FIDELITY D & D BANCORP INC - Quarter Report: 2003 June (Form 10-Q)
COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED JUNE 30, 2003
COMMISSION FILE NUMBER: 333-90273
FIDELITY D & D BANCORP, INC.
| STATE OF INCORPORATION | IRS EMPLOYER IDENTIFICATION NO: |
| PENNSYLVANIA | 23-3017653 |
BLAKELY & DRINKER ST.
DUNMORE, PENNSYLVANIA 18512
TELEPHONE:
570-342-8281
The Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
The Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)
The number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc. at July 31, 2003, the latest practicable date was 1,815,729 shares.
DUNMORE, PA 18512
FORM 10-Q JUNE 30, 2003
INDEX
PART I. FINANCIAL INFORMATION Page
----
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheet as of June 30, 2003
and December 31, 2002 3
Consolidated Statement of Income for the three and six
months ended June 30, 2003 and 2002 4
Consolidated Statement of Changes in Shareholders' Equity
for the six months ended June 30, 2003 and 2002 5
Consolidated Statement of Cash Flows for the six months
ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk 22
ITEM 4. Controls and Procedures 26
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 27
ITEM 2. Change in Securities and Use of Proceeds 27
ITEM 3. Defaults upon Senior Securities 27
ITEM 4. Submission of Matters to a Vote of Security Holder 27
ITEM 5. Other Information 27
ITEM 6. Exhibits and Reports on Form 8-K 28
Signatures 29
Certifications 30
Exhibit Index 32
CONSOLIDATED BALANCE SHEET
As of June 30, 2003 and December 31, 2002
June 30, 2003 December 31, 2002
(unaudited) (audited)
----------- ---------
ASSETS
Cash and due from banks $ 21,614,767 $ 18,763,322
Federal funds sold 11,000,000 -
Interest bearing deposits with financial institutions 561,389 7,455,925
-------- ---------
Total cash and cash equivalents 33,176,156 26,219,247
Available-for-sale securities 136,336,655 137,770,804
Held-to-maturity securities 7,822,090 11,778,803
Loans available-for-sale (fair value approximates $30,427,000
and $29,660,000 in 2003 and 2002, respectively) 29,352,040 28,715,355
Loans and leases, net of allowance for loan losses of
$3,782,125 and $3,899,753 in 2003 and 2002, respectively 354,033,147 354,262,050
Premises and equipment, net 12,552,591 12,735,201
Accrued interest receivable 2,371,387 2,347,332
Foreclosed assets held for sale 255,905 436,932
Life insurance cash surrender value 7,111,473 -
Other assets 2,769,323 3,723,512
---------- ---------
Total assets $ 585,780,767 $ 577,989,236
============== =============
LIABILITIES
Deposits
Noninterest-bearing $ 62,039,356 $ 61,151,465
Certificates of deposit of $100,000 or more 149,961,441 129,486,498
Other interest-bearing deposits 220,596,815 223,150,213
------------ -----------
Total deposits 432,597,612 413,788,176
Securities sold under repurchase agreements 39,214,894 47,231,946
Short-term borrowings 1,060,547 3,981,068
Long-term debt 63,000,000 63,000,000
Accrued expenses and other liabilities 4,263,484 4,753,613
---------- ---------
Total liabilities 540,136,537 532,754,803
------------ -----------
SHAREHOLDERS’
EQUITY
Preferred stock authorized 5,000,000 shares,
no par value, none issued - -
Common stock authorized 10,000,000 shares,
no par value 9,698,455 9,590,142
Treasury stock (457,920) (221,559)
Accumulated other comprehensive income 794,974 1,265,224
Retained earnings 35,608,721 34,600,626
----------- ----------
Total shareholders' equity 45,644,230 45,234,433
----------- ----------
Total liabilities and shareholders' equity $ 585,780,767 $ 577,989,236
============== =============
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
Interest Income
Interest and fees on loans:
Taxable $ 5,695,878 $ 6,279,804 $ 11,617,961 $ 12,492,690
Nontaxable 99,665 145,552 205,337 306,998
Interest and fees on leases 79,101 133,747 170,835 284,274
Interest-bearing deposits with financial institutions 2,464 4,853 4,369 10,760
Investment securities:
US Government agencies 1,081,193 1,977,464 2,392,964 3,935,447
States & political subdivisions (nontaxable) 113,116 119,417 224,886 251,886
Other securities 59,209 59,620 133,050 119,019
Federal funds sold 16,210 38,789 35,180 88,786
------- ------- ------- ------
Total interest income 7,146,836 8,759,246 14,784,583 17,489,860
---------- ---------- ----------- ----------
Interest expense
Certificates of deposit of $100,000 or more 1,319,105 1,494,447 2,607,286 2,925,789
Other deposits 1,367,259 1,915,985 2,829,695 3,940,367
Securities sold under repurchase agreements 127,495 257,854 291,924 563,207
Other short-term borrowings & long term debt 903,837 897,788 1,794,570 1,784,783
-------- -------- ---------- ---------
Total interest expense 3,717,696 4,566,074 7,523,475 9,214,146
---------- ---------- ---------- ---------
Net interest income 3,429,140 4,193,172 7,261,108 8,275,714
Provision for loan losses 460,000 496,000 760,000 956,000
-------- -------- -------- -------
Net interest income, after provision for loan losses 2,969,140 3,697,172 6,501,108 7,319,714
---------- ---------- ---------- ---------
Other income:
Service charges on deposit accounts 436,256 289,398 820,891 543,275
Net gain on sale of investment securities 132,277 40,173 213,828 59,861
Net gain on sale of loans 356,305 180,833 424,406 262,419
Net gain/(loss) on foreclosed assets held for sale (36,644) (29,824) (40,172) 54,935
Other income 372,404 498,683 798,630 1,030,957
-------- -------- -------- ---------
Total other income 1,260,598 979,263 2,217,582 1,951,447
---------- -------- ---------- ---------
Other operating expenses:
Salaries and employee benefits 1,567,548 1,545,435 3,228,177 3,137,025
Premises and equipment 682,206 549,782 1,379,411 1,194,784
Advertising 68,238 120,197 142,505 186,332
Other operating expenses 696,128 942,844 1,558,953 1,784,702
-------- -------- ---------- ---------
Total other operating expenses 3,014,120 3,158,258 6,309,046 6,302,843
---------- ---------- ---------- ---------
Income before provision for income taxes 1,215,618 1,518,177 2,409,644 2,968,318
Provision for income taxes 292,647 409,424 599,373 781,436
-------- -------- -------- -------
Net income $ 922,971 $ 1,108,753 $ 1,810,271 $ 2,186,882
========== ============ ============ ===========
Per share data:
Net income - basic $ 0.49 $ 0.61 $ 0.99 $ 1.20
Net income - diluted $ 0.49 $ 0.61 $ 0.99 $ 1.20
Dividends $ 0.22 $ 0.21 $ 0.44 $ 0.41
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Six Months Ended June 30, 2003 and 2002
(Unaudited)
Accumulated Other
Capital Stock Treasury Stock Retained Comprehensive
Shares Amount Shares Amount Earnings Income/(Loss) Total
----------------------------------------------------------------------------------------------------
Balance, December 31, 2001 1,819,168 $ 9,353,452 - $ - $ 32,080,824 $ (1,262,046) $ 40,172,230
---------------
Net income 2,186,882 2,186,882
Change in net unrealized holding
gains/(losses) on available-for-sale
securities, net of reclassification
adjustments and tax effects 1,372,688 1,372,688
---------------
Comprehensive income 3,559,570
---------------
Dividends declared ($.41 per share) (746,483) (746,483)
Treasury stock purchased (12,960) (479,640) (479,640)
Issuance of shares of common stock
through Dividend Reinvestment Plan 6,202 230,967 230,967
----------------------------------------------------------------------------------------------------
Balance, June 30, 2002 1,825,370 $ 9,584,419 (12,960) $ (479,640) $ 33,521,223 $ 110,642 $ 42,736,644
====================================================================================================
Balance, December 31, 2002 1,825,363 $ 9,590,142 (5,987) $ (221,559) $ 34,600,626 $ 1,265,224 $ 45,234,433
---------------
Net income 1,810,271 1,810,271
Change in net unrealized holding
gains/(losses) on available-for-sale
securities, net of reclassification
adjustments and tax effects (470,250) (470,250)
---------------
Comprehensive income 1,340,021
---------------
Dividends declared ($.44 per share) (802,176) (802,176)
Issuance of shares of common stock
through Stock Option Plan - - 800 29,800 29,800
Issuance of shares of common stock
through Employee Stock Purchase Plan - - 1,264 42,654 42,654
Issuance of shares of common stock
through Dividend Reinvestment Plan 3,068 108,313 3,923 149,105 257,418
Treasury stock purchased (12,720) (457,920) (457,920)
----------------------------------------------------------------------------------------------------
Balance June 30, 2003 1,828,431 $ 9,698,455 (12,720) $ (457,920) $ 35,608,721 $ 794,974 $ 45,644,230
====================================================================================================
Comprehensive income for the three months ended June 30, 2003 and June 30, 2002 was ($232,382) and $2,019,541, respectively.
