UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from __________ to __________
COMMISSION FILE NO.: 0-18833
CHESTER VALLEY BANCORP INC.
---------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-2598554
------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 E. LANCASTER AVENUE, DOWNINGTOWN, PA 19335
---------------------------------------- ------
(Address Of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 269-9700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
------- --------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): YES NO X
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
COMMON STOCK ($1.00 PAR VALUE) 4,833,001
------------------------------ ------------------------
(Title of Each Class) (Number of Shares Outstanding
as of November 6, 2003)
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
INDEX
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Page
PART 1. FINANCIAL INFORMATION Number
- ------------------------------ ------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 2003 and June 30, 2003 (Unaudited) 1
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended September 30, 2003 and 2002 (Unaudited) 2
STATEMENT OF OTHER COMPREHENSIVE INCOME
Three Months Ended September 30, 2003 and 2002 (Unaudited) 3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended September 30, 2003 and 2002 (Unaudited) 4
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 5 - 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 13 - 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK 21 - 23
ITEM 4. CONTROLS AND PROCEDURES 24
PART 2. OTHER INFORMATION
- --------------------------
ITEM 1. LEGAL PROCEEDINGS 25
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 25
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES 26
- ----------
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
SEPTEMBER 30, JUNE 30,
2003 2003
------------ -----------
(UNAUDITED)
ASSETS $ 12,284 $ 16,311
Cash and due from banks
Interest-bearing deposits 13,435 9,438
--------- ---------
TOTAL CASH AND CASH EQUIVALENTS 25,719 25,749
--------- ---------
Investment securities available for sale 107,733 114,230
Investment securities held to maturity (fair value -
September 30, 2003, $36,804;
June 30, 2003, $34,432) 36,164 33,390
Loans held for sale 4,398 3,866
Loans receivable 402,928 387,310
Deferred fees (794) (933)
Allowance for loan losses (5,774) (5,415)
--------- ---------
Loans receivable, net 396,360 380,962
--------- ---------
Accrued interest receivable 2,461 2,428
Property and equipment - net 12,321 12,349
Bank owned life insurance 5,235 5,164
Other assets 7,895 6,390
--------- ---------
TOTAL ASSETS $ 598,286 $ 584,528
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 398,785 $ 400,586
Securities sold under agreements to repurchase 26,164 27,358
Advance payments by borrowers for taxes and insurance 733 2,038
Federal Home Loan Bank advances 111,755 94,049
Trust preferred securities 10,000 10,000
Accrued interest payable 621 652
Other liabilities 315 274
--------- ---------
TOTAL LIABILITIES 548,373 534,957
--------- ---------
Commitments and contingencies (Note 4)
Stockholders' Equity:
Preferred stock - $1.00 par value;
5,000,000 shares authorized; none issued -- --
Common stock - $1.00 par value;
10,000,000 shares authorized;
4,833,034 and 4,570,993 shares issued at September 30,
2003 and June 30, 2003, respectively 4,833 4,571
Additional paid-in capital 35,600 30,315
Retained earnings - partially restricted 10,038 14,064
Treasury stock (583 and 556 shares at September 30, 2003 and
June 30, 2003, respectively, at cost) (13) (13)
Accumulated other comprehensive loss, net of tax (545) 634
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 49,913 49,571
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 598,286 $ 584,528
========= =========
See accompanying notes to unaudited consolidated financial statements
1
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except for Per Share Amounts)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2003 2002
--------------- ---------------
(Unaudited)
INTEREST INCOME:
Loans $ 6,094 $ 6,612
Mortgage-backed securities 342 387
Interest-bearing deposits 8 91
Investment securities:
Taxable 546 862
Non-taxable 437 468
---------- ----------
TOTAL INTEREST INCOME 7,427 8,420
---------- ----------
INTEREST EXPENSE:
Deposits 1,430 2,233
Securities sold under agreements to repurchase 32 59
Short-term borrowings 27 310
Long-term borrowings 1,230 1,175
---------- ----------
TOTAL INTEREST EXPENSE 2,719 3,777
---------- ----------
NET INTEREST INCOME 4,708 4,643
Provision for loan losses 380 141
---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 4,328 4,502
---------- ----------
OTHER INCOME:
Investment services income 984 892
Service charges and fees 771 714
Gain on the sale of:
Loans 72 9
Available for sale securities 75 116
Other 112 42
---------- ----------
TOTAL OTHER INCOME 2,014 1,773
---------- ----------
OPERATING EXPENSES:
Salaries and employee benefits 2,440 2,480
Occupancy and equipment 709 706
Data processing 233 257
Advertising 29 35
Deposit insurance premiums 15 16
Other 961 827
---------- ----------
TOTAL OPERATING EXPENSES 4,387 4,321
---------- ----------
Income before income taxes 1,955 1,954
Income tax expense 441 489
---------- ----------
NET INCOME $ 1,514 $ 1,465
========== ==========
EARNINGS PER SHARE (1)
Basic $ 0.32 $ 0.31
========== ==========
Diluted $ 0.30 $ 0.30
========== ==========
DIVIDENDS PER SHARE PAID DURING PERIOD (1) $ 0.10 $ 0.09
========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING (1)
Basic 4,804,445 4,755,167
========== ==========
Diluted 4,995,730 4,814,008
========== ==========
(1) Earnings per share, dividends per share and weighted average shares
outstanding have been restated to reflect the effects of the 5% stock
dividends paid in September 2003 and 2002
See accompanying notes to unaudited consolidated financial statements
2
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
STATEMENT OF OTHER COMPREHENSIVE INCOME
(Dollars in Thousands)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2003 2002
--------------- ---------------
(Unaudited)
NET INCOME $ 1,514 $ 1,465
Other comprehensive income, net of tax:
Net unrealized holding (losses) gains on
securities available for sale during the period (1,129) 676
Reclassification adjustment for (gains)
included in net income (50) (77)
---------- ----------
COMPREHENSIVE INCOME $ 335 $ 2,064
========== ==========
See accompanying notes to unaudited consolidated financial statements.
3
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------
(Unaudited)
Net income $ 1,514 $ 1,465
Add (deduct) items not affecting cash flows provided by operating activities:
Depreciation 259 267
Provision for loan losses 380 141
(Gain) loss on sale of securities available for sale (75) (116)
Originations of loans held for sale (7,123) (4,823)
Proceeds from sale of loans held for sale 6,663 3,660
Gain on sale of loans held for sale (72) (9)
Amortization of deferred loan fees, discounts and premiums 66 (100)
Increase in accrued interest receivable (33) (224)
Increase in value of bank owned life insurance (71) --
(Increase) decrease in other assets (1,052) 151
Increase in other liabilities 41 170
Decrease in accrued interest payable (31) (14)
- ------------------------------------------------------------------------------------------------------------------
Net cash flows provided by operating activities 466 568
- ------------------------------------------------------------------------------------------------------------------
Cash flows (used in) provided from investment activities:
Capital expenditures (231) (291)
Net increase in loans (15,607) (12,277)
Purchase of investment securities (5,328) (1,822)
Proceeds from maturities, payments and calls of investment securities 2,516 6,719
Purchase of securities available for sale (24,124) (21,253)
Proceeds from sales and calls of securities available for sale 28,865 10,008
- ------------------------------------------------------------------------------------------------------------------
Net cash flows used in investment activities (13,909) (18,916)
- ------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Net (decrease) increase in deposits before interest credited (3,147) 11,049
Interest credited to deposits 1,346 2,033
(Decrease) increase in securities sold under agreements to repurchase (1,194) 6,041
Proceeds from FHLB advances 134,477 --
Repayments of FHLB advances (116,771) (311)
Decrease in advance payments by borrowers for taxes and insurance (1,305) (1,775)
Cash dividends on common stock (458) (431)
Common stock issued -- 275
Payment for fractional shares (7) --
Stock options exercised 472 --
- ------------------------------------------------------------------------------------------------------------------
Net cash flows provided by financing activities 13,413 16,881
- ------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents (30) (1,467)
CASH AND CASH EQUIVALENTS:
Beginning of period 25,749 39,395
--------- ---------
End of period $ 25,719 $ 37,928
========= =========
SUPPLEMENTAL DISCLOSURES:
Cash payments during the year for:
Taxes $ 75 $ 150
Interest $ 2,750 $ 3,791
NON-CASH ITEMS:
Stock dividend issued $ 5,075 $ 3,518
Net unrealized (loss) gain on investment securities available for sale,
net of tax $ (1,179) $ 599
See accompanying notes to unaudited consolidated financial statements.
