Statement.
In October 1998, the FASB issued Statement of Financial Accounting
Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise". This statement shall be effective for the first fiscal
quarter beginning after December 15, 1998. Sterling has not yet completed
the analysis of the effects of this Statement.
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, which are 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. The bank also utilizes 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 1 year, as
this time frame directly impacts net interest income and is most difficult to
make reactive adjustment to current market rate movements.
The bank has various investments structured to change investment yield with
current market conditions. Assets subject to repricing include:
federal funds sold which reprice daily,
loans floating to "treasury bill" indexes which reprice 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 to the point of affecting balances. 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 repricing projections as expected over future
time periods based on past history. As illustrated in Table 15,
management's view of interest rate sensitivity
reflects a calculated interpretation of net interest margin exposure to rate
changes. Rate correlations are constantly refined by management. There is no
guarantee that past history will accurately reflect future changes.
Table 15 - Interest Rate Sensitivity Gaps
0-90 91-365 Over 1 Year Over 3 Years Over
Days Days to 3 Years to 5 Years 5 Years
Assets
Fed funds sold...........$ 26,850 $ 0 $ 0 $ 0 $ 0
Interest bearing balances. 57 0 500 0 0
Investment securities..... 19,218 29,410 77,202 56,676 59,781
Loans and leases.......... 103,132 76,534 151,317 115,693 93,538
Allowance for loan losses. 0 0 0 0 (7,618)
Non earning assets........ 0 0 0 0 116,974
-------- -------- -------- -------- --------
Total.....................$ 149,257 $ 105,944 $ 229,019 $ 172,369 $ 262,675
Cumulative................$ 149,257 255,201 484,220 656,589 919,264
Liabilities and Capital
Interest Deposits - NOW,
SuperNOW, Savings and
Money Market.............$ 24,036 $ 72,693 $ 39,564 $ 46,586 $ 190,112
Certificates of Deposit... 54,765 178,535 76,266 8,113 0
Borrowings-US Treasury.... 1,558 0 0 0 0
Other libilities for
borrowed money........... 2,010 6,031 17,700 8,053 309
Noninterest bearing
deposits................. 0 0 0 0 90,713
Noninterest bearing
liabilities.............. 0 0 0 0 20,907
Stockholders' Equity...... 0 0 0 0 81,313
-------- -------- -------- ------- --------
Total.....................$ 82,369 $ 257,259 $ 133,530 $ 62,752 $ 383,354
Cumulative................$ 82,369 $ 339,628 $ 473,158 $535,910 $ 919,264
Period GAP (Dollars)......$ 66,888 $(151,315) $ 95,489 $109,617 $(120,679)
as % of total assets...... 7% (16)% 10% 12% (13)%
Cumulative GAP (Dollars)..$ 66,888 $ (84,427) $ 11,062 $120,679 $ 0
Cumulative
as % of total assets...... 7% (9)% 1% 13% 0%
During 1998, the net interest income tax-equivalent yield margin on
average earning assets dropped to 4.48% from 4.72% in 1997. Prime rate in
1998 started at 8.50%, decreased by .25% on 3 occasions during October and
November, ending the year at 7.75%. The average tax-equivalent yield
on earning assets decreased in 1998 to 8.09%, down from
8.34% in 1997. Average earning assets increased by $74,200,000 in 1998.
Average deposit funding increased $81,400,000 in 1998. Total deposit funding
cost increased to 3.48% from 3.46% in 1997.
Compression of the net interest margin was the result of several factors:
earning assets grew by 10.6% during 1998,
loan growth could not be acheived at the same level and grew at 6.5%
in 1998 and
as a result, there was a 20% growth in investment securities.
This change in earning asset mix from loans to investment securities,
compounded by lower rates resulted in a decrease in the yield on earning
assets. Funding by deposits increased 12.2% in 1998. Time deposits increased
19.5% and other deposits increased 7.5%. The change in mix in deposits
resulted in higher total cost which offset lower rates paid on deposits.
Future change in net income as a result of interest rate movement is
presented in the graph in Table 15a. This analysis, completed by Sheshunoff
Information Services, 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 decrease with increasing market rates, and future
income will increase with decreasing market rates
during the next fiscal year. Negative income exposure, resulting from
increasing market rates, as an impact to the interest margin
is (1.4)%, (3.1)% and (4.9)% with market rate
increases of 100, 200 and 300 basis points. The risk position of the
bank is within the guidelines set by the bank's asset/liability policies.
Present value of equity as a result of interest rate change is presented
in the graph in Table 15b. This analysis, completed by Sheshunoff,
depicts the projected change in the value of equity as a
result of interest rate movements. Future value of equity would
decrease with increasing market rates, and increase with decreasing market
rates. The risk position of the bank is within the guidlines set
by the bank's asset/liability policies.