CONSOLIDATED STATEMENT OF CASH FLOWS For the Six Months Ended June 30, 2003 and 2002
(Unaudited)
2003 2002
--------------------- ----------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,810,271 $ 2,186,882
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 624,529 514,297
Net amortization/(accretion) of securities 870,453 (33,429)
Provision for loan losses 760,000 956,000
Deferred income tax (89,307) 203,376
Writedown of foreclosed assets held for sale 444,403 151,460
Increase in cash surrender value of life insurance (111,473) -
(Gain)/loss sale of investment securities (213,828) (59,861)
(Gain)/loss on sale of loans (424,406) (262,419)
(Gain)/loss on sale of foreclosed assets held for sale 40,172 (74,356)
(Gain)/loss on sale of leased assets 89,594 10,928
Amortization of loan servicing rights 108,738 46,125
Net change in interest receivable (24,055) 229,988
Net change in interest payable (48,161) (125,401)
Net change in other assets 897,824 489
Net change in other liabilities (110,410) 311,420
--------- -------
Net cash provided by operating activities 4,624,344 4,055,499
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Held-to-maturity securities:
Maturities, calls and paydowns 3,906,383 1,083,389
Purchases - (9,057,722)
Available-for-sale securities:
Sales 48,933,261 29,274,261
Maturities, calls and paydowns 26,441,406 22,283,358
Purchases (75,259,314) (38,990,429)
Net increase in loans available-for-sale (15,059,447) (18,702,263)
Net increase in loans and leases (2,274,017) (9,771,847)
Purchase of life insurance policies (7,000,000) -
Purchase of bank premises and equipment (441,919) (1,873,495)
Proceeds from sale of available-for-sale loans 11,869,642 18,879,873
Proceeds from sale of credit card recievables 2,977,526 -
Proceeds from sale of leased assets 894,072 209,809
Proceeds from sale of foreclosed assets held for sale 403,333 699,680
-------- -------
Net cash used in investing activities (4,609,074) (5,965,386)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in noninterest-bearing deposits 887,891 3,506,111
Net change in certificates of deposit of $100,000 or more 20,474,943 18,831,542
Net change in interest bearing deposits (2,553,398) (4,150,067)
Net change in short term borrowings (10,937,573) (11,526,835)
Purchase of treasury stock (457,920) (479,640)
Dividends paid, net of dividend reinvestment (544,758) (515,516)
Proceeds from employee stock purchase plan 42,654 -
Proceeds from exercise of stock options 29,800 -
------- -
Net cash provided by financing activities 6,941,639 5,665,595
---------- ---------
Net increase in cash and cash equivalents 6,956,909 3,755,708
Cash and cash equivalents, beginning 26,219,247 25,644,972
----------- ----------
Cash and cash equivalents, ending $ 33,176,156 $ 29,400,680
============= ============
FIDELITY D & D BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Nature of Operations and Critical Accounting Policies
Principles of Consolidation
The accompanying unaudited consolidated financial statements of Fidelity D&D Bancorp, Inc., and its wholly owned subsidiary, The Fidelity Deposit & Discount Bank (Bank), (collectively, the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the periods have been included. All significant inter-company balances and transactions have been eliminated in the consolidation. Prior period amounts are reclassified when necessary to conform to the current year’s presentation.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates. For additional information and disclosures required under GAAP, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
Nature of OperationsThe Bank is a commercial bank chartered by the Commonwealth of Pennsylvania. Having commenced operations in 1903, the Bank provides a full range of traditional banking services, trust services and alternative financial products from its main office located in Dunmore and other branches throughout Lackawanna and Luzerne counties.
Management is responsible for the fairness, integrity and objectivity of the unaudited financial statements included in this report. Management prepared the unaudited financial statements in accordance with GAAP. In meeting its responsibility for the financial statements, management depends on the Company’s accounting systems and related internal controls. These systems and controls are designed to provide reasonable, but not absolute, assurance that the financial records accurately reflect the transactions of the Company, the Company’s assets are safeguarded and that financial statements present fairly the financial position and results of operations of the Company.
In the opinion of management, the consolidated balance sheets as of June 30, 2003 and December 31, 2002 present fairly the consolidated financial position of the Company as of those dates. The related statements of income, changes in shareholders’ equity and cash flows for the three months ended June 30, 2003 and 2002, present fairly the consolidated results of its operations and its cash flows for the periods then ended. All material adjustments required for fair presentation have been made. These adjustments are of a normal reoccurring nature. There have been no material changes in accounting principles, practices or in the method of application and there have been no retroactive adjustments during this period.
This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2002 and the notes included therein, included within the Company’s Annual Report on Form 10-K. The results of operations for interim periods are not necessarily indicative of the results of operations to be expected for the entire year.
Critical Accounting PoliciesThe presentation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate and reasonable. The Company’s methodology for determining the allowance for loan losses is described in “Allowance for Loan Losses” within Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in the future. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
Another material estimate is the calculation of fair values of the Company’s investment securities. The Company receives estimated fair values of investment securities from an independent valuation service through a broker. In developing these fair values, the valuation service uses estimates of cash flows based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of investment securities tend to vary among valuation services. Accordingly, when selling investment securities, management typically obtains price quotes from more than one source. The majority of the Company’s investment securities are classified as available-for-sale. Accordingly, these securities are carried at fair value on the consolidated balance sheet, with unrealized gains and losses, net of income tax, excluded from earnings and reported separately through accumulated other comprehensive income, which is included within shareholders’ equity.
The fair value of residential mortgage loans classified as available-for-sale is obtained from the Federal National Mortgage Association (Fannie Mae). The fair value of SBA loans classified as available-for-sale is obtained from an outside pricing source. The market to which the Bank sells mortgage and other loans is restricted and price quotes from other sources are not typically obtained.
2. Earnings per Share
The following data shows the amounts used in computing earnings per share and the effects on income and the weighted average number of shares of dilutive potential common stock for the six months ended June 30, 2003 and 2002.
Weighted Average Earnings
Income Common Shares per
June 30, 2003 Numerator Denominator Share
--------- ----------- -----
Basic EPS $ 1,810,271 1,822,438 $0.99
=====
Dilutive effect of potential common stock:
Stock options;
Exercise of outstanding options 10,600
Hypothetical share repurchase at $35.90 (9,785)
-------------------------------------------
Diluted EPS $ 1,810,271 1,823,253 $0.99
======
===========================================
June 30, 2002
Basic EPS $ 2,186,882 1,820,071 $1.20
=====
Dilutive effect of potential common stock:
Stock options;
Exercise of outstanding options 17,800
Hypothetical share repurchase at $37.50 (15,673)
-------------------------------------------
Diluted EPS $ 2,186,882 1,822,198 $1.20
======
===========================================
3. Stock Compensation Plans
As permitted by Accounting Principles Board Opinion No. 25, the Company uses the intrinsic value method of accounting for stock compensation plans. Utilizing the intrinsic value method, compensation cost is measured by the excess of the quoted market price of the stock, as of the grant date (or other measurement date) over the amount an employee or director must pay to acquire the stock. Stock options issued under the Company’s stock option plans have no intrinsic value, and accordingly, no compensation cost is recorded for them.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-based Compensation,” to stock options.
Six Months Ended
(Net Income in Thousands) June 30,
2003 2002
---- ----
Net income, as reported $ 1,810 $ 2,187
Deduct: Total stock option compensation expense determined
under fair value method for all awards, net of tax effects (-) (8)
------- -------
Pro forma net income $ 1,810 $ 2,179
======= =======
Net Income per share-basic:
As reported $ 0.99 $ 1.20
Pro forma $ 0.99 $ 1.20
Net Income per share-diluted
As reported $ 0.99 $ 1.20
Pro forma $ 0.99 $ 1.20
4. Bank Owned Life Insurance
The Bank invested in bank owned life insurance (BOLI) with the intent that the tax-free earnings from the increase in cash surrender value will be used to offset employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a chosen group of employees. The Bank is the owner and beneficiary of the policies. The tax-free income generated from the increase in cash surrender value of the policies is included in other income on the income statement. A more detailed discussion of BOLI is included in “Managements Discussion and Analysis”, below.
FIDELITY D & D BANCORP, INC.
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is management’s discussion and analysis of the significant changes in the results of operations for the three and six months ended June 30, 2003 as compared to the same periods in 2002 and changes in the balance sheet from December 31, 2002 to June 30, 2003. Current performance may not be indicative of future performance. This discussion should be read in conjunction with the Company’s 2002 Annual Report on Form 10-K.
Readers should note that many factors, some of which are discussed elsewhere in this Form 10-Q, could affect the future financial results of the Company and could cause those results to differ materially from those expressed in the forward-looking statements contained in this Form 10-Q. These factors include but are not limited to the following:
- operating, legal and regulatory risks, such as continued levels of loan quality and origination volumes, continued relationships with major customers, and technological changes;
- economic, political and competitive forces affecting the Bank’s business, such as changes in economic conditions, especially in the Bank’s market area, interest rate fluctuations, competitive product and pricing pressures within the Bank’s market, personal and corporate bankruptcies, monetary policy and inflation;
- our ability to grow internally or through acquisitions; and
- the risk that management’s analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.
Management cautions readers not to place undue reliance on the forward-looking statements, which reflect analysis only as of this date. Management is not obliged to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after this date. Readers should carefully review the risk factors described in other documents that we file, from time to time, with the Securities and Exchange Commission, including Annual Reports on Form 10-K and any Current Reports on Form 8-K.
1. RESULTS OF OPERATIONS
Net income was $ 923,000 or
$0.49 per common share, on a diluted basis, for the three months ended June 30,
2003. This represents a decrease of $186,000 or 17% from the net income of
$1,109,000 or $0.61 per common share, on a diluted basis, reported for the same
period in 2002. Net interest income was $764,000 lower in 2003 compared to 2002
due to reduced net interest rate spread and margin. Interest yielding assets
repriced lower, while certain long-term time deposits and borrowings, due to the
contractual time frame, lagged in the corresponding reduction of rates paid on
the interest-bearing liabilities. Our net interest rate spread decreased 43
basis points from 2.65%, for the three months ended June 30, 2002, to 2.22% for
the three months ended June 30, 2003. Our net interest margin decreased 49 basis
points from 3.14%, for the three months ended June 30, 2002, to 2.65% for the
three months ended June 30, 2003. Other non-interest income was $281,000 or 29%
higher for the three months ended June 30, 2003, compared to the same period in
2002. Other income was higher, in 2003, due primarily to increased fees on
deposit accounts, increase in the cash surrender value of bank owned life
insurance, gains on the sales of loans, and investment securities
available-for-sale. Other operating expenses were $144,000 or 5% lower for the
three months ended June 30, 2003 compared to the same period in 2002. Salaries
and benefits and premises and equipment expenses continue to trend higher due in
part to the general inflationary increases in employee benefit costs, the branch
addition and core processing system conversion, which occurred late in 2002.
Other operating expenses have declined primarily from the effect of the
accounting treatment for direct loan origination costs and from the significant
increase in number of loans closed, which is attributable to the historically
low interest rate environment.