4
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Chester Valley Bancorp Inc. (the "Holding Company") was incorporated in the
Commonwealth of Pennsylvania in August 1989. The business of the Holding Company
and its subsidiaries (collectively, the "Company") consists of the operations of
First Financial Bank ("First Financial" or the "Bank"), a Pennsylvania-chartered
commercial bank founded in 1922 as a Pennsylvania-chartered savings association,
and Philadelphia Corporation for Investment Services ("Phila. Corp."), a full
service investment advisory and securities brokerage firm. Effective September
1, 2001, the Bank converted to a Pennsylvania-chartered commercial bank. As a
consequence of such charter conversion and with the approval by the Federal
Reserve Bank of Philadelphia under delegated authority from the Board of
Governors of the Federal Reserve System ("FRB"), the Holding Company became a
bank holding company that has also been designated by the FRB as a financial
holding company. Prior to such conversion, the Holding Company was a unitary
thrift holding company.
The Bank provides a wide range of banking services to individual and corporate
customers through its ten full-service branch offices in Chester County,
Pennsylvania. The Bank provides a wide range of lending products including
commercial real estate, commercial business, consumer as well residential real
estate. Its lending activities are funded primarily with retail and business
deposits and borrowings. Phila. Corp. is a registered broker/dealer in all 50
states and the District of Columbia and it is also registered as an investment
advisor with the Securities and Exchange Commission ("SEC"). It provides many
additional services, including self-directed and managed retirement accounts,
safekeeping, daily sweep money market funds, portfolio and estate valuations,
life insurance and annuities, and margin accounts, to individuals and smaller
corporate accounts. Phila. Corp.'s offices are located in Wayne and
Philadelphia, Pennsylvania.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The accompanying consolidated financial statements include the accounts of the
Company, the Bank and Phila. Corp. The accounts of the Bank include its
wholly-owned subsidiaries, First Financial Investments Inc. and D & S Service
Corp., which owns D & F Projects and Wildman Projects, Inc., both of which are
wholly-owned subsidiaries thereof. All material inter-company balances and
transactions have been eliminated in consolidation. Prior period amounts are
reclassified when necessary to conform to the current period's presentation.
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting
principles in the United States ("GAAP") for complete financial statements.
However, such information reflects all adjustments, which are, in the opinion of
management, necessary for a fair presentation of results for the three-month
unaudited interim periods.
5
The results of operations for the three-month period ended September 30, 2003
are not necessarily indicative of the results to be expected for the fiscal year
ending June 30, 2004. The consolidated financial statements presented herein
should be read in conjunction with the audited consolidated financial statements
and the notes thereto included in the Company's Annual Report to Stockholders
for the fiscal year ended June 30, 2003.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company, as permitted, has elected not to adopt the fair value accounting
provisions of SFAS No. 123 "Accounting for Stock-based Compensation", and has
instead continued to apply APB Opinion 25 and related Interpretations in
accounting for plans and provide the required pro-forma disclosures of SFAS
No. 123.
In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amends FASB Statement No. 123,
Accounting for Stock-Based Compensation. This statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results.
The requirements of Statement No. 148 are effective for financial statements for
fiscal years beginning after December 15, 2002; the disclosure requirements for
the annual period financial statements of the Statement are included in this
report.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation (dollars in thousands except per share amounts):
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------
2003 2002
------------------------
Net income, as reported $ 1,514 $ 1,465
Deduct: Total stock-based compensation expense
determined under fair value based method for all
awards, net of related tax effects (59) (284)
------------------------
Pro forma net income $ 1,455 $ 1,181
========================
Earnings per share:
Basic - as reported $ 0.32 $ 0.31
========================
Basic - pro forma $ 0.30 $ 0.25
========================
Diluted - as reported $ 0.30 $ 0.30
========================
Diluted - pro forma $ 0.29 $ 0.25
========================
6
The effects of pro-forma net income and diluted earnings per share of applying
the disclosure requirements of Statement No. 123 and Statement No. 148 for past
fiscal quarters may not be representative of the future pro-forma effects on net
income and earnings per share due to the vesting provisions of the options and
future awards that are available to be granted.
EARNINGS PER SHARE
The dilutive effect of stock options is excluded from the computation of basic
earnings per share but included in the computation of diluted earnings per
share. Earnings per share and weighted average shares outstanding for the
periods presented herein have been adjusted to reflect the effects of the 5%
stock dividends paid in September 2003 and 2002.
The following table sets forth the computation of basic and diluted earnings per
share (dollars in thousands, except per share amounts):
THREE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2003 2002
---------- -----------
Numerator:
Net income $ 1,514 $ 1,465
========== ==========
Denominator:
Denominator for basic per share-
weighted average shares 4,804,445 4,755,167
Effect of dilutive securities:
Stock options 191,285 58,841
---------- ----------
Denominator for diluted earnings
per share-adjusted weighted
average shares and assumed
Exercise 4,995,730 4,814,008
========== ==========
Basic earnings per share $ 0.32 $ 0.31
========== ==========
Diluted earnings per share $ 0.30 $ 0.30
========== ==========
The number of anti-dilutive stock options included was 138,285 and 119,923 for
the three-month periods ended September 30, 2003 and 2002, respectively.
7
NOTE 2 - LOANS RECEIVABLE
Loans receivable are summarized as follows (in thousands):
SEPTEMBER 30, June 30,
2003 2003
------------- ------------
First mortgage loans:
Residential real estate $84,586 $101,997
Construction-residential 21,846 22,877
Land acquisition and development 17,242 17,964
Commercial real estate 134,933 122,207
Construction-commercial 18,048 16,232
Commercial business 44,634 43,059
Consumer 105,460 88,918
------------- ------------
TOTAL LOANS 426,749 413,254
------------- ------------
Less:
Undisbursed loan proceeds:
Construction-residential (20,771) (22,359)
Construction-commercial (3,050) (3,585)
Deferred loan fees - net (794) (933)
Allowance for loan losses (5,774) (5,415)
------------- ------------
NET LOANS $396,360 $380,962
============= ============
NOTE 3 - ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that represents
management's best estimate of known and inherent losses, which are probable and
reasonably determinable based upon an evaluation of the loan portfolio.