Table 15a Table 15b
1999 Net Income Projections Present Value Equity
Changes in Changes in
Basis Points % Change Basis Points % Change
-300 17.10% -300 12.44%
-200 15.81% -200 10.07%
-100 9.07% -100 5.45%
-50 4.46% -50 2.74%
0 0.00% 0 0.00%
50 -0.64% 50 -1.17%
100 -1.42% 100 -2.38%
200 -3.14% 200 -4.70%
300 -4.94% 300 -6.85%
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 26
Consolidated Balance Sheets 27
Consolidated Statements of Income 28
Consolidated Statements of Changes in Stockholders' Equity 29
Consolidated Statements of Cash Flows 30
Notes to Consolidated Financial Statements 31
(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) 49
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, 1998 and 1997,
and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in
the period ended December 31, 1998. 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, 1998
and 1997 and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
Trout, Ebersole & Groff, LLP
Trout, Ebersole & Groff, LLP
Certified Public Accountants
Lancaster, Pennsylvania
January 21, 1999 except for Note 22
as to which the date is February 10, 1999
Consolidated Balance Sheets
Sterling Financial Corporation and Subsidiaries
As of December 31,
(Dollars in thousands) 1998 1997
Assets
Cash and due from banks...........................................$ 34,089 $ 34,292
Interest bearing deposits in other banks.......................... 557 15
Federal funds sold................................................ 26,850 28,150
Mortgage loans held for sale...................................... 6,005 792
Investment Securities:
Securities held-to-maturity
(market value - $66,290 - 1998 and $86,465 - 1997)............. 64,409 85,155
Securities available-for-sale.................................... 177,878 121,474
Loans............................................................. 534,319 512,073
Less: Unearned income........................................... (110) (436)
Allowance for loan losses................................. (7,618) (7,730)
-------- -------
Loans, net........................................................ 526,591 503,907
-------- -------
Premises and equipment............................................ 22,195 21,938
Other real estate owned........................................... 180 341
Accrued interest receivable and prepaid expenses.................. 12,829 12,243
Other assets...................................................... 47,681 37,181
-------- -------
Total Assets..................................................... $919,264 $845,488
======== ========
Liabilities
Deposits:
Noninterest bearing.............................................$ 90,713 $ 82,565
Interest bearing................................................ 690,670 636,096
-------- --------
Total Deposits.................................................... 781,383 718,661
-------- --------
Interest bearing demand notes issued to U.S. Treasury ............ 1,558 3,000
Other liabilities for borrowed money.............................. 34,103 32,312
Accrued interest payable and accrued expenses..................... 11,233 10,165
Other liabilities................................................. 9,674 7,363
-------- --------
Total Liabilities................................................. 837,951 771,501
Stockholders' Equity -------- --------
Common Stock -(par value:$5.00)
No. shares authorized: 1998 and 1997 - 35,000,000
No. shares issued: 1998 - 6,471,057; 1997 - 6,237,009
No. shares outstanding: 1998 - 6,440,171; 1997 - 6,149,795...... 32,355 31,185
Capital surplus................................................... 24,783 16,321
Retained earnings................................................. 20,666 25,828
Accumulated other comprehensive income............................ 4,694 2,916
Less: Treasury Stock (30,886 shares in 1998 and
87,214 shares in 1997) - at cost........................... (1,185) (2,263)
-------- --------
Total Stockholders' Equity........................................ 81,313 73,987
-------- --------
Total Liabilities and Stockholders' Equity........................$919,264 $845,488
======== ========
See accompanying notes to financial statements
Consolidated Statements of Income
Sterling Financial Corporation and Subsidiaries
For the years ended December 31,
(Dollars in thousands, except per share data) 1998 1997 1996
Interest Income
Interest and fees on loans...........................$ 46,124 $ 44,744 $ 41,611
Interest on deposits in other banks.................. 10 13 6
Interest on federal funds sold....................... 985 730 398
Interest and dividends on investment securities:
Taxable............................................ 9,278 7,681 7,442
Tax-exempt......................................... 3,418 3,103 2,882
Dividends on stock................................. 251 228 219
--------- --------- ---------
Total Interest Income................................ 60,066 56,499 52,558
--------- --------- ---------
Interest Expense
Interest on time certificates of deposit of
$100,000 or more................................... 1,999 1,710 934
Interest on all other deposits....................... 23,943 21,214 19,775
Interest on demand notes issued to the U.S. Treasury. 142 113 95
Interest on federal funds purchased.................. none 1 89
Interest on other borrowed money..................... 1,841 2,288 1,930
--------- --------- ---------
Total Interest Expense............................... 27,925 25,326 22,823
--------- --------- ---------
Net Interest Income.................................. 32,141 31,173 29,735
Provision for loan losses............................ 896 1,129 580
--------- --------- ---------
Net Interest Income after Provision for Loan Losses.. 31,245 30,044 29,155
--------- --------- ---------
Other Operating Income
Income from fiduciary activities..................... 1,879 1,513 1,139
Service charges on deposit accounts.................. 2,908 2,909 2,485
Other service charges, commissions and fees.......... 1,729 1,456 944
Mortgage banking income.............................. 1,811 1,305 1,192
Income from sale of assets........................... 1,338 none none
Other operating income............................... 4,522 4,539 3,524
Investment securities gains or (losses).............. none 208 158
--------- --------- ---------
Total Other Operating Income......................... 14,187 11,930 9,442
--------- --------- ---------
Other Operating Expenses
Salaries and employee benefits....................... 17,638 16,398 15,027
Net occupancy expense................................ 2,088 2,290 2,109
Furniture and equipment expense (including depreciation
of $1,659 in 1998, $1,500 in 1997 and $1,256 in 1996) 2,755 2,480 2,044
FDIC insurance assessment............................ 87 81 2
Other operating expenses............................. 7,620 6,833 6,457
--------- --------- ---------
Total Other Operating Expenses....................... 30,188 28,082 25,639
--------- --------- ---------
Income Before Income Taxes........................... 15,244 13,892 12,958
Applicable income taxes.............................. 3,643 3,491 3,147
--------- --------- ---------
Net Income...........................................$ 11,601 $ 10,401 $ 9,811
========= ========= =========
Earnings per common share:
Net Income - Basic earnings per share...............$ 1.80 $ 1.60 $ 1.50
Net Income - Diluted earnings per share.............$ 1.79 $ 1.60 $ 1.50
Cash dividends declared per common share.............$ .83 $ .78 $ .70
See accompanying notes to financial statements
Consolidated Statements of Changes in Stockholders' Equity
Sterling Financial Corporation and Subsidiaries
Accumulated
Shares Other
Common Common Capital Retained Comprehensive Treasury
Stock Stock Surplus Earnings Income Stock Total
(Dollars in thousands)
Balance, January 1, 1996..............5,932,686 $29,663 $ 9,987 $ 22,848 $ 1,624 $ (213) $ 63,909
Comprehensive Income:
Net income........................... 9,811 9,811
Change in net unrealized gain (loss)
on securities available-for-sale, net
of reclassification adjustment and
tax effects......................... (21) (21)
Total comprehensive income......... 9,790
Common stock issued
Dividend Reinvestment Plan........... 2,517 13 58 71
Employee Stock Plan.................. 5,690 28 140 168
Stock dividends 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
Balance, December 31, 1996............6,237,009 31,185 16,325 20,502 1,603 (436) 69,179
Comprehensive Income:
Net income........................... 10,401 10,401
Change in net unrealized gain (loss)
on securities available-for-sale, net
of reclassification adjustment and
tax effects......................... 1,313 1,313
Total comprehensive income......... 11,714
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
Balance, December 31, 1997............6,237,009 31,185 16,321 25,828 2,916 (2,263) 73,987
Comprehensive Income:
Net income........................... 11,601 11,601
Change in net unrealized gain (loss)
on securities available-for-sale, net
of reclassification adjustment and
tax effects......................... 1,778 1,778
Total comprehensive income......... 13,379
Common stock issued - Stock Options... 2,624 13 48 61
Stock dividends issued -
Common stock - 5%, including cash
paid in lieu of fractional shares
(231,424 shares including 79,332
shares of Treasury Stock)............ 231,424 1,157 8,042 (11,407) 2,168 (40)
Cash dividends declared-Common Stock. (5,356) (5,356)
Purchase of Treasury Stock
(70,266 shares)..................... (2,492) (2,492)
Issuance of Treasury Stock
Dividend Reinvestment Plan
(36,448 shares)..................... 301 1,080 1,381
Employee Stock Plan (7,414 shares).. 73 190 263
Director's Compensation Plan
(2,000 shares)...................... 18 79 97