Net income was $1,810,000
or $0.99 earnings per common share, on a diluted basis, for the six months ended
June 30, 2003. This represents a decrease of $377,000 or 17% from the net income
of $2,187,000 or $1.20 earnings per common share, on a diluted basis, reported
for the same period in 2002. Net interest income was $1,015,000 lower in 2003
compared to 2002. Net interest rate spread decreased 28 basis points from 2.64%,
for the six months ended June 30, 2002, to 2.36% for the six months ended June
30, 2003. Net interest margin decreased 36 basis points from 3.14%
for the six
months ended June 30, 2002, to 2.78% for the six months ended June 30, 2003.
Other non-interest income was $266,000 or 14% higher for the six months ended
June 30, 2003 compared to the same period in 2002. Other income was higher, in
2003, due primarily to an increase in service charges and other deposit related
fees, increase in the cash surrender value of bank owned life insurance, and
gains from the sales loans and investment securities available for sale. Other
operating expenses were relatively the same for the six months ended June 30,
2003, compared to the same period in 2002. Salaries and benefits and premises
and equipment expenses continue to trend higher due in part to the general
inflationary increases in employee benefit costs, the branch addition and core
processing system conversion, which occurred late in 2002. Other operating
expenses have declined primarily from the effect of the accounting treatment for
direct loan origination costs and from the significant increase in number of
loans closed, which is attributable to the historically low interest rate
environment.
Return on average assets
and return on average equity on an annualized basis were 0.64% and 7.99%,
respectively, for the six months ended June 30, 2003, compared to 0.77% and
10.59%, respectively, for the same period in 2002.
Net interest income
Net interest income is the
most significant component of our operating income. Net interest income depends
upon the levels of interest-earning assets and interest-bearing liabilities and
the difference or “spread” between the respective yields earned and
rates paid. The interest rate spread is influenced by the overall interest rate
environment, composition and characteristics of interest-earning assets and
interest-bearing liabilities, and by competition. The interest rate spread is
also influenced by differences in the maturity and repricing of assets versus
the liabilities that fund them.
Responding to generally
weak economic conditions, the Federal Reserve cut the targeted federal funds
rate to 1.00%, in 2003. As a result, the current interest rate environment is at
one of its all time historic low levels. The Bank’s interest-earning assets
and interest-bearing liabilities continue to originate and reprice in this lower
rate environment. The yields on average loans, for the six months ended June 30,
2003, were 6.25% compared to 6.89%, for the six months ended June 30, 2002.
Similarly, the yields on average investments, for the six months ended June 30,
2003, were 3.79%, compared to 5.67%, for the six months ended June 30, 2002,
mainly due to the repricing of called securities and the restructuring of the
portfolio at current rates. The rate on average interest-bearing liabilities
declined from 3.89%, for the six months ended June 30, 2002, to 3.24%, for the
same period in 2003, due in part to lower rates on interest-bearing transaction
deposits and short-term certificates of deposit. In the current environment we
had success in raising non-maturity deposits that are generally less costly than
time deposits. Changes in the composition and yield of our interest-earning
assets and relatively stable rates on interest-bearing liabilities combined had
a negative effect on the net interest rate spread and margin, for the six months
ended June 30, 2003, compared to the same period in 2002.
For the three and six
months ended June 30, 2003, net interest income, on a tax-equivalent
basis, was $778,000 and $1,057,000 lower, respectively, than for the same
periods in 2002. The decrease in net interest income in 2003 was primarily a
function of average interest-earning asset decline and a greater reduction in
yield on interest-earning assets over the rate savings on average
interest-bearing liabilities. The net interest margin, on a tax-equivalent
basis, decreased 49 basis points from 3.14%, for the three months ended June
30, 2002, to 2.65%, for the same period in 2003. The net interest rate spread
decreased 43 basis points from 2.65%, for the three months ended June 30, 2002,
to 2.22%, for the same period in 2003.
The net interest margin on
a tax-equivalent basis decreased 36 basis points from 3.14%, for the six
months ended June 30, 2002, to 2.78%, for the same period in 2003. The net
interest rate spread decreased 29 basis points from 2.65%, for the six months
ended June 30, 2002, to 2.36%, for the same period in 2003.
Average interest-earning
assets declined $7,384,000 from $546,705,000, for the six months ended June 30,
2002, to $539,321,000, for the six months ended June 30, 2003. Average loan
balances increased $4,526,000, while average investments, federal funds sold and
average interest-bearing deposits decreased $6,826,000, $4,798,000 and $284,000,
respectively. The ratio of average interest-earning assets to average
interest-bearing liabilities increased from 114.35%, for the six months ended
June 30, 2002, to 115.14%, for the six months ended June 30, 2003. The yield on
average interest-earning assets and the rate on average interest-bearing
liabilities decreased 93 basis points and 65 basis points, respectively, due to
the decline in overall interest rates. The decrease in rate on average
interest-bearing liabilities is mostly due to the repricing of short-term
certificates of deposit in the lower interest rate environment and the change in
deposit mix. Short-term borrowings and repurchase agreements also repriced lower
during 2003.
The following tables set forth, for the periods indicated, certain average balance sheet amounts and their corresponding full tax equivalent earnings or expenses and annualized tax equivalent yields or rates:
(Dollars in Thousands)
TAX EQUIVALENT YIELD Six months ended Year ended Six months ended
June 30, 2003 December 31, 2002 June 30, 2002
-----------------------------------------------------------------
Average earning assets:
Loans and leases $ 387,244 $ 384,791 $ 382,718
Investments 145,565 154,000 152,392
Federal funds sold 5,613 11,584 10,411
Interest-bearing deposits 899 919 1,184
-----------------------------------------------------------------
Total $ 539,321 $ 551,294 $ 546,705
=================================================================
Average interest-bearing liabilities:
Other Interest-bearing deposits $ 96,252 $ 84,782 $ 80,200
Certificates of deposit 263,963 286,496 288,048
Other borrowed funds 65,723 64,045 64,047
Repurchase agreements 42,441 45,872 45,794
-----------------------------------------------------------------
Total $ 468,379 $ 481,195 $ 478,089
=================================================================
Interest Income
Loans and leases $ 12,074 $ 26,402 $ 13,211
Investments 2,856 8,382 4,406
Federal funds sold 35 190 89
Interest-bearing deposits 4 17 11
-----------------------------------------------------------------
Total $ 14,969 $ 34,991 $ 17,717
=================================================================
Interest Expense
Other Interest-bearing deposits $ 385 $ 934 $ 483
Certificates of deposit 5,051 12,351 6,383
Other borrowed funds 1,795 3,601 1,785
Repurchase agreements 292 996 563
-----------------------------------------------------------------
Total $ 7,523 $ 17,882 $ 9,214
=================================================================
Net Interest Income $ 7,446 $ 17,109 $ 8,503
=================================================================
Yield on average earning assets 5.60% 6.35% 6.54%
Cost of average interest-bearing liabilities 3.24% 3.72% 3.89%
-----------------------------------------------------------------
Interest rate spread 2.36% 2.63% 2.65%
=================================================================
Net yield on average earning assets 2.78% 3.10% 3.14%
=================================================================
Provision for loan losses
The provision for loan
losses represents the amount necessary to be charged to operations to bring the
allowance for loan losses to a level that represents management’s best
estimate of known and inherent losses in the Bank’s loan portfolio. Loans
and leases determined to be uncollectible are charged-off against the allowance
for loan loss.
The
amount of the provision for loan losses and the amount of the allowance for loan
losses is subject to ongoing analysis of the loan portfolio. The Bank maintains
a Special Asset Committee which meets monthly to review problem loans and
leases. The committee is comprised of Bank management, credit administration
officer, loan workout officer, and collection personnel. The committee reports
quarterly to the Credit Administration Committee of the Board of Directors.
Management
continuously reviews the risks inherent in the loan and lease portfolio.
Specific factors used to evaluate the adequacy of the loan loss provision during
the formal process include:
- Specific loans that could have loss potential
- Levels of and trends in delinquencies and non-accrual loans
- Levels of and trends in charge-offs and recoveries
- Trends in volume and terms of loans
- Changes in risk selection and underwriting standards
- Changes in lending policies, procedures and practices
- Experience, ability and depth of lending management
- National and local economic trends and conditions
- Changes in credit concentrations
The provision for loan
losses was $460,000, for the three months ended June 30, 2003, compared to
$496,000, for the same period in 2002. The amount of the loan loss provision,
for the three months ended June 30, 2003, was driven by the risk profile of the
portfolio rather than an increase in loan volume. During the three months ended
June 30, 2003, total gross loans grew $356,000, compared to $1,040,000, for the
same period in 2002. Non-performing loans, which consist of loans past due 90
days and over and non-accrual loans, were $7,974,000 at June 30, 2003, compared
to $7,005,000, at June 30, 2002.
For the six months ended
June 30, 2003, the provision for loan losses was $760,000 or $196,000 lower than
the $956,000 recorded during the comparable period in 2002. Net charge-offs were
$877,628 and $875,860, for the six months ended June 30, 2003, and 2002. Total
gross loans grew $290,000, during the six months ended June 30, 2003, compared
to $8,689,000 during the same period in 2002. The relatively flat amount in
gross loan portfolio during 2003 compared to the growth during 2002, attributed
to the reduction in the current year’s provision.
The loan loss allowance as a percentage of total loans was 0.98% at June 30, 2003 and 1.00%, at June 30, 2002.
Other income
Other income consists
primarily of service charges and other deposit related fees, fees from trust and
financial services, increase in the cash surrender value of bank owned life
insurance and gains (losses) on the sale of investment securities
available-for-sale, loans held for sale and foreclosed assets held for sale.
For the three months ended
June 30, 2003, other income was $1,261,000 or $281,000 higher than the $979,000
recorded during the same period in 2002. Of this increase, $147,000 pertained to
service charges and activities related to deposit accounts, $88,000 from the
increase in the cash surrender value of bank owned life insurance and $175,000
pertained to the gain on the sale of loans. During 2003, we recorded $132,000 in
gains on the sale of investment securities available-for-sale, compared to
$40,000 in 2002. In addition, we recognized $36,000 in losses on the sale of
foreclosed assets held for sale, during the second quarter of 2003, compared to
$30,000 in losses, during the second quarter of 2002.