Homogeneous portfolios of loans, which include residential mortgage, home equity
and other consumer loans, and commercial business loans less than $100,000 are
evaluated as a group. Commercial business loans greater than $100,000,
commercial mortgage and construction loans are evaluated individually. Specific
portions of the allowance are developed by analyzing individual loans for
adequacy of collateral, cash flow and other risks unique to that particular
loan. General portions of the allowance are developed by grading individual
loans in the commercial and construction portfolios and applying loss factors by
grade. The general portion of the allowance also includes loss factors applied
to the homogeneous portfolios as a group. The loss factors applied to graded
loans were developed based on the Company's loss history for loans with similar
attributes as well as input from the Company's primary banking regulators. Loss
factors are applied to homogeneous loans based upon prior loss experience of the
portfolio, delinquency trends, economic conditions as well as the volume of
non-performing loans. Although management believes it has used the best
information available to it in making such determinations, and that the present
allowance for loan losses is adequate, future adjustments to the allowance may
be necessary, and net income may be adversely affected if circumstances differ
substantially from the assumptions used in determining the level of the
allowance. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for losses
on loans. Such agencies may require the Bank to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination. The allowance is increased by the provision for loan
losses, which is charged to operations. Loan losses, other than those incurred
on loans held for sale, are charged directly against the allowance and
recoveries on previously charged-off loans are added to the allowance.
8
For purposes of applying the measurement criteria for impaired loans, the
Company excludes large groups of smaller balance homogeneous loans, primarily
consisting of residential real estate loans and consumer loans as well as
commercial business loans with balances of less than $100,000. For applicable
loans, the Company evaluates the need for impairment recognition when a loan
becomes non-accrual or earlier if, based on management's assessment of the
relevant facts and circumstances, it is probable that the Company will be unable
to collect all proceeds under the contractual terms of the loan agreement. At
September 30, 2003 and June 30, 2003, the recorded investment in impaired loans
was $3.8 million and $3.2 million, respectively. The Company's policy for the
recognition of interest income on impaired loans is the same as for non-accrual
loans: impaired loans are charged off when the Company determines that
foreclosure is probable and the fair value of the collateral is less than the
recorded investment of the impaired loan.
NOTE 4 - COMMITMENTS
Commitments to potential mortgagors of the Bank amounted to $7.0 million as of
September 30, 2003, of which $3.0 million were variable-rate loans. The balance
of the commitments represents $4.0 million fixed rate loans (primarily
consisting of single-family residential mortgages) bearing interest rates of
between 4.63% and 7.50%. At September 30, 2003, the Company had $23.8 million of
undisbursed construction loan funds as well as $65.1 million of undisbursed
remaining consumer and commercial line balances.
NOTE 5 - TRUST PREFERRED SECURITIES
On March 26, 2002, the Company issued $10.3 million of Junior Subordinated
Debentures to Chester Valley Statutory Trust, a Pennsylvania Business Trust, in
which the Company owns all of the common equity. The Trust then issued $10.0
million of Trust Preferred Securities to investors, which are secured by the
Junior Subordinated Debentures and the guarantee of the Company. The Junior
Subordinated Debentures are treated as debt of the Company but they qualify as
Tier I capital, subject to certain limitations under the risk-based capital
guidelines of the Federal Reserve. The Trust Preferred Securities are callable
by the Company on or after March 26, 2007, or at any time in the event the
deduction of related interest for federal income taxes is prohibited, the
treatment as Tier I capital is no longer permitted or under certain other
circumstances. The Trust Preferred Securities must be redeemed by the Company
upon their maturity date in the year 2032.
NOTE 6 - REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company's and the Bank's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors.
9
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
adjusted total assets (as defined). At September 30, 2003 and June 30, 2003 the
Bank was in compliance with all such requirements and is deemed a
"well-capitalized" institution for regulatory purposes. There are no conditions
or events since September 30, 2003 that management believes have changed the
institution's category.
The Bank's regulatory capital amounts and ratios are presented in the table as
follows (dollars in thousands):
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------- ------------------------ -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ---------- ----------- --------- ----------- ----------
AS OF SEPTEMBER 30, 2003:
HOLDING COMPANY
Total Capital
(to Risk-Weighted Assets) $66,077 14.71% $35,948 8.00% $44,935 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $60,458 13.45% $17,974 4.00% $26,961 6.00%
Tier 1 Capital
(to Average Assets) $60,458 10.36% $23,341 4.00% $29,176 5.00%
BANK
Total Capital
(to Risk-Weighted Assets) $62,250 13.88% $35,888 8.00% $44,860 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $56,640 12.63% $17,944 4.00% $26,916 6.00%
Tier 1 Capital
(to Average Assets) $56,640 9.77% $23,186 4.00% $28,983 5.00%
AS OF JUNE 30, 2003:
HOLDING COMPANY
Total Capital
(to Risk-Weighted Assets) $64,243 15.14% $33,950 8.00% $42,437 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $58,937 13.89% $16,975 4.00% $25,462 6.00%
Tier 1 Capital
(to Average Assets) $58,937 10.29% $22,903 4.00% $28,629 5.00%
BANK
TOTAL CAPITAL
(to Risk-Weighted Assets) $60,424 14.26% $33,901 8.00% $42,377 10.00%
Tier 1 Capital
(to Risk-Weighted Assets) $55,126 13.01% $16,951 4.00% $25,426 6.00%
Tier 1 Capital
(to Average Assets) $55,126 9.67% $22,814 4.00% $28,518 5.00%
10
NOTE 7 - ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
The Company may from time to time utilize derivative instruments such as
interest rate swaps, interest rate collars, interest rate floors, interest rate
swaptions or combinations thereof to assist in its asset/liability management.
At September 30, 2003, the Company was positively gapped whereby its
interest-earning assets were re-pricing at a quicker rate than its
interest-bearing liabilities. To partially offset the negative impact of the
current low market interest rate environment, the Company entered into three
separate interest rate swap transactions aggregating $41.0 million notional
amount to hedge certain of its higher rate Federal Home Loan Bank Advances. The
swaps had the effect of converting the higher fixed rate advances to lower
adjustable rate borrowings, which positively impacts the Company's net interest
margin in the current interest rate environment. Further, since the Company is
positively gapped, if the balance sheet were to remain static, future increases
should have similar impacts to the earnings and costs of the interest-earning
assets and interest-bearing liabilities. Additionally, in August 2003, the
Company purchased a $30.0 million notional amount 3.50% Three Month LIBOR
interest rate cap while simultaneously selling a $30.0 million notional amount
6.00% Three Month LIBOR interest rate cap ("Interest Rate Corridor"). The
Company paid a net premium, which entitles it to receive the difference between
Three Month LIBOR and 3.50% up to 6.00% times the $30.0 million notional amount.
The Interest Rate Corridor is being used to hedge the cash flows of $10.0
million in floating rate Trust Preferred Securities as well as the cash flows of
certain deposits, which could negatively impact earnings in a rising interest
rate environment.
The fair market value of the cap has two components: the intrinsic value and the
time value of the option. The cap is marked-to-market quarterly, with changes in
the intrinsic value of the cap, net of tax, included as a separate component of
other comprehensive income and change in the time value of the option included
directly as interest expense as required under SFAS 133. In addition, the
ineffective portion, if any, would have been expensed in the period in which
ineffectiveness was determined. The fair value of the interest rate cap at
September 30, 2003 was $646,400.