Stock Options (1,400 shares)......... (20) 53 33
Balance, December 31, 1998...........6,471,057 $32,355 $24,783 $20,666 $4,694 $(1,185) $81,313
========= ======= ======== ======== ====== ======= =======
See accompanying notes to financial statements
Consolidated Statements of Cash Flows
Sterling Financial Corporation and Subsidiaries
For the years ended December 31,
(Dollars in thousands) 1998 1997 1996
Cash Flows from Operating Activities
Net Income...........................................$ 11,601 $ 10,401 $ 9,811
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation...................................... 2,113 1,948 1,625
Accretion & amortization of investment securities. 395 266 356
Provision for possible loan losses................ 896 1,129 580
Provision for deferred income taxes............... 579 638 824
(Gain) on sale of property and equipment.......... (2) (456) (2)
(Gain) on sales of investment securities.......... none (208) (158)
(Gain) on sale of mortgage loans.................. (642) (319) (262)
Proceeds from sales of mortgage loans............. 89,517 41,188 33,480
Originations of mortgage loans held for sale...... (94,088) (40,645) (33,272)
Change in operating assets and liabilities:
(Increase) decrease in accrued interest receivable
and prepaid expenses............................ (586) (981) 517
(Increase) in other assets....................... (10,339) (4,148) (6,583)
Increase in accrued interest payable
and accrued expenses........................... 489 822 (350)
Increase (decrease) in other liabilities........ 1,394 711 836
--------- --------- ---------
Net cash provided by/(used in) operating activities.. 1,327 10,346 7,402
Cash Flows from Investing Activities
Proceeds from interest bearing deposits
in other banks..................................... 361 968 1,023
Purchase of interest bearing deposits in other banks. (903) (339) (1,643)
Proceeds from sales of investment securities
available-for-sale.................................. none 214 670
Proceeds from maturities or calls of investment
securities held-to-maturity.... .................... 29,354 30,541 37,508
Proceeds from maturities or calls of investment
securities available-for-sale....................... 19,637 10,007 8,948
Purchases of investment securities held-to-maturity.. (8,614) (22,185) (9,791)
Purchases of investment securities available-for-sale (73,735) (49,678) (19,310)
Federal funds sold, net.............................. 1,300 (4,000) (14,800)
Net loans and leases made to customers............... (23,580) (39,004) (48,080)
Purchases of premises and equipment.................. (2,382) (2,562) (7,880)
Proceeds from sale of premises and equipment......... 14 1,790 49
--------- --------- ---------
Net cash provided by/(used in) investing activities.. (58,548) (74,248) (53,306)
Cash Flows from Financing Activities
Net increase in demand deposits, NOW and
savings accounts................................... 42,003 18,429 12,013
Net increase in time deposits........................ 20,719 53,195 24,918
Net increrase (decrease) in interest bearing demand
notes issued to the U.S. Treasury................... (1,442) 259 507
Proceeds from borrowings............................. 19,080 25,652 58,474
Repayments of borrowings............................. (17,289) (23,774) (49,563)
Proceeds from issuance of common stock............... 61 none 239
Cash dividends paid.................................. (5,356) (5,075) (4,508)
Cash paid in lieu of fractional shares............... (40) none (24)
Acquisition of treasury stock........................ (2,492) (3,302) (547)
Proceeds from issuance of treasury stock............. 1,774 1,471 320
--------- --------- ---------
Net cash provided by/(used in) financing activities.. 57,018 66,855 41,829
--------- --------- ---------
Increase (decrease) in cash and due from banks....... (203) 2,953 (4,075)
Cash and due from banks:
Beginning............................................ 34,292 31,339 35,414
--------- --------- ---------
Ending...............................................$ 34,089 $ 34,292 $ 31,339
========= ========= =========
Supplemental Disclosure of Cash Flow Information:
Cash payments for:
Interest paid to depositors and on borrowed money..$ 27,626 $ 24,702 $ 22,637
Income taxes....................................... 3,151 2,600 2,230
Supplemental Schedule of Noncash Investing and
Financing Activities:
Other real estate acquired in settlement of loans....$ 353 $ 630 $ 119
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., became the
wholly owned subsidiary of Sterling Financial Corporation, 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 2 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 subsidiaries, Bank
of Lancaster County, N.A., and its subsidiary, Town & Country, Inc., and T & C
Leasing, Inc., provides a full range of banking services to individual and
corporate customers. The principal market area is Lancaster County,
Pennsylvania. Sterling Financial Corpoation 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 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., T & C Leasing, Inc. and Sterling Mortgage Services, Inc., which
is 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, "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:
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;
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
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.
Costs to maintain the assets and subsequent gains and losses
on sales are included in other income or other expense.
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 retaining all mortgage servicing. Mortgage sale income
had 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
will 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 did not 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.
Comprehensive Income - In June, 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 130 - "Reporting
Comprehensive Income". SFAS No. 130 establishes standards to provide prominent
disclosure of comprehensive income items. Statement No. 130 was effective for
fiscal years beginning after December 15, 1997. This statement requires the
corporation to set forth additional disclosures in the financial statements.
The adoption of this statement had no effect on the corporation's consolidated
financial position or results of operations.
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 years ended December 31, 1998 and 1997
were approximately $4,052,000 and $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 $56,894,078 in 1998 and $49,320,182 in 1997.
The amortized cost and fair values of investment securities held-to-
maturity are as follows:
December 31, 1998
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities............$ 2,508 $ 20 $ none $ 2,528
Obligations of other U.S. Government
agencies and Corporations......... 2,208 30 none 2,238
Obligations of states and political
subdivisions...................... 44,465 1,642 4 46,103
Mortgage-backed securities.......... 1,219 64 none 1,283
Other bonds, notes and debentures... 10,808 129 none 10,937
---------- --------- -------- --------
Subtotal............................ 61,208 1,885 4 63,089
Nonmarketable equity securities..... 3,201 none none 3,201
---------- --------- -------- --------
Total...............................$ 64,409 $ 1,885 $ 4 $ 66,290
========== ========= ======== ========
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
=========== ========= ========== =========
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, 1998, 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, 1998
Amortized Fair
Cost Value
Due in one year or less................$ 9,803 $ 9,885
Due after one year through five years.. 19,958 20,425
Due after five years through ten years. 22,943 23,989
Due after ten years.................... 7,285 7,507
----------- -----------
59,989 61,806
Mortgage-backed securities............. 1,219 1,283
----------- -----------
$ 61,208 $ 63,089
=========== ===========
The amortized cost and fair values of investment securities
available-for-sale are as follows:
December 31, 1998
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities..............$ 29,265 $ 666 $ 1 $ 29,930
Obligations of other U.S. Government
agencies and Corporations............ 37,713 613 41 38,285
Obligations of states and political
subdivisions......................... 36,938 1,074 26 37,986
Mortgage-backed securities............ 461 none none 461
Other bonds, notes and debentures..... 66,215 1,119 22 67,312
-------- ------- ------ --------
Subtotal.............................. 170,592 3,472 90 173,974
Equity securities and corporate
stock............................... 174 3,730 none 3,904
-------- ------- ------ --------
Total.................................$170,766 $ 7,202 $ 90 $177,878
======== ======= ====== ========
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities............$ 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
=========== ========= ======== ========
The amortized cost and fair values of available-for-sale debt securities at
December 31, 1998 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, 1998
Amortized Fair
Cost Value
Due in one year or less...................$ 24,019 $ 24,199
Due after one year through five years..... 108,479 110,855
Due after five years through ten years.... 26,098 26,799
Due after ten years....................... 11,535 11,660
-------- --------
170,131 173,513
Mortgage-backed securities................ 461 461
-------- --------
$170,592 $173,974
======== ========
Proceeds from sales of investment securities available-for-sale
during 1997 were $214,000. Gains of $208,457 in 1997 were
realized on these sales. There were no sales of investments
securities in 1998.