For the six months ended June 30, 2003, other income was $2,218,000 or $266,000 higher than the $1,951,000, recorded during the same period in 2002. Of this increase, $278,000 pertained to service charges and activities related to
deposit accounts, which
have grown considerably during 2003, $111,000 from the increase in the cash
surrender value of bank owned life insurance and $162,000 pertained to the gain
on the sale of loans. During 2003, we recorded $214,000 in gains on the sale of
investment securities available for sale, compared to $60,000 during 2002. Also,
we recorded $40,000 in losses on the sale of foreclosed assets held for sale, in
2003, compared to $55,000 in gains in 2002. Other income classifications were
$232,000 lower from exiting certain unprofitable lines of business during 2002
and increased amortization of mortgage servicing rights. Gross earnings recorded
during 2002, such as fees from providing merchant in-house processing, had no
corresponding earnings recorded in 2003. Another reduction in other income
during 2003 was the significantly increased amortization of mortgage servicing
rights, due to mortgage re-financings caused by the historically low interest
rates. Finally, $90,000 in losses from sale of vehicles returned from full-term
leases was recorded during 2003 contributing to the total other income decline.
Other operating expense
For the three months ended
June 30, 2003, other operating expenses were $3,014,000 or $144,000 lower than
the $3,158,000, recorded during the same period in 2002. For the six months
ended June 30, 2003, other operating expenses were $6,309,000 or $6,000 higher
than the $6,303,000, recorded during the same period in 2002.
Salaries and benefits were
$22,000 higher in the second quarter of 2003 compared to the same period in
2002. Premises and equipment expenses increased $132,000 or 25% primarily due to
the increased depreciation expense on the growth of the branch network and on
the core processing computer system. Advertising expenses reduced $ 52,000
because of reduced advertising space purchased and using lower cost advertising
approaches directly at branch locations. Other expenses, which consist primarily
of professional services, office supplies, printing and postage, data
processing, employee travel, meals and entertainment, and Board of
Directors’ fees, decreased $247,000 or 26% compared to the second quarter
of 2002. Of this decrease, $236,000 pertained to the accounting treatment for
direct loan origination costs from the number of loans
closed during the second quarter of 2003, attributed to the historically low
interest rate environment.
Salaries and benefits were
$91,000 or 3% higher for the six months ended June 30, 2003 compared to the same
period in 2002. This increase was principally due to an increase in the number
of employees and salary and benefit increases. Premises and equipment expenses
increased $185,000 primarily due to the increased depreciation expense on the
growth of the branch network and on the core processing computer system.
Advertising expenses decreased from the overall reduction of advertising space
purchased during the six months ended June 30, 2003. Other expenses decreased
$226,000 or 23% in 2003 compared to 2002. This decrease pertained to the
accounting treatment of $262,000 in direct loan origination costs resulting from
the number of loans closed during 2003. Excluding this
accounting treatment, other expenses have increased for the six months ended
June 30, 2003 as compared to the same period during 2002 primarily to increased
professional services resulting from required legal and audit services.
Income tax expense
The difference between the
expected provision and actual provision for income taxes is primarily due to
tax-free interest income and use of low-income housing tax credits.
We recorded a $293,000 tax
provision representing an effective tax rate of 24% for the three months ended
June 30, 2003 compared to $409,000 or 27% for the same period in 2002. We
recorded a $599,000 tax provision representing an effective tax rate of 25% for
the six months ended June 30, 2003 compared to $781,000 or 26% for the same
period in 2002. The effective tax rates for the three and six months ended June
30, 2003 were lower than the comparable periods in 2002 principally due to
tax-free earnings decreasing slightly, but representing a larger percentage of
pre-tax earnings.
2. FINANCIAL CONDITION
Consolidated assets grew
$7,792,000 or 1.4%, during the six months ended June 30, 2003, to $585,781,000.
Cash and cash equivalents and life insurance cash surrender value increased by
$6,957,000 and $7,111,000, respectively, during the six months ended June 30,
2003. Asset growth was primarily funded by a $18,809,000 increase in deposits,
mostly certificates of deposit of $100,000 or more. Investments decreased
$5,391,000, during the six months ended June 30, 2003. Securities sold under
repurchase agreements and short-term borrowings decreased $8,017,000 and
$2,921,000, respectively. Shareholders’ equity increased $410,000 from
$45,234,000, at December 31, 2002, to $45,644,000, at June 30, 2003. This
increase was attributable to net increase of $1,008,000 in earnings after
payment of
dividends, a $108,000 increase in common stock from shares issued
under the employee stock purchase and dividend re-investment plans, a $470,000
reduction in the estimated fair value of investment securities
available-for-sale, net of tax,and $236,000 increase for the purchase of
treasury stock.
Investment securities
Investment policies dictate
permissible investment categories, credit quality, maturity intervals and
investment concentrations. Management is responsible for making the specific
investment purchases within these standards. The carrying value of investment
securities, at June 30, 2003, was $144,159,000 or 25% of total assets. At June
30, 2003 approximately 67% of the investment portfolio was comprised of
mortgage-backed securities that amortize and provide monthly cash flow. Agency
bonds and municipal bonds comprised 20% and 7% of the investment portfolio,
respectively.
Management buys and sells
investment securities from time to time depending on market conditions, business
trends, liquidity, and capital levels. Investment purchases provide a way to add
assets quickly and generate additional earnings. The Bank generally earns a
positive interest spread by assuming interest rate risk and using deposits
and/or borrowings to purchase securities with longer maturities.
Management classifies
investment securities at the time of purchase by one of three categories:
trading, available for sale (AFS) or, held to maturity (HTM). To date,
management has not purchased any securities for trading purposes. Management
classifies most securities as AFS even though it has no immediate intent to sell
them. The AFS designation affords management the flexibility to sell securities
and adjust the balance sheet in response to capital levels, liquidity needs
and/or changes in market conditions. Securities AFS are marked to market in the
consolidated balance sheet with an adjustment to equity, net of tax, that is
presented in the caption “Accumulated other comprehensive income
(loss).”
At June 30, 2003, the AFS
portfolio had an estimated market appreciation of $1,205,000 before tax and an
equity adjustment of $795,000, net of tax. This represents a $470,000 reduction
in the estimated fair value of securities AFS, net of tax, over the prior
year-end. This reduction occurred due to the addition of securities in this low
rate environment, in which these underlying securities will de-value temporarily
as corresponding market yields increase.
Investment Securities held-to-maturity and available-for-sale at June 30, 2003 consist of the following:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------------------------------------------------------------------
Securities held-to-maturity:
----------------------------
Mortgage-backed securities $ 7,822,090 $ 301,201 $ - $ 8,123,291
--------------------------------------------------------------------------
Total securities held-to-maturity $ 7,822,090 $ 301,201 $ - $ 8,123,291
--------------------------------------------------------------------------
Securities available-for-sale:
------------------------------
Agencies $ 28,168,786 $ 142,301 $ 43,084 $ 28,268,003
State and municipal 9,858,590 171,056 1,338 10,028,308
Corporate Bonds 3,989,899 20,935 1,458 4,009,375
Mortgage-backed securities 89,335,250 1,005,306 153,326 90,187,230
--------------------------------------------------------------------------
Sub total 131,352,525 1,339,597 199,206 132,492,916
Equity securities 3,779,625 64,114 - 3,843,739
--------------------------------------------------------------------------
Total securities available-for-sale $ 135,132,150 $ 1,403,712 $ 199,206 $ 136,336,655
--------------------------------------------------------------------------
Total Securities $ 142,954,240 $ 1,704,913 $ 199,206 $ 144,459,946
==========================================================================
At June 30, 2003, the contractual maturities of securities held-to-maturity and available-for-sale are listed below. Federal agency securities are listed based upon their stated maturities. Mortgage backed securities, which are based upon weighted-average lives and subject to monthly principal reductions, are listed in total. Equity securities have no stated maturity dates and are also listed in total.
Amortized Market
Securities held-to-maturity cost value
--------------------------- ---- -----
Mortgage-backed securities $ 7,822,090 $ 8,123,291
-----------------------------------------------------------------------------------------------------
Total securities held-to maturity $ 7,822,090 $ 8,123,291
-----------------------------------------------------------------------------------------------------
Securities available-for-sale
-----------------------------
One year or less $ - $ -
One through five years 5,448,580 5,494,001
Five through ten years 25,828,926 25,992,939
Over ten years 10,739,768 10,818,746
-----------------------------------------------------------------------------------------------------
sub total 42,017,275 42,305,686
Mortgage-backed securities 89,335,250 90,187,230
Equity securities 3,779,625 3,843,739
-----------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------
Total securities available-for-sale $ 135,132,150 $ 136,336,655
-----------------------------------------------------------------------------------------------------
Total securities $ 142,954,240 $ 144,459,946
=====================================================================================================
Loans held for sale
The balance of loans held for sale was $29,352,000, at June 30, 2003, compared to $28,715,000, at December 31, 2002. The increase in loans held for sale relates to the timing of residential mortgage loan originations versus their sale.
Residential
mortgages, SBA loans and student loans of $11,445,000 and $18,617,000 were sold,
during the six months ended June 30, 2003 and 2002, respectively. Residential
mortgage originations and sales are significantly influenced by the interest
rate environment.
Loans and leases, net
Gross loans increased from $386,877,000, at December 31, 2002, to $387,167,000, at June 30, 2003.
We originate a wide variety
of loans primarily to small to mid-sized businesses and professionals. Our
policies as well as applicable laws and regulations require risk analysis and
ongoing portfolio and credit management. The majority of our loan portfolio is
collateralized, at least in part, by real estate in the greater Lackawanna and
Luzerne counties of Pennsylvania. Real estate values are typically subject to
risks associated with the general economy, among other matters.
Inherent in the lending
function is the evaluation and acceptance of credit risk and interest rate risk.
We manage credit risk through portfolio diversification, underwriting policies
and procedures, and loan monitoring practices. We manage interest rate risk
using various asset/liability modeling techniques and analyses. Most loans are
adjustable rate that reset in intervals of five years or less. When possible,
the Bank also originates strictly variable rate loans.