NOTE 8 - SEGMENT REPORTING
The Company has two reportable segments: First Financial and Phila. Corp. First
Financial operates a branch bank network with ten full-service banking offices
and provides primarily deposit and loan services to customers. Additionally, the
Bank offers trust services at its Downingtown headquarters and at Phila. Corp..
Phila. Corp. operates a full service investment advisory and securities
brokerage firm through two offices. Both segments operate in southeastern
Pennsylvania.
The Company evaluates performance based on profit or loss from operations before
income taxes not including nonrecurring gains and losses. There are no material
intersegment sales or transfers.
Phila. Corp. was acquired by the Company on May 29, 1998. Since such time, the
Company's reportable segments have been its two independent financial services
institutions.
11
The following table highlights income statement and balance sheet information
for each of the segments at or for September 30, 2003 and 2002:
AT AND DURING THE THREE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------------------------------------- ----------------------------------------
PHILA. PHILA.
BANK CORP. TOTAL BANK CORP. TOTAL
------------ ----------- ------------ ----------- ------------ ---------
Net interest
Income $ 4,706 $ 2 $ 4,708 $ 4,639 $ 4 $ 4,643
Other income 1,134 880 2,014 982 791 1,773
Total net income 1,422 92 1,514 1,377 88 1,465
Total assets 596,017 2,269 598,286 583,323 1,810 585,133
Total interest-
bearing deposits 11,574 1,861 13,435 32,370 1,537 33,907
NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - AMENDMENT OF STATEMENT 133
In April 2003, the FASB issued Statement No.149, Amendment of Statement No.133
on Derivative Instruments and Hedging Activities, which establishes accounting
and reporting standards for derivative instruments, including derivatives
imbedded in other contracts and hedging activities. This Statement amends
Statement No. 133 for decisions made by the FASB as part of its Derivatives
Implementation Group process. This Statement also amends Statement No. 133 to
incorporate clarifications of the definition of a derivative. The Statement is
effective for contracts entered into or modified and hedging relationships
designated after June 30, 2003. The provisions of this Statement did not have a
material impact on the Company's consolidated earnings, financial condition or
equity.
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY
In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Some of the provisions of
this Statement are consistent with the current definition of liabilities in FASB
Concepts Statement No. 6, Elements of Financial Statements. The remaining
provisions of this Statement are consistent with the FASB's proposal to revise
that definition to encompass certain obligations that a reporting entity can or
must settle by issuing its own equity shares, depending on the nature of the
relationship established between the holder and the issuer. Effective for
financial instruments entered into or modified after May 31, 2003 and otherwise,
is effective at the beginning of the first interim period after June 15, 2003.
The adoption of this Statement did not have an impact on the Company's financial
position or results of operations.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
In this Form 10-Q, the Company has included certain "forward looking
statements", either express or implied, which concern anticipated future
operations of the Company. It is management's desire to take advantage of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. This statement is for the express purpose of availing the Company of the
protections of such safe harbor with respect to all "forward looking statements"
contained in this Form 10-Q. The Company has used "forward looking statements"
to describe certain of its future plans and strategies including management's
current expectations of the Company's future financial results. Management's
ability to predict results or the effect of future plans and strategy involve
certain risks, uncertainties, estimates, and assumptions, which are subject to
factors beyond the Company's control. Consequently, the Company's actual results
could differ materially from management's expectations. Factors that could
affect results include, but are not limited to, interest rate trends, loan
delinquency rates, changes in federal and state banking regulations,
competition, the general economic climate in Chester County, the mid-Atlantic
region and the country as a whole, and other uncertainties described in the
Company's filings with the Securities and Exchange Commission, including this
Form 10-Q. These factors should be considered in evaluating the "forward looking
statements", and undue reliance should not be placed on such statements. The
Company undertakes no obligation to update or revise any forward-looking
statements, whether written or oral that may be made from time to time by or on
the Company's behalf.
GENERAL
The Company's results of operations depend largely on its net interest income,
which is the difference between interest income on interest-earning assets,
which consists principally of loans and investment securities, and interest
expense on interest-bearing liabilities, which consist primarily of deposits and
borrowings. Net interest income is determined by the Company's interest rate
spread (the difference between the yields earned on its interest-earning assets
and the rates paid on its interest-bearing liabilities) and the relative amounts
of interest-earning assets and interest-bearing liabilities.
The Company's results of operations also are affected by the provision for loan
losses resulting from management's assessment of the allowance for loan losses;
the level of its non-interest income, including investment service fees, loan
and deposit service fees and related income, and gains and losses from the sales
of loans and securities; the level of its non-interest expense, including
salaries and employee benefits, occupancy and equipment expense, data processing
services, deposit insurance premiums, advertising, other operating costs; and
income tax expense.
The Bank is a community-oriented bank, which emphasizes customer service and
convenience. As part of this strategy, the Bank offers products and services
designed to meet the needs of its customers. The Company generally has sought to
achieve long-term financial growth and strength by increasing the amount and
stability of its net interest income and non-interest income and by maintaining
a high level of asset quality. In pursuit of these goals, the Company has
adopted a business strategy emphasizing growth in basic financial services. The
focus is on expanding its commercial and construction lending activities,
increasing its commercial deposits and treasury management, consumer deposits
and loans as well as expanding its trust and investment management services.
13
BUSINESS STRATEGY
GROWTH. The Company seeks to increase its assets primarily through internal
growth and by expanding its operations.
The two primary objectives of the Company's strategic plan are to increase
loans, in particular commercial business and real estate and construction loans,
consumer loans and core deposits (consisting of all deposits other than
certificates of deposits). The Company's net loans increased by $15.4 million,
or 4.04%, from $381.0 million at June 30, 2002 to $396.4 million at September
30, 2003. The growth of core deposits was $15.4 million, or 6.1%, from $254.0
million at June 30, 2003 to $269.4 million at September 30, 2003.
EMPHASIS ON COMMERCIAL LENDING. The Company has been and will continue to seek
to increase its higher yielding portfolios of commercial real estate and
commercial business loans. The Company's commercial real estate, commercial
business and construction and land acquisition loans comprised in the aggregate
55.5% of its total loan portfolio at September 30, 2003 compared to 53.8% at
June 30, 2003. Single-family and multi-family residential loans comprised 19.8%
of the Company's loan portfolio at September 30, 2003 as compared to 24.7% at
June 30, 2003.
MAINTAIN LOAN QUALITY. Management believes that maintaining high loan quality is
key to achieving and sustaining long-term financial success. Accordingly, the
Company has sought to maintain a high level of loan quality and moderate credit
risk by using underwriting standards which management believes are conservative
and by generally limiting its lending activity to the origination of loans
secured by property located in its market area. The Company's non-accrual loans
increased to $4.6 million at September 30, 2003 compared to $4.2 million at June
30, 2003. Included in the totals at both dates is a single commercial real
estate loan in the amount of $3.0 million. Although the loan is current in the
payment of interest as it has been due and the next quarterly payment is backed
by a letter of credit from an independent bank, the loan was placed on
non-accrual as principal was not repaid in accordance with the original stated
maturity, the borrower has encountered financial difficulties, the underlying
real estate is outside the Bank's primary lending area and repayment is
dependent upon factors not under the complete control of the borrower. The
increase of non-accrual loans of $400,000 from June 30, 2003 is attributed to a
single borrower who is current in his debt service payments but has encountered
financial difficulties. The loan was placed on non-accrual and payments received
are being applied to reduce principal, as the underlying collateral may be
insufficient to cover the principal balance of the loans.