Note 5 - Loans
Loans outstanding at December 31, are as follows:
1998 1997
Commercial, financial and agricultural..................$ 290,619 $ 271,605
Real estate - construction.............................. 6,053 6,045
Real estate - mortgage.................................. 48,381 49,438
Consumer................................................ 131,939 132,778
Lease financing receivables (net of unearned income).... 57,327 52,207
----------- -----------
Total loans, gross......................................$ 534,319 $ 512,073
=========== ===========
Loans on a non-accrual status amounted to $812,000 at December 31, 1998,
compared to $1,314,000 at December 31, 1997. If interest income had been
recorded on all such loans for the years indicated, such interest income would
have increased by approximately $85,667 and $152,755 for 1998 and 1997.
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 average amount of impaired loans for the fourth quarter of 1998 was
$2,961,327 compared to $3,586,053 for the fourth quarter 1997, while the average
for the year 1998 was $3,125,142 compared to $2,203,003 for 1997.
The following table presents information concerning impaired loans at
December 31, 1998 and 1997:
1998 1997
Gross impaired loans which have allowances..........$ 2,805 $3,419
Less: Related allowances for loan losses......... (140) (410)
------- ------
Net impaired loans..................................$ 2,665 $3,009
======= ======
Note 6 - Allowance for Loan Losses
Changes in the Allowance for Loan Losses were as follows:
1998 1997 1996
Balance at January 1..................................$ 7,730 $ 7,800 $ 7,780
Recoveries credited to allowance...................... 261 303 143
Provisions for loan losses charged to income.......... 896 1,129 580
--------- -------- --------
Total................................................. 8,887 9,232 8,503
Losses charged to allowance........................... 1,269 1,502 703
--------- -------- --------
Balance at December 31................................$ 7,618 $ 7,730 $ 7,800
========= ======== ========
Ratio of Allowance to loans, net of unearned income
at end of year..................................... 1.43% 1.51% 1.65%
Note 7 - Premises and Equipment
Premises and equipment at December 31, 1998 and 1997 is summarized as follows:
1998 1997
Land...........................................$ 3,539 $ 3,539
Buildings...................................... 16,586 15,977
Buildings under capitalized lease.............. 104 104
Leasehold improvements......................... 830 796
Equipment, furniture and fixtures.............. 13,953 12,604
---------- ----------
35,012 33,020
Less: Accumulated depreciation................ (12,817) (11,082)
---------- ----------
$ 22,195 $ 21,938
========== ==========
Depreciation expense amounted to $2,113,379 in 1998, $1,947,904 in 1997 and
$1,625,184 in 1996.
Note 8 - Other Assets
Included in other assets for 1998 and 1997 is $37,171,117 and $30,650,237
respectively which represents operating leases generated by Town & Country, Inc.
and T & C Leasing, Inc. The income generated from the leases for 1998 and 1997
amounted to $3,473,966 and $3,050,664 and is reflected in other operating
income.
The following schedule provides an analysis of Town & Country's and T & C
Leasing's investment in property on operating leases and property held for lease
by major classes as of December 31, 1998 and 1997:
1998 1997
Construction equipment...........$ 1,985 $ 932
Transportation equipment......... 20,032 17,108
Automobiles...................... 21,051 18,855
Manufacturing equipment.......... 1,063 1,044
Trucks........................... 21,007 17,889
Other............................ 8,166 5,107
---------- -----------
Total............................ 73,304 60,935
Less: Accumulated depreciation... (36,133) (30,285)
---------- -----------
$ 37,171 $ 30,650
========== ===========
The following is a schedule by years of minimum future rentals on
noncancelable operating leases as of December 31, 1998:
Year ending December 31:
1999...............................$ 16,688
2000............................... 3,280
2001................................ 1,460
2002................................ 739
2003................................ 611
Later years ........................ 661
-------
Total minimum future rentals.......$ 23,439
=======
Also included in other assets is mortgage servicing rights activity. The
activity for the year ended December 31, 1998 and 1997 is as follows:
1998 1997
Balance beginning of year.............$ 892 $ 442
Capitalized mortgage servicing rights. 840 563
Amortization.......................... (350) (113)
------- -------
Balance at end of year................$ 1,382 892
Valuation allowance .................. (41) none
------- -------
$ 1,341 $ 892
======= =======
The corporation adopted, effective January 1, 1996, Statement of Financial
Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights", an
ammendment of FASB Statement No. 65. In June 1996, the Financial Accounting
Standards Board 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. Mortgage
servicing rights are a result of originated mortgages. There have been no
mortgage servicing rights purchased.
The bank's mortgage servicing portfolio totaled $221 million as of December
31, 1998 compared to $175 million at December 31, 1997.
Note 9 - Time Certificates of Deposit
At December 31, 1998, scheduled maturities of certificates of deposit are
as follows:
Years ended December 31,
1999 2000 2001 2002 2003 Thereafter Total
Amount $233,300 $ 59,518 $ 16,748 $ 7,802 $ 311 $ none $ 317,679
======= ======= ======= ======= ======= ========= ========
At December 31, 1998 and 1997, time certificates of deposit of $100,000 or
more aggregated $31,758,924 and $36,164,467.
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, 1998 or
1997. Interest-bearing demand notes issued to U.S. Treasury were $1,558,000 and
$3,000,000 for 1998 and 1997. 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, 1998 was $17,300,000. There were no advances from the
Federal Home Loan Bank considered as short-term borrowings
at December 31, 1998 or 1997.
The average balance outstanding for any category of short-term borrowings
during the periods reported was less than 30% of stockholders' equity at the end
of each period reported.