The following table reflects the composition of the loan portfolio:
June 30, 2003 December 31, 2002
------------- -----------------
Residential real estate $ 84,109,827 $ 85,447,703
Commercial and commercial real estate 209,955,570 202,974,155
Consumer and home equity 52,573,871 56,984,927
Real estate construction and development 6,806,248 6,797,002
Direct lease financing 4,763,382 6,578,720
-----------------------------------------------------------------------------------------
Gross loans and leases 358,208,899 358,782,507
Less:
Unearned income 393,627 620,704
Allowance for loan losses 3,782,125 3,899,753
-----------------------------------------------------------------------------------------
Loans and leases, net $ 354,033,147 $ 354,262,050
=========================================================================================
Allowance for Loan Losses
Management continually
evaluates the credit quality of the Bank’s loan portfolio and performs a
formal review of the allowance for loan loss adequacy, on a quarterly basis. The
allowance for loan loss reflects management’s best estimate of losses, both
known and inherent, in the existing loan portfolio. Management’s judgment
is based on the evaluation of individual loans, past experience, the assessment
of current economic conditions, and other relevant factors. The provision for
loan losses represents the amount necessary to maintain an appropriate
allowance. Loan losses are charged directly against the allowance for loan
losses when loans are deemed to be uncollectible. Recoveries on previously
charged-off loans are added to the allowance when received.
Management applies two
primary components to in the loan review process to determine proper allowance
levels. The two levels are specific loan loss allocation for loans that are
deemed impaired and a general loan loss allocation for those loans not
specifically allocated. The methodology to analyze the adequacy of the allowance
for loan losses is as follows:
- Identification of specific problem loans by loan category by the credit administration
- Calculation of specific reserves required based on collateral and other persuasive evidence
- Identification of loans collateralized by cash
- Determination of remaining homogenous pools by loan category and eliminating loans collateralized by cash and loans with specific reserves
- Application of historical loss percentages (3 year average) to pools to determine the allowance allocation
- Application of qualitative factor adjustment percentage for trends or changes in the loan portfolio
Allocation of the allowance
for loan losses for different categories of loans is based on the methodology
used by the Bank, as explained above. The changes in the allocations from period
to period are based upon reviews of the loan and lease portfolios.
Net charge offs for the six
month period, ended June 30, 2003, were $878,000, compared to $876,000, for the
same period in 2002. Commercial loan net charge-offs decreased from $394,000,
through June 30, 2002, to $247,000, through June 30, 2003. Consumer loans
remained relatively steady at $369,000 of net charge offs, for the first six
months of 2003, compared to same period in 2002. The increase in net charge offs
occurred in the mortgage loans as $178,000 was taken through June 30, 2003,
compared to $20,000, during 2002. The mortgage charge offs were the result of
properties foreclosed upon in the first half of 2003 and a required write down
was taken to the fair market value of the real estate prior to transfer to Other
Real Estate. The reduction in the allowance for loan losses balance was mainly
due to the credit card portfolio sale, which occurred in the first quarter of
2003, and resulted in a reduction of $141,000 in the allowance.
The Bank is unaware of any
potential problem loans that have not been reviewed. Potential problem loans are
those where there is known information that leads the Bank to believe repayment
of principal and/or interest is in jeopardy and the loans are neither
non-accrual nor past due 90 days or more.
Management believes that
the allowance, at June 30, 2003, provides adequate protection against portfolio
loss. However, there could be instances of which the Bank is unaware that may
require additional charge-offs and/or increases to the provision.
At June 30, 2003, the
allowance for loan losses was $3,782,125 or 0.98% of total loans, compared to
1.01% and 1.00%, at December 31, 2002, and June 30, 2002, respectively.
The following table sets forth the activity in the allowance for loan losses and certain key ratios for the period indicated:
ALLOWANCE FOR LOAN LOSSES
For the Six For the For the Six
Months Ended Year Ended Months Ended
June 30, 2003 December 31, 2002 June 30, 2002
---------------------- --------------------- ----------------------
Balance, beginning of period $ 3,899,753 $ 3,741,933 $ 3,741,933
------------ ------------ -----------
Provision 760,000 1,664,000 956,000
-------- ---------- -------
Charge-Offs
Commercial 317,352 928,543 466,724
Real Estate - Mortgages 186,182 39,659 20,227
Consumer 439,598 850,226 468,243
Leases 51,539 130,941 40,433
------- -------- ------
Total Charge-Offs 994,671 1,949,369 995,627
Recoveries
Commercial 70,190 358,908 72,628
Real Estate - Mortgages 8,086 110 60
Consumer 38,767 69,040 34,402
Leases - 15,131 12,677
-- ------- ------
Total Recoveries 117,043 443,189 119,767
Net Charge-Offs 877,628 1,506,180 875,860
-------- ---------- -------
Balance, end of period $ 3,782,125 $ 3,899,753 $ 3,822,073
============ ============ ===========
Total Loans, end of period $ 387,167,312 $ 386,877,158 $ 382,557,516
============== ============== =============
Ratios:
Net Charge-Offs to:
Loans, end of period 0.23% 0.39% 0.23%
Allowance for Loan Losses 23.20% 38.62% 22.92%
Provisions for Loan Losses 115.48% 90.52% 91.62%
Allowance for Loan Losses to:
Total Loans 0.98% 1.01% 1.00%
Non-Accrual Loans 77.66% 97.52% 98.97%
Non-Performing Loans 47.43% 59.10% 54.56%
Non-performing assets are
defined as accruing loans past due 90 days or more, non-accruing loans,
restructured loans, other real estate owned, and repossessions. Non-performing
assets represented 1.64% of total assets, at June 30, 2003, compared to 1.52% of
total assets, at June 30, 2002, and 1.45%, at December 31, 2002.
The non-accrual/impaired
loan balance increased $870,660, for the first six months of 2003, due to the
addition of two commercial loan borrowers that filed bankruptcy. Efforts are
ongoing with the courts to release the Bank’s collateral in order to
liquidate the collateral and repay the debts.
As shown in the table
below, non-performing loans, defined as non-accrual loans and loans past due 90
days or more and still accruing, increased $1,624,926, since the beginning of
2003. The increase was primarily in commercial loans, both non-accrual and 90
days past due. The ratio of non-performing loans to end of period total loans
rose 36 basis points, for the six month period. For the same period in 2002, the
ratio of non-performing loans to total loans was 1.83%, compared to 2.06% in
2003, or an increase of 23 basis points. The ratio of non-performing assets to
total assets increased to 1.64%, at June 30, 2003, from 1.45%, at year end 2002.
Restructured loans shown
below represent outstanding loans to one borrower that were modified as to
terms, in June 2002. The loans have been performing as agreed since the
restructuring; however, as of June 30, 2003, the account has been reported as
past due 30-89 days.
Other Real Estate
represents three properties that were recently foreclosed upon and transferred
to the account. All properties are currently listed with a realtor and one
property is under agreement of sale. Repossessions represent indirect auto loans
that became delinquent and vehicles were repossessed.
NON-PERFORMING ASSETS
June 30, 2003 December 31, 2002 June 30, 2002
------------------ --------------------- ------------------
Loans past due 90 days or more
and accruing $ 3,103,903 $ 2,599,489 $ 3,143,564
Non-accrual Loans 4,870,361 3,999,701 3,861,905
---------- ---------- ---------
Total Non-Performing Loans 7,974,264 6,599,190 7,005,469
Restructured Loans 1,351,461 1,474,252 1,655,973
Other Real Estate 145,892 262,000 45,000
Repossessions 110,013 174,932 99,465
-------- -------- ------
Total Non-Performing Assets $ 9,581,630 $ 8,510,374 $ 8,805,907
============ ============ ===========
Ratio of Non-Performing Loans to
end of period Total Loans 2.06% 1.71% 1.83%
Ratio of Non-Performing Assets to
end of period Total Assets 1.64% 1.45% 1.52%
Bank Owned Life InsuranceDuring February 2003, the Bank purchased $7 million of bank owned life insurance (BOLI) for a chosen group of employees, namely its officers, where the Bank is the owner and beneficiary of the policies. The Bank’s excess liquidity from investment and loan pay downs funded the BOLI. The earnings from the BOLI are recognized as other income. The BOLI is profitable from the appreciation of the cash surrender values of the pool of insurance, and its tax-free advantage to the Bank. This profitability is used to offset a portion of current and future employee benefit costs. The BOLI is an asset that can be liquidated, if necessary, with tax costs associated. However, the Bank intends to hold this pool of insurance, because it provides income that enhances the Bank’s capital position. Therefore, the Bank has not provided for deferred income taxes on the earnings from the increase in cash surrender value.
The $954,000 decrease in
other assets from $3,723,000, at December 31, 2002, to $2,769,000, at June 30,
2003, was primarily due to the satisfaction of a $750,000 investment security
settlement-pending receivable, at December 31, 2002, that was traded prior to
year-end and settled during 2003. Other asset decreases resulted from normal
operations, including amortization of mortgage servicing rights and prepaid
expenses.
Deposits
The Bank is largely
dependent upon its base of competitively priced core deposits to provide a
stable source of funding. The Bank has retained and grown its customer base
through a combination of rate, quality service, customer confidence and
convenience, a stable and experienced staff and expansion of our office
locations. Core deposits, which exclude time deposits of $100,000 and greater,
declined $1,666,000 or 1%, during the six months ended June 30, 2003, to
$284,302,000. Although core deposits declined in total, growth had occurred
within certain transactional deposit products. The growth in these products was
primarily generated by non-interest demand deposit accounts, NOW accounts, which
are an interest-bearing checking account, and savings products. Checking
accounts increased $2,047,000 or 2.0% and savings and club accounts increased
$5,066,000 or 13.2%, during the six months ended June 30, 2003. However, money
market deposits declined $910,000 or 5.5% after experiencing $4,025,000 in
public funds shift from money market accounts to certificates of deposit during
the first six months of 2003. The Bank’s deposit mix, although already
heavily concentrated in time deposits, shifted significantly toward time
deposits of $100,000 and greater. Time deposits of $100,000 and greater at June
30, 2003, were $149,961,000, a $20,475,000 or 15.8% increase over $129,486,000,
at December 31, 2002. Total time deposits, at June 30, 2003, were $269,443,000
or 62% of total deposits compared to $256,836,000 or 62% of total deposits, at
December 31, 2002. Approximately $194,963,000 or 72% of time deposits are
scheduled to mature within the year. These time deposits, maturing within the
next year, account for about 45% of the Bank’s total deposit base and
provide a significant opportunity for the Bank to retain these deposits at
substantially lower market rates. Of the amount maturing within the next year,
over $103,478,000 had original maturity terms of between thirty to sixty months
and have weighted average rates ranging between 4.25% to over 5.50%. The vast
majority of these time deposits reside in the thirty-month product, which
offered the customer the option to add to principal over the term at the
original contractual rate and the ability to withdraw principal once quarterly.