STABLE SOURCE OF LIQUIDITY. The Company purchases investment securities that
management believes to be appropriate for liquidity, yield and credit quality in
order to achieve a managed and more predictable source of liquidity to meet loan
demand and, to a lesser extent, a stable source of interest income. The
portfolio totaled, in the aggregate, $143.9 million at September 30, 2003
compared to $147.6 million at June 30, 2003. This decrease was largely due to
accelerated principal repayment within the mortgage-backed security portfolio.
In addition, the Company had short-term interest-bearing deposits of $13.4
million at September 30, 2003 compared to $9.4 million at June 30, 2003.
14
EMPHASIS ON DEPOSITS AND CUSTOMER SERVICE. The Company, as a community-based
financial institution, is largely dependent upon its base of competitively
priced core deposits to provide a stable source of funding. The Company has
retained many loyal customers over the years through a combination of high
quality service, competitively priced service fees, customer convenience, an
experienced staff and a strong commitment to the communities in which it serves.
Lower costing core deposits totaled $269.4 million or 67.6% of the Company's
total deposits at September 30, 2003, as compared to $254.0 million or 63.4% at
June 30, 2003. This increase in lower costing deposits is primarily attributable
to the continuing effort to grow core deposits. Pursuant to the Company's
strategy, the major focus in 2004 is on increasing commercial and consumer core
deposits and relying less on higher rate certificates of deposits. In addition,
the Company has not used brokered deposits as a source of funds and presently
has no plans to do so in the future.
ASSET/LIABILITY MANAGEMENT
The primary asset/liability management goal of the Company is to manage and
control its interest rate risk of the bank subsidiary, thereby reducing its
exposure to fluctuations in interest rates, and achieving sustainable growth in
net interest income over the long term. Other objectives of asset/liability
management include: (1) ensuring adequate liquidity and funding, (2) maintaining
a strong capital base and (3) maximizing net interest income opportunities.
In general, interest rate risk is mitigated by closely matching the maturities
or repricing periods of interest-sensitive assets and liabilities to ensure a
favorable interest rate spread. Management regularly reviews the Bank's
interest-rate sensitivity, and uses a variety of strategies as needed to adjust
that sensitivity within acceptable tolerance ranges established by the Board of
Directors. Changing the relative proportions of fixed-rate and adjustable-rate
assets and liabilities is one of the primary strategies utilized by the Company
to accomplish this objective.
The Company may from time to time utilize derivative instruments such as
interest rate swaps, interest rate collars, interest rate floors, interest rate
swaptions or combinations thereof to assist in its asset/liability management.
At September 30, 2003, the Company was positively gapped whereby its
interest-earning assets were re-pricing at a quicker rate than its
interest-bearing liabilities. To partially offset the negative impact of the
current low market interest rate environment, the Company entered into three
separate interest rate swap transactions aggregating $41.0 million notional
amount interest rate swap transaction to hedge certain of its higher rate
Federal Home Loan Bank Advances. The swaps had the effect of converting the
higher fixed rate advances to lower adjustable rate borrowings, which positively
impacts the Company's net interest margin in the current interest rate
environment. Further, since the Company is positively gapped, if the balance
sheet were to remain static, future increases should have similar impacts to the
earnings and costs of the interest-earning assets and interest-bearing
liabilities. Additionally, in August 2003, the Company purchased a $30.0 million
notional amount 3.50% Three Month LIBOR interest rate cap while simultaneously
selling a $30.0 million notional amount 6.00% Three Month LIBOR interest rate
cap ("Interest Rate Corridor"). The Company paid a net premium, which entitles
it to receive the difference between Three Month LIBOR and 3.50% up to 6.00%
times the $30.0 million notional amount. The Interest Rate Corridor is being
used to hedge the cash flows of $10.0 million in floating rate Trust Preferred
Securities as well as the cash flows of certain deposits, which could negatively
impact earnings in a rising interest rate environment.
15
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest-rate sensitive" and by
monitoring an institution's interest-sensitivity gap. An interest-sensitivity
gap is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities repricing within a
defined period and is considered negative when the amount of interest-rate
sensitive liabilities exceeds the amount of interest-rate sensitive assets
repricing within a defined period.
To provide a more accurate one-year gap position of the Company, certain deposit
classifications are based on the interest-rate sensitive attributes and not on
the contractual repricing characteristics of these deposits. Management
estimates, based on historical trends of the Bank's deposit accounts, that money
market, NOW accounts and savings deposits are sensitive to interest rate
changes. Accordingly, the interest-sensitive portions of these deposits are
classified in the less than one-year categories with the remainder in the over
five years category. Deposit products with interest rates based on a particular
index are classified according to the specific repricing characteristic of the
index. Deposit rates other than time deposit rates are variable, and changes in
deposit rates are typically subject to local market conditions and management's
discretion and are not indexed to any particular rate. The Interest Rate
Sensitivity Analysis at September 30, 2003 is on page 23.
Generally, during a period of rising interest rates, a positive gap would result
in an increase in net interest income while a negative gap would adversely
affect net interest income. However, the interest-sensitivity table on page 23
does not provide a comprehensive representation of the impact of interest rate
changes on net interest income. Each category of assets or liabilities will not
be affected equally or simultaneously by changes in the general level of
interest rates. Even assets and liabilities, which contractually reprice within
the same period may not, in fact, reprice at the same price or the same time or
with the same frequency. It is also important to consider that the table
represents a specific point in time. Variations can occur as the Company adjusts
its interest-sensitivity position for the Bank throughout the year.
FINANCIAL CONDITION
-------------------
The Company's total assets increased to $598.3 million at September 30, 2003
from $584.5 million at June 30, 2003, principally due to a $15.4 million
increase in loans receivable to $396.4 million at September 30, 2003 from $381.0
million at June 30, 2003. In line with its strategy, the growth occurred
principally in the consumer and commercial loan portfolios. Residential mortgage
loans as a percentage of total loans was reduced from 24.7% at June 30, 2003 to
19.8% at September 30, 2003. The loan growth was partially offset by a $3.7
million decrease in investment securities due largely to accelerated principal
repayments within the mortgage-backed security portfolio.
Deposits decreased by $1.8 million as higher rate municipal and retail
certificates of deposit totaling $17.2 million matured and were partially
replaced by money market and demand deposits aggregating $15.4 million. Federal
Home Loan Bank Advances increased $17.7 million to fund the above noted asset
growth as well as the net decrease in deposits.
Stockholders' equity increased by $342,000 at September 30, 2003 as compared to
June 30, 2003, primarily as a result of net income of $1.5 million and the
issuance of common stock as a result of the exercise of stock options of
$472,000. These were partially offset by the payment of cash dividends of
$457,000 and a change in accumulated other comprehensive income of $1.2 million
related to unrealized losses on securities available for sale, net of tax.