The following represents other liabilities for borrowed money at December 31:
1998 1997
Notes payable-Town & Country, Inc.(subsidiary of bank)
borrowings from various lenders for leasing operations.....$32,115 $30,313
Federal Home Loan Bank advances.............................. 1,988 1,999
------- -------
Total........................................................$34,103 $32,312
======= =======
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 $17,044,517 at December 31, 1998. The borrowings from the Federal
Home Loan Bank of Pittsburgh, which total $1,987,894, 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, 1998 was $369,194.
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 $160,000, effective in the year
1997, is disregarded in determining a participant's retirement benefit pursuant
to IRS regulations. All employees with 1 year of service who work at
least 1,000 hours per year and who are at least age 21 are eligible
to participate. A participant becomes 100% vested upon completion
of 5 years with a vesting credit.
The following represents the components of net periodic benefit cost for
1998, 1997 and 1996:
1998 1997 1996
Service cost....................................$ 639 $ 583 $ 614
Interest cost................................... 672 608 567
Actual return on assets......................... (918) (2,208) (1,049)
Amortization of unrecognized net
transition (asset) or obligation............. (69) (69) (69)
Amortization of unrecognized prior service cost. (9) (9) (9)
Amortization of unrecognized net (gain) or loss. none none 40
Asset gain or (loss) deferred .................. (44) 1,429 406
------ ------ ------
Net periodic benefit cost.......................$ 271 $ 334 $ 500
====== ====== ======
The following table sets forth the plan's change in benefit obligation,
change in plan assets and funded status at December 31, 1998, 1997 and 1996:
Pension Benefits
Change in Benefit Obligation: 1998 1997 1996
Benefit obligation at beginning of year..................$ 9,670 $ 8,451 $ 8,143
Service cost............................................. 639 583 614
Interest cost ........................................... 672 608 567
Actuarial (gain) or loss................................. 205 286 (601)
Benefits paid............................................ (322) (258) (272)
------- ------- -------
Benefit obligation at end of year........................ 10,864 9,670 8,451
------- ------- -------
Change in Plan Assets:
Fair value of plan assets at beginning of year........... 10,554 8,265 6,728
Actual return on plan assets............................. 918 2,208 1,049
Employer contribution ................................... none 339 760
Benefits paid ........................................... (322) (258) (272)
------- ------- -------
Fair value of plan assets at end of year ................ 11,150 10,554 8,265
------- ------- -------
Funded status ........................................... 286 884 (186)
Unrecognized net (gain) or loss ......................... (445) (694) 449
Unrecognized net transition (asset) or obligation ....... (69) (138) (207)
Unrecognized prior service cost ......................... (102) (111) (120)
------- ------- -------
Prepaid (accrued) benefit cost .......................... $ (330) $ (59) $ (64)
======= ======= =======
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 for 1998, 1997 and 1996 are as follows:
Weighted-Average Assumptions as of December 31: 1998 1997 1996
Discount rate........................................ 6.5% 7.0% 7.25%
Expected return on plan assets....................... 9.0% 9.0% 9.00%
Rate of compensation increase........................ 4.0% 4.5% 5.25%
The Bank of Lancaster County maintained during 1998, an Employee Stock Plan
which was approved by the shareholders in 1982. All employees of the bank who
have attained the age of 18, have completed 1 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 2 components, a salary deferral feature and a performance
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 5 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, 1998 and December 31, 1997 was 559,688
and 553,944 with an approximate market value of $23,227,000 and $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 contributions 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 Corporationstock are reinvested
in additional share of Sterling Financial Corporation stock.
The amount of dividends received during 1998 and 1997 amounted to $454,268 and
$423,093.
The contribution to the performance incentive portion of the plan was
$273,000, $245,000 and $235,000 for 1998, 1997 and 1996. The contribution to
the salary deferral portion of the plan was $120,318 in 1998, $100,682 in 1997
and $75,619 in 1996.
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, 1998, 1997 and 1996:
1998 1997 1996
Service cost...................................... $ 70 $ 77 $ 96
Interest cost..................................... 84 86 100
Amortization of unrecognized net
transition (asset) or obligation............... 51 51 51
Amortization of unrecognized prior service cost... (19) (19) none
Amortization of unrecognized net (gain) or loss... (16) (4) none
---- ---- ----
Net periodic benefit cost......................... $170 $191 $247
==== ==== ====
Sterling's postretirement benefits other than pensions are currently not
funded. The status of the plans at December 31, 1998, 1997 and 1996 is as
follows:
Postretirement Benefits
Change in Benefit Obligation: 1998 1997 1996
Benefit obligation at beginning of year... $1,219 $1,210 $1,182
Service cost ............................. 70 77 96
Interest cost ............................ 84 86 100
Actuarial (gain) or loss ................. (158) (124) (138)
Benefits paid ............................ (35) (30) (30)
----- ----- -----
Benefit obligation at end of year ........ $1,180 $1,219 $1,210
----- ----- -----
Change in Plan Assets:
Fair value of plan assets at beginning of
year ................................... 0 0 0
Actual return on plan assets ............. 0 0 0
Employer contribution .................... 35 30 30
Benefits paid ............................ (35) (30) (30)
----- ----- -----
Fair value of plan assets at end of year.. 0 0 0
----- ----- -----
Funded Status ............................ (1,180) (1,219) (1,210)
Unrecognized net(gain) or loss ........... (457) (315) (195)
Unrecognized net transition (asset) or
obligation ............................. 719 770 821
Unrecognized prior service cost........... (213) (232) (251)
----- ----- -----
Prepaid (accrued) benefit cost............$(1,131) $ (996) $ (835)
===== ===== =====
Weighted-Average Assumptions as of
December 31:
Discount rate 6.50% 7.00% 7.25%
The health care cost trend rate assumption has a significant effect on the
amounts reported. The following table reflects the effect of a 1-percentage-
point increase and a 1-percentage-point decrease in the healthcare cost trend
rates:
1-Percentage- 1-Percentage-
Point Increase Point Decrease
Effect on total of service and interest cost components.... $ 36 $ 29
Effect on postretirement benefit obligation ............... 215 170
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, which are
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 1998,
1997 and 1996 included the following:
1998 1997 1996
Service cost................................. $ 13 $ 13 $ 8
Interest cost................................ 15 15 8
Amortization of unrecognized prior service
cost ...................................... 20 20 14
----- ----- -----
Net periodic benefit cost.................... $ 48 $ 48 $ 30
===== ===== =====
The following table sets forth the change in benefit obligation, change in
plan assets and funded status for the Retirement Restoration Plan at December
31, 1998, 1997 and 1996.