Approximately $74,312,000 in time deposits will mature after one year.
Total deposits increased
$18,809,000 or 4.6%, during the six months ended June 30, 2003, to $432,598,000.
Total average deposits decreased $3,460,000 or 1% from $421,361,000, for the six
months ended June 30, 2002, to $417,901,000, for the six months ended June 30,
2003. Non-interest-bearing deposits are an important source of funds for a Bank
because they lower overall deposit costs. The average balance of these accounts
increased $4,573,000 or 8.6%, during the six months ended June 30, 2003,
compared to the same period in 2002. The interest rates offered on most deposit
products were lowered in 2002 and through the first half of 2003 in response to
overall market conditions. Management expects a significant portion of the
certificate of deposit portfolio, specifically in the thirty-month time deposit
product, to continue to reprice lower, as these higher rate accounts mature.
In 2002 and continuing to
date, the returns of the domestic equity markets were weak and volatile as the
U.S. economy was generally sluggish. These conditions improved the environment
for deposit growth for financial institutions as investors sought the relative
safety of FDIC insured deposits, despite a low interest rate environment.
As the U.S. economy begins
to recover and the domestic equity markets once again produce favorable returns,
the dollars deposited with financial institutions as a flight to safety may
revert back to the equity markets. As this occurs, the deposit base would erode
and without proper planning to replace these funds, the Bank’s asset size
may curtail.
We plan to continue to grow
deposits through strategic promotions, business development programs, maturation
of existing branches and branch expansion. In addition, The Bank introduced the
Fidelity 100th Anniversary $100,000 Checking Account Sweepstakes to
allow individuals to visit our branch locations and complete the entry form.
Along with this anniversary sweepstakes, we are celebrating our 100th
anniversary with a brand new free checking program designed to develop Bank
customers and grow our demand deposit accounts. By opening a Fidelity checking
account, the free checking program offers no minimum balance requirements or
monthly service charge for one year, free first order of “Anniversary”
checks, a $5 cash debit card activation reward following card activation and the
first point of sale transaction and based upon availability, a free small safe
deposit box for one year. We have also redesigned and employed through our
branch network our tiered money market account with rates graduating up based
upon balances. This money market account offers check writing capabilities and
complements our existing money market savings
account. Pricing of this tiered
money market account at current market rates offers our customers, especially
time deposit customers, the choice and flexibility during this low interest rate
environment.
The following table
represents the composition of total deposits, as of June 30, 2003, and
comparative funding changes since previous year end.
Dollar Percent
June 30, 2003 December 31, 2002 change change
------------- ----------------- ------ ------
Noninterest-bearing deposits
Personal $ 23,903,012 $ 22,956,626 $ 946,386 4.12%
Non-personal 27,603,401 24,877,991 2,725,410 10.96%
Public fund 5,038,316 4,039,547 998,769 24.72%
Bank checks 5,494,627 9,277,301 (3,782,674) -40.77%
-----------------------------------------------------------------------------------------------------------
Total $ 62,039,356 $ 61,151,465 $ 887,891 1.45%
===========================================================================================================
Certificates of deposit
of $100,000 or more
-------------------
Personal $ 82,901,711 $ 79,169,750 $ 3,731,962 4.71%
Non-personal 25,236,275 23,571,462 1,664,813 7.06%
Public fund 35,918,295 21,111,991 14,806,305 70.13%
IRA's 5,905,159 5,633,296 271,863 4.83%
-----------------------------------------------------------------------------------------------------------
Total $149,961,441 $ 129,486,498 $ 20,474,943 15.81%
===========================================================================================================
Other interest-bearing deposits
-------------------------------
CD's less than $100,000:
Personal $ 92,537,843 $ 95,302,987 $ (2,765,144) -2.90%
Non-personal 6,312,000 11,054,526 (4,742,526) -42.90%
Public fund 661,419 633,489 27,930 4.41%
IRA's 19,970,106 20,358,968 (388,862) -1.91%
-----------------------------------------------------------------------------------------------------------
sub total 119,481,368 127,349,970 (7,868,602) -6.18%
NOW acounts 41,878,224 40,719,446 1,158,779 2.85%
Money market deposits 15,651,292 16,561,358 (910,065) -5.50%
Savings and clubs 43,585,930 38,519,440 5,066,490 13.15%
-----------------------------------------------------------------------------------------------------------
Total $220,596,815 $ 223,150,213 $ (2,553,398) -1.14%
===========================================================================================================
Total deposits
--------------
Noninterest-bearing deposits $ 62,039,356 $ 61,151,465 $ 887,891 1.45%
Interest-bearing deposits 370,558,256 352,636,711 17,921,545 5.08%
-----------------------------------------------------------------------------------------------------------
Total $432,597,612 $ 413,788,176 $ 18,809,436 4.55%
===========================================================================================================
Public funds have been a
significant source of deposits and account for $58,932,000 or 13.6% of total
deposits, at June 30, 2003. The Bank was able to attract public funds due to
long established relationships and competitive product pricing. However, it is
recognized that public fund deposits are sensitive to the operating demands of
the various public entities and the changing political landscape. Thus the Bank
could experience material shifts in these outstanding balances throughout the
year.
Borrowings
Borrowings totaled $103,275,000 at June 30, 2003 compared to $114,213,000 at December 31, 2002.
Included in borrowings are
customer repurchase agreements of $39,215,000 and $47,232,000, at June 30, 2003,
and December 31, 2002, respectively. The balance in customer repurchase
agreements fluctuates daily because it is dependent on the level of available
funds in depositor accounts. Customer repurchase agreements are collateralized
by investment securities in an amount equal to or exceeding such borrowings. The
Bank controls these pledged securities and monitors them on a daily basis.
Borrowings included $63,000,000 in long-term advances from the FHLB, at both June 30, 2003 and December 31, 2002.
The weighted average interest rate on borrowings was 5.51% and 5.60% at June 30, 2003 and 2002,
respectively.
Deferred taxes decreased
$89,000 from $775,000, at December 31, 2002, to $686,000, at June 30, 2003. This
net decrease relates to the change in the estimated fair value of investment
securities available-for-sale.
Other liabilities decreased
$401,000 from $3,978,000, at December 31, 2002, to $3,577,000, at June 30, 2003.
This decrease relates principally to a $746,000 pending investment purchase
obligation at the previous year-end. This decrease was partially offset by a
$387,000 increase in accrued expenses from normal operating activities.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
Interest Rate Sensitivity
The Company is subject to
the interest rate risks inherent in our lending, investing and financing
activities. Fluctuations of interest rates will impact interest income and
interest expense along with affecting market values of all interest-earning and
interest-bearing liabilities, except for those assets or liabilities with a
short term remaining to maturity. Interest rate risk management is an integral
part of the Asset/Liability management process. The Company has instituted
certain procedures and policy guidelines to manage the interest rate risk
position. Those internal policies enable the Company to react to changes in
market rates to protect net interest income from significant fluctuations. The
primary objective in managing interest rate risk is to minimize the adverse
impact of changes in interest rates on net interest income along with creating
an asset/liability structure that maximizes earnings.
Asset/Liability
Management: One major objective of the Company when managing the rate
sensitivity of its assets and liabilities is to stabilize net interest income.
The management of and authority to assume interest rate risk is the
responsibility of the Company’ Asset/Liability Committee (ALCO), which is
comprised of senior management and Board members. ALCO meets quarterly to
monitor the ratio of interest sensitive assets to interest sensitive
liabilities. The process to review interest rate risk management is a regular
part of management of the Company. Consistent policies and practices of
measuring and reporting interest rate risk exposure, particularly regarding the
treatment of non-contractual assets and liabilities, are in effect. In addition,
there is an annual process to review the interest rate risk policy with the
Board of Directors which includes limits on the impact to earnings from shifts
in interest rates.
Interest Rate Risk
Measurement: Interest rate risk is monitored through the use of three
complementary measures: static gap analysis, earnings at risk simulation and
economic value at risk simulation. While each of the interest rate risk
measurements has limitations, taken together they represent a reasonably
comprehensive view of the magnitude of interest rate risk in the Company and the
distribution of risk along the yield curve, the level of risk through time, and
the amount of exposure to changes in certain interest rate relationships.
Static Gap: The
ratio between assets and liabilities repricing in specific time intervals is
referred to as an interest rate sensitivity gap. Interest rate sensitivity gaps
can be managed to take advantage of the slope of the yield curve as well as
forecasted changes in the level of interest rate changes.
To manage this interest
rate sensitivity position, an asset/liability model called ‘cumulative gap
analysis’ is used to monitor the difference in the volume of the
Company’s interest sensitive assets and liabilities that mature or reprice
within given periods. A positive gap (asset sensitive) indicates that more
assets reprice during a given period compared to liabilities, while a negative
gap (liability sensitive) has the opposite effect. The Company employs
computerized net interest income simulation modeling to assist in quantifying
interest rate risk exposure. This process measures and quantifies the impact on
net interest income through varying interest rate changes and balance sheet
compositions. The use of this model assists the ALCO to gauge the effects of the
interest rate changes on interest sensitive assets and liabilities in order to
determine what impact these rate changes will have upon the net interest spread.
At June 30, 2003, the
Company maintained a one year cumulative gap of negative $6,078,000 or 1.0% of
total assets. The effect of this gap position provided a negative mismatch of
assets and liabilities, which can expose the Bank to interest rate risk during a
period of increasing interest rates. Conversely, in a declining interest rate
environment, net income could be positively affected because more liabilities
than assets will reprice during a one year period.