16
RESULTS OF OPERATIONS
---------------------
INTEREST INCOME AND INTEREST SPREAD ANALYSIS
- --------------------------------------------
The following table sets forth, for the periods indicated, information on a tax
equivalent basis regarding (1) the total dollar amount of interest income of the
Company from interest-earning assets and the resultant average yields; (2) the
total dollar amount of interest expense on interest-bearing liabilities and the
resultant average cost; (3) net interest income; (4) interest rate spread; and
(5) net interest-earning assets and their net yield. Average balances are
determined on a daily basis.
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------
2003 2002
-------------------------------- --------------------------------
(DOLLARS IN THOUSANDS)
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
--------- --------- -------- --------- --------- -------
ASSETS:
Loans and loans held for sale (1) $ 398,650 $ 6,108 6.13% $ 372,994 $ 6,631 7.11%
Securities and other investments (1) 154,281 1,496 3.88% 174,157 1,982 4.55%
--------- --------- -------- --------- --------- -------
Total interest-earning assets (1) 552,931 7,604 5.50% 547,151 8,613 6.30%
--------- ---------
Non-interest earning assets 41,552 36,566
--------- ---------
TOTAL ASSETS $ 594,483 $ 583,717
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits and repurchase agreements (2) $ 422,610 1,462 1.38% $ 410,052 2,292 2.22%
FHLB advances and other borrowings (2) 111,551 1,257 4.48% 112,293 1,485 5.25%
--------- --------- -------- --------- --------- -------
TOTAL INTEREST-BEARING LIABILITIES (2) 534,161 2,719 2.03% 522,345 3,777 2.87%
--------- --------- -------- --------- --------- -------
Non-interest-bearing liabilities 10,886 16,174
Stockholders' equity 49,436 45,198
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 594,483 $ 583,717
========= =========
NET INTEREST INCOME/INTEREST RATE SPREAD $ 4,885 3.47% $ 4,836 3.43%
========= ======== ========= =======
NET INTEREST INCOME/AVERAGE
INTEREST-EARNING ASSETS (2) $ 18,770 3.51% $ 24,806 3.51%
========= ======== ========= =======
RATIO OF AVERAGE INTEREST-EARNING ASSETS TO
INTEREST-BEARING LIABILITIES 104% 105%
======== =======
(1) Yield calculated using 30/360 day basis.
(2) Yield calculated based on the actual number of days.
The following details the tax equivalent adjustments in the above table:
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------
2003 2002
----------------------------------------- ---------------------------------------
INTEREST TAX ADJUSTED INTEREST TAX ADJUSTED
INCOME ADJUSTMENT INCOME INCOME ADJUSTMENT INCOME
----------------------------------------- ---------------------------------------
(Dollars in thousands)
Loans $ 6,094 $ 14 $ 6,108 $ 6,612 $ 19 $ 6,631
Investments 1,333 163 1,496 1,808 174 1,982
-------------------------------------- --------------------------------------
Total $ 7,427 $ 177 $ 7,604 $ 8,420 $ 193 $ 8,613
====================================== ======================================
17
RATE/VOLUME ANALYSIS
The following table presents certain information regarding changes in interest
income and interest expense of the Company for the periods indicated. Interest
income and the annual rate are calculated on a taxable equivalent basis using
the Federal marginal income tax rate of 34% adjusted for the 20% interest
expense disallowance resulting in an effective tax rate of 27.2%. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided with respect to changes attributable to (1) changes in
volume (change in volume multiplied by old rate), (2) changes in rate (change in
rate multiplied by old volume) and (3) changes in rate/volume (change in rate
multiplied by change in volume). The changes in rate/volume are allocated to the
change in volume variance and the change in the rate variance on a pro rata
basis.
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------------
2003 COMPARED TO 2002 2002 COMPARED TO 2001
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
------------------------------ ------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------------------------------ ------------------------------
(Dollars in thousands)
Interest income on interest-earning assets:
Loans and loans held for sale $ 2,256 $(2,779) $ (523) $ 1,969 $(2,176) $ (207)
Securities and other investments (207) (279) (486) 176 (776) (600)
------------------------------- -------------------------------
Total interest income 2,049 (3,058) (1,009) 2,145 (2,952) (807)
------------------------------- -------------------------------
Interest expense on interest-bearing liabilities:
Deposits and repurchase
agreements 443 (1,273) (830) (32) (1,408) (1,440)
FHLB advances and other
borrowings (12) (216) (228) 1,008 (710) 298
------------------------------- -------------------------------
Total interest expense 431 (1,489) (1,058) 976 (2,118) (1,142)
------------------------------- -------------------------------
Net change in net interest income $ 1,618 $(1,569) $ 49 $ 1,169 $ (834) $ 335
=============================== ===============================
Net interest income, on a fully tax equivalent basis, increased $49,000 or 1%
for the three-month period ended September 30, 2003, compared to the same period
in 2002. The net interest margin was stable at 3.51% for both periods. Total
interest income, on a fully tax equivalent basis, decreased 11.6% to $7.6
million for the three-month period ended September 30, 2003, from $8.6 million
for the same period in 2002, primarily as a result of declining market interest
rates during the year which was partially offset by an increase in average
interest-earning assets of $5.8 million.
Total interest expense decreased 28.9% to $2.7 million from $3.8 million for the
three month periods ended September 30, 2003 and September 30, 2002,
respectively. The decline is due largely to (a) general decline in market
interest rates over the twelve month period, (b) a change in the mix of the
deposit base from higher costing certificates of deposits to core deposits
(Demand deposits, Savings and Money Market Accounts) and (c) the conversion of
approximately $41.0 million of high costing fixed rate Federal Home Loan Bank
Advances to lower costing variable rates through the use of interest rate swaps
entered into during the period June 2003 through August 2003. Offsetting part of
the decrease was an increase in the average balance of interest-bearing
liabilities of $11.8 million to $534.2 million.
PROVISION FOR LOAN LOSSES
The provision for loan losses increased by $239,000, or 169.5%, for the
three-months ended September 30, 2003 to $380,000 as compared to $141,000 for
the three-months ended September 30, 2002. The increase is due principally to
growth in the loan portfolio as well as a change in the mix of the portfolio.
18
OTHER INCOME
Total other income increased $241,000 or 13.6% for the three-months ended
September 30, 2003 compared to the three-months ended September 30, 2002. The
increase is due principally to (a) $92,000 increase in investment services
income from Uvest and Phila. Corp.'s revenues increased as brokerage
transactions increased year over year, (b) loan and deposit fees increased
$57,000 due primarily to a larger core deposit base and (c) increased gains on
the sale of loans due to an increase in the volume of loan sales.
OPERATING EXPENSES
Total operating expenses increased by $66,000 or 1.5% for the three-months ended
September 30, 2003 as compared to the three-months ended September 30, 2002.
Increases in expenses associated with checking accounts and other core deposits
as well as legal expense associated with a Corporate Governance review were
offset by small declines in compensation and employee benefits, data processing
and deposit insurance premiums.
INCOME TAX EXPENSE
Income tax expense declined by $48,000 for the three-month period ended
September 30, 2003 as compared to the three-month period ended September 30,
2002 due to a reduction in the effective tax rate from 25.0% to 22.6% from
September 30, 2002 to September 30, 2003. The reduction is the result of higher
percentage of the Company's income before taxes being derived from tax-exempt
investments as well as various federal tax credits received by the Company.