Retirement Restoration Plan
1998 1997 1996
Change in Benefit Obligation:
Benefit obligation at beginning of year.... $ 216 $ 205 $ 180
Service cost .............................. 13 13 8
Interest cost ............................. 15 15 8
Actuarial (gain) or loss .................. 0 (17) 9
Benefits paid ............................. 0 0 0
---- ---- ----
Benefit obligation at end of year ......... $ 244 $ 216 $ 205
---- ---- ----
Change in Plan Assets:
Fair value of plan assets at beginning of
year .................................... $ 0 $ 0 $ 0
Actual return on plan assets .............. 0 0 0
Benefits paid ............................. 0 0 0
---- ---- ----
Fair value of plan assets at end of year .. $ 0 $ 0 $ 0
---- ---- ----
Fund Status ............................... (244) (216) (205)
Unrecognized net (gain) or loss ........... (8) (8) 9
Unrecognized prior service cost ........... 126 146 166
---- ---- ----
Prepaid (accrued) benefit cost ............ $(126) $ (78) $ (30)
==== ==== ====
Weighted-Average Assumptions as of
December 31:
Discount rate ............................. 6.50% 7.00% 7.25%
Expected return on plan assets ............ 9.00% 9.00% 9.00%
Rate of compensation increase ............. 4.00% 4.50% 5.25%
Note 12 - Advertising
The corporation expenses advertising costs as incurred. The expenses for
1998, 1997 and 1996 were $518,789, $569,484 and $552,451.
Note 13 - Stock Options
On November 19, 1996, the Board of Directors of the corporation adopted the
Sterling Financial Corporation 1996 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 an opportunity for employees to purchase shares of the corporation's
common stock at a grant price established by market conditions on the date of
the grant. The shares of common stock that may be issued under the Stock
Incentive Plan shall not exceed in the aggregate 525,000 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" 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:
1998 1997 1996
---- ---- ----
Net Income:
As reported ................................ $11,601 $10,401 $9,811
Proforma ................................... 10,858 10,090 9,594
Earnings Per Share - Basic
As reported ................................ $ 1.80 $ 1.60 $ 1.50
Proforma ................................... 1.68 1.54 1.47
Earnings Per Share - Diluted
As reported ................................ $ 1.79 $ 1.60 $ 1.50
Proforma ................................... 1.68 1.54 1.47
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
1998 1997 1996
Weighted Weighted Weighted
Average Average Average
Exercised Exercised Exercised
Shares Price Shares Price Shares Price
Outstanding at January 1.... 71,505 25.59 34,492 $23.14 0 $ ----
Granted ...... 53,675 42.25 38,588 27.68 34,492 23.14
Exercised .... (4,024) 23.22 0 --- 0 ----
Forfeited .... (14,090) 26.10 (1,575) 23.14 0 ----
Outstanding at December 31 . 107,066 33.96 71,505 25.59 34,492 23.14
Options Exercisable
at December 31............. 25,269 24.89 10,973 23.14 0 ----
Weighted Average Fair Value
of Options granted during
the year................... $13.85 $8.05 $6.30
The fair value of each option granted is estimated on the grant date using
the Black-Scholes model. The following assumptions were made in estimating
the fair value.
Assumption 1998 1997 1996
---------- ---- ---- ----
Dividend Yield .......................... 2.01% 2.53% 2.91%
Risk-Free Interest Rate ................. 4.58% 5.78% 6.39%
Expected Life ........................... 10 years 10 years 10 years
Expected Volatility ..................... 26.645% 12.103% 10.617%
Note 14 - Operating Leases
The bank leases certain banking facilities under operating leases which
expire on various dates to 2022. Renewal options are available on these
leases. Minimum future rental payments as of December 31, 1998
are as follows:
Operating
Leases
1999.........................$ 576
2000......................... 473
2001......................... 420
2002......................... 335
2003......................... 280
Later years.................. 1,663
-------
Total minimum future rental
payments...................$ 3,747
=======
Total rent expense charged to operations amounted to $600,098 in 1998,
$587,126 in 1997 and $562,547 in 1996.
Note 15- Applicable Income Taxes
The effective income tax rates for financial reporting purposes are less
than the Federal statutory rate of 34% for 1998, 1997 and 1996
for reasons shown as follows:
For the years ended December 31,
Statutory Statutory Statutory
1998 Rate 1997 Rate 1996 Rate
Federal income tax expense
at statutory rate.............$ 5,183 34.0% $ 4,723 34.0% $ 4,406 34.0%
Reduction resulting from:
Non-taxable interest income..... (1,643) (10.8%) (1,213) (8.7%) (1,153) (8.9%)
Other, net...................... 35 .2% (112) (.9%) (186) (1.4%)
------- ------ ------- ------ ------- ------
Applicable Federal income taxes.$ 3,575 23.4% $ 3,398 24.4% $ 3,067 23.7%
State income taxes.............. 68 .5% 93 .7% 80 .6%
------- ------ ------- ------ ------- ------
Applicable income taxes.........$ 3,643 23.9% $ 3,491 25.1% $ 3,147 24.3%
======= ====== ======= ====== ======= ======
Taxes currently payable.........$ 3,064 $ 2,853 $ 2,323
Deferred income taxes........... 579 638 824
------- ------- -------
Applicable income taxes.........$ 3,643 $3,491 $ 3,147
======= ======= =======
The Corporation had net deferred tax credits of $7,135,000, $5,639,000 and
$4,326,000 at December 31, 1998, 1997 and 1996. The tax effect of temporary
differences that gave rise to significant portions of the deferred tax
liabilities at December 31, 1998 and 1997, are as follows:
December 31,
1998 1997
---- ----
Deferred tax assets:
Allowance for loan losses.....................$ 2,590 $ 2,628
Deferred loan fees and costs.................. 43 29
Postretirement benefits other than pensions... 385 339
Foreclosed assets............................. 7 7
Pension....................................... 194 49
Other......................................... 107 79
------- -------
Total deferred tax assets...................$ 3,326 $ 3,131
======= =======
Deferred tax liabilities:
Leasing....................................... (7,413) (6,930)
Depreciation.................................. (257) (271)
Unrealized gains on investments............... (2,418) (1,501)
Other......................................... (373) (68)
------- -------
Total deferred tax liabilities.............$(10,461) $(8,770)
======= =======
Net deferred tax liability.................$ (7,135) $(5,639)
======= =======
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 1997 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 present value of such deposits at short
term inteest rates. 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:
1998 1997
--------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- --------
Financial Assets:
Cash and short-term investments...$ 34,646 $ 34,646 $ 34,307 $ 34,307
Investment securities
held-to-maturity............... 64,409 66,290 85,155 86,465
Investment securities
available-for-sale............. 177,878 177,878 121,474 121,474
Loans............................. 482,997 460,658
Less: Allowance for loan losses.. (6,984) (7,131)
-------- --------- -------- --------
Net loans..........................$476,013 $ 481,177 $453,527 $ 454,042
Financial Liabilities:
Deposits.........................$781,383 $ 714,879 $718,661 $ 680,629
U.S. Treasury demand notes....... 1,558 1,558 3,000 3,000
Other borrowings................. 34,103 34,243 32,312 32,183
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..... (69) (69) (50) (50)
Standby letters of credit........ (72) (72) (50) (50)
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, 1998 and
1997 are as follows:
Financial instruments whose contract amounts
represent credit risk:
1998 1997
Standby letters of credit ....................$ 6,688 $ 3,932
Commitments to extend credit..................$131,451 $ 103,357
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 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
1998 1997
Carrying value at December 31,..............$ 0 $ 0
Commitment available not yet exercised......$ 41,978 24,992
Commitment revalued at existing rates with
estimated activity........................$ 41,953 24,992
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 1998 and 1997. 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, 1998 and 1997
amounted to $8,498,187 and $3,039,888. During 1998, $6,622,194
of new loans were made and repayments totaled $1,163,895.