Interest Sensitivity Gap at June 30, 2003
-----------------------------------------------------------------
3 months 3 through 1 through Over
or less 12 months 3 years 3 years Total
------------ --------- ----------- ------- -----
(Dollars in thousands)
Cash and cash equivalents................... $ 11,583 $ - $ - $ 21,593 $ 33,176
Investment securities....................... 11,011 38,715 49,042 45,391 144,159
Loans....................................... 128,615 90,292 100,821 63,657 383,385
Fixed and other assets...................... - 7,111 - 17,950 25,061
Total assets............................. $151,209 $ 136,118 $149,863 $148,591 $ 585,781
======== ========= ======== ======== =========
Total cumulative assets.................. $151,209 $ 287,327 $437,190 $585,781
======== ========= ======== ========
Non interest-bearing transaction deposits... $ - $ 6,052 $ 17,107 $ 38,880 $ 62,039
Interest-bearing transaction deposits....... 3,130 48,992 38,310 10,683 101,115
Time deposits............................... 70,610 124,353 64,112 10,368 269,443
Repurchase Agreements....................... 32,486 6,721 8 - 39,215
Short-term borrowings....................... 1,061 - - - 1,061
Long-term debt.............................. - - 5,000 58,000 63,000
Other liabilities........................... - - - 4,263 4,263
Total liabilities........................ $107,287 $ 186,118 $ 124,537 $ 122,194 $ 540,136
======== ========= ======== ======== =========
Total cumulative liabilities............. $107,287 $ 293,405 $ 417,942 $ 540,136
======== ========= ======== ========
Interest sensitivity gap.................... $ 43,922 $ (50,000) $ 25,326 $ 26,397
========= ========= ======== ========
Cumulative gap.............................. $ 43,922 $ (6,078) $ 19,248 $ 45,645
========= ========= ======== ========
Cumulative gap to total assets.............. 7.50% -1.04% 3.29% 7.80%
Investments and loans are
included in the earlier of the period in which interest rates were next
scheduled to adjust or the period in which they are due. In addition, loans were
included in the periods in which they are scheduled to be repaid based on
scheduled amortization. For amortizing loans and mortgage-backed securities,
annual prepayment rates are assumed reflecting historical experience as well as
management’s knowledge and experience of its loan products.
The Bank’s demand and
savings accounts were generally subject to immediate withdrawal. However,
management considers a certain amount of such accounts to be core accounts
having significantly longer effective maturities based on the retention
experiences of such deposits in changing interest rate environments. The
effective maturities presented are the recommended maturity distribution limits
for non-maturing deposits based on historical deposit studies.
Certain shortcomings are
inherent in the method of analysis presented in the above table. Although
certain assets and liabilities may have similar maturities or periods of
repricing, they may react in different degrees to changes in market interest
rates. 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 of assets and liabilities may lag behind changes in market
interest rates. Certain assets, such as adjustable-rate mortgages, have features
which restrict changes in interest rates on a short-term basis and over the life
of the asset. In the event of a change in interest rates, prepayment and early
withdrawal levels may deviate significantly from those assumed in calculating
the table. The ability of many borrowers to service their adjustable-rate debt
may decrease in the event of an interest rate increase.
Earnings at Risk and
Economic Value at Risk Simulations: The Company recognizes that more
sophisticated tools exist for measuring the interest rate risk in the balance
sheet beyond static gap analysis. Although it will continue to measure its
static gap position, the Company utilizes additional modeling for identifying
and measuring the interest rate risk in the overall balance sheet. The ALCO is
responsible for focusing on “earnings at risk” and “economic
value at risk”, and how both relate to the risk-based capital position when
analyzing the interest rate risk.
Earnings at Risk:
Earnings at risk simulation measures the change in net interest income and net
income should interest rates rise and fall. The simulation recognizes that not
all assets and liabilities reprice one for one with market rates (e.g., savings
rate). The ALCO looks at “earnings at risk” to determine income
changes from a base case scenario under an increase and decrease of 200 basis
points in interest rates simulation model.
Economic Value at Risk: Earnings at risk simulation measures the short-term risk in the
balance sheet. Economic value (or portfolio equity) at risk measures the
long-term risk by finding the net present value of the future cash flows from
the Company’s existing assets and liabilities. The ALCO examines this ratio
quarterly utilizing an increase and decrease of 200 basis points in interest
rates simulation model. The ALCO recognizes that, in some instances, this ratio
may contradict the “earnings at risk” ratio.
Actual results may differ
from simulated results due to various factors including the time and magnitude
of interest rate changes, changes in customer behavior, effects of competition,
and other factors. These variables influence the interest-rate spread and
product mix. The consulting model predicts a base net interest income amount
that is larger than that actually earned in the past 12 months or last fiscal
year. This is principally the result of an actual increase in earning assets
over the past year, which created a larger starting point for the next 12-month
projection. Past experience drives many of the assumptions used in the models.
Actual results could vary substantially if our future performance differs from
past experience.
The following table
illustrates the simulated impact of 200 basis points upward or downward movement
in interest rates on net interest income, net income, and the change in economic
value (portfolio equity). This analysis assumed that interest-earning asset and
interest-bearing liability levels at June 30, 2003 remained constant. The impact
of the rate movements was developed by simulating the effect of rates changing
over a twelve-month period from the June 30, 2003 levels.
Rates +200 Rates -200
---------- ----------
Earnings at risk:
Percent change in:
Net Interest Income 6.3% (11.4)%
Net Income 22.8 (40.3)
Economic value at risk:
Percent change in:
Economic value of equity (16.2) (3.5)
Economic value of equity
as a percent of book assets (1.2) (0.3)
Economic value has the most
meaning when viewed within the context of risk-based capital. Therefore, the
economic value may change beyond the Company’s policy guideline for a short
period of time as long as the risk-based capital ratio, after adjusting for the
excess equity exposure, is greater than 10%.
The table below summarizes
estimated changes in net interest income over a twelve-month period beginning
July 1, 2003, under alternate interest rate scenarios using the income
simulation model described above:
Net Interest
Change in Interest Rates Income Dollar change Percent change
------------------------ ------------- ------------- --------------
(Dollars in Thousands)
+200 Basis Points $ 16,971 $ 1,001 6.3%
+100 Basis Points 16,573 603 3.8%
Flat Rate 15,970 - -
-100 Basis Points 15,084 (886) -5.5%
-200 Basis Points 14,157 (1,813) -11.4%
Simulation models require assumptions about certain categories of assets and liabilities. The models schedule existing assets and liabilities by their contractual maturity, estimated likely call date, or earliest repricing opportunity. Mortgage-backed securities and amortizing loans are scheduled based on their anticipated cash flow including estimated prepayments. For investment securities, we use a third party service to provide cash flow estimates in the various rate environments. Savings accounts, including passbook, statement savings, money market, and interest checking accounts, do not have a stated maturity or repricing term and can be withdrawn or repriced at any time. This may impact the margin if more expensive alternative sources of deposits are required to fund loans or deposit runoff. Management projects the repricing characteristics of these accounts based on historical performance and assumptions that it believes reflect their rate sensitivity. The consulting model reinvests all maturities, repayments and prepayments for each type of asset or liability into the same product for a new like term then applies growth or run-off estimates provided by management. As a result, the mix of interest-earning assets and interest bearing-liabilities is not held constant.
Liquidity
Liquidity for a bank is the
ability to fund customers’ needs for borrowings, deposit withdrawals and
maturities and normal operating expenses of the Bank. Current sources of
liquidity are:
- Cash and cash equivalents
- Asset maturities and pay downs within one year
- Loans and investments available-for-sale
- Growth of core deposits
- Growth of repurchase agreements
- Increase of other borrowed funds from correspondent banks
- Issuance of capital stock
As detailed in the
statement of cash flows, total cash and cash equivalents had a net $6,957,000
increase from net cash provided by financing activities due to the $20,475,000
growth in certificates of deposit of $100,000 or greater. This cash provided was
offset by the $2,553,000 decrease in other interest bearing deposits and
$10,938,000 decrease in short-term borrowings. Other cash usage was primarily in
purchasing investment securities and funding the $7,000,000 purchase of life
insurance policies. Funding new loan growth was offset by proceeds received from
the credit card portfolio sale and proceeds from loans available-for-sale. The
net cash utilized to fund operations throughout the six months was funded
through the increase in short-term public fund time deposits greater than
$100,000.
Management believes that
the present level of liquidity is strong and adequate for current operations
based upon the short-term liquidity position of $22,176,000 in cash and due from
banks along with $11,000,000 in Federal Funds sold. A secondary source of
liquidity is provided from expected cash flow from principal reductions in the
investment and loan portfolios and the ability to sell $27,660,000 in mortgage
loans available for sale at June 30, 2003. Management monitors asset and
liability maturities to match anticipated large cash flow requirements. These
cash flow requirements are reviewed daily with the use of internally generated
reports.
The Bank considers our core
deposit base as the primary source of liquidity. However, the Bank can also
borrow in the Federal Funds market to meet temporary liquidity needs. The Bank
has other sources to obtain liquidity from borrowings with the Federal Reserve
Discount Window and Federal Home Loan Bank advances.
Capital
The Company is subject to
various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possible additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company’s financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company must meet specific capital guidelines that
involve quantitative measures of the Company’s assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Company’s capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Capital is fundamental to
support our continued growth. In addition, the Company and Bank are subject to
various regulatory capital requirements. Regulatory capital is defined in terms
of Tier 1 capital (shareholders’ equity plus the allowable portion of the
minority interest in equity of subsidiaries, minus unrealized gains or plus
unrealized losses on available for sale securities, and minus certain intangible
assets), Tier 2 capital (which includes a portion of the allowance for loan
losses, minority interest in equity of subsidiaries and subordinated debt), and
total capital (Tier 1 plus Tier 2). Risk-based capital ratios are expressed as a
percentage of risk-weighted assets. Risk-weighted assets are determined by
assigning various weights to all assets and off-balance sheet financial
instruments, such as letters of credit and loan commitments, based on associated
risk. Regulators have also adopted minimum Tier 1 leverage ratio standards,
which measure the ratio of Tier 1 capital to total average quarterly assets.
Quantitative measures
established by regulation to ensure capital adequacy require the Company to
maintain minimum amounts and ratios (set forth in the table below as defined in
the regulations) of total and Tier I capital to risk-weighted assets, and of
Tier I capital to average assets. As of March 31, 2003, the Company meets all
capital adequacy requirements to which it is subject.
The Company's capital amounts and ratios, at June 30, 2003, are as follows:
To be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital
(to Risk Weighted Assets) $ 48,619,499 12.62% $ 30,818,012 8.00% $ 38,522,515 10.00%
Tier 1 Capital
(to Risk Weighted Assets) $ 44,808,522 11.63% $ 15,409,006 4.00% $ 23,113,509 6.00%
Tier 1 Capital
(to Average Assets) $ 44,808,522 7.80% $ 22,990,599 4.00% $ 28,738,249 5.00%
The ratios for the Bank are not materially different from those of the Company.
ITEM 4. Controls and Procedures
The Company maintains a
system of controls and procedures designed to provide reasonable assurance as to
the reliability of the financial statements and other disclosures included in
this report, as well as to safeguard assets from unauthorized use or
disposition. The Company evaluated the effectiveness of the design and operation
of our disclosure controls and procedures under the supervision and with the
participation of management, including our Chief Executive Officer and Chief
Financial Officer, within 90 days prior to the filing date of this report. Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective, except for
the internal control components of risk assessment and monitoring, in timely
alerting them to material information required to be included in our periodic
Securities and Exchange Commission filings. The Company has made significant
changes to our internal controls and other factors that could significantly
affect these controls subsequent to the date of evaluation by the Chief
Executive Officer and Chief Financial Officer, as follows:
- A formal risk assessment was not completed for the year ended December 31, 2002. It was management’s intention to have a formally documented risk assessment completed and submitted to the Company’s Audit Committee for approval. The Company’s internal audit department completed a formal risk assessment. On April 30, 2003, the Company’s Audit Committee reviewed and approved the risk assessment.
- Management worked with the Internal Audit Department to complete a risk assessment, from which an internal audit schedule was developed and submitted to the Company’s Audit Committee for approval. The Company’s internal audit department completed the internal audit schedule for calendar years 2003 through 2005. On April 30, 2003, the Company’s Audit Committee reviewed and approved the risk assessment and internal audit schedule. The Audit Committee has taken on the responsibility to monitor the risk assessments and the timely completion of each scheduled internal audit.
ITEM 1. Legal Proceedings.
On July 1, 2002, the Bank
was served with a civil complaint that was filed in the Court of Common Pleas of
Lackawanna County, Pennsylvania, on June 28, 2002. Scaccia Construction Company,
the plaintiff, based upon multiple causes of action, demands approximately
$250,000 in connection with certain environmental remediation activities. The
activities were purportedly performed prior to the opening of the Bank’s
new Eynon branch. On July 22, 2002, the Bank filed preliminary objections to the
complaint. The preliminary objections were decided on November 26, 2002, and the
Bank filed its answer and new matter raising various legal defenses. Formal
discovery has commenced and depositions are rescheduled through August 2003. The
Bank intends to vigorously defend this action.
The nature of the
Company’s business generates some litigation involving matters arising in
the ordinary course of business. However, in the opinion of the Company after
consulting with legal counsel, no other legal proceedings are pending, which, if
determined adversely to the Company or the Bank, would have a material effect
the Company’s undivided profits or financial condition. No other legal
proceedings are pending other than ordinary routine litigation incident to the
business of the Company and the Bank. In addition, to management’s
knowledge, no governmental authorities have initiated or contemplated any
material legal actions against the Company or the Bank.
ITEM 2. Changes in Securities and Use of Proceeds.
None.
ITEM 3. Default Upon Senior Securities.
None.
ITEM 4. Submission of matters to a Vote by Security Holders.
At the annual meeting of Shareholders held on May 6, 2003, the Judges of Election made the report concerning the results of the balloting. Holders of 1,554,759 shares of common stock, representing 85.2% of the total number of shares outstanding, were represented in person or by proxy at the 2003 Annual Meeting of Shareholders. The following votes were cast:
ELECTION OF CLASS A DIRECTORS TO SERVE FOR A FOUR-YEAR TERM
Withhold
For Authority Abstain
--------- --------- -------
Paul A. Barrett 1,544,766 6,185 3,808
John T. Cognetti 1,544,531 6,419 3,808
John F. Glinsky, Jr. 1,545,120 5,831 3,808
Michael J. McDonald 1,544,419 6,532 3,808
Mrs. Mary E. McDonald and Messer Brian C. Cali, Patrick J. Dempsey, Michael F. Marranca, Samuel C. Cali and David L. Tressler,
Sr. term of office as a Director continued after the meeting, until at least next years annual meeting.
ITEM 5. Other Information.
None.
| ITEM 6. | Exhibits and Reports on Form 8-K. |
a) Exhibits
| 3(i) | Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Exhibit 3(i) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. |
| 3(ii) | Bylaws of Registrant. Incorporated by reference to Exhibit 3(ii) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. |
| 10.1 | 1998 Independent Directors Stock Option Plan of The Fidelity Deposit and Discount Bank, as assumed by Registrant. Incorporated by reference to Exhibit 10.1 to Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. |
| 10.2 | 1998 Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by Registrant. Incorporated by reference to Exhibit 10.2 of Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. |
| 10.3 | Form of Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.Incorporated by reference to Exhibit 10.3 to Registrant’s Registration Statement No.333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as amended on October 11, 2000. |
| 10.4 | Registrant's 2000 Dividend Reinvestment Plan. Incorporated by reference to Exhibit 4 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as amended by Pre-Effective Amendment No. 1 on October 11, 2000 and by Post-Effective Amendment No. 1 on May 30, 2001. |
| 10.5 | Registrant's 2000 Independent Directors Stock Option Plan. Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-64356 on Form S-8 filed with the SEC on July 2, 2001. |
| 10.6 | Registrant's 2000 Stock Incentive Plan. Incorporated by reference to Exhibit 4.4 to Registrant's Registration Statement No. 333-64356 on Form S-8 filed with the SEC on July 2, 2001. |
| 10.7 | Form of Employment Agreement with Joseph J. Earyes. Incorporated by reference to Exhibit 10.1 to Registrant's Form 8-K filed with the SEC on March 25, 2002. |
| 11 | Statement regarding computation of earnings per share. Included herein in Note 2 “Earnings per Share”, contained within the Notes to Consolidated Financial Statements, and incorporated herein by reference. |
| 99.1 | Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
| 99.2 | Certification of Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
b) No Current Report on Form 8-K was filed by the Registrant during the quarter ended March 31, 2003.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DATE: August 12, 2003 /s/ Michael F. Marranca
-----------------------------------
Michael F. Marranca,
Chairman of the Board of Directors and President
DATE: August 12, 2003 /s/ Joseph J. Earyes
-----------------------------------
Joseph J. Earyes,
Executive Vice President and Chief Executive Officer
DATE: August 12, 2003 /s/ Salvatore R. DeFrancesco
-----------------------------------
Salvatore R. DeFrancesco,
Treasurer and Chief Financial Officer
I, Joseph J. Earyes, certify that:
- I have reviewed this quarterly report on Form 10-Q of Fidelity D & D Bancorp, Inc;
- Based on my knowledge,
this quarterly report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;
- Based on my knowledge,
the financial statements, and other financial information included in this
quarterly report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
- The registrant’s
other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and we have:
- designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
- evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
- presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
- The registrant’s
other certifying officers and I have disclosed, based on our most recent
evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent
function):
- all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant’s ability to
record, process, summarize and report financial data and have identified for the
registrant’s auditors any material weaknesses in internal controls; and
- any fraud, whether or not material, that involves management or other employees
who have a significant role in the registrant’s internal controls; and
- all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant’s ability to
record, process, summarize and report financial data and have identified for the
registrant’s auditors any material weaknesses in internal controls; and
- The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| Date: August 12, 2003 | /s/Joseph J. Earyes |
| Joseph J. Earyes | |
| Executive Vice President and | |
| Chief Executive Officer |
I, Salvatore R. DeFrancesco, certify that:
- I have reviewed this quarterly report on Form 10-Q of Fidelity D & D Bancorp, Inc;
- Based on my knowledge,
this quarterly report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;
- Based on my knowledge,
the financial statements, and other financial information included in this
quarterly report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
- The registrant’s
other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and we have:
- designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
- evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
- presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
- The registrant’s
other certifying officers and I have disclosed, based on our most recent
evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent
function):
- all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant’s ability to
record, process, summarize and report financial data and have identified for the
registrant’s auditors any material weaknesses in internal controls; and
- any fraud, whether or not material, that involves management or other employees
who have a significant role in the registrant’s internal controls; and
- all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant’s ability to
record, process, summarize and report financial data and have identified for the
registrant’s auditors any material weaknesses in internal controls; and
- The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| Date: August 12, 2003 | /s/Salvatore R. DeFrancesco |
| Salvatore R. DeFrancesco | |
| Treasurer and Chief Financial Officer |
| Exhibit Index | Page | |
| 3(i) | Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Exhibit 3(i) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. | * |
| 3(ii) | Bylaws of Registrant.Incorporated by reference to Exhibit 3 (ii) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. | * |
| 10.2 | 1998 Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by Registrant.Incorporated by reference to Exhibit 10.2 of Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on Nov. 3, 1999 and as amended on April 6, 2000. | * |
| 10.3 | Form of Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.Incorporated by reference to Exhibit 10.3 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as amended on October 11, 2000. | * |
| 10.4 | Registrant's 2000 Dividend Reinvestment Plan.Incorporated by reference to Exhibit 4 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as amended by Pre-Effective Amendment No. 1 on October 11, 2000 and by Post-Effective Amendment No. 1 on May 30, 2001. | * |
| 10.5 | Registrant's 2000 Independent Directors Stock Option Plan.Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-64356 on Form S-8 filed with the SEC on July 2, 2001. | * |
| 10.6 | Registrant's 2000 Stock Incentive Plan.Incorporated by reference to Exhibit 4.4 to Registrant's Registration Statement No. 333-64356 on Form S-8 filed with the SEC on July 2, 2001. | * |
| 10.7 | Form of Employment Agreement with Joseph J. Earyes.Incorporated by reference to Exhibit 10.1 to Registrant's Form 8-K filed with the SEC on March 25, 2002. | * |
| 11 | Statement regarding computation of earnings per share. | 8 |
| 99.1 | Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. | 34 |
| 99.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. | 35 |
* - Incorporated by Reference