ASSET QUALITY
Non-performing loans totaled $4.6 million and $4.2 million at September 30, 2003
and June 30, 2003, respectively. It is the policy of the Company to discontinue
the accrual of interest when principal or interest payments are delinquent 90
days or more (unless the loan principal and interest are determined by
management to be fully secured and in the process of collection), or earlier, if
the financial condition of the borrower raises significant concern with regard
to the ability of the borrower to service the debt in accordance with the
current loan terms. Interest income is not accrued until the financial condition
and payment record of the borrower clearly demonstrates the borrower's ability
to service the debt. Included in the totals at both dates is a single commercial
real estate loan in the amount of $3.0 million. Although the loan is current in
the payment of interest as it has been due and the next quarterly payment is
backed by a letter of credit from an independent bank, the loan was placed on
non-accrual as principal was not repaid in accordance with the original stated
maturity, the borrower has encountered financial difficulties, the underlying
real estate is outside the Bank's primary lending area and repayment is
dependent upon factors not under the complete control of the borrower. The
increase of non-accrual loans of $400,000 from June 30, 2003 is attributed to a
single borrower who is current in his debt service payments but has encountered
financial difficulties. The loan was placed on non-accrual and payments received
are being applied to reduce principal, as the underlying collateral may be
insufficient to cover the principal balance of the loans.
19
At September 30, 2003 and June 30, 2003, the Company's classified loans, which
consisted of loans classified as substandard, doubtful or loss totaled $10.1
million and $10.4 million, respectively. Included in loans classified
substandard at September 30, 2003 and June 30, 2003, were all loans 90 days past
due and loans which were less than 90 days delinquent but inadequately protected
by the current paying capacity of the borrower or of the collateral pledged, or
which were subject to one or more well-defined weaknesses which may jeopardize
the satisfaction of the debt. Also included in classified loans at September 30,
2003 were loans totaling $8.9 million, which are current but have been listed as
substandard and are being closely monitored.
At September 30, 2003, in addition to classified loans, classified assets
include three (four at June 30, 2003) Non-rated Pennsylvania Municipal Authority
Bonds that have been classified as substandard. These bonds were originally
purchased during the period from June 1998 through June 2000. The aggregate book
value of the bonds at September 30, 2003 is $5.8 million ($7.0 million at June
30, 2003). Two of the three bonds with an aggregate book value of $4.7 million
are zero coupon bonds with maturities extending up to 2034. Both bonds are
secured by the revenue streams of commercial office buildings, which are leased
to various agencies of the Commonwealth of Pennsylvania under long-term lease
arrangements with renewal options.
A third bond was issued by the Housing Authority of Chester County and has a
book balance of $1.1 million at an interest rate of 6% and final maturity in
June 2019. This bond involves low-income scattered housing in Chester County
under a program of the Office of Housing and Urban Development ("HUD"). HUD has
committed to provide additional funds to build additional houses, which would be
donated to this bond issues. The retirement of the bond issue is dependent upon
proceeds from either the rental or sale of the existing and additional houses.
This bond is on non-accrual at June 30, 2003
The fourth bond was sold in September 2003 resulting in a net after tax loss of
approximately $51,000.
LIQUIDITY AND CAPITAL RESOURCES
Management monitors liquidity daily and maintains funding sources to meet
unforeseen changes in cash requirements. The Company's primary sources of funds
are deposits, borrowings, repayments, prepayments and maturities of outstanding
loans and mortgage-backed securities, sales of assets available for sale,
maturities of investment securities and other short-term investments, and funds
provided from operations. While scheduled loan and mortgage-backed securities
repayments and maturing investment securities and short-term investments are
relatively predictable sources of funds, deposit flows and loan prepayments are
greatly influenced by the movement of interest rates in general, economic
conditions and competition. The Company manages the pricing of its deposits to
maintain a deposit balance deemed appropriate and desirable. Although the
Company's deposits represent the majority of its total liabilities, the Company
has also utilized other borrowing sources, namely Federal Home Loan Bank
advances.
Liquidity management is both a daily and long-term function. Excess liquidity is
generally invested in short-term investments such as Federal Home Loan Bank
overnight deposits. On a longer-term basis, the Company maintains a strategy of
investing in various lending and investment securities products. The Company
uses its sources of funds to primarily fund loan commitments and maintain a
substantial portfolio of investment securities, and to meet its ongoing
commitments to pay maturing savings certificates and other deposits. At
September 30, 2003, the Company had $7.0 million in commitments to fund loan
originations. In addition, at such date the Company had undisbursed loans in
process for construction loans of $23.8 million and $65.1 million in undisbursed
lines of credit. Management of the Company believes that the Company has
adequate resources, including principal prepayments and repayments of loans and
investment securities and borrowing capacity, to fund all of its commitments to
the extent required.
20
The Company's current dividend policy is to declare a regular quarterly dividend
with the intent that the level of the dividend per share be reviewed and
determined by the Board of Directors on a quarterly basis. Dividends will be in
the form of cash and/or stock after giving consideration to all aspects of the
Company's performance for the current and prior quarter and other relevant
aspects. On August 14, 2003, the Board of Directors declared a 5% stock dividend
and a quarterly cash dividend of $.10 per share, both of which were paid on
September 15, 2003. Cash dividends from the Holding Company are primarily
dependent upon dividends paid to it by First Financial, which, in turn, are
subject to certain restrictions established by federal regulators and
Pennsylvania law.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises primarily from the interest rate risk inherent
in its lending, investments and deposit taking activities. To that end,
management actively monitors and manages its interest rate risk exposure. At
September 30, 2003, the Company's management believes that the interest rate
exposure has not significantly changed since disclosed at June 30, 2003.
The primary asset/liability management goal of the Company is to manage and
control its interest rate risk, thereby reducing its exposure to fluctuations in
interest rates, and achieving sustainable growth in net interest income over the
long term. Other objectives of asset/liability management include: (1) ensuring
adequate liquidity and funding, (2) maintaining a strong capital base and (3)
maximizing net interest income opportunities.
In general, interest rate risk is mitigated by closely matching the maturities
or repricing periods of interest-sensitive assets and liabilities to ensure a
favorable interest rate spread. Management regularly reviews the Company's
interest-rate sensitivity, and uses a variety of strategies as needed to adjust
that sensitivity within acceptable tolerance ranges established by management.
Changing the relative proportions of fixed-rate and adjustable-rate assets and
liabilities is one of the primary strategies utilized by the Company to
accomplish this objective.
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest-rate sensitive" and by
monitoring an institution's interest-sensitivity gap. An interest-sensitivity
gap is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities repricing within a
defined period and is considered negative when the amount of interest-rate
sensitive liabilities exceeds the amount of interest-rate sensitive assets
repricing within a defined period.
To provide a more accurate one-year gap position of the Company, certain deposit
classifications are based on the interest-rate sensitive attributes and not on
the contractual repricing characteristics of these deposits. Management
estimates, based on historical trends of the Bank's deposit accounts, that money
market, NOW and savings deposits are sensitive to interest rate changes.
Accordingly, some of the interest sensitive portions of such liabilities are
classified in the less than one-year categories with the remainder placed in the
other categories. Deposit products with interest rates based on a particular
index are classified according to the specific repricing characteristic of the
index. Deposit rates other than time deposit rates are variable, and changes in
deposit rates are typically subject to local market conditions and management's
discretion and are not indexed to any particular rate.