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 1999 without
approval of the Comptroller of the Currency of approximately $6,446,000 plus an
additional amount equal to the bank's net profits for 1999 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 data 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
6,456,896, 6,511,742, 6,545,925 for 1998, 1997 and 1996, after giving
retroactive effect to a 5% stock dividend paid in June 1998. 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 6,478,290, 6,514,984 and 6,546,002 at
1998, 1997 and 1996, after giving retroactive effect to a 5% stock
dividend paid in June 1998.
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.
1998 1997 1996
Net Income................................... $ 11,601 $10,401 $ 9,811
-------- ------- -------
Income available to common stockholders
used in basic and diluted earnings per share.$ 11,601 $10,401 $ 9,811
======== ======= =======
Weighted average number of common shares used
in basic earnings per share.................6,456,896 6,511,742 6,545,925
Effect of dilutive securities
Stock Options................................. 21,394 3,242 77
--------- --------- ---------
Weighted number of common shares and dilutive
potential common stock used in diluted
earnings per share......................... 6,478,290 6,514,984 6,546,002
========= ========= =========
Note 21 - Segment Information
In 1998, the corporation adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information". SFAS 131 requires disclosure of segment information
on the basis used internally by management to
evaluate segment performance.
The corporation's segments are commercial and retail banking, leasing,
mortgage banking, and trust and investment services. The accounting policies of
each segment are the same as described in Note 2. Intersegment income (expense)
is based upon commercial and retail bank funding of the leasing and mortgage
banking segments and of trust funding of the commercial and retail bank segment.
The commercial and retail bank segment consist of all the general banking
of the corporation. Leasing includes the vehicle and equipment leasing
of Town and Country, Inc. and T & C Leasing, Inc. Mortgage
banking includes the origination sales and servicing of mortgages.
The trust and investment services segment is
the trust department of the Bank of Lancaster County, N.A.
Commercial Trust and
and Retail Mortgage Investment Consolidated
Banking Leasing Banking Services Total
Interest Income......$ 50,591 $ 5,463 $ 4,012 $ --- $ 60,066
Interest Expense..... 25,071 1,736 25 1,093 27,925
Intersegment Income
(Expense)........... 5,465 (3,795) (2,875) 1,205 ---
Other Income......... 6,504 3,888 1,829 1,966 14,187
Operating Expenses... 26,266 2,769 602 1,447 31,084
Profit before tax.... 11,223 1,051 2,339 631 15,244
Assets............... 766,216 100,114 52,934 530,931 919,264
Expenditures for long-
lived assets........ 2,021 320 8 43 2,392
Depreciation and
amortization........ 1,870 181 22 40 2,113
Income taxes......... 2,213 420 795 215 3,643
Not included in the above information under the leasing segment are
expenditures for long-lived assets consisting of operating leases of $21,629,000
and depreciation of $12,452,000.
The following is a reconcilement of total assets as reported on the
accompanying financial statements.
Assets
Reportable segments......................$1,450,195
Less: Trust assets not included
on consolidated financial statements... 530,931
----------
Total assets.............................$ 919,264
==========
Note 22 - Merger and Acquisition Activity
On February 10, 1999, the corporation entered into an agreement to acquire
Northeast Bancorp, Inc., the parent company of First National Bank of North
East, based in Maryland. Northeast Bancorp is an $82 million bank
holding company for First National Bank of North East,
with 4 branches located in Cecil County, Maryland.
Under the terms of the agreement, Northeast Bancorp shareholders will
receive 2 shares of Sterling Financial Corporation common stock for each share
of Northeast Bancorp's common stock in a tax-free exchange.
The purchase, which is subject to regulatory approval, will give Sterling
Financial its first banking presence outside of
Pennsylvania. The transaction is expected to be completed in
mid 1999 and the acquisition is expected to be accounted for as a pooling of
interests. First National Bank of North East will continue to operate as a
separate bank after the acquisition.
Note 23 - Sterling Financial Corporation (Parent Company Only) Financial
Information
Condensed Balance Sheets
As of December 31,
1998 1997
Assets
Cash.......................................................$ 1,901 $ 1,760
Securities available-for-sale.............................. 237 216
Investment in subsidiaries at equity....................... 80,033 72,980
Other assets............................................... 70 68
-------- -------
Total Assets.................................................$ 82,241 $ 75,024
======== ========
Liabilities
Other liabilities..........................................$ 928 $ 1,037
Stockholders' Equity
Common Stock...............................................$ 32,355 $ 31,185
Capital Surplus............................................ 24,783 16,321
Retained Earnings.......................................... 20,666 25,828
Accumulated other comprehensive income..................... 4,694 2,916
Less: Treasury Stock at cost............................... (1,185) (2,263)
-------- --------
Total Stockholders' Equity...................................$ 81,313 $ 73,987
-------- --------
Total Liabilities and Stockholders' Equity...................$ 82,241 $ 75,024
======== ========
Condensed Statements of Income
Years Ended December 31,
1998 1997 1996
Income
Dividends from subsidiaries...............$ 7,948 $ 7,876 $ 4,847
Dividends on investment securities........ 6 4 3
Other income.............................. 4 1 1
Investment securities gains............... none 4 none
-------- ------- -------
Total Income............................ 7,958 7,885 4,851
-------- ------- -------
Expenses
Other expense............................. 215 210 155
-------- ------- -------
Total Expenses.......................... 215 210 155
-------- ------- -------
Income before income taxes and equity
in undistributed net income
of subsidiaries........................... 7,743 7,675 4,696
Income taxes (credits)...................... (70) (68) (51)
-------- ------- -------
7,813 7,743 4,747
Equity in undistributed income of
subsidiaries.............................. 3,788 2,658 5,064
-------- ------- -------
Net Income..................................$ 11,601 $10,401 $ 9,811
======== ======= =======
Statements of Cash Flows
Years Ended December 31,
1998 1997 1996
Cash flows from operating activities
Net income........................................$ 11,601 $ 10,401 $ 9,811
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Undistributed (earnings) loss of subsidiaries..... (3,788) (2,658) (5,064)
(Gain) on sales of investment securities.......... none (4) none
Changes in operating assets and liabilities:
(Increase) decrease in other assets............. (2) (17) 796
(Decrease) increase in other liabilities........ (117) (165) 164
-------- -------- --------
Net cash provided by/(used in)
operating activities............................ 7,694 7,557 5,707
-------- -------- --------
Cash flows from investing activities
Proceeds from sales of investment securities
avaiable-for sale............................... none 9 none
Purchase of investment securities
available-for-sale.............................. none (9) (83)
Payments for investment in subsidiary ........... (1,500) none none
-------- -------- --------
Net cash provided by/(used in) investing
activities...................................... (1,500) none (83)
-------- -------- --------
Cash flows from financing activities
Proceeds from issuance of common stock........... 61 none 239
Cash dividends paid.............................. (5,356) (5,075) (4,508)
Cash dividends paid in lieu of
fractional shares............................... (40) none (24)
Acquisition of treasury stock.................... (2,492) (3,302) (547)
Proceeds from issuance of treasury stock......... 1,774 1,471 320
-------- -------- --------
Net cash provided by/(used in) financing
activities...................................... (6,053) (6,906) (4,520)
-------- -------- --------
Increase (decrease) in cash....................... 141 651 1,104
Cash
Beginning....................................... 1,760 1,109 5
-------- -------- --------
Ending.........................................$ 1,901 $ 1,760 $ 1,109
========= ======== ========
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, 1998 and 1997. Net income per share of common stock
has been restated to retroactively reflect a 5% stock dividend paid in
June 1998.
1998
Quarter Ended
March June September December
31 30 30 31
Interest income................. $ 14,722 $15,116 $15,201 $15,027
Interest expense................ 6,824 7,023 7,197 6,881
-------- ------- ------- -------
Net interest income............. 7,898 8,093 8,004 8,146
Provision for loan losses....... 360 346 175 15
-------- ------- ------- -------
Net interest income after
provision for loan losses..... 7,538 7,747 7,829 8,131
Other income.................... 3,303 4,414 3,424 3,046
Other expenses.................. 7,110 7,831 7,548 7,699
-------- ------- ------- -------
Income before income taxes...... 3,731 4,330 3,705 3,478
Applicable income taxes......... 906 1,106 867 764
-------- ------- ------- -------
Net income.......................$ 2,825 $ 3,224 $ 2,838 $ 2,714
======== ======= ======= =======
Net income per share (basic).....$ .44 $ .50 $ .44 $ .42
Net income per share (diluted)...$ .43 $ .50 $ .44 $ .42
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
(basic and diluted)............ $ .40 $ .39 $ .41 $ .40
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
"Executive Officers" in the 1999 Annual Meeting Proxy Statement.
Item 11 - Executive Compensation
Incorporated by reference is the information under the headings
"Compensation of Directors" and "Executive Compensation" in the 1999 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" in the 1999 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" in the 1999 Annual Meeting
Proxy Statement and under "Notes to Consolidated Financial Statements -
Note 18 - Related Party Transactions" on page 56 in 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 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 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 the corporation's Registration
Statement No. 33-55131 on Form S-3, filed with the Securities
and Exchange Commission on August 18, 1994, and ammended by the
registrant's Rule 424 (b) prospectus filed with the Commission
on December 23, 1998.)
10e Letter Agreement between Sterling Financial Corporation and
Howard E. Groff, Sr., dated June 30, 1994. (Incorporated by
reference to Exhibit 10b on Form 10-Q, 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. 33-28101 on Form S-8,
filed with the Securities and Exchange Commission on May 10,
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, 1998.
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 23, 1999
(John E. Stefan) Executive Officer; Director
/s/ J. Roger Moyer, Jr. Executive Vice President, February 23, 1999
(J. Roger Moyer, Jr.) Assistant Secretary, Director
/s/ Jere L. Obetz Executive Vice President/Treasurer,
(Jere L. Obetz) Chief Financial Officer February 23, 1999
/s/ Ronald L. Bowman Vice President/Secretary, February 23, 1999
(Ronald L. Bowman) Principal Accounting Officer
/s/ Richard H. Albright, Jr. Director February 23, 1999
(Richard H. Albright, Jr.)
Director February 23, 1999
(Robert H. Caldwell)
/s/ Howard E. Groff, Jr. Director February 23, 1999
(Howard E. Groff, Jr.)
/s/ Joan R. Henderson Director February 23, 1999
(Joan R. Henderson)
/s/ J. Robert Hess Director February 23, 1999
(J. Robert Hess)
/s/ Calvin G. High Director February 23, 1999
(Calvin G. High)
/s/ David E. Hosler Director February 23, 1999
(David E. Hosler)
/s/ E. Glenn Nauman Director February 23, 1999
(E. Glenn Nauman)
/s/ W/ Garth Sprecher Director February 23, 1999
(W. Garth Sprecher)
/s/ Glenn R. Walz Vice Chairman of the Board, February 23, 1999
(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
T & C Leasing, Inc. Pennsylvania
1097 Commercial Avenue
East Petersburg, PA 17520
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 21, 1999, except for Note 22 as to which the date is February 10, 1999,
on the consolidated financial statements of Sterling Financial Corporation for
the year ended December 31, 1998 as set forth in this form 10-K.
/s/ Trout, Ebersole & Groff, LLP
Trout, Ebersole & Groff, LLP
Certified Public Accountants
Lancaster, Pennsylvania
March 11, 1999
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 19, 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 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 the corporation's
Statement No. 33-55131 on Form S-3, filed with the Securities
and Exchange Commission on August 18, 1994 and ammended by the
registrant's Rule 424 (b) prospectus filed with the Commission
on December 23, 1998.)
10e Letter Agreement between Sterling Financial Corporation and
Howard E. Groff, Sr., dated June 30, 1994. (Incorporated by
reference to Exhibit 10b on Form 10-Q, 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. 33-28101 on Form S-8,
filed with the Securities and Exchange Commission on May 10, 1997.)
11 Statement re: Computations of Earnings Per Share (included
herein at Item 8 at Notes to Consolidated Financial
Statements, Note 2.)
21 List of Subsidiaries 54
23 Consent of Auditors 55
27 Financial Data Schedule