21
Generally, during a period of rising interest rates, a positive gap would result
in an increase in net interest income while a negative gap would adversely
affect net interest income. However, the interest sensitivity table does not
provide a comprehensive representation of the impact of interest rate changes on
net interest income. Each category of assets or liabilities will not be affected
equally or simultaneously by changes in the general level of interest rates.
Even assets and liabilities, which contractually reprice within the same period
may not, in fact, reprice at the same price or the same time or with the same
frequency. It is also important to consider that the table represents a specific
point in time. Variations can occur as the Company adjusts its interest
sensitivity position throughout the year. Although interest rate sensitivity gap
is a useful measurement and contributes towards effective asset/liability
management, it is difficult to predict the effect of changing interest rates
solely on that measure. An alternative methodology is to estimate the changes in
the Company's portfolio equity over a range of interest rate scenarios.
The Company periodically identifies certain loans as held for sale at the time
of origination, primarily consisting of fixed-rate, single-family residential
mortgage loans which meet the underwriting characteristics of certain
government-sponsored enterprises (conforming loans). The Company regularly
re-evaluates its policy and revises it as deemed necessary. The majority of
loans sold to date have consisted of sales to Freddie Mac of whole loans and 95%
participation interests in long-term, fixed-rate, single-family residential
mortgage loans in furtherance of the Company's goal of better matching the
maturities and interest-rate sensitivity of its assets and liabilities. When
selling loans, the Company has generally retained servicing in order to increase
its non-interest income. At September 30, 2003, the Company serviced $4.1
million of mortgage loans for others. Sales of loans produce future servicing
income and provide funds for additional lending and other purposes.
The following is an interest rate sensitivity analysis for the Bank at September
30, 2003:
22
INTEREST RATE SENSITIVITY ANALYSIS AT SEPTEMBER 30, 2003
(Dollars in thousands)
MORE THAN MORE THAN MORE THAN
THREE MONTHS SIX MONTHS ONE YEAR
THREE MONTHS THROUGH THROUGH THROUGH
OR LESS SIX MONTHS ONE YEAR THREE YEARS
-------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Loans: (1)
Real estate (2) $ 80,678 $ 21,736 $ 39,094 $ 63,299
Commercial business 33,198 1,407 2,434 5,698
Consumer 42,685 5,652 9,728 18,135
Securities and interest-bearing deposits (3) 51,153 5,037 9,446 34,033
-------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS $207,714 $ 33,832 $ 60,702 $121,165
-------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 1,517 $ 1,518 $ 3,038 $ 12,188
NOW accounts 1,550 1,551 3,104 12,451
Money market accounts 93,073 1,553 3,115 9,171
Certificate accounts 36,139 24,971 22,683 27,374
Repo sweep 26,164 -- -- --
Borrowings 43,575 257 2,023 20,263
-------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES $202,018 $ 29,850 $ 33,963 $ 81,447
-------------------------------------------------------------------------------
Cumulative (deficit) excess of interest-earning $ 5,696 $ 9,678 $ 33,963 $ 76,135
to interest-bearing liabilities
===============================================================================
Cumulative ratio of interest rate-sensitive
assets to interest rate-sensitive liabilities 102.8% 104.2% 113.7% 121.9%
===============================================================================
CUMULATIVE DIFFERENCE AS A PERCENTAGE OF
TOTAL ASSETS 1.0% 1.6% 6.1% 12.8%
===============================================================================
MORE THAN
THREE YEARS
THROUGH MORE THAN
FIVE YEARS FIVE YEARS TOTAL
-------------------------------------------------
INTEREST-EARNING ASSETS:
Loans: (1)
Real estate (2) $ 39,710 $ 11,921 $256,438
Commercial business 1,897 -- 44,634
Consumer 9,701 19,559 105,460
Securities and interest-bearing deposits (3) 9,672 45,816 155,157
------------------------------------------------
TOTAL INTEREST-EARNING ASSETS $ 60,980 $ 77,296 $561,689
------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 12,245 $ -- $30,506
NOW accounts 12,507 31,515 62,678
Money market accounts 5,867 -- 112,779
Certificate accounts 12,698 5,521 129,386
Repo sweep -- -- 26,164
Borrowings 15,290 30,347 111,755
------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES $ 58,607 $ 67,383 $473,268
------------------------------------------------
Cumulative (deficit) excess of interest-earning $ 78,508 $ 88,421 $ 88,421
to interest-bearing liabilities
================================================
Cumulative ratio of interest rate-sensitive
assets to interest rate-sensitive liabilities 119.3% 118.7% 118.7%
================================================
CUMULATIVE DIFFERENCE AS A PERCENTAGE OF
TOTAL ASSETS 13.2% 14.9% 14.9%
================================================
(1) Net of undisbursed loan proceeds.
(2) Includes commercial mortgage loans.
(3) Excludes SFAS 115 available for sale adjustment.
Certain shortcomings are inherent in the method of analysis presented in
the table above. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in
different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance
of changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. Additionally, certain assets, such
as adjustable-rate loans, have features, which restrict changes in interest
rates both on a short-term basis and over the life of the asset. Further,
in the event of changes in interest rates, prepayment and early withdrawal
levels would likely deviate significantly from those assumed in calculating
the table. Finally, the ability of many borrowers to service their
adjustable-rate loans may decrease in the event of an interest rate
increase.
23
ITEM 4. CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS
Within the 90 days prior to the date of this Quarterly Report on Form 10-Q, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" ("Disclosure Controls") in accordance with
the provisions of Rules 13a-14 and 13a-15 of the Securities Exchange Act of 1934
(the "Exchange Act"). This evaluation ("Controls Evaluation") was done under the
supervision and with the participation of management, including the Chief
Executive Officer ("CEO") and Chief Financial Officer ("CFO").
Disclosure Controls are the Company's controls and other procedures that are
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by the Company in the reports that it files under the Exchange
Act is accumulated and communicated to the Company's management, including its
CEO and CFO, as appropriate to allow timely decisions regarding required
disclosure.
Based upon the Controls Evaluation, the CEO and CFO have concluded that the
Disclosure Controls are effective to timely alert management to material
information relating to the Company, including its consolidated subsidiaries,
during the period for which its periodic reports are being prepared.
In accord with SEC requirements, the CEO and CFO note that, since the date of
the Controls Evaluation to the date of this Quarterly Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in other routine, non-material legal
proceedings occurring in the ordinary course of business which
management believes will not have a material adverse effect on the
financial condition or operations of the Company.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Reports on Form 8-K
(1) Form 8K, filed July 23, 2003 - Results of Operations
and Financial Condition at June 30, 2003 (Items 7
and 9).
(b) The following exhibits are filed as part of this
Form 10-Q.
INDEX TO EXHIBITS
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14 of the Securities Exchange Act of 1934, as amended, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 dated November 12, 2003
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14 of the Securities Exchange Act of 1934, as amended, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 dated November 12, 2003
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 dated November 12, 2003
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 dated November 12, 2003
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Chester Valley Bancorp Inc.
Date 11/13/03 /s/ Donna M. Coughey
----------------------------- --------------------------------------
Donna M. Coughey
President and Chief Executive Officer
Date 11/13/03 /s/ Joseph T. Crowley
----------------------------- --------------------------------------
Joseph T. Crowley
CFO and Treasurer